Monopoly Profit

Monopoly Profit

In economics, a firm is a monopoly when, because of the lack of any viable competition, it is able to become the sole producer of the industry's product. In a normal competitive situation, the price the firm gets for its product is exactly the same as the Marginal cost of producing the product. Because the monopoly firm does not have to worry about losing customers to competitors, it can set a price that is significantly higher the Marginal (Economic) cost of producing (the last unit of) the product. Therefore, a monopoly Situation usually allows the firm to set a monopoly price which is higher than the price that would be found in a more competitive industry., and to generate an economic profit over and above the normal profit that is typically found in a perfectly competitive industry. The economic profit obtained by a monopoly firm is referred to as monopoly profit. The existence of a monopoly, and therefore the existence of a monopoly price and monopoly profit, depend on the existence of barriers to entry: these stop other firms from entering into the industry and sapping away profits.

In a perfectly competitive market, firms are said to be price takers: since a customer can buy widgets from one producer as easily as another, any widget producer on the market faces a horizontal demand curve at the equilibrium price: if the firm tries to sell widgets above the equilibrium price, customers will simply buy their widgets elsewhere and the firm will lose all of their business. (In most actual markets, of course, a situation in which exactly comparable goods are available just as easily from one firm as from another does not exist ? though this situation does seem to exist in Commodity markets, the theory of perfect competition is usually a useful idealized model rather than a naturalistic description).

By contrast, lack of competition in a market creates a downward sloping demand curve for a monopolist or oligopolist: although they will lose some business by raising prices, they will not lose it all, and it may be more profitable in most situations to sell at a higher price. Though monopolists are constrained by consumer demand, they are not price takers. The monopolist can either have a target level of output that will ensure the monopoly price for the given consumer demand it faces in the industry, or it can set the monopoly price at the onset and adjust output to ensure no excess inventories occur as a result of the output level. Essentially, they can set their own price and accept a level of output determined by the market, or they can set their output quantity and accept the price determined by the market. The price and output are co-determined by consumer demand and the firm's production cost structure.

A firm with monopoly power setting prices will typically set price at the profit maximizing level. The most profitable price that they can set (what will become the monopoly price) is where the optimum output level (where marginal cost (MC) equals marginal revenue (MR), although not in the diagram below, because it is drawn incorrectly) meets the demand curve. Under normal market conditions for a monopolist, this price will be higher than the marginal cost of producing the product, thereby indicating the price paid by the consumer, which is equal to the marginal benefit for the consumer, is above the firm's marginal cost. In the chart below the shaded area represents the profits of the monopolist, except that it is incorrect because the graph does not set MR = MC for the case of monopoly. The lower half represents the normal profits that would go to a competitive firm (ignoring output losses). The upper half represent the additional economic profit going to the monopolist.