ADVERTISEMENTS:
The following article will guide you about how to determine price and output under monopoly market.
Price and Output Determination during Short Period:
Each monopolist aims at maximisation of his profit. He has full control over the supply of a commodity. The elasticity of demand is inelastic under monopoly market structure and he determines the output and supply of his product so that he maximises his profit.
Price and output are determined with the help of two techniques, namely, TR and TC method and MR and MC method. The second method is always used in all sorts of market and the firms are in equilibrium where MC is equal to MR (MR=MC) and the MC curve cuts the MR curve from its below and not from above.
ADVERTISEMENTS:
During short period a monopolist may attain its equilibrium and can have the three situations given below:
(1) Profit making situation.
(2) Normal profit situation.
(3) Loss incurring situation.
ADVERTISEMENTS:
All these situations are found during short period when price and output are determined under monopoly market situation as discussed one by one here under:
(1) Profit Making Situation:
A monopoly firm will earn profit and it will be in equilibrium when the average revenue is greater than its average cost (AR>AC) and marginal cost curve cuts its marginal revenue curve from its below. This situation is also called super profit or abnormal profit.
It is shown by the following diagram:
Output is shown on OY-axis while price, cost and revenue are shown on OY-axis. E is the point of equilibrium where MC is equal to MR (MC=MR). AR and MR are average revenue and marginal revenue, AC and MC average cost and marginal cost of the firm under the monopoly during short period.
(2) Normal Profit Situation:
When a monopoly firm earns neither profit nor incurs losses the situation is called normal profit. AR is equal to AC of an individual firm.
It can be seen from the following diagram:
The point of equilibrium of a monopoly firm is at E where marginal cost is equal to marginal revenue (MC=MR). At point L, the AC curve is tangent to AR curve. Here AR is equal to AC (AR=AC) so the firm is earning normal profit only.
(3) Loss Incurring Situation:
A monopoly firm can even have losses during short period. It can be possible when a monopoly firm’s cost is greater than its revenue.
It can be seen from the following diagram:
Price, costs and revenue are shown on OY-axis while output has been shown on OX-axis. The equilibrium of a monopoly firm is at point E where MC is equal to MR (MC=MR). The average profit is ST and total profit is LPTs with OP price and OQ output.
Price and Output Determination under Monopoly during Long Period:
A monopoly firm aims at maximisation of profit. In the long run there will be only profit making situation under monopoly market structure. During long period all the factors of production are variable and even the scale of production can be changed. The long run equilibrium of a monopoly firm will be at point E where the long run marginal cost is equal to its long run marginal revenue (LMC=LMR).
The firm will earn profit during this period as is shown in the diagram given below:
Price, cost and revenue are shown on OY-axis while output on the OX-axis. The point of equilibrium of a monopoly firm is at point E where the long run marginal cost (LMC) is equal to its long run marginal revenue (LMC=LMR). The average profit is ST total profit is PLTS with OP price and OQ output.
Price and Output Determination under Different Laws of Returns during Long Period:
Each monopoly firm will earn profit during long period but the volume of profit is affected by the law of production. There are three stages of production under which the profit of a monopolist will differ.
These are given below:
(1) Law of Increasing Returns or Law of Decreasing Cost:
Under this situation the output is increasing more than in proportion to the change in the proportion of factors of production. It means the cost of production is decreasing. The average cost and marginal cost will also be shown as decreasing and other conditions of equilibrium of a monopoly firm will remain the same.
It is shown by the following diagram:
The monopoly firm is at equilibrium on point E where MC is equal to MR (MC=MR). Average profit is ST, total profit is PLST with OP price and OQ output.
(2) Law of Constant Returns or Law of Constant Cost:
Under this situation the production increases in the same proportion in which the inputs are changed. Hence the cost of production remains same. The point of equilibrium will be at point where MC is equal to MR (MC=MR) as shown in the Diagram 6.
Price, cost and revenue are shown on OY-axis while output on OX-axis. E is the point of equilibrium of a monopoly firm where its MC is equal to MR. The average profit is SE, total profit is PLES, price is OP and output is OQ. The firm is earning profit.
(3) Law of Diminishing Returns or Law of Increasing Cost:
In this situation output increases less than in proportion to the factors of production employed. In other words, the cost of production increases more than the resultant output.
It can be explained with the following diagram:
The point of equilibrium of a monopoly firm is E where its MC is equal to MR (MC=MR). The average point is SL, total profit is PRLS, price is OP and output is OQ.
Is Monopoly Price Always Higher than the Competitive Price?
Price is equal to marginal cost of the product under perfect competition but in case of monopoly, market structure price is generally higher than the marginal cost. But we should not derive the conclusion that the monopoly price is always higher than that of competitive market.
In practice, sometimes it is possible that the prices of monopoly market are long than that of perfect competition. But generally the prices in monopoly market are always higher than those of competitive market.
It can be explained with the help of the following diagram:
Price, cost and revenue have been shown on OY-axis while output has been shown on OX-axis. AR and MR are relating to perfect competition while AR1 and MR1 are average revenue and marginal revenue curves in monopoly market. MC is the marginal cost curve. The point of equilibrium in a competitive market is at point E where the marginal cost is equal to marginal revenue (MC=MR).
The output is OQ and price is OP in perfect competition while the point of equilibrium of a monopoly market is at E1 where marginal cost is equal to its marginal revenue (MC=MR1).
The price is OP1 and output is OQ1 in monopoly market. Thus, the price in monopoly market is higher (OP1>OP) than that of competitive market while the output is lower (OQ1<OQ) than that of competitive market. Price equivalent to PP1 is higher and output equivalent to Q1Q is lower under monopoly markets as has been shown in Diagram 8.
But it is not always correct to say that a monopoly firm charges high prices than that of the competitive market. It is a myth that monopoly prices are higher than those of competitive market.
There are some situations in which a monopolist charges lower prices than that of competitive markets.
These are the following conditions:
(1) When the demand for a product is highly elastic and the production is carried on under the law of increasing returns or law of decreasing cost, then a monopolist sells its product at lower price and maximises his profits.
(2) When the production of a monopoly firm is reaping, the harvest of internal and external economies of large scale, the cost of production will decrease and he will charge low price which is lower than the competitive price.
(3) Monopoly firm is a single seller of a product and it does spend on advertisement and sales promotions. The cost of sales is reduced. In such a situation he can sell its product at lower price.
(4) A monopolist may charge lower price from buyers because he is afraid of new substitutes, government intervention and regulation, opposition from the public and consumers’ associations, etc.
(5) He (monopolist) may also resort to policy of price discrimination charging lower price in one market and higher price in another market, thus maximising his profit and can continue in the market.
Comments are closed.