Equilibrium of Monopoly

Equilibrium of Monopoly

Price and Output Determination

Under monopoly equilibrium output and price are determined by two different approach

(i) Total Revenue and total cost Analysis

(ii) Marginal Revenue and Marginal Cost Analysis

• Total Revenue and Total Cast Analysis

The TR and TC curve method applies to a monopoly firm as well as to firms in other kinds of market structure.

According to this approach the firm is in equilibrium when it produces that amount of output at which the difference between Total Revenue (TR) and Total cost (TR), i.e., Total profit, is maximum.

• Marginal Revenue and Marginal cost Analysis

Another method to find out the profit maximising output and price for a firm under monopoly is to calculate its marginal cost (MC) and marginal revenue (MR) at different level of output.

According to this approach, a monopolist will be in equilibrium when two conditions are fulfilled, i.e., (i) MC = MR and (ii) MC must cut MR from below, i.e., slope of MC> slope of MR. Once the profit maximises output level is determined, the monopolist finds out the price at which this quantity can be sold. Accordingly the price id determined.

The equilibrium output level and the corresponding prices are illustrated with the help of the following table:

Table: Determination of Equilibrium Output & Profit

Monopolist earns maximum profit of Rs. 59 when he produces 13 units of the commodity. At this output level, the MR is Rs. 16 and it is just to MC which is also Rs. 16 total profits are less if the monopolist produces more than 13 units.

Short period and Long period Equilibrium

A monopolist earns maximum profit when he is in equilibrium. The situation of equilibrium may be studied with reference to: (i) short period and (ii) Long period.

Price and output determination under short period or short-run Equilibrium

Since in the short period, the time available is not sufficient to alter production, to adjust with the demand. Hence in the short-run a firm can be in equilibrium in the following three positions with respect to profits.

The difference between AR and AC gives us profit or loss per unit of output

1. If at equilibrium, Average cost is less than Average Revenue (price) (i.e., AR>AC). The firm gets supernormal profits.
2. If at equilibrium, Average Revenue is equal to Average cost (i.e.AR-AC) the firm gets normal profits.
3. If at equilibrium, Average Revenue is less than Average cost (i.e.AR<AC), firm gets least negative profits or suffers minimum losses.

Let us elaborate the three position with suitable diagram.

In Fig. three different situations have been illustrated. In all the three situations, point E is the equilibrium point (where MR-MC). OP is the price at which the monopolist decides to sell his product.

1. Super Normal profit

In Fig. (a) the monopolist will produce OM output, and sell it at MB price which is more than average cost AM by BA per unit (BA-AM-BA). Thus in this situation the total super normal profit of the monopolist will be ABPC.

2. Normal profit

In fig. (b) OM is equilibrium output. At this output, average cost (AC) curve touches average revenue (AR) curve at point A. ‘A’ price OP (AR) is equal to the average cost (AM)of the product. Monopoly firm, therefore, earns only normal profit in equilibrium situation as at equilibrium output is AC=AR.

3. Incurring loss

In fig. (c), OM output is being produced at MN cost per unit, but this is being sold at AM price per unit. Monopoly incurs a loss of AN per unit. His total loss is being represented by the shade area ANP,P.

But a question arises as to why the firm produces when it is incurring losses?

A loss -incurring monopolist’s decision to continue with production will depend on its average variable costs (AVC) (as in the case of perfect competitive firm, as already illustrated). We can conceive of three situation.

(i) AR > VC, (ii) AR = AVC, (iii) AR < AVC

A loss- incurring monopolist will continue to produce as long as his AR is more than or equal to his AVC. This situation of equilibrium is Fig. (c). According to this figure, the price of equilibrium output OM is fixed at OP (AM). At this price, the average variable cost (AVC) curve touches AR curve at point A. It means that the firm will cover only average variable cost (AVC). So it will be incurring the loss total fixed cost. It will constitute the minimum loss to the firm and it will continue its production even at this price.

In case price falls below op1 then firm will not be able to meet its average variable cost even it will constitute more than minimum loss and to avoid it the firm will prefer to shut down its production. Thus shut down price is the price below which the firm choose not the produce at all.

Determination of Long-run price or Long-run Equilibrium

The monopoly price determination in the long run is similar to that under the short period. In the long run the monopoly firm adjusts its capacity to changes in long-run demand. After these adjustments are completed the monopoly firm will have a long- period equilibrium diagrammatically by the equality of long -period marginal cost (LMC) and long-period marginal revenue (MR)as shown diagrammatically in Fig.

In Figure monopolist’s equilibrium is determined at the point E, where MR= LMC, corresponding output OM is produced at OB cost per unit, and is sold at AM per unit. And is sold at AM per unit the firm makes profit, equal to BM per unit. Total profits of a monopolist are being shown by the shaded area ABPN.

Existence of super normal profit in the Long period

It may be noted that there is always a tendency for the monopoly firm to secure excess profits, even in the long run. Since entry into the industry is prohibited, it is due to the fact that unlike perfect-competition no firm can enter into the market. Thus even enter the market in the hope of sharing whatever super normal profit in the long run no other producer can enter the market in the hope of sharing whatever super normal profit potential exists. Therefore, super normal profits are not eliminated even in the long-run.

Lack of enter into the industry as well as lack of substitutes in the market means that the monopolist does not have an optimum size plant in the long run or has to use it at optimum capacity. The monopolist will adjust his plant to the demand conditions in the market. Three possibilities are available:

• The monopolist may build a less than optimum size plant.
• He may build a plant having size greater than optimum.
• He may build an optimum-sized plant.

In all the above situations, the monopolist gains more than normal profits.

Important links

• Law of Variable Proportions- Assumption, Explanation, Stages etc.
• Cost Curve: Nature, Relationship between LMC & SMC
• Market- Definition, Features & Factors Affecting its Size
• Traditional Theory of Costs- Short-run & Long-run
• Perfect Competition- Definition, Equilibrium firm & Conditions
• Equilibrium of an Industry in the short remand Long-Run

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