price and output under a pure monopoly

THE MONOPOLISTS DEMAND CURVE- CONSTRAINTS ON MONOPOLY

Be careful of saying that "monopolies can charge any price they like" - this is wrong. It is true that a firm with monopoly has price-setting power and will look to earn high levels of profit. However the firm is constrained by the position of its demand curve. Ultimately a monopoly cannot charge a price that the consumers in the market will not bear.

A pure monopolist is the sole supplier in an industry and, as a result, the monopolist can take the market demand curve as its own demand curve. A monopolist therefore faces a downward sloping AR curve with a MR curve with twice the gradient of AR. The firm is a price maker and has some power over the setting of price or output. It cannot, however, charge a price that the consumers in the market will not bear. In this sense, the position and the elasticity of the demand curve acts as a constraint on the pricing behaviour of the monopolist. Assuming that the firm aims to maximise profits (where MR=MC) we establish a short run equilibrium as shown in the diagram below.

Assuming that the firm aims to maximise profits (where MR=MC) we establish a short run equilibrium as shown in the diagram below.

The profit-maximising output can be sold at price P1 above the average cost AC at output Q1. The firm is making abnormal "monopoly" profits (or economic profits) shown by the yellow shaded area. The area beneath ATC1 shows the total cost of producing output Qm. Total costs equals average total cost multiplied by the output.

A CHANGE IN DEMAND

A change in demand will cause a change in price, output and profits.

In the example below, there is an increase in the market demand for the monopoly supplier. The demand curve shifts out from AR1 to AR2 causing a parallel outward shift in the monopolist's marginal revenue curve (MR1 shifts to MR2). We assume that the firm continues to operate with the same cost curves. At the new profit maximising equilibrium the firm increases production and raises price.

Total monopoly profits have increased. The gain in profits compared to the original price and output is shown by the light blue shaded area.

Not all monopolies are guaranteed profits - there can be occasions when the costs of production are greater than the average revenue a monopolist can charge for their products. This might occur for example when there is a sharp fall in market demand (leading to an inward shift in the average revenue curve). In the diagram below notice that ATC lies AR across the entire range of output. The monopolist will still choose an output where MR=MC for this reduces their losses to the minimum amount.

How do monopolies continue to earn supernormal profits in the long run - revise barriers to entry. See also the pages on price discrimination

Mobile Phone Operators and Supernormal Profits

In the first of its mobile market reviews, OFTEL, the telecommunications industry regulators has found that mobile phone operators are making profits greater than would be expected in a fully competitive market. Their research finds that mobile phone charges have fallen by nearly a quarter since January 1999. And, the level of consumer satisfaction with their mobile phone service continues to run high (at around 90%).

But the OFTEL review finds that consumers do not have sufficient information on the range of prices available from the mobile phone networks and they are being over-charged for calls between mobile networks. OFTEL have stated that some sectors of the industry may require more intensive regulation unless there are improvements in pricing in the coming months.

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