PRICE AND OUTPUT DETERMINATION UNDER MONOPOLY: Features of the monopoly, short run and long run equilibrium

PRICE AND OUTPUT DETERMINATION UNDER MONOPOLY

Monopoly is that market form in which a single producer controls the whole supply of a single commodity that has no close substitutes.

Spencer has defined a monopolist market in the following words:

 

"A monopolist market can be defined as one market where there is no perfect substitute for the product of an individual seller so that there is a separate demand curve for the product of each seller in the market"

This definition emphasizes two main points:

1-The single producer may be an individual owner or a group of partners. Since there is only one firm under monopoly, that single firm constitutes the whole industry. Therefore, the distinction between the firm and industry disappears under the condition of monopoly.

2- There must not be the close substitutes, i.e, there are no other firms producing a similar product or products varying only slightly from that of the monopolist. For example, there are no close substitutes for electricity and water supplied by the local public utilities. These local public utilities are examples of a monopoly.

The above two conditions ensure that monopolist has the power to influence the price.

Features of the monopoly:

1-Existence of a single seller- There will be only one seller in the market having single control over the market.

2-Absence of substitutes- No close substitutes must be present so that buyers have no alternatives.

3-Absence of competition- In the monopoly, the seller faces no threat of competition.

4- Control oversupply- In a monopoly, the seller has full control over the supply of the commodity.

5- Price-maker- The monopolist is the price maker and can easily set the price to the best of his advantage.

6- Firm and industry- The distinction between the firm and industry disappears under the condition of monopoly.

7-Entry barriers- There is a difficulty in the entry of new firms. Hence, the monopolist does not have direct competitors in the market.

8- Nature of firm- The monopoly firm maybe a proprietary concern, partnership concern, joint-stock company, or a public utility pursuing an independent price-output policy.

9- Seller makes supernormal profits- Supernormal profit is possible under monopoly because the seller set the market price higher than the cost of production.

Price-output determination under Monopoly

In a monopoly market, there is no difference between firm and industry. Therefore, there is no need for a separate analysis of the equilibrium of the firm and of the industry. The firm’s demand curve constitutes the industry’s demand curve.

A firm under a monopoly faces a downward-sloping demand curve or average revenue [AR]. Therefore, if the monopolist lowers the price of his product, the quantity demanded increases and vice versa. In monopoly, average revenue falls as more units of output are produced and sold, the marginal revenue is always less than the average revenue, and the MR curve lies below the AR curve. Which particular price-output combinations will be chosen by the monopolist, depends not only on the demand conditions but also on the cost situation faced by the monopolist. The average cost curve and marginal cost curve are generally U-shaped, and

 Marginal cost curve cuts the average cost curve at its minimum point.

Price output determination in the short run

In a short period, production can be changed only by changing the variable factors of production, hence, supply can be changes to some extent.

In a short period, a monopolist will maximize profit or minimize losses by producing that output for which marginal cost (MC) equals marginal revenue (MR). He may earn supernormal profit or normal profit or even incur losses in the short run.

Conditions for the Equilibrium of a Monopoly Firm:

There are two basic conditions for the equilibrium of the monopoly firm.

1. MR = MC

2. MC curve cuts MR from below.

In the short-run, the firm can change only the variable factors and fixed factors can not be changed.

there are three possibilities for a firm. These are –

(a) A firm makes supernormal profits when AR > AC.

(b) It earns an only normal profit when AR = AC.

(c) It incurs losses when AR<AC. Firms will operate till they are able to get variable costs.

1-    Short-run supernormal profit: A firm in the short run earns Super-normal profits when the market price exceeds the short-run average total cost (SATC) or when AR>AC.

In the above diagram, the output is measured along the OX axis and price, revenue, and cost on the OY axis. AR is the demand curve or average revenue curve The MR curve lies below the AR curve. MC curve cuts the MR curve from below at point C. The firm produces and sells an output OQ, as at this level of output MR = MC. The firm sells output OQ at OP/EQ per unit price. The total revenue of the firm is equal to the area OQEP, whereas the total cost of producing output OQ is OQFP1. The total profits of the firm are equal to the orange rectangle PP1EF. The per-unit profit is indicated by the distance PP1 or EF.

2-    Short Run Zero Profit:

A firm, in the short run, maybe making zero economic profit or normal economic profit when AR=AC.

In the above diagram, the MR curve lies below the AR curve. MC curve cuts the MR curve from below at point C. The firm sells output OQ at OP/EQ per unit price. The total revenue of the firm is equal to the area OQEP, whereas the total cost of producing output OQ is also OQEP. Hence, a firm is making a normal profit.

3-Short-run loss:

The firm under monopoly in the short run may be in loss if the market price is lesser than the average total cost []AR<AC]

 

In the above diagram, the MR curve lies below the AR curve. MC curve cuts the MR curve from below at point C. The firm sells output OQ at OP/EQ per unit price. AC is greater than AR. The total revenue of the firm is equal to the area OQEP, whereas the total cost of producing output OQ is also OQFP1. Hence, a firm is suffering a net loss PP1EF.

Price output determination in the long run

In the short run, the monopolist’s decision problem is to maximize his profit subject to the given size plant, already built and operating. In the long run, there is an adequate time to make all kinds of adjustments in both fixed as well as variable factors,  the monopolist will choose the most profitable size of the plant and will operate it at the most profitable rate. Hence, in the long run, a monopolist firm will earn supernormal profits. 

In the above diagram, monopolist’s equilibrium is determined at point C, where MR=MC, corresponding output, OQ is produced at QF or OP1 cost per unit and is sold at QE or OP price per unit. The total profit of the monopolist is shown by the orange rectangle PP1EF. The monopolist can continue to earn profits in the long run because of blocked entry for other firms.

Dr. Swati Gupta

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