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Monopoly and Price Discrimination: Pricing When There Is Only One Seller
What happens when a market has only one seller? That seller becomes a price maker and can often earn profits that others cannot. This guide explains monopoly and price discrimination together, because price discrimination is one of the most common ways a seller with market power increases its profit. You will see how a monopolist decides price and output, and how the same product can be sold at different prices to different buyers.
1. Monopoly: price and output
Features of a monopoly
- A single seller controls the whole supply, so the firm and the industry are the same.
- No close substitutes for its product.
- Barriers to entry prevent others from joining.
- The monopolist is a price maker and can fix either price or output (but not both independently, because it must follow the demand curve).
- Downward-sloping demand curve: to sell more, the monopolist must reduce its price.
Sources of monopoly power
- Legal protection: patents, copyrights and government licences. A company that holds a patent on a new medicine can be the only seller for years.
- Control of key raw materials.
- Natural monopoly: when the cost of production is lowest if a single firm serves the whole market, as with electricity distribution or water supply networks in a city.
- Government ownership: public utilities and services, such as passenger rail services in many countries.
- Economies of scale that make it hard for small entrants to compete.
Revenue of a monopolist
Because the demand curve slopes downward, AR is above MR at every output (see Part 4). The monopolist’s MR curve lies below its AR (demand) curve, and falls twice as fast in the straight-line demand case.
Price and output determination
Like every profit-maximising firm, the monopolist produces where MR = MC, with MC cutting MR from below. The steps are:
- Find the output where MR = MC.
- From that output, go up to the demand (AR) curve to read the price the market will pay.
- Profit per unit = price − average cost at that output.
Hence, the monopolist’s price is higher than its marginal cost (P > MC), unlike in perfect competition where P = MC.
Profit in the short and long run
- In the short run, a monopolist may earn supernormal profit, normal profit or even a loss, depending on where demand lies relative to cost.
- In the long run, because entry is blocked, a monopolist can continue to earn supernormal profits. That is the key reason why monopolies are criticised.
No supply curve
A monopolist does not have a supply curve, because it chooses price and quantity together depending on the demand curve. The same output may be sold at different prices if demand shifts.
Monopoly vs perfect competition
| Basis | Perfect competition | Monopoly |
| Sellers | Very many | One |
| Price decision | Price taker | Price maker |
| Demand curve of firm | Horizontal | Downward sloping |
| Equilibrium rule | P = MR = MC | MR = MC, with P > MR |
| Price and output | Lower price, higher output | Higher price, lower output |
| Long-run profit | Normal profit only | Can earn supernormal profit |
| Efficiency | Efficient | Inefficient (deadweight loss) |
Harms and benefits
Harms: higher prices, lower output, less choice, possible lower quality and a loss of consumer welfare (called the deadweight loss).
Possible benefits: a monopoly can use large profits for research and innovation, and natural monopolies can achieve low costs through large-scale production.
How governments respond
Governments use price controls, competition laws, public ownership or regulation of natural monopolies. In India, the Competition Commission of India (CCI) is the body that checks abuse of dominant positions.
2. Price discrimination under monopoly
Have you noticed that a cinema charges less for a morning show, or that museums give student discounts? Sellers know that different customers will pay different amounts. When a seller charges different prices for the same product to different buyers, without a difference in cost, it is called price discrimination. Monopolists often use it to raise their profits.
Meaning
Price discrimination means selling the same good or service at different prices to different buyers, in different places or at different times, where the price difference is not based on differences in cost. (A higher price for faster delivery is not discrimination, since it reflects extra cost.)
Conditions needed
- The seller must have some market power, so it can set prices.
- Markets must be separable, so that buyers cannot easily move from one market to another.
- No resale: buyers who get the lower price must not be able to sell to those who pay the higher price.
- Different price elasticities of demand in different markets.
Kinds of price discrimination
- Personal: different prices for different persons (a doctor charging richer patients more).
- Place: different prices in different locations (a theatre seat near the front costs more).
- Use or trade: different rates for different uses (electricity is cheaper for homes than for commercial use in many places).
- Time: different prices at different times (peak and off-peak, weekday and weekend).
Three degrees of price discrimination
| Degree | Meaning | Example |
| First degree (perfect) | The seller charges each buyer the maximum price they are willing to pay, taking all consumer surplus | Auctions, bargaining in a bazaar, an individual consultant quoting each client a different fee |
| Second degree | Price depends on the quantity bought (block pricing); buyers choose the pack or slab | Electricity slabs, bulk discounts, bigger packs costing less per unit |
| Third degree | The market is split into groups, each charged a different price based on elasticity | Student and senior citizen discounts, different ticket prices for Indian and foreign visitors at monuments, cinema matinee rates |
How a discriminating monopolist sets prices (third degree)
Suppose a monopolist sells in two separate markets, A and B. The steps are:
- Step 1: Decide the total output. Add the MR curves of both markets horizontally to get combined MR. The firm produces where combined MR = MC.
- Step 2: Divide output between the markets. Share it so that MR in market A = MR in market B = MC. This ensures the last unit sold gives the same extra revenue in both markets.
- Step 3: Set prices. Read the price in each market from its own demand curve.
Result: the monopolist charges a higher price in the market with less elastic demand and a lower price in the market with more elastic demand. This follows from MR = P(1 − 1/Ed). For MR to be equal in both markets, the market with a lower Ed needs a higher price.
Real-life examples
- Airlines: tickets booked at the last minute (less elastic demand, mostly business travellers) cost more than early-booked fares.
- Cab apps: higher fares at peak times.
- Software: student and trial versions at lower prices; business versions at higher prices.
- Dumping in international trade: a firm sells at a high price at home and a lower price abroad, where competition (and elasticity) is higher.
Is price discrimination good or bad?
Possible benefits: it may allow poorer consumers to buy the product, it can make a business viable, and it may increase output.
Possible harms: it reduces consumer surplus, can look unfair and may harm rivals if used to drive them out.
Read next (Part 7): Monopolistic Competition and Oligopoly: Features, Equilibrium and the Kinked Demand Curve
