Monopoly and Price & Output determination under Monopoly
What is Monopoly? How are Price and Output are determined under it?
Monopoly is defined as the market structure where there is a single seller or producer of a product having no close substitutes, In this market, there are a large number of buyers.
Price and Output Determination under Monopoly
Short-run refers to that period in which time is so short that a monopolist cannot change the fixed factors like plant and machinery. However, the monopolist is free in making price decision due to the lack of competition. It means that the monopolist can fix the price for the product as she/he likes. A monopolist has control over the market supply. Hence, she/he is a price-maker. Thus, under the given cost and demand situation of his/her product in any period, she/he has to determine the price and the output simultaneously. His/Her price and output decision is motivated by profit maximization. Therefore, she/he will adjust the output and the price in such a way that the marginal cost and the marginal revenue are equal, whereby she/he achieves maximum profit. In other words, a monopolist produces the appropriate level of output at which s/he can obtain the maximum level of profit.
Conditions for Equilibrium
The following conditions must be fulfilled in order to attain equilibrium under monopoly:
- MR = MC
- MC must intersect MR from below.
The equilibrium position of a monopoly firm has been graphically represented in the given figure:
There are three possibilities in the short-run under monopoly. These three possibilities are explained as dino follows:
- Abnormal profit (Super normal profit Excess profit): In the above figure I, X-axis represents the output and Y-axis represents cost, revenue, and price. The downward slopping curves AR and MR represent the average revenue and the marginal revenue curves respectively. The U-shaped curves AC and MC represent the average cost curve and the marginal cost curve respectively. In the figure the point E is the equilibrium point because at this point MC and MR are equal and MC is intersecting MR from below or both conditions of equilibrium are fulfilled. Hence, the equilibrium price is OP and the quantity is OQ. The average cost of production is OC. At this price, output, and average cost of production, the monopoly firm or monopolist is earning the abnormal profit equal to the shaded rectangle area ABPC. The firm is carning abnormal profit because AR (Price) is greater than AC
In the figure,
- Total revenue (TR) = OQBP
- Total cost (TC) = OQAC
- Total profit (TP) = TR – TC = OQBP – UQAC = ABPC
- Loss: In the above figure II, the equilibrium point is E. Thus, the equilibrium amount of output is OQ and the equilibrium price is OP. The average cost of production is OC. Since, AR is lower than AC the firm is bearing loss, which is represented by the shaded rectangle area CBAP
- Normal profit: In the above figure ‘III, the equilibrium point is E. Thus, the equilibrium amount of output is OQ and the equilibrium price is OP. Since AR is equal to AC, the firm is earning just the normal profit.
Long-run is a period in which a firm can change both fixed and variable factors. In long-run, the monopolist has enough time to adjust the size of the plant at a certain level of output to maximize its profit. In the monopoly, the entry of new firms being ruled out, the abnormal profit (super normal or excess profits) is possible even in the long-run.
Conditions for Equilibrium
The following conditions must be fulfilled in order to attain equilibrium in the long run under monopoly:
- MR = LMC
- LMC must intersect MR from below.
The long-run equilibrium under monopoly has been graphically shown in the given figure:
In the above figure, AR is the average revenue curve of a monopoly firm. LAC and LMC are the long-run averages and marginal cost curves. In the figure, the monopolist is in the equilibrium at point E with OP price, OQ quantity, and OC as the long-run average cost of production. As AR > AC the monopolist is operating under abnormal profit equal to the shaded area ABPC in the long-run.