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Long run for monopoly
1. The document explains the long-run equilibrium for a monopoly, including how changes in demand and supply impact the market structure. 2. It discusses three scenarios for a monopoly making supernormal profits: an increase in demand increases output and profits; an increase in costs decreases output and profits; and an increase in fixed costs eliminates supernormal profits. 3. For each scenario, the document uses diagrams to show how the relevant curves shift and how the monopoly should adjust its output level to maximize profits.
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Long run for monopoly
- 1. LEVEL 3 ECONOMICSAS3.1 Understand marginal analysis and the behaviour of firms Understanding Economics Chapter 10, P100 Long run equilibrium for a Monopoly Learning The long run for a Monopolist Objectives Causes of shift in D and S. KNOW Why a Monopoly can sustain supernormal profits in the long run How changes in supply and demand UNDERSTAND impact on this market structures THINKING – MANAGING SELF – PARTICIPATING AND CONTRIBUTING - RELATING TO OTHERS – USING LANGUAGE, SYMBOLS and TEXT
- 2. Many of theprinciples of what you have learnt about Perfect Competitors apply when you are looking at Monopolies. For example a Monopoly still maximises profit at the level of output where MR=MC, and the shapes of the MC and AC curves are the same. I want to highlight the differences that you need to be aware of; 1. The Monopoly can maintain supernormal profits in the long run because it is the only firm. 2. The MR curve is downward sloping and cuts the horizontal axis half way between zero and where the AR=P=D curve cuts it. We will look at Monopoly long run positions including how they impact on allocative efficiency and what happens when demand and supply conditions change.
- 3. A Monopoly PRICE COST MC REVENUE Pe Qmax AR=P=D QUANTITY MR The profit maximising level of output Qmax and the price the Monopoly will receive Pe
- 4. A Monopoly PRICE COST MC REVENUE Pe Qmax AR=P=D QUANTITY MR CORRECT METHOD Run up though CAUTION: A number of students get caught in the MC=MR right up to trap of labelling Pe where MC cuts MR – THIS IS the demand curve to illustrate the price WRONG
- 5. PRICE A Monopoly COST MC REVENUE Remember earlier in this course we learned that the MC Pe curve represented the supply curve for a firm? AR=P=D Qmax QUANTITY MR Recall that we showed 2 graphs for a perfectly competitive situation, The firm and the market. With a monopoly the firm is the market so we only need to look at a single graph.
- 6. PRICE A Monopoly COST MC REVENUE Remember earlier in this course we learned that the MC Pe curve represented the supply curve for a firm? AR=P=D Qmax QUANTITY MR Recall also that the MC curve is the supply curve above breakeven. You can hopefully see that in this market (if a Monopoly did not exist) our expected equilibrium is where SUPPLY + DEMAND (the green lines, remember Level 1 eco?)
- 7. PRICE A Monopoly COST MC REVENUE Pe Deadweight Loss AR=P=D Qmax QUANTITY MR You should then be able to identify that because there is a Monopoly that will produce at Qmax, we have deadweight loss in this market. This is the loss of efficiency caused by the existence of a Monopoly situation.
- 8. A Monopoly PRICE COST This is consumer surplus MC REVENUE maximised We call this price and quantity combination the Social Equilibrium AR=P=D QUANTITY You know it as the normal market equilibrium where the forces of demand and supply determine the market price. MR It is sometimes referred to as Marginal cost pricing because it is where MC equals P.
- 9. Now lets lookat different profit situations for a MONOPOLY
- 10. A Monopoly makingSupernormal Profit PRICE COST MC REVENUE Remember that AC must cut MC at its minimum point and AC for a supernormal Pe profit AC will be lower than AR Ce AR=P=D Qmax QUANTITY MR Pe is the price the firm receives for each unit sold (AR) and Ce is the Average Cost of making each unit. In this case AR < AC so the yellow area shows the supernormal profit. This is a sustainable long run position for a Monopoly
- 11. A Monopoly makingSupernormal Profit PRICE The area of the red COST triangle is called MC REVENUE Consumer Surplus AC AR=P=D QUANTITY MR
- 12. A Monopoly makingNormal Profit PRICE COST MC REVENUE AC Remember that AC Pe &Ce must cut MC at its minimum point and for a supernormal profit AC will be lower than AR AR=P=D Qmax QUANTITY MR Pe is the price the firm receives for each unit sold (AR) and Ce is the Average Cost of making each unit. In this case AR = AC so this is a normal profit.
- 13. A Monopoly makingSubnormal Profit PRICE COST AC MC REVENUE Ce Remember that AC must cut MC at its Pe minimum point and for a supernormal profit AC will be lower than AR AR=P=D Qmax QUANTITY MR Pe is the price the firm receives for each unit sold (AR) and Ce is the Average Cost of making each unit. In this case AC < AR so the red area shows the subnormal profit. This firm would have no interest in staying in the market so would want to leave.
- 14. Now lets lookat different scenarios for a MONOPOLY
- 15. A Monopoly makingSupernormal Profit PRICE COST MC REVENUE AC Pe Ce AR=P=D Qmax QUANTITY MR SCENARIO 1: What would happen if there was an increase in demand in this market?
- 16. A Monopoly makingSupernormal Profit PRICE COST MC REVENUE AC Pe Ce AR1=P1=D1 AR=P=D Qmax QUANTITY MR MR1 SCENARIO 1: An increase in Demand Shift the demand curve (AR=P=D) right – the MR curve must move too. Remember it cuts half way.
- 17. A Monopoly makingSupernormal Profit PRICE COST MC REVENUE AC Pe Ce AR1=P1=D1 AR=P=D Qmax QUANTITY MR MR1 SCENARIO 1: An increase in Demand DO YOU KNOW what effect the level of dmenad has on the Monopoly?? Lets take a look!
- 18. A Monopoly makingSupernormal Profit PRICE COST MC REVENUE AC Pe Ce AR1=P1=D1 AR=P=D Qmax Qmax1 QUANTITY MR MR1 SCENARIO 1: An increase in Demand Qmax is now not the profit maximising level of output, So we need to move to where MR = MC (Qmax1)
- 19. A Monopoly makingSupernormal Profit PRICE COST MC REVENUE AC Pe Ce AR1=P1=D1 AR=P=D Qmax Qmax1 QUANTITY MR MR1 SCENARIO 1: An increase in Demand This firm will enjoy an increased price, no change in costs, and increase in revenue and a much larger supernormal profit
- 20. Remember you willbe asked to explain what the Monopoly will do based on marginal analysis Like this; After demand increased in this market the Monopoly was no longer producing at the profit maximising level of output (I hope you have memorised this term by now?). The firm should increase its output as currently its MR is greater than its MC so there are additional marginal profits to be made. They should continue to increase output to the point where MC = MR which will be its new profit maximising level of output.
- 21. A Monopoly makingSupernormal Profit PRICE COST MC REVENUE AC Pe Ce AR=P=D Qmax QUANTITY MR SCENARIO 2: What would happen if variable costs increased in this market?
- 22. A Monopoly makingSupernormal Profit PRICE COST MC REVENUE AC Pe Ce AR=P=D Qmax QUANTITY MR SCENARIO 2: variable costs increased As you know variable costs affect marginal costs and will affect AC. Do you think you know what will happen? Lets take a look.
- 23. A Monopoly makingSupernormal Profit PRICE MC1 COST MC REVENUE AC Pe Ce AR=P=D Qmax QUANTITY MR SCENARIO 2: variable costs increased When variable costs increase we lift the MC curve directly upwards.
- 24. A Monopoly makingSupernormal Profit PRICE MC1 COST MC REVENUE AC1 AC Pe Ce AR=P=D Qmax QUANTITY MR SCENARIO 2: variable costs increased The AC curve will havre to move as well to reflect the change in costs. Remember it must cut the MC curve at the minimum point.
- 25. A Monopoly makingSupernormal Profit PRICE MC1 COST MC REVENUE AC1 AC Pe Ce AR=P=D Qmax QUANTITY MR SCENARIO 2: variable costs increased What should the Monopolist do now?
- 26. A Monopoly makingSupernormal Profit PRICE MC1 COST MC REVENUE AC1 Pe1 AC Pe Ce AR=P=D Qmax Qmax1 QUANTITY MR SCENARIO 2: variable costs increased Qmax is now no longer the profit maximising level of output, so identify and label the new Qmax.
- 27. A Monopoly makingSupernormal Profit PRICE MC1 COST MC REVENUE AC1 Try and ignore all the fact that the Pe1 AC diagram looks Pe Ce1 complicated. Just look for the key points and label Ce correctly. AR=P=D Qmax Qmax1 QUANTITY MR SCENARIO 2: variable costs increased Now as a result of this change in output what is the profit situation of the Monopolist? Label the new profit, it’s the green shaded area.
- 28. A Monopoly makingSupernormal Profit PRICE MC1 COST MC REVENUE AC1 Pe1 AC Pe Ce1 Ce AR=P=D Qmax Qmax1 QUANTITY MR SCENARIO 2: variable costs increased The Monopolist in this situation will find themselves making a much lower level of supernormal profit
- 29. A Monopoly makingSupernormal Profit PRICE COST MC REVENUE AC Pe Ce AR=P=D Qmax QUANTITY MR SCENARIO 3: What would happen if fixed costs increased in this market?
- 30. A Monopoly makingSupernormal Profit PRICE COST MC REVENUE AC1 AC Pe Ce AR=P=D Qmax QUANTITY MR SCENARIO 3: fixed costs increase This has no effect on MC so only the AC curve will move. Recall that it slides up the MC curve.
- 31. A Monopoly makingSupernormal Profit PRICE COST MC REVENUE AC1 AC Pe Ce AR=P=D Qmax QUANTITY MR SCENARIO 3: fixed costs increase You will identify quite quickly that Qmax does not change.
- 32. A Monopoly makingSupernormal Profit PRICE COST MC REVENUE AC1 AC Pe Ce AR=P=D Qmax QUANTITY MR SCENARIO 3: fixed costs increase You should also see in this case that AC now cuts the Demand curve or AR so AC=AR after fixed costs increase. This has eliminated the supernormal profit
- 33. A Monopoly makingSupernormal Profit PRICE COST MC REVENUE AC1 The monopolist in this case will look Ce Pe for opportunities to raise the price and return to supernormal profit. AR=P=D Qmax QUANTITY MR SCENARIO 3: fixed costs increase You should also see in this case that AC now cuts the Demand curve or AR so AC=AR after fixed costs increase. This has eliminated the supernormal profit