Price Determination

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:

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1. Single Producer: There must be only one producer who 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.
2. No Close Substitute: The commodity produced by the producer must have no closely competing substitutes, if he is to be called a monopolist.

This ensuresthat there is no rival of the monopolist. Therefore, the cross elasticity ofdemand between the product of the monopolist and the product of any otherproducer must be very low.

Price-Output Determination Under Monopoly:

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 average revenue, ML is the average cost, therefore, P’L is the profit per unit. Now the total 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 run MC.

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