Question

Monopoly Vs. Perfect Competition  

• Monopolists do not produce at minimum efficient scale in the short run or long run
• Monopolists are not allocatively efficient
• Monopolists have the ability to earn profits in the long run

Our main concern about monopoly power is that you have power you will use it for your own benefit. Monopolists, therefore, produce "too little" which is sold at "too high" a price.

Draw the case of:

the Price Setter

Profit Maximizer

Profit < 0

Answer 1

Answer

The monopolist is a single producer or seller of a particular good or service, which has no close substitute in the market. There are many buyers in the market for that particular good or service and the demand for the good or the service depends on the price of it.Higher the price, lower would be demand, and lower the price, higher would be demand for the good or the service.Thus the monopolist faces a negatively sloped demand curve for its good or the service.

The total revenue(TR), the monopolist earns is the product of price(P) and quantity(Q).

Thus, TR = P*Q

Average revenue (AR) = TR / Q = P*Q / Q =P

Thus, for each quantity, the monopolist earns the average revenue, which is equal to the price of the good or the service.The rise in average revenue means the fall in quantity (Q).So the monopolist's average revenue curve is just the demand curve of the monopolist's good or the service.

In all the three figures below,we are measuring quantity of the monopolist's good or the service on the horizontal axis, and the price and costs are measured on the vertical axis.The 'MC' curve shows the monopolist's marginal cost curve, 'AR' curve shows the average revenue curve, 'MR' curve shows the marginal revenue curve, and the 'AC' curve in figure-2, and in figure-3, shows the average cost curve,

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Price Setter

Figure-1

The profit maximizing monopolist produces the quantity of goods or the services, at which the marginal revenue(MR) and marginal cost(MC) are same, i.e., in the graph, the point where the 'MC' curve cuts the 'MR' curve, shows the profit maximizing output point of the monopolist. Now after producing the profit maximizing quantity of output, the monopolist sets the price on the demand curve it faces in the market.

In the above figure, the monopolist produces the profit-maximizing quantity 'Q' amount of output. Now the monopolist sets the price on the demand curve corresponding to 'Q'.In the figure, this price is 'P'. So, 'P' is the price, the monopolist sets for quantity of output 'Q'.

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Profit Maximizer

Figure - 2

In the above figure, we see that for the profit maximizing quantity of output 'Q', the monopolist sets the price 'P'. The vertical line from 'Q' touches the 'AC' curve at point 'S', which shows the average cost of production for 'OQ' amount of output. Now QS = OC . So the average cost of production of 'OQ' amount of output is 'OC' , and the price per unit of 'OQ' amount of output is 'OP', where 'OP' is greater than 'OC'. So the profit (Price - AC) per unit of output is 'PC'. Therefore for 'OQ' ( =CS) amount of output, the total profit (PC * OQ) is the area of the rectangle PTSC or the 'yellow' shaded area. This is the maximum profit the monopolist can earn at this output and average cost.

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Profit < 0

Figure -3

Profit < 0 means the monopolist earns loss. The monopolist's profit is less than zero or negative means, the per unit cost or the average cost at profit-maximizing quantity is greater than the price of the output. This situation is depicted in the above figure,Figure - 3. We see here , that at the profit maximizing output, 'Q', the average cost is 'QT' or 'OC' ,and the price is 'QS' or 'OP'. Now, 'OC' > 'OP', i.e., average cost is greater than the price per unit. The monopolist earns loss of amount 'CP' (OC-OP) for each unit of output. Therefore, for 'OQ' (=PS) amount of output, the monopolist earns the total loss or negative profit (CP * OQ) shown by the area of the rectangle CPST , or the 'yellow' shaded area.

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