Calculating the Monopolist's Profit

 

In Figure 1 the point at which your marginal cost curve crosses your marginal revenue curve is your output. According to Figure 1, MC equals MR at 5 units of output. Using the formula, we can find the total profit:

Total profit = (Price - ATC) x Output = ($12 - $10) x 5 = $2x5 = $10

The perfect competitor produced at the most profitable output, which in the long run always happened to be the most efficient output. But we see that the monopolist does not produce where output is at its most efficient level (the minimum point of the ATC curve). Remember, every firm will produce at its most profitable output, where MC equals MR.

To summarize, the monopolist makes a profit, whereas in the long run the perfect competitor makes zero profit. The monopolist operates at less than peak efficiency, while the perfect competitor operates at peak efficiency (the lowest point on the ATC curve). Finally, the perfect competitor charges a lower price and produces a larger output than the monopolist.

The monopolist operates on a much larger scale than the individual perfect competitor. But the sum of output under perfect competition would be larger than it would be under monopoly.

There is no distinguishing between the short run and the long run mainly because the monopolist has no rivals. With perfect competition, the fact that the firms entered the industry (attracted by profits) or left the industry (driven out of business by losses) made the short run differ from the long run. Under monopoly, even larger profits wouldn't attract rival firms; otherwise, it would no longer be a monopoly. If a monopoly were losing money, in the long run it too would go out of business.

How to Read a Graph

Example: Our output is always determined by the intersection of the MC and MR curves. That occurs at an output of about 4.25.

How much is price? First, price is read off the demand curve. Where on the demand curve—at what output? At the maximum profit output we just found—4.25. How much is price at that output? It appears to be about $9.

Next we calculate total profits.

Total profits = (Price - ATC)xOutput = ($9 - $7.50) x 4.25=$1.50x4.25= $6.38

You might have noticed that once we find output (where MC = MR), everything else lines up. Price is located on the demand curve above the output of 4.25. ATC is on the ATC curve, also above an output of 4.25. When we find total profits, we plug price, ATC, and output into our formula.

Figure 2. Monopoly

Microeconomics is based largely on the three-step problems you've come to know: (1) filling in the table, (2) drawing the graph, and (3) doing the analysis.

We need to find the monopolist's total profit. Do that right here. Then check your work with the calculations that follow.

Total profit = (Price - ATC) x Output = ($17 - $14) x 5 = $3x5 = $15

Table 2

Hypothetical Demand and Cost Schedule for a Monopoly

Output	Price	Total Revenue	Marginal Revenue	Total Cost	ATC	MC
	$21	$21	$21	$30	$30	-
						$10
					14.25
					15.50

 

Analyze:

1. At what output would the firm produce most efficiently?

2. At what output would the perfect competitor produce in the long run?

3. What price would the perfect competitor charge in the long run?

Here are the answers.

1. The output at which the firm would produce most efficiently would be about
5.1, which is the minimum point of the ATC curve.

2. The perfect competitor would produce at an output of 5.1 in the long run.

3. In the long run, the perfect competitor would charge a price of about $13.97 (the minimum, or break-even, point of the ATC curve).

 

Demand and Supply under Monopoly

Since the monopolist is the only seller in the industry, he not only faces the entire market demand curve, but her supply curve is the market supply curve (figure 1). The market demand curve is labeled D, the market supply curve is labeled MC. The monopolist's supply curve is his MC curve. His supply curve begins at the break-even point (i.e., the minimum point of the ATC curve) and runs up the MC curve. (Because we're not distinguishing between the monopolist's short run and long run, we won't bother with a short-run supply curve.)

Barriers to Entry

 

There are three barriers to entry: (1) control over an essential resource, (2) economies of scale, and (3) legal barriers to entry.

Figure 2. Hypothetical Production Costs for Cars

In some industries, low unit costs may be achieved only through large-scale production. Such economies of scale put potential entrants at a disadvantage. To be able to compete effectively in the industry, a new firm has to enter on a large scale, which can be costly and risky. The effect is to deter entry. Only rarely do new firms attempt to enter the automobile manufacturing industry, for example, because it uses highly automated production techniques on a large scale to keep costs down.

Natural monopoly: A monopoly that occurs because of a particular relation between industry demand and the firm's average total costs that makes it possible for only one firm to survive in the industry.

Legal barriers: legal franchise, license, or patent granted by government that prohibits other firms or individuals from producing particular products or entering particular occupations or industries.

The whole idea is for the government to allow just one firm or a group of individuals to do business.

First, it may be necessary to obtain a public franchise to operate in an industry.

Second, in many industries and occupations a government license is required to operate.

Public franchise: A right granted to a firm or industry allowing it to provide a good or service and excluding competitors from providing that good or service.

Government license: A right granted by state or federal government to enter certain occupations or industries.

Patent: A monopoly granted by government to an inventor for a product or process.

LECTURE 5: MONOPOLISTIC COMPETITION

1. Monopolistic Competition Definition

2. The monopolistic competitor in the short and long runs

3. Product differentiation

4. Price discrimination