Q3Managerial Economics & Financial Accounting
Question
Explain the price and output determination under monopoly.
Answer
A monopolist maximizes profit where MR equals MC. Due to barriers to entry, they restrict output and charge a higher price, often earning supernormal profit.
A monopoly is a market structure with a single seller. The monopolist constitutes the entire industry, making them a Price Maker.
Because the monopolist is the only supplier, the firm's demand curve is the market demand curve, which slopes downwards. To sell more output, the monopolist must lower the price. Therefore, the Marginal Revenue (MR) curve always lies below the Average Revenue (AR, or Demand) curve and falls twice as fast.
Like any rational firm, a monopolist maximizes total profit at the output level () where: 1. (Marginal Revenue equals Marginal Cost). 2. The MC curve cuts the MR curve from below.
1. Find the intersection of MR and MC. Drop a line down to the X-axis to find the profit-maximizing Output (). 2. To find the price, follow that exact quantity line straight UP until it hits the Demand (AR) curve, and trace over to the Y-axis. This is the Monopoly Price (). Notice that price is strictly greater than Marginal Cost (). 3. To determine profit, find the Average Cost (AC) at output . The difference between the Price (AR) and Average Cost (AC) multiplied by the quantity gives the total profit area.
Because of high barriers to entry, a monopolist usually earns Supernormal Profit in both the short run and the long run.