Question

Discuss the problems of monopoly and how to control monopoly firms with taxation. Show how a monopolist discriminates two different markets with price(with graph)

Answer 1

Monopoly is a market situation where there is a single seller for a particular commodity and many buyers.

Problems of monopoly includes:

I) Monopoly charges a very high price for a good as compared to perfectly competitive firm.

II)It doesn't produce at full capacity which leads to inefficient allocation of resources.

III) It also leads to price discrimination.

To control monopoly firms with taxation there are two ways:

I) Imposition of a per unit or specific tax increases the cost of production and reduces the total output produced and the overall profit of the monopolist also reduces. Since it also increases the price so its burden falls on buyers.

II) Imposition of a lump some tax doesn't change price and output produced but it reduces profit as fixed cost is increased, so its burden falls totally on seller. So the efficient way to control a monopoly with taxation is to impose a lump some tax like licence fee or other duties.

Price discrimination is one of the most important features of a monopoly, price discrimination means charging different prices for a same good in two different markets, monopoly discriminates prices in order to gain a huge profit.

Price discrimination is possible because of the difference in the elasticity of demand in different markets. A monopolist charges a high price in a market where elasticity of demand is low and charges a low price in the market where elasticity of demand is high. This can also be seen from the graph.There are two markets A and B, price elasticity of demand is high in market B, so here MR curve equal to demand curve hence there is lower price and in market A price elasticity is low so whatever the price there will be same demand so the monopolist charges a high price here.