Price and output determination under monopoly in Short-run:
Short-run refers to that period in which a monopolist cannot change the fixed factors. However, the monopolist is free in determining price due to lack of competition. A monopolist has control over the market supply. So, he/ she is the price maker. His/ her price and output determination is motivated by profit as well as sales maximization. Therefore, he/ she will adjust the output in such a way that the marginal cost and marginal revenue are equal.
In short run equilibrium whether the firm makes an abnormal profit, normal profit or loss, it depends on the level of AC and AR which can be shown as follows:-
- If AR=AC, the firm receives a normal profit.
- If AR> AC, the firm receives abnormal profit.
- If AR< AC, the firm bears the loss.
The following conditions must be fulfilled in order to attain equilibrium under monopoly:-
- MR must be equal to MC
- MC must intersect MR from below.
The equilibrium position of a monopoly firm can be graphically presented as follows:-
In the above figures, the three different possibilities of profit and loss situation in the short run under monopoly firm are shown. These possibilities are explained as follows:-
1. Abnormal profit:-
In the first figure, we see that the equilibrium point is ‘E’ when MC cuts MR from below. The equilibrium level of output is determined at OQ. The level of revenue earned is OP and the cost incurred is OC. Since Revenue is greater than cost, the firm earns abnormal profit equal to the shaded area (ABPC).
In the second figure, point E is the equilibrium point where MC intersects MR from below. The equilibrium level of output is OQ. The cost incurred is OC and the revenue earned is OP. Since cost is higher than revenue, the firm bears loss equal to the shaded area (ABCP).
3. Normal profit:-
In the third figure, we can see that the equilibrium point is at ‘E’ where the conditions for equilibrium are fulfilled. The equilibrium level of output is OQ. The revenue and cost are at the same level (OP). The firm earns just a normal profit to sustain its business in this case.