Show and explain how a monopolist maximises profit in a market
A pure monopolist is a single seller in an industry – in this case, the firm is the industry – and it can take market demand as its own demand curve.
The firm is a price maker but a monopoly cannot charge a price that the consumers in the market will not bear. In this sense, the price elasticity of the demand curve acts as a constraint on the pricing-power of the monopolist.
Assuming that the monopolist aims to maximise profits (where MR=MC), we establish a short run price and output equilibrium as shown in the diagram below
The profit-maximising level of output is at Q1 at a price P1. This will generate total revenue equal to OP1aQ1, but the total cost will be OAC1aQ. As total revenue exceeds total costs the firm makes abnormal (supernormal) profits equal to P1baAC1.
If, at its current level of output a monopolist is on the price-inelastic part of its demand curve, in order to maximise its profits it should reduce output and raise price
The second diagram below shows the effect of a rise in market demand, assuming the conditions of supply remain unchanged. Market price, monopoly revenue and profit all increase.
When monopoly profits are being made, a key issue is the extent to which the monopolist is able to maintain and protect these throug hentry barriers.
Barriers to entry are designed to block potential entrants from entering a market profitably. They seek to protect the power of existing firms and maintain supernormal profits and increase producer surplus
Our diagrams show a single price monopoly, keep in mind that monopoly suppliers have the option of engaging in price discrimination as a way of generating higher revenues and profits, and turning consumer surplus into producer surplus. Price discrimination occurs when a business charges a different price to different groups of consumers for the same good or service, for reasons not associated with costs.
Market Power and Market Pricing