Question

Suppose you are running a business and thinking to enter the monopoly market. As per your calculation, you can make a profit by keeping your product price 20% less than the monopolist. Explain, how the monopolist might react to stop you to enter the business?Suppose you are running a business and thinking to enter the monopoly market. As per your calculation, you can make a profit by keeping your product price 20% less than the monopolist. Explain, how the monopolist might react to stop you to enter the business?

Answer 1

To understand the resction of a monopolist at the entry of of a new competitior, we need to first understand what a monopoly business is. A momopolist is the one who is the sole seller in the entire market with large number of buyers. A monopolist also faces a demand curve which is inelastic and therefore, the monoplist exploits the buyers by chrging higher prices for the product that would otherwise prevail in a perfectly competitive market.

When a new entrant would try to enter the market with Selling price 20 percent less than the prices charged by the monopolist, the monopolist may drastically reduce the selling price as a reaction to the same. The monopolist, being a large seller, has the capacity to even bear losses for a perod of time in order to restrict the entry of any new business. Thus, as a reaction to the strategy of the new entrant, the monopolist would reduce the prices to such a level that it will not be sustainable for the new business to meet its expenses by selling at such a lower price. The new business would start incurring losses if it tried to match the low prices being charged by the monoplist. This would result as an entry barrier for the new entrant.

However, once the new entrant decides not to enter the market because of such a strategy of the monopolist, the monopolist would immediately increase its prices back to what it were before the entry of the new entrant.