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How does a monopoly firm determine price in short run? Explain.

How does a monopoly firm determine price in short run? Explain.

(अल्पकालमा एउटा एकाधिकार फर्मले मूल्य निर्धारण कसरी गर्दछ ? व्याख्या गर्नुहोस् ।)

Solution

A monopoly is a market with a single seller, many buyers and a product with no close substitutes. The word comes from the Greek mono (single) and poly (seller). The monopolist controls supply and is a price maker. Because it faces the whole market demand, its AR (demand) curve slopes downward and its MR curve lies below AR. An example is Nepal Oil Corporation’s legal right to import petroleum.

The features relevant to pricing are:

  1. Single seller with no close substitutes: buyers have no alternative.
  2. Barriers to entry: rivals cannot enter, at least in the short run.
  3. Downward-sloping AR curve: to sell more, the monopolist must lower its price, so MR is less than AR.

The conditions for short-run equilibrium are:

  1. Necessary condition: MR = MC. The monopolist expands output while MR is greater than MC and stops when they are equal.
  2. Sufficient condition: MC cuts MR from below.

Price is determined as shown below:

Short-run equilibrium of a monopoly firm
  1. Determining output: MC cuts MR from below at point E, so the equilibrium output is OQ.
  2. Determining price: the monopolist does not charge a price equal to MC. It charges the highest price buyers will pay for output OQ, read from the AR (demand) curve directly above Q. So the price is OP, which is greater than MC. This shows that the monopolist restricts output and charges a higher price.
  3. Supernormal profit (AR > AC): at output OQ, the average cost is OC, which is below the price OP. Profit per unit is PC, and total supernormal profit is the shaded rectangle PC × OQ, as shown in the figure.
  4. Normal profit or loss: if the AC curve just touches AR at the equilibrium output (AR = AC), the monopolist earns only normal profit. If AC lies above AR (AR < AC), it suffers a loss, but it continues production in the short run as long as the price covers average variable cost (AVC). If the price falls below AVC, it shuts down.
  5. Key points of monopoly pricing:
    a. Price is always greater than MR and MC (P > MR = MC), which is the source of the monopolist’s market power.
    b. The monopolist always produces on the elastic part of the demand curve, where Ep > 1, because MR must be positive to equal a positive MC.
    c. A monopolist has no unique supply curve, because the same output can be sold at different prices depending on demand.

A monopolist determines output where MR = MC, with MC cutting MR from below, and charges the price given by the demand curve at that output. In the short run it may earn supernormal profit, normal profit or a loss, but because of entry barriers it usually keeps supernormal profit.

Explore more questions

  1. 1.

    How do the tax policy, subsidy policy and price control policy of the government affect the market equilibrium?

    (सरकारको कर नीति, अनुदान नीति र मूल्य नियन्त्रण नीतिले बजार सन्तुलनलाई कसरी प्रभाव पार्दछन् ।)

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  2. 2.

    Critically analyze the Marginal Productivity Theory of Wages.

    (ज्यालाको सीमान्त उत्पादकत्वको सिद्धान्तको आलोचनात्मक विश्लेषण गर्नुहोस् ।)

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  3. 3.

    Complete the following schedule if the market demand function is D = 1000 - 10P and the market supply function is S = 100 + 20P. (4+3+4+4).

    (यदि बजार मागफलन D = 1000 - 10P छ र बजार पूर्ति फलन S = 100 + 20P छ भने, दिइएको सूची पूरा गर्नुहोस्।)

    Price Market demand Market supply Shortage/ Surplus Pressure in price
    10
    20
    30
    40
    50

    a) Plot the market demand curve and the market supply curve in a figure. Show the equilibrium price and quantity both in schedule and figure.

    (एउटा चित्रमा बजार मागवक्र र बजार पूर्तिवक्र खिच्नुहोस् । सूची र चित्र दुवैमा सन्तुलन मूल्य र परिमाण देखाउनुहोस् ।)

    b) Calculate price elasticity of demand

    (i) when price increases from 10 to 20 and,

    (ii) when price decreases from 20 to 10.

    (मागको मूल्यलोच गणना गर्नुहोस् (अ) जब मूल्य रु. १० बाट बढेर रु. २० हुन्छ र (आ) जब मूल्य रु. २० बाट घटेर रु. १० हुन्छ ।)

    c) Calculate price elasticity of supply

    (i) when price increases from 10 to 20 and,

    (ii) when price decreases from 20 to 10.

    (पूर्ति लोच गणना गर्नुहोस्

    (अ) जब मूल्य रु. १० बाट बढेर रु. २० हुन्छ र,

    (आ) जब मूल्य रु. २० बाट घटेर रु. १० हुन्छ ।)

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  4. 4.

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    (दिइएको तालिका पूरा गर्नुहोस् तथा औसत लागत र सिमान्त लागत बिचको सम्बन्ध व्याख्या गर्नुहोस् ।)

    Output TFC TC TVC AVC AC MC
    0 24 24 - - - -
    1 - 30 - - - -
    2 - 32 - - - -
    3 - 36 - - - -
    4 - 48 - - - -
    5 - 74 - - - -
    6 - 120 - - - -
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  5. 5.

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    Schedule 1 Schedule 2
    Combination K L Output Combinations K L Output
    A1 10 60 1000 A2 10 75 1500
    B1 20 25 1000 B2 20 40 1500
    C1 30 10 1000 C2 30 25 1500
    D1 40 5 1000 D2 40 15 1500

    a. Compute total cost for each combination of capital and labor if price of use of capital is Rs.10, price of labor is Rs.5 and the producer has total cost outlay Rs.400 and identify the least cost combination.

    (यदि पूँजीको प्रयोगको मूल्य रु. १० श्रमको मूल्य रु. ५ छ र उत्पादकसँग कूल लागत खर्च रु. ४०० छ भने पूँजी र श्रमको हरेक संयोगको कूल लागत गणना गर्नुहोस् र न्यूनतम लागत संयोग पत्ता लगाउनुहोस्।)

    b. Sketch the isoquants \( \text{IQ}_1 and \text{IQ}_2 \) by using schedule 1 and schedule 2 respectively and sketch the isocost line also. Identify the optimal combination of capital and labor in figure.

    (सूचि १ र सूचि २ प्रयोग गरेर सम उत्पादन रेखाहरू क्रमशः \( \text{IQ}_1 र \text{IQ}_2 \) खिच्नुहोस् तथा सम लागत रेखा समेत खिच्नुहोस् । चित्रमा पूँजी र श्रमको अधिकतम संयोग पत्ता लगाउनुहोस् ।)

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  6. 6.

    Explain the consumer's equilibrium in indifference curve analysis approach.

    (तटस्थ वक्ररेखा विश्लेषण विधिमा उपभोक्ताको सन्तुलन व्याख्या गर्नुहोस् ।)

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