Monopoly - Product Pricing, Business Economics & Finance Video Lecture | Business Economics & Finance - B Com

in today's video lesson we're going to
introduce a new market structure we'll
be talking about perfect monopolies or
pure monopolies a purely monopolistic
market structure exists when there is a
single seller in other words the market
for a good is dominated by one firm
finally the demand for the good in the
entire market is the demand for the
individual firm's output these
characteristics of pure monopoly will be
very important when we begin our
analysis of this market structure today
so before we can illustrate the amount
of output that a monopolist will wish to
produce and show the area of economic
profits a monopolist might enjoy we
first must derive a demand curve for a
monopolists products so in our graph on
the Left we're going to be examining the
market for airplanes now we're making
some assumptions here we're assuming
that the airplane market is a pure
monopoly in reality of course there are
several companies that manufacture
airplanes but we are hypothetically
referring to a purely monopolistic
monopoly market here in which there is
only one firm supplying airplanes to the
entire industry and they are considering
producing up to six airplanes and
charging prices ranging from zero
dollars to sixty million dollars as we
can see on a vertical axis here so let's
move over to our demand schedule on the
right a demand schedule shows the
relationship between the price of a good
and the quantity demanded by consumers
for that good we've got a range of
quantities here ranging from six to one
airplane let's now think about the
relationship that will exist between the
quantity demanded and the price of
airplanes that the monopolist attempts
to charge so earlier in the course we
learned the law of demand which stated
that there is an inverse relationship
between the price of a good and the
quants
demanded a monopolist can expect to sell
more airplanes at lower prices while at
higher prices sell fewer airplanes so
we're going to assume that there is an
inverse relationship between the price
of airplanes in the market dominated by
one monopolistic firm and the quantity
demanded so at higher prices let's say
at sixty million dollars the monopolist
should only expect to sell one airplane
however by lowering its price to 50
million dollars the quantity demanded
among airlines the buyers of airplanes
will increase to two and as the price of
airplanes continues to fall the quantity
demanded will continue to rise at ten
million dollars this monopolist could
expect to sell six airplanes now this is
all very hypothetical but it's not
unrealistic to assume that is the price
of airplanes Falls more airplanes will
be demanded by the consumers of
airplanes so we can plot the monopolists
demand curve by plotting the points from
the demand schedule in the graph on the
left so it's 60 million dollars this
firm and the industry as a whole can
expect to sell only one airplane but as
the price of airplanes Falls to 50 the
quantity demanded will increase to two
airplanes and so on we clearly have a
linear relationship here between the
price and the quantity demanded for
airplanes at ten million dollars six
airplanes will be demanded if we connect
the dots what we'll have is the
monopolists demand curve and in fact the
industry demand curve for airplanes
since the monopolist is the only
producer of airplanes we're going to
label this curve demand for airplanes
now the first thing we should notice in
a monopolistic market compared to a
perfectly competitive market which we
have already studied that demand for an
individual firms output is downward
sloping that's an important
characteristic of a monopolistic market
the individual firms demand is downward
sloping this means that the firm has
some price making power by which I mean
if the firm wish to raise its price all
it would have to do is reduce its output
and it could charge a higher price for
its product however if the firm wish to
lower its price it could do so by
increasing its output since in order to
sell the additional output it would have
to lower its price so we can say that
purely monopolistic firms are price
makers in contrast to perfect
competition in which individual firms
face a horizontal or perfectly elastic
demand curve meaning that pure
competitors are price takers they cannot
control the price of their own output
since they must accept the price
determined in the market but since a
monopolist is the market in other words
there are no competitors the monopolist
determines the price that it sells its
output for as the price changes the
quantity demanded will change based on
the market demand for its product so the
next question we want to ask is how will
a monopolist
know what the profit maximizing quantity
to produce that is before we can
determine where the monopolist should
produce we should review the profit
maximization rule learned earlier in the
course in order to maximize profits a
firm should produce where its marginal
cost equals the marginal revenue for its
product the profit maximization rule
says produce where M R equals MC now
looking at our graph we can see that
there is no marginal revenue curve nor
is there a marginal cost curve in our
previous market structure perfect
competition we saw the demand
correspondent with the marginal revenue
of individual firms since the firm can
sell as much output Addison wished at
the given equilibrium price therefore
the equilibrium price was the marginal
revenue however in pure monopoly demand
is not equal to marginal revenue because
of the very nature of this market
structure marginal revenue will always
be less than the price the firm can sell
its product for to illustrate why let's
look back at our table here on the right
we can find the total revenue at any
level of output by multiplying the price
times the quantity at
that level of output and once we know
total revenue we can find the marginal
revenue which is simply the change in
total revenue over the change in
quantity so let's start by finding total
revenue at each of the levels of output
ranging from one airplane to six
airplanes total revenue is just price
times quantity so the total revenue of
the first airplane at sixty million
dollars is sixty million dollars it's
the price that the firm's sold the
airplane for at the second airplane the
total revenue increases to one hundred
million dollars fifty million dollars
times the two airplanes sold I'll go
ahead and fill in the rest of this
column now notice that as the firm
increased its output from one to six
airplanes total revenue increased at
first from sixty million dollars to one
hundred and twenty million dollars but
beyond the fourth airplane total revenue
began to decrease back down to sixty
million dollars this firm would clearly
not wish to produce six airplanes since
its total revenue of producing six
airplanes would be less than if it
produced only three or four or even five
airplanes now marginal revenue is what
we're really interested in here because
knowing the marginal revenue will allow
us to determine the profit maximizing
quantity that the firm will wish to
produce that marginal revenue is just
the change in total revenue divided by
the change in quantity in this case the
change in quantity is always one
airplane so marginal revenue will just
be the change in the total revenue as we
went from zero to one airplanes the
marginal revenue equal the price of the
first airplane sixty million dollars but
then marginal revenue began to decrease
more rapidly than the price decreases
the marginal revenue of the third plane
is only twenty million dollars and for
the fourth plane there is no change in
total revenue so marginal revenue is
zero then marginal revenue becomes
negative and ultimately marginal revenue
will be negative forty million dollars
for the last airplane by increasing its
output from five to six airplanes this
monopolistic sellers total revenue fell
by forty million dollars not a good idea
to increase output to six airplanes if
we pluck the points from this marginal
revenue table we will have the marginal
revenue
curve the first unit of output marginal
revenue equals the price but as output
increases marginal revenue Falls more
rapidly than price at the fourth unit of
output the marginal revenue is equal to
0 and then marginal revenue becomes
negative beyond that if we connect these
points from our marginal revenue table
we will have our marginal revenue curve
which as you can see lies below the
demand curve there is our marginal
revenue curve for this airplane
manufacturer now we have half of what we
need in order to determine the profit
maximizing quantity all we must do now
is add some cost curves to this graph
now a firm in pure monopoly will face
the same sorts of costs that a firm in
perfect competition will marginal cost
average total cost and average variable
cost for our sake we're only going to
bother drawing the marginal cost and the
average total cost curve here because
that's all we need to determine whether
or not a monopolist will be earning
economic profits or losses or breaking
even notice the relationship between the
marginal and average total cost curve
just like in perfect competition
marginal costs will intersect ATC at its
lowest point now that we have our
marginal cost and our marginal revenue
curve we can determine the profit
maximizing level of output for the
monopolist
in our graph we see that marginal cost
and marginal revenue intersect just
around 3 airplanes if we draw a dotted
line up we can see that at a output of 3
the price that the firm can sell for is
around 40 million dollars so the
equilibrium price in this market will be
around 40 million dollars and the firm's
average total cost lies below the price
at around 30 million dollars our
monopolist in this airplane industry
will want to produce 3 airplanes and
sell them at a price of 40 million
dollars each at this quantity and price
combination our monopolist is earning
economic profits equal to the yellow
rectangle in our study of perfect
competition we recognized that anytime
economic profits exist firms will enter
the market the price of the good will
fall and those economic profits will be
eliminated
the long run as the firms are forced to
produce at their minimum average total
cost in order to remain competitive in
the market will this happen in our
monopolistic market we need to go back
to our characteristics of pure
monopolies in order to determine whether
or not this firms profits will be
eliminated due to the entrance of new
firms in fact one of the most important
characteristics of pure monopolies is
that there are high barriers to entry
this means that economic profits can be
earned in the long run it is very
difficult for new firms to enter this
market due to the barriers to entry in
our airplane market one of the more
significant barriers to entry is
probably economies of scale and airplane
manufacturer in the real world such as
Boeing or Airbus has achieved many
economies of scale that new potential
competitors will not be able to achieve
at a low cost
therefore the profits earned by real
airplane manufacturers or other firms in
monopolistic or nearly monopolistic
markets are likely to persist in the
long run as long as demand for their
product remains stable or high if demand
for airplanes Falls then yes these
profits might be reduced or even
eliminated however assuming demand for
airplanes remains constant monopolist
can expect to earn economic profits in
the long run so these profits that we
have drawn here will persist in the long
run as long as the firm's costs do not
increase or the demand for the firm's
product does not decrease but one thing
we should notice about pure monopolies
is that the quantity produced by a
monopolistic firm and therefore in a
monopolistic market is less than that
which would be produced under perfect
competition under perfect competition
the price of the good will always equal
the marginal cost in the long run
therefore a greater quantity will be
produced we're going to explore it later
the reason that purely monopolistic
firms are inefficient their price making
power and the fact that the marginal
revenue lies below the demand and the
price of the good indicates that in the
long
when monopolistic firms will produce
less output than would be produced in a
similar competitive market in addition
the firms are more likely to earn
economic profits due to the high
barriers to entry such as economies of
scale enjoyed by firms in these markets
so this lesson was meant to introduce
the concept of demand and marginal
revenue for a purely monopolistic firm
what we need to see is that the marginal
revenue lies below the demand curve yet
the demand curve is downward-sloping due
to the fact that the monopolistic firm
is the only seller in this market
therefore the demand as seen by the firm
is the market demand which according to
the law of demand should always show an
inverse relationship between the price
of the product and the quantity that
consumers are willing and able to pay