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

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

The profit-maximizing 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 maximizing 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
have 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.
Pricing under Monopolistic competition

Monopolistic competition is a form of imperfect competition where many competing producers

sell products that are differentiated from one another (that is, the products are substitutes, but,
with differences such as branding, are not exactly alike). In monopolistic competition firms can
behave like monopolies in the short-run, including using market power to generate profit. In the
long-run, other firms enter the market and the benefits of differentiation decrease with
competition; the market becomes more like perfect competition where firms cannot gain
economic profit. Unlike perfect competition, the firm maintains spare capacity. Models of
monopolistic competition are often used to model industries. Textbook examples of industries
with market structures similar to monopolistic competition include restaurants, cereal, clothing,
shoes, and service industries in large cities. The "founding father" of the theory of monopolistic
competition was Edward Hastings Chamberlin in his pioneering book on the subject Theory of
Monopolistic Competition (1933). Joan Robinson also receives credit as an early pioneer on the
concept.

Short-run equilibrium of the firm under monopolistic competition. The firm maximizes its profits
and produces a quantity where the firm's marginal revenue (MR) is equal to its marginal cost
(MC). The firm is able to collect a price based on the average revenue (AR) curve. The
difference between the firms average revenue and average cost gives it a profit.

Monopolistically competitive markets have the following characteristics:

• There are many producers and many consumers in a given market, and no business has
total control over the market price.
• Consumers perceive that there are non-price differences among the competitors' products.
• There are few barriers to entry and exit
• Producers have a degree of control over price.

The long-run characteristics of a monopolistically competitive market are almost the same as in
perfect competition, with the exception of monopolistic competition having heterogeneous
products, and that monopolistic competition involves a great deal of non-price competition
(based on subtle product differentiation). A firm making profits in the short run will break even
in the long run because demand will decrease and average total cost will increase. This means in
the long run, a monopolistically competitive firm will make zero economic profit. This gives the
amount of influence over the market; because of brand loyalty, it can raise its prices without
losing all of its customers. This means that an individual firm's demand curve is downward
sloping, in contrast to perfect competition, which has a perfectly elastic demand schedule.

Long-run equilibrium of the firm under monopolistic competition. The firm still produces where
marginal cost and marginal revenue are equal; however, the demand curve (and AR) has shifted
as other firms entered the market and increased competition. The firm no longer sells its goods
above average cost and can no longer claim an economic profit