Determination of Price and Equilibrium Under Monopoly

Monopoly is a market situation in which there is a single seller of a product that has no close substitutes and strong barriers to entry for new firms.​
A monopolist is guided by the profit motive and chooses that price and output combination which gives maximum profit (maximum difference between total revenue and total cost).​

A monopolist can influence either the price or the quantity supplied at a time, but not both independently.
Once the monopolist chooses an output level, the corresponding price is determined by the market demand (AR) curve.​

To increase sales, a monopolist must reduce the price; hence, total revenue initially rises, then can fall when price reductions start reducing revenue more than the gain from extra units sold.

Like a firm under perfect competition, a monopolist seeks to maximise profit. However, the monopolist faces the entire market demand curve and has control over price.​
A monopolist will continue to expand output as long as marginal revenue is greater than marginal cost. Profit is maximised at the output where:

• Marginal Revenue equals Marginal Cost (MR=MC), and
• The MC curve cuts the MR curve from below (MC rising at the point of intersection).​

At this equilibrium output, the monopolist charges the price indicated by the demand (AR) curve above that quantity.​

In the short run, the monopolist may earn supernormal profits, normal profits, or even incur losses but will still produce as long as price covers average variable cost.​
In the long run, if conditions remain favourable, a monopolist can continue earning supernormal profits due to barriers to entry.​

Under monopoly, equilibrium price and output can be determined using two equivalent approaches.

(A) Total Revenue – Total Cost (TR–TC) approach
(B) Marginal Revenue – Marginal Cost (MR–MC) approach

Consider a railway company that alone provides passenger service on a particular route:

• There are no close substitutes for travellers on that route.
• The railway company observes how many passengers travel at different fare levels (this is the demand curve).
• It chooses the number of seats (output) where MR = MC and then charges the fare indicated by demand at that output.​

This leads to a higher price and lower output compared to a perfectly competitive situation, where many transport providers compete and price tends to equal marginal cost.

• A monopolist is a single seller with no close substitutes and strong entry barriers.​
• Under monopoly, AR is downward sloping and MR lies below AR; MR is less than AR.​
• The monopolist is in equilibrium where MR = MC and MC cuts MR from below.​
• Equilibrium can be found by the TR–TC approach (maximum profit where TR − TC is highest) or the MR–MC approach (intersection of MR and MC).​
• In the short run, a monopolist may earn supernormal or normal profit or even incur losses but will produce as long as price covers average variable cost.