Download Monopoly - Dr. Waheeda Thomas

Monopoly
A monopoly market form exists when the output of an entire industry is
produced and sold by a single firm. The word monopoly is derived from two
Greek words ‘monos’ means one and ‘polein’ means to sell. Therefore,
monopoly is market characterized by a single seller, who can charge different
price for his product by changing the quantity of output.As a result a
monopolist has total control over price and the quantity he offers for sale.
From the above definition we can bring forth several important characteristics
of monopoly.
a) In monopolistic form of market there is a single producer, selling a product
which does not have close substitutes,
b) There are strong barriers to entry of other firms into the market,
c) A monopolist is a price marker he can decide the price of his product by
increasing or decreasing the output,
d) The product has no close substitute, and
e) A monopolist discriminates the price.
Price and output determination under monopoly
Monopolist like a perfectly competitive firm tries to maximize his profit. This is
to say that the motive of a monopolist is same as the motive a perfectly
competitive firm. A firm under perfect competition faces a horizontal straight
line parallel to x-axis demand curve and MR=AR .Where as a monopolist faces
a downward sloping demand curve or AR curve. It should be noted that the MR
curve of a monopolist lies below the AR curve. This is because a monopolist
can decide the price of his product and profit maximization is his objective so
he will sell lesser quantity at higher price and higher quantity at lower price.
With help of equilibrium a monopolist is able to determine the profit
maximizing output. The producer will continue producer as long as marginal
revenue exceeds the marginal cost. At the point where MR is equal to MC the
profit will be maximum and beyond this point the producer will stop producing.
Under monopoly there are two types of equilibrium, short run and long run.
They are explained as under -
Equilibrium under short run: During short run there are three possibilities
under the monopoly market form. They are as follows i) Abnormal profit
ii) Normal Profit
iii) Loss
Price and output determination under these three scenarios is explained below
Short run equilibrium-Abnormal profit
The average revenue curve of the firm is downward sloping straight line. And
marginal revenue is lying half way between AR curve and y- axis. As shown in
figure 1 MR and MC are equal at point E. The monopolist is in equilibrium at E
where both first order (MR=MC) and second order (MC cuts MR from below)
conditions are fulfilled.
Figure 1- short run equilibrium - Abnormal profit
Y
R
E
V
E
N
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E
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C
O
S
T
MC
AC
P
T
R
S
E
AR
0
Q
X
MR
OUTPUT
The firm produces equilibrium output OQ at price OP. Firm earns total revenue
of OPRQ where as its total cost is OTSQ. The difference between total revenue
and total cost is TPRS. Thus the firm makes more than normal profit equal to
the area PRST.
Short run equilibrium - Normal Profit
In figure 2 both the conditions of equilibrium [first order (MR=MC) and second
order (MC cuts MR from below)] are satisfied of point E and the total revenue of
the firm is equal to total cost.
Y
R
E
V
E
N
U
E
/
C
O
S
T
AC
MC
R
P
S
E
AR
0
Q
OUTPUT
X
MR
The firm produces equilibrium output OQ at price OP. The total revenue of the
firm is OPRQ and the total cost is also the same. Thus TR=TC and the
monopolist is earning only normal profit.
Short run equilibrium - Loss
A monopolist operating during short run may also incur losses as shown in
figure 3. Though both the conditions of equilibrium are satisfied at E, firm’s
total revenue is less than total cost.
Figure 3: Short run –Losses.
MC
Y
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E
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E
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E
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O
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T
AC
S
T
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P
E
AR
0
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OUTPUT
X
MR
The total revenue is OPRQ and total cost is OTSQ. As the TC is greater than
TR, the monopolist loss is equal to the shaded portion PTSR.
Long Run Equilibrium:
During long run when a monopoly firm is in equilibrium, the industry is also in
equilibrium. Under perfect competition if a firm is making abnormal profit
during short run, more firms will join the industry and during long run the
abnormal profit will disappear. But in monopoly, due to entry barriers this is
not possible.
In the long run, the monopolist can change the size of plant in according to a
change in demand. He will also make adjustment in the amount of the factors,
fixed and variable, so that MR equals not only to short run MC but also long
run MC. The long run equilibrium of the firm is explained with the help of
figure 4.
It can be seen in figure 4 that till OQ output, marginal cost is less than
marginal revenue and beyond OQ the marginal cost is greater than marginal
revenue. Thus OQ is the equilibrium output of the monopolist where marginal
revenue is equal to marginal cost and the profits are the maximum. The
equilibrium determines the prices OP or RQ . It can be seen from the diagram
at output OQ, while RQ is the average revenue, SQ is the average cost,
therefore, RS is the profit per unit.
Y
R
E
V
E
N
U
E
/
C
O
S
T
MC
AC
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P
S
T
E
AR
0
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X
OUTPUT
MR
Figure 4 : Long run equilibrium of a monopolist
Now the total profit is equal to RS (profit per unit) multiplied by OQ (total
output). In other words the total revenue of the firm is OPRQ and the total cost
is OTSQ. The difference between TR and TC (as TR is greater than TC) is total
profit i.e. PRST.