Price and Output Determination in Monopoly4 min read


Learning Objectives

  • Monopoly and Producer’s Equilibrium
    • TR – TC Approach
    • MR – MC Approach
  • Short Run Analysis of Monopoly Firms 
  • Long Run Analysis of Monopoly Firms

Producer’s Equilibrium

A monopoly firm is said to be in equilibrium when it maximizes profit or produces profit maximizing level of output.  A monopolist profit will be maximum either when the difference between the total revenue (TR) and total cost (TC) is maximum or when additional cost incur for production of an additional unit of output that is marginal cost (MC) is equal to the additional revenue received from sell of an additional unit of output that is marginal revenue (MR).

  • Total Revenue (TR) and Total Cost (TC) Approach
  • Marginal Revenue (MR) and Marginal Cost (MC) Approach

TR-TC Approach

The monopolist is said to be in equilibrium at that point where the gap between Total Revenue and Total Cost is maximum. It means that the producer produces only that quantity of goods or products that maximizes its profit.

The monopolist’s total revenue curve is concave in nature as the total revenue increases in the decreasing return, and total cost first increases in the decreasing rate, remains constant, and again increases in the increasing rate.

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MR-MC Approach

In MR-MC approach, the firm is said to be in equilibrium if the MR equals to MC, and the MC curve cuts MR from below.

The MR and AR curve of the monopolist is downward sloping. This is because the monopolist can control either price or quantity at a time; he or she cannot control both price and quantity. Hence, when price of good increases the quantity demanded decreases, thus the AR curve or demand curve decreases, so as the MR curve also decreases.

Mathematically,

Profit of the firm is maximum when the gap between TR and TC is maximum.

so,

Profit (Π)=TR-TC

Differentiating with respect to Q,

d(Π)/d(Q) = d(TR)/d(Q) – d(TC)/d(Q)

0 = MR – MC

MR = MC ————— First order condition

For profit maximum Second Derivative must be less than zero (0),

d(MR)/d(Q) – d(MC)/d(Q) < 0

d(MR)/d(Q) < d(MC)/d(Q)

Slope of MR must be less than Slope of MC  ————— Second order condition.

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Short Run Analysis

  • Super Normal Profit of Monopolist

The monopolist will be in super normal profit if the average revenue is more than average cost of the monopolist.

Mathematically,

Super Normal Profit = Area under Average Revenue – Area under Average Cost

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  • Normal Profit of Monopolist

The monopolist will be in normal profit if the average revenue is equals to average cost of the monopolist. 

Mathematically,

Normal Profit = Area under Average Revenue – Area under Average Cost = 0

In general sense, if revenue equals to cost then, there is neither profit nor loss. But Economists have called this situation called Normal Profit. This is because the clever firm owners or entrepreneurs add implicit cost or opportunity cost to form total cost.

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  • Loss of Monopolist

The monopolist will be in normal profit if the average revenue is lower than average cost of the monopolist.

Loss = Area under Average Cost –  Area under Average Revenue

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Long Run Analysis

In long run, the monopolist earns super normal profit. This is because the monopolist enjoys market power, no free entry and exit of firms, and no availability of close substitute. Thus in long run, the monopolist always have long run average revenue more than long run average cost.

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