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How Do Equilibrium Condition is Determined in Monopoly Market?(Short-run and Long-run Equilibrium)

Updated on May 9, 2015
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IRSHAD CV has been a student in Economics. Now he is doing Masters in Economics. He completed B.A. Economics from the University of Calicut.

Introduction

Monopoly is the market, where the commodities are supplied by a single firm or producer. And large numbers of buyers bring in to contact him to purchase the commodity. The ultimate aim of a monopoly firm is to make maximum profit. So, the monopolist may impose any price, he like. Further the monopolist may charge different prices for different consumers for the same commodity. Here this hub is very briefly described, how the equilibrium condition is determined in a monopoly market. On the basis of the time, equilibrium determination can be classified in to two. They are

1) Short run equilibrium

2) Long run equilibrium

Short Run Equilibrium of Monopolist

Even though the ultimate aim of the monopolist is to make maximum profit, the monopolist cannot determine both the market price and the quantity he decides to sell. The monopolist can produce output for which the price accepted by the customers. Or the monopolist can fix price, but it may not demanded by the market. Short run equilibrium of monopolist can be represented as in the Figure I. At equilibrium, the following two conditions must satisfy.

1) Marginal Cost (MC) curve must cut Marginal Revenue (MR) from below.

2) Marginal Cost (MC) must be equal to Marginal Revenue (MR).

In the Figure I, the two equilibrium conditions are satisfied.

1) Marginal Cost (MC) curve cut Marginal Revenue (MR) curve from below.

2) Marginal Cost (MC) equals to Marginal Revenue (MR) curve

Further ‘R’ is the point demand curve tangent. And ‘P’ is the price of the commodity. Here the monopolist can earn an excess profit equals to the shaded area ‘PQRS’, because Average Total Cost (ATC) passes through the point ‘S’ and price is above that point. So, the monopolist can earn excess profit.

Long Run Equilibrium of Monopolist

In the long run, the monopoly firm can change both the variable and fixed costs like labor, land and building etc. with respect to the changes in demand for the commodity. The monopolist can use the plant either optimum level or a partial level. It depends on the super normal profit earned by the firm. The monopolist can fix price since new entries of firms are blocked. So, cost is not a challenge for monopolist. In short a monopolist can survive in the economy by producing commodity at different costs. On the basis of the costs incurred for the monopoly firm, the long run equilibrium determination can be explained in three methods as listed below.

1) Sub optimal scale, here the cost is not minimal and the capacity of firm is used less

2) Surpass optimal scale, here the cost is not minimal and capacity of the firm is over utilized.

3) Optimal scale, here the cost is minimal and the firm’s capacity is used well.

Each of these cases is very briefly and separately described below.

1) Suboptimal Scale with Under Utilization of Capacity

In a small monopoly market, the monopolist never uses his maximum capacity of the firm or plant limited demand. So, monopolist never produces his output with least cost. But he can earn profit, because he is the price maker in the market. It can be described with Figure II shown below.

In the Figure II, Marginal Cost (MC) curve cut Marginal Revenue (MR) from below and equilibrium is determined at point Marginal Cost (MC) equal to Marginal Revenue (MR). it tangent the demand curve at point ‘Q’ and so price will be equal to the point ‘P’ and quantity will be ‘X’ on x axis. The area ‘PQRS’ will be the profit of monopolist.

Here another thing is also noted that, Long run Average Cost (LAC) is not in its minimum. The monopolist chooses point ‘S’ (falling part of LAC). Actually the monopolist can produce more until the cost reaches to the point ‘K’, where he can produce with minimum cost. So, monopolist works in a suboptimal scale and will not use their maximum capacity.

2) Surpass Optimal Scale with Over Utilization

It is a system workable when the market condition of monopolist is very large. So, the demand will be higher. To meet this heavy demand, monopolist wanted to produce more even at a higher (not minimum). It can be understand with the help of the Figure III showing below.

In the Figure III, Marginal Cost (MC) cut Marginal Revenue (MR) from below and MC equals MR at point ‘E’. The area ‘PQRS’ will be the profit of monopolist. Long run Average Cost (LAC) is the cost of firm which is determined at the raising part of LAC. This shows that the cost of monopolist is not minimum.

3) Optimal Scale with Efficient Utilization of the Capacity

Actually this case is workable when the monopolist deal with a just large, but not big market. Here the monopolist uses his optimum capacity. So, cost of production will be very less. It can be explained as shown in the Figure IV.

In the Figure IV, Marginal Cost (MC) Marginal Revenue (MR) from below and MC equals MR at point ‘E’. Demand is tangent at point ‘Q’ and price will be at ‘P’. Here the Long run Average Cost (LAC) is determined at its minimum point, meaning that cost is minimum and so, the monopolist can use their optimal capacity.

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