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Price Determination Under Monopoly

Price Determination Under Monopoly

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Price determination under monopoly, study notes for M.A. Economics, Karachi University
Visit http://maeconomics.webs.com for more study notes on Economics.

Price determination under monopoly, study notes for M.A. Economics, Karachi University

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Published by: maeconomics on Jan 08, 2009
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12/05/2013

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Price Determination under Monopoly
Monopoly is that market form in which a single producer controls the whole supply of a single commodity which has no close substitute.
 From this definition there are two points that must be noted:
(i) Single Producer:
There must be only one producer w
 
ho may be anindividual, a partnership firm or a joint stock company. Thus single firmconstitutes the industry. The distinction between firm and industry disappearsunder conditions of monopoly.
(ii) No Close Substitute:
The commodity produced by the producer must have noclosely competing substitutes, if he is to be called a monopolist. This ensuresthat there is no rival of the monopolist. Therefore, the cross elasticity of demand between the product of the monopolist and the product of any other  producer must be very low.
 P 
 RICE 
-O
UTPUT 
D
 ETERMINATION 
 
UNDER
ONOPOLY 
:
A firm under monopoly faces a downward sloping demand curve or average revenuecurve. Further, in monopoly, since average revenue falls as more units of output are sold,the marginal revenue is less than the average revenue. In other words, under monopolythe MR curve lies below the AR curve.The Equilibrium level in monopoly is that level of output in which marginal revenueequals marginal cost. The producer will continue producer as long as marginal revenueexceeds the marginal cost. At the point where MR is equal to MC the profit will bemaximum and beyond this point the producer will stop producing.It can be seen from the diagram that up till OM output, marginal revenue is greater thanmarginal cost, but beyond OM the marginal revenue is less than marginal cost.Therefore, the monopolist will be in equilibrium at output OM where marginal revenue isequal to marginal cost and the profits are the greatest. The corresponding price in thediagram is MP’ or OP. It can be seen from the diagram at output OM, while MP’ is the
MXYPTORevenue /CostOutputMCACAR MR 
 
P’LE
 
average revenue, ML is the average cost, therefore, P’L is the profit per unit. Now thetotal profit is equal to P’L (profit per unit) multiply by OM (total output).In the short run, the monopolist has to keep an eye on the variable cost, otherwise he willstop producing. In the long run, the monopolist can change the size of plant in responseto a change in demand. In the long run, he will make adjustment in the amount of thefactors, fixed and variable, so that MR equals not only to short run MC but also long runMC.
OMPARISON 
 
OF 
 RICE 
D
 ETERMINATION 
 
UNDER
 ERFECT 
OMPETITION 
 
 AND
ONOPOLY 
:
The key points of comparison of price determination under Perfect Competition andMonopoly is as below:
Perfect CompetitionMonopoly(i)
The demand curve or average revenuecurve is perfectly elastic and is a horizontalstraight line.
(i)
The demand curve or average revenuecurve is relatively elastic and a downwardsloping from left to right.
(ii)
The firm is in equilibrium at the levelof output where MC is equal to MR. Sincein perfect competition MR is equal to AR or price, therefore, when MC is equal toMR, it is also equal to AR or price at theequlibrium position, i.e., MC=MR=AR (Price)
(ii)
The firm is in equilibrium at the levelof output where MC is equal to MR.
(iii)
In equilibrium position, the pricecharged by the firm equals to MC.
(iii)
In equilibrium position, the pricecharged by the firm is above MC.
(iv)
The firm is in long-run equilibrium atthe minimum point of the long-run ACcurve.
(iv)
The firm is in long-run equilibrium atthe point where AC curve is still decliningand has not reached the minimum point.
 
(v)
The firm is in equilibrium at the level of output at which MC curve is rising, and iscutting MR curve from below.
(v)
The firm is in equilibrium at the level of output at which MR curve is slopingdownwards, and MC curve is cutting itfrom below or above.
(See figure 1)
(vi)
In the long run, the firm is earningnormal profit. There may be super normal profit in the short run but they will beswept away in the long run, as new firmsentered into the industry.
(vi)
The firm can earn abnormal or supernormal profit even in the long run, asthere is no competitor in the industry.
(vii)
Price can be set lower at greater outputin case of constant-cost and decreasing-costindustries.
(vii)
Price is set higher and output smaller  by the monopolist.
(See Figure 2)
MXYOEuilibrium with fallin MCPP’TLACAR MCMR MXYP’TOEuilibrium with constant MCMXYP’TOEuilibrium with risin MCMCACMRALPPLAC=MCMR AR 
Figure 1: Equilibrium with rising, constant & falling MC under Monopoly

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This was usefull. can also provide case laws for the benefit of students.
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