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The Equilibrium Of The Monopolist Economics Essay

Law of demand is one of the best known and the most important laws of economic theory. It explains the general tendency of the consumer to buy more of a good at a lower price and less of it at a higher price. Lower price attracts consumer to buy more. Besides, some consumers who were not buying the good at a higher price can also afford to buy it at a lower price. Consequently, with the fall in the price of the good, demand for it generally increases. Thus, the law of demand expresses the inverse relationship between the price and the quantity demanded of a commodity, other things being equal. In other words, when the price of a good rises, demand falls and when the price falls, demand rises, provided factors other than the price remain unchanged. The law is based on the assumption that the other determinants of demand, viz. income of the consumer, tastes and preferences of the consumer, prices of the related goods, future expectations, size and composition of population, distribution of income, etc. do not change during the operation of the law. If they do change the law may fail to operate. For example, if with the fall in the price of the good, consumer develops disliking for it or his income declines, he may not buy more of it.

Law of demand states the inverse relationship between price of a commodity and its quantity demanded, other things remaining the same. That is why, the demand curve slopes downward. But, a question arises as to why more quantity is demanded at a lower price and less quantity is demanded at a higher price.

Income effect:

A fall in the price of a commodity increases the purchasing power (or the real income) of the consumer. In other words, the consumer has to spend less to buy the same quantity of the commodity as before. The money so saved because of a fall in the price of the commodity can be spent by the consumer in any way he likes. He will spend a part of this money on buying some more units of the same commodity, whose price has fallen. Thus, a fall in the price of this commodity increases its demand. This is called income effect. Same explanation

can be given for a rise in price. In this case, demand for the commodity under consideration will increase due to fall in purchasing power of the consumer.

The law of demand can be illustrated through a demand curve which is shown in the following figure: -

http://futures.tradingcharts.com/learning/graphics/figure1.gif

Exceptions to Law of Demand

Law of demand expressing the inverse relationship between price and quantity demanded of a commodity is generally valid in most of the situations. But, there are some situations under which there may be direct relationship between price and quantity demanded of a commodity. These are known as exceptions to the law of demand. One of the exceptions is associated with the name of Robert giffen (1837-1910).

Giffen Goods

A giffen good is an inferior good with the unique characteristic that an increase in price actually increases the quantity of the good that is demanded.  This provides the unusual result of an upward sloping demand curve.

This happens because of the interactions of the income and substitution effects.  Depending on whether the good is inferior or normal, the income effect can be positive or negative as the price of a good increase. 

Example:

Imagine an inferior good being Top Ramen (an inexpensive noodle dish, common among students).  As your income rises, you actually consume less Top Ramen, because you may begin to buy more spaghetti, or steak, or something you enjoy more than Top Ramen.  But if you lose your job, and your income goes down, you will consume more Top Ramen, because it is inexpensive.

The curve for demand for giffen goods is shown below; it’s an upward slopping curve:

http://1.bp.blogspot.com/-TcQrrwWRtBs/TyGlhfjiJmI/AAAAAAAAAaQ/RIzXV2GgOSI/s320/giffen+good.png

The law of demand does not hold in times of emergency like flood, drought, famine or war, as households do not behave in normal way in such periods. Fear of shortage of goods in future in such periods increases their present demand, although the prices are rising.

There are some other exceptions to the law of demand, which are only apparent and not real. One of these is related to the people expectations about future prices.

Another apparent exception to the law of demand is found when a commodity is sold under different brand names at different prices. This is so because those who buy higher price brand think that the two brands are different.

Inferior Goods.

A type of good for which demand declines with the level of income or real GDP in the economy increases. This occurs when there are more costly substitutes of the good that see an increase in demand as the society's economy improves. An inferior good is the opposite of a normal good, which experiences an increase in demand along with increases in the income level.

Examples:

Cheaper cars are examples of the inferior goods. Consumers will generally prefer cheaper cars when their income is constricted. But as a consumer's income increases the demand of the cheap cars will decrease, but on the other hand demand of costly cars will increase, so cheap cars are inferior goods.

Inexpensive foods like bologna, hamburger, mass-market beer, frozen dinners, and canned goods are additional examples of inferior goods. As incomes rise, one tends to purchase more expensive, appealing and nutritious foods.

Inter-city bus service is also an example of an inferior good. This form of transportation is cheaper than air or rail travel, but is more time-consuming. When money is constricted, traveling by bus becomes more acceptable, but when money is more abundant than time, more rapid transport is preferred.

Explanation of the statement

So we have seen in the above examples that inferior good is that good whose income effect is negative while giffen good is that inferior good whose income effect is negative but price effect is positive.

In case of inferior goods, when the income increases, the demand decreases i.e there is inverse relationship between income and demand, but there is not necessarily a positive relationship between price and demand.

In case of Giffen goods, there is an inverse relationship between income and demand and positive relationship between price and demand.

Thus, all Giffen goods are inferior goods (because of inverse relationship between income and demand) but all inferior goods are not giffen goods (because they may not show inverse relationship between price and demand).

Ans: 2 CONCEPT OF MONOPOLY

Pure monopoly or simply monopoly (form two Greek words mono, which means single, and polein which means seller) is a market situation in which there is a single seller of a good with no close substitutes. Good examples are public utilities such as railways, electric, water and telephone undertakings.

Since the monopolist is the only seller in the market, the demand curve facing him is the market demand curve itself. Being the sole supplier of a good without close substitutes, the monopolist has substantial control over the price he charges. He may lower the price and increase the quantity sold, or he may limit his output to raise the price. Thus, a monopolist is a price maker or price searcher who is in search of the price-quantity combination that will maximise his profit. However, even a monopolist cannot set both his price and quantity; given a demand function, selecting a price necessarily implies choosing the corresponding quantity.

EQUILIBRIUM OF THE MONOPOLIST

In the case of pure monopoly, the firm and the industry coincide by definition. The output of the monopolist firm should, therefore, be compared with that of the industry under perfect competition. The following fig. compares the demand supply analysis of the competitive industry with the marginal apparatus of the theory of the firm.

http://www.transtutors.com/Uploadfile/CMS_Images/17244_Derivation%20of%20Monopoly.JPG

In fig., DDı and SSı represent the demand and supply curves of the competitive industry. The two curves intersect each other at point ‘E’. Hence, the equilibrium price and quantity under perfect competition are determined as EQc and OQc respectively. Suppose, now, a monopolist takes over the competitive industry or all the firms constituting the industry combine together to form a monopoly. The demand curve now becomes the monopolist’s average revenue curve. Further, the long run supply curve under competitive industry tends to approximate the average cost curve, since the long run equilibrium condition also requires that price equals long run average cost.

The monopolist is in equilibrium at point ‘E’, where his marginal cost curve cuts marginal revenue curve from below. The monopolist’s profit optimum output OQᴍ is clearly smaller than the competitive output OQᴄ. This will happen, as long as the slope of the supply curve of competitive industry is positive or is less steep than the demand curve (when the supply curve has negative slope). Further, monopoly price PQᴍ exceeds competitive price EQc.

In the above fig. the total monopoly profits are shown in the shaded area SDEı. That is equal to difference between the area ODEıQM under (below) the MRC (including total revenue) and the area OSEıQM under the marginal cost curve (showing total cost) for OQᴍ level of output corresponding to the equilibrium point Eı of the monopolist. In equilibrium, total profit, i.e., the difference between total revenue and total cost is maximised.

IN THE GIVEN SITUATION, A MONOPOLIST POSSESSES A MINERAL SPRING FOR WHICH IT HAS TO PAY NOTHING. THE PRODUCTION COST OF WATER WILL BE ZERO. WE SHALL EXPLAIN WITH THE HELP OF FOLLOWING THEORY AND A DIAGRAM, AS TO HOW THIS MONOPOLIST DETERMINES PRICE AND MAXIMISE PROFITS IN SUCH A SITUATION.

MONOPOLIST EQUILIBRIUM

WITH ZERO MARGINAL COST

Under certain exceptional cases, the cost of additional units of output, i.e., marginal cost (MC) may be equal to zero. With constant value 'zero' of marginal cost, the value of average cost is also constant and is equal to zero. With zero cost of production, the monopolist has only to decide at which output, the total revenue will be maximum. And total revenue is maximum at the output level at which marginal revenue is equal to zero. Further, with zero marginal cost, the condition of profit maximization, i.e., the equality of marginal cost (MC) and marginal revenue (MR) can be achieved, where the latter is also equal to zero. 

Fig shows the equilibrium of the monopolist, where marginal cost is equal to zero. 'E' is the point of monopolist equilibrium, where MC cuts MR from below. The equilibrium price and the equilibrium quantity at this equilibrium are OP and OQ respectively. Here, total revenue and hence total profits (area OPBE in fig.) of the monopolist are maximum. Beyond OQ level of output, MR becomes negative and total revenue starts declining. Therefore, with zero cost of production, monopolist equilibrium will be established at a level, where elasticity of demand is unitary.

Zero Cost of Production.JPG

Fig. : Monopolist Equilibrium with Zero Cost of Production

It is important to note that the monopolist will never produce the output at any level, where MR is negative. If he does so, his total revenue will fall as output increases. He can increase total revenue by reducing the output. In other words, the monopolist can earn larger profits by restricting the output. Further, since MC cannot be negative, equality of MC and MR (equilibrium condition) cannot be achieved, where MR is negative.

We know from the relationship among average revenue (AR), marginal revenue (MR) and elasticity of demand7 that when marginal revenue is negative, elasticity of demand is less than one. Therefore, no rational monopolist will produce on that portion of the demand curve, where MR is negative, i.e., the elasticity of demand is less than one? That is why; no monopolist ever operates on the inelastic portion of the average revenue curve or the demand curve.

With the positive marginal costs (which is most usually the case), the monopolist fixes his level of output for which MR is also positive, i.e., total revenue rises with increase in the level of output. In other words, the equilibrium will always lie, where elasticity of demand is greater than one.

In fig., if the price is fixed at point 'B' (middle point of the demand curve), where the elasticity of demand is equal to one, the MC (whether straight line or U-shaped) curve will pass through the MR curve at zero point. Here, both the MC and the MR are zero. It is a rare possibility. Further, below the middle point 'B' of the demand curve, elasticity of demand is less than one. If the price is fixed in this inelastic portion of the demand curve, both the MC and the MR assume negative values, as the point of intersection between them is below point 'E' on the MR curve in  fig. . However, MC can never be negative. Given positive costs, MC curve must cut the MR curve from below at a point, where both the MC and the MR are positive. The equilibrium in this case will be established at a point above 'E' on the MR curve in the figure and the price will be fixed in the elastic portion of the demand curve, i.e., above the middle point of the AR curve in  fig.

ADVANCED ECONOMIES

It is a term used by the IMF to describe developed economies. While there is not any established numerical convention for determining whether an economy is developed or not, advanced economies have a high level of gross domestic product, per capita income, as well as a very significant degree of industrialization.sydney-harbour-bridge-at-night-300x200.jpg

A view of the Sydney’s advanced infrastructure

It implies a high level of development compared to the underdeveloped economies. An advanced economy is potentially self-dependent in many sectors of the economy. The typical indicators of development are per capita income, literacy rate, life expectancy etc. All these factors are increasing with consistent growth or have achieved a remarkable level.

Some of the advanced economies of the world are USA, Australia, Canada, Japan and western European countries. These countries have achieved a reputed level of growth and development and have the major parts in the world GDP. We can see above, a night view of the major city of Australia- Sydney. It has one of the most developed infrastructures among the cities of the world. Like this, many of the countries over the world have the best infrastructures, life expectancy etc.

But these all advanced economies do not remain same forever. From time to time, there are always some changes in the economies of the developed countries. For example, we take the GDP of USA; it was at a time negative in between the years 2008-2010 recessions. However, it showed a tremendous growth in the past two years and was at 1.3% in the second quarter of 2012. The United States’ economic freedom scores of 76.3 drops it to 10th place in the 2012 Index. Its score is 1.5 points lower than last year, reflecting deteriorating scores for government spending, freedom from corruption, and investment freedom. The U.S. is ranked second out of three countries in the North American continent, and its overall score remains well above the world and regional averages. The U.S. economy faces enormous challenges.

Like this we can see many other major changes in the economies of the developed countries. For example, most of the European countries are facing mass economic crisis but England has successfully managed itself to organize the 2012 Olympics. It is facing huge unemployment among the citizens. On the other hand, its high level of education is attracting foreign students and making a major part in its national income.

For all that means is, advanced economies have been changed during recent years due to recessions and change in technology. But, the advanced economies are able to fight back with their other economic sectors and maintain their economic strength.

DEVELOPING ECONOMIES6f5d3f864064853daa9691c19b5f_16745_0.jpeg

Developing economy is an economy with a low living standard, undeveloped industrial base, and low Human Development Index (HDI) relative to other countries.

A village of Kenya

In our world of disparity, every country has its own wealth standard. But, even after this, some countries are still struggling to fill their people’s stomach. These countries cannot provide clothes to their people and struggling with the economic inequalities. Some of the developing economies are Africa, Latin America, and Asian economies such as Bangladesh, Nicaragua and Zaire.

These countries are still referred to as poor countries having low level of GDP and per capita income. According to WDR (2007), the economies with per capita income lower than $875 are underdeveloped economy. Not only the income is the factor for low level of development, many other factors are also considered for determining the level of development like life expectancy, low level of living, slow growth rate etc.

indexmundi_ex67.jpg

Even after all these challenges, some of the countries have shown surprising growth and potential to develop. Let us take the example of Kenya. It’s GDP per capita (PPP) was fallen once under $1000 in 2001, but it showed a good growth in next 10 years and climbed up to $1800.

Some more countries are also facing economic changes in recent years. Take an example of another African country Ghana. Ghana is currently world’s largest Gold producing country. But, even after this, 27% of Ghana's population is living on less than $1.25 per day. Though, it has difficulties, shortage of electricity and gas, Ghana has shown significant growth over two decades. It has received dramatic increase in education, urbanization, health improvements etc. It has also showed changes in its people’s primary occupation. The people are less dependent in farming, and more in profession and trading.

EMERGING MARKET ECONOMIES

These are the former developing economies that have achieved substantial industrialization, modernization, improved living standards, and remarkable economic growth. marine-drive.jpg

A view of the emerging infrastructure of Mumbai

The emerging market economies are those nations which showed rapid growth and industrialization. This term is not officially noted by the traditional economists. But, the modern economists and organizations approved them and their own separate lists of these countries. India and China currently emerges as two largest emerging countries on the basis of their GDP per capita PPP. The International Monetary Fund, on 16th July, 2012 gave its list of emerging economies which include 24 countries including India, China, Pakistan and Russia.

During the recent years, the economies of the developing countries are also changed in many ways. For example, in 1950-1960, around 80% of Indian population was dependent on agriculture. But now, only 52% contributes in agriculture and has shown growth in the service sector with 34%. Additionally, in China, the manufacturing sector has shown an extraordinary growth with 70% of the labor force in this sector.

With all these changes, the Emerging Economies have made their strong appearance in the world economy.

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