Wednesday, April 17, 2013

Monopoly Market Situation

In a monopoly market situation the industry comprises of only one firm. There is no close substitute for the product produced by the monopolist. The demand for the monopoly product is the same as the industry demand.  This demand has finite price elasticity. Fresh entry of producers cannot take place. There is no pronounced supply curve for the industry. However, a single firm monopoly is a rare situation. More prevalent is the monopolistic competition, where elements of both perfect competition and monopoly are present.

A monopolistic market situation is characterized by the following features:

1. The product produced by the monopolist has no close substitutes.

2. There is only one seller in the industry. Hence there is no distinction between the monopolistic firm and the industry.

3. In a monopoly market the producing firm is the price-maker. This means the firm can sell more at a lower price, or sell less at a higher price.

4. The monopolist may also be guided by the motive of profit maximization.

In a monopoly market the profit maximizing condition is fulfilled in terms of marginal revenue (MR) and marginal cost (MC). If MR > MC, production will increase. If MR < MC, production will decrease. Thus the equilibrium condition for the monopoly firm is reached where MR = MC. Also the slope of the MR curve must be less than that of the MC curve.

In the adjoining diagram we measure quantity along the horizontal (X) axis, and price, revenue and costs along the vertical (Y) axis. Average revenue curve is the demand curve for the firm's product. At point E, MC = MR. The shaded area IFGH measures the profit. Equilibrium price is OH and equilibrium quantity is OQ. The MC curve passes through the minimum point of the AC curve. At E, where MC intersects MR, equilibrium position of maximum profit is found. Any shift from E will result into loss of profit. Under monopoly or imperfect conditions, the firm will have to reduce the price in order to sell more. That is why marginal revenue is less than average revenue (MR < AR) and the MR curve lies below the AR curve. The gap between these two curves measures the degree of monopoly or imperfect competition.

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