MCom I Semester Managerial Economics Price Determination Under Monopoly Study Material Notes

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MCom I Semester Managerial Economics Price Determination Under Monopoly Study Material Notes

MCom I Semester Managerial Economics Price Determination Under Monopoly Study Material Notes: Meaning and Definition of Monopoly Characteristics of Monopoly Object of a Monopolist  A Monopolis Cannot Fix Both The price and output Simultaneously Price Determination Under Monopoly Equilibrium of a Monopolist in Ver Short PeroidIs monopoly Price Always Higher Than Competitive Price Comparison on Demand Curve of a Firm Under Perfect Competition and Monopoly

MCom I Semester Managerial Economics Price Determination Under Monopoly Study Material Notes
MCom I Semester Managerial Economics Price Determination Under Monopoly Study Material Notes

MCom I Semester Analysis Statistical Quality Control Study Material Notes

PRICE DETERMINATION UNDER MONOPOLY

MEANING AND DEFINITION OF MONOPOLY

The term monopoly is derived from two words mono+poly. The term mono means alone and the term poly means producer or seller. Thus, monopoly is the state of market in which the following three elements are present : (i) Only one producer or seller of a commodity, (ii) No close substitute of commodity, (iii) Restricted entry of new firms in market.

In the words of Prof. Boulding, “A Pure monopolist, therefore, is a firm producing a product which has no effective substitutes among the products of any other firm.”

Thus, a monopolist is a single producer of his commodity and there is no close substitute of the commodity in market. Therefore, he has complete control over the supply of his commodity.

CHARACTERISTICS OF MONOPOLY

1 There must be a single producer or seller of a particular commodity in market.

2.There should be no close substitute of product in market.

3. No new firm should be allowed to enter into the market.

OBJECT OF A MONOPOLIST

Main object of a monopolist is to maximise his total profit and not the profit per unit. Secondly, a monopolist does not feel satisfied with normal profit only. He always wants to get abnormal profit. Prof. Marshall has named this abnormal profit as net monopoly revenue. A monopolist can achieve it only when marginal cost and marginal revenue are equal (MR=MC).

A MONOPOLIST CANNOT FIX BOTH THE PRICE AND OUTPUT SIMULTANEOUSLY

An important fact regarding monopoly is that a monopolist cannot control both the demand and supply. He cannot fix both the price and output simultaneously. If he decides to control the quantity of supply, he cannot control price which will be determined by market forces in accordance with demand. If he decides to control the price, he cannot control the quantity of supply which will have to be adjusted according to demand.

A monopolist prefers to control the price of commodity which is more profitable for him. He fixes a certain price for his commodity and allows the quantity of production to be determined by market forces. He adjusts the quantity of output in accordance with the quantity of demand.

PRICE DETERMINATION UNDER MONOPOLY

Monopoly is a state of market which satisfies following conditions : (i) There is a single seller or producer of a particular commodity, (ii) There is no close substitute of the commodity, (iii) No new firm can enter into the market.

Main object of a monopolist firm is to maximise total profit. A monopolist does not feel satisfied with normal profit. Its want to earn abnormal profit. A monopolist commands complete control over its demand. He cannot fix both the price and output simultaneously. Following points are important to consider for determining the price under monopoly.

Demand Force :

A monopolist is the only producer of his product. Therefore, a monopolist firm is an industry in itself. Demand curve of a monopolist is the demand curve for whole industry. It slopes downwards to the right. It implies that monopolist also will have to reduce the price of his product if he wants to sell more quantity of it. As a result, marginal Y revenue curve of a monopolist firm is downwards to the right and MA curve always below average revenue curve as is evident from the following diagram.

In the diagram, AR is average revenue curve and MR is marginal revenue curve of monopolist. Both the AR=Demad curve curves slope downwards to the right. MR curve is always below AR curve. It implies that MR of a monoplist is always less than AR. AR of a monopolist is Quantity of Production demand curve also. If further implies that a monopolist wili have to lower Revenue of product to sell more of it.

Supply Force :

Supply curve of a monopolist is also his average cost curve. Relationship between average cost and marginal cost of a monopolist firm depends upon laws of returns. If law of diminishing returns is applying, both the average, and marginal cost curves will slope upwards and marginal cost will be me than average cost. If low of increasing returns is applying both the average cost and marginal cost curves will slope downwards and marginal cost will be less than average cost. If law of constant returns is applying, both the average cost and marginal cost curves will be straight line and will be equal.

Diagram A: AC is average cost curve and MC is marginal cost curve. Law of diminshing returns is applying. Both the curves slope upward to the right. AC will always be less than MC. Both AC and MC will go on increasing on an increase in the quantity of production.

Diagram B : Law of increasing returns in applying. Both the AC and MC curves slope downwards to the right. MC will always be less than AC. Both AC and MC will go on declining on an increase in the quantity of production.

Diagram C: AC and MC are equal and constant at all the levels of production when the law of constant returns is applying. Therfore, AC and MC curve is a straight line.

EQUILIBRIUM OF A MONOPOLIST IN VERY SHORT PERIOD

In very short period, price of a monopoly product is determined according to its demand because supply remains constant. There- fore, cost curves do not play any role in the determination of price in this period. Main object of monopolist firm is to maximise total profit. It will be achieved at the point at which marginal revenue is zero. It can be illust-rated with the help of following diagram :

In this diagram, AR is average revenue curve and MR is marginal revenue curve. QQ is the total quantity of production. Price is determined at E point at which MR is zero. At this point, price will be OP and quantity sold will be 09. OP If monopolist wants to sell his entire Pit production, he will have to lower his price to OP

EQUILIBRIUM OF A MONOPOLIST IN SHORT PERIOD

There are two methods of price determination during short period : Fig. 21.3. Determination of Monopoly

(1) Marginal Cost and Marginal Price in Very Short Period Revenue Method. In short period, a or Market Period. monopolist price can be determined where MR is equal to MC. In short run, a monopolist may face three conditions abnormal profit, normal profit or loss. These three conditions can be illustrated with help of three diagrams as under.

Price Determination Under Monopoly
Price Determination Under Monopoly

Diagram A: AR is average revenue curve, MR is marginal revenue curve, AC is average cost curve, MC is marginal cost curve. Price of product is fixed at the point at which MC is equal to MR. Quantity sold will be OQ. In this case, monopolist will be earning Abnormal Profit equal to EPEP, because normal selling price should be P, where AC = AR.

Diagram B : Since a monopoly price is fixed at the point at which MC is! equal to MR, it will be fixed at point E. At this point, price will be OP and quantity sold will be OQ. At his point, he will be earning only normal profit (Zero If demand is low, firm profit because normal profit is a part of because AC and AR and equal.

Diagram C : Since a mono- poly price is determined at the point at which MC is equal to MR, it will be at point E. At price will be OP and quantity Equilibrium sold will be oQ. Since AC curve is passing over and above this point, firm will be suffering loss equal to EP EP.

(2) Total Revenue and Total Cost O Method. Some economists have propounded total revenue and total cost Fig.21.4.C. Price Determination method for the determination of price Under Monopoly During Short under monopoly during short run. Under this method, total cost and total revenue curves are drawn for a monopolist. They the point at which the gap between total monopolist will get maximum profit at

Break-Even points the point at which the gap between these two will be maximum. It can be illustrated with the help of following diagram :

In this diagram, TC is total cost curve and TR is total revenue curve. TR curve starts from the point of origin which implies that if the production of monopolist is zero, his total revenue will also be zero. TC curve starts from N point which implies that even at the level of zero production, fixed costs will have toTotal Revenue and Total be incurred.

The firm is getting maximum profit During VeryShort Period. at E because the difference between TC and TR is maximum at this point. Firm will be producing OQ quantity of commodity. If the firm produces less or more quantity than OQ, its profit will decline. TC and TR are intersecting each other at two points: A and B. The monopolist is getting zero profit (Normal proft) at these points. Therefore, these points are known as break even points also..

EQUILIBRIUM OF A MONOPOLIST IN

In long run, a monopolist can earn only abnormal profit. In long run, a onopolist can adjust his production capacity according to the demand of his product. Determination of price under monopolist earns super normal profit. AC will be less the point of equilibrium monopoly in long run can be illustrated with

In this diagram, Since monopolist price is determined, where MC is equal to it will be at E point. At this point, price will be OP and quantity sold will be Since AC curve is below this point, firm will be earning abnormal profit equal to EPEP. Thus, in long-run a  Is monopoly price always higher than competitive price ? Compare the two.

IS MONOPOLY PRICE ALWAYS HIGHER THAN COMPETITIVE PRICE?

A monopolist has complete control over the supply of a product. He always tries to get maximum profits. Under monopoly, there is no close substitute of product. Therefore, it is a general thinking that monopoly price is always higher than competitive price but the reality is not so. Price of a monopoly product also depends upon the elasticity of demand. If demand of a monopolist product is inelastic, higher price can be fixed demand is elastic, lower price will to be fixed. In addition to this, if average cost and marginal cost of a monopolist are declining, he will have to fix lower price for his product (declining average and marginal costs imply that the law of increasing returns is applying and the profit can be increased by increasing production). To avail this situation, he will reduce the price of his product so that he may produce and sell more. Thus, monopolist price is not always higher than competitive price. However, monopolist price tends to be higher than competitive price.

COMPARISON OF DEMAND CURVE OF A FIRM UNDER PERFECT COMPETITION AND MONOPOLY

Under perfect competition, demand curve of a firm is paralld to OX axis becuase all the units are sold at a uniform rate and AR= MR. Under monopoly, demand curve moves downward form left to right because under monopoly, price will have to be reduced in order to sell more units and AR > MR. It can be illustrated with the help of following diagrams:

 

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