Question

Suppose you are a consultant for a monopoly firm that asks for an assessment of its pricing policies in the short run. What would you recommend in terms of price changes (raise, cut, or stay put) in each of the following situations (a through d): a. MR = $2100; MC = $250; and AVC = $290 b. P = $275; MR = $260; MC = $250; and AVC = $260 c. MR = $2100; MC = $2150; and AVC = $290 d. MR = $2100; MC = $2100; and AVC = $290 [Note: P = price; MR = marginal revenue; AVC = average variable cost; MC = marginal cost]

Answer 1

The Monopoly firm attains market equilibrium in short-run when :

i. Marginal Reveneue= Short Run Marginal Cost

ii. Increasing Short Run Marginal Cost Curve cuts Marginal Revenue Curve.

The monopoly firm always prefers to produce at the point where MR=MC, because below this point its profit does not get maximized, and above this point ( equilibrium) leads to short-run losses.

Now, We have

1. MR ( $2100) > MC ( $250)

Here the revenue on the production of an additional unit of output is more than the cost incurred on the production of that unit. Hence the firm will decide to sell more output to exploit all the profit available in the market. A monopolist can only sell more by lowering its price. Therefore, the firm would be recommended to lower its prices to exploit the extra profits available in the market.

2. MR ( $260) > MC ( $ 250)

Here the firm is earning abnormal profits. Where marginal revenue and price is above the cost incurred in the production of an additional quantity of the commodity. Here the monopoly firm would likely produce more to exploit each extra profit available in the market. Hence, it will consider lowering its prices to earn more profit. and eventually, it will reach a point of profit maximization ( MR=MC).

3. MR( $2100 ) <MC ( $2150 )

Here, Revenue on each additional unit of output produced is less than the cost of that each additional unit of output produced by the firm. This refers that firm is incurring loses. The firm would like to do away with this cost. Hence, It would be suggested to the firm to raise prices in the short-run and eventually reduce output. This will help the firm to realize its equilibrium level of output.

4. MR ( $2100 ) = MC ( $2100 )

As already mentioned above in the definition of the market equilibrium in monopoly, Marginal revenue should be equal to Marginal cost. And also average variable cost is also covered by the firm. Hence, It will be suggested to the firm to remain at the same price level.