Economics (NCERT) Notes

6.4 Zero Cost Monopoly Firm

Short Run Equilibrium of the Monopoly Firm
•As in the case of perfect competition, we regard the monopoly firm as one which maximises profit.
•This behaviour determines the quantity produced by a monopoly firm and price at which it is sold.
•It is assumed that a firm does not maintain stocks of the quantity produced and that the entire quantity produced is put up for sale.
The Simple Case of Zero Cost
•Suppose there exists a village situated sufficiently far away from other villages.
•In this village, there is exactly one well from which water is available.
•All residents are completely dependent for their water requirements on this well.
•The well is owned by one person who is able to prevent others from drawing water from it except through purchase of water.
•The well owner is thus a monopolist firm which bears zero cost in producing the good.
•How to determine the amount of water sold and the price at which it is sold?
Price and Revenue of a Monopoly firm
•Let the demand function be given by the equation
     •q = 20 2p,
     •where q is the quantity sold and p is the price in rupees.
Hence, p = 10 0.5q
•Substituting different values of q from 0 to 13 gives us the prices from 10 to 3.5.  
•The total revenue (TR) received by the firm from the sale of the commodity equals the product of the price and the quantity sold.
Profit at zero cost firm
•Figure depicts the TR, AR and MR curves,
•The profit received by the firm equals the revenue received by the firm minus the cost incurred,
     •Profit = TR TC.
•Since in this case TC is zero, profit is maximum when TR is maximum.
•This occurs when output is of 10 units and when MR equals zero.
•The amount of profit is given by the length of the vertical line segment from ‘a’ to the horizontalaxis.
•The price at which this output will be sold is the price that the consumers as a whole are willing to pay.
•This is given by the market demand curve D.
•At output level of 10 units, the price is Rs 5.
•Since the market demand curve is the AR curve for the monopolist firm, Rs 5 is the average revenue received by the firm.
•The total revenue is given by the product of AR and the quantity sold, ie Rs 5 × 10 units = Rs 50.
•This is depicted by the area of the shaded rectangle.
Comparison with Perfect Competition
•Let us assume that there is an infinite number of such wells.
•Suppose a well-owner decides to charge Rs.5/bucket of water.
•No one will buy from him because any other wellowner can attract all the buyers willing to buy for Rs. 5/bucket, by offering to sell to them at a lower price, say, Rs. 4/bucket or lower price.
•Thus the competition among well-owners will drive the price down to zero.
•At this price, higher quantity (say 20 buckets of water) will be sold.
•In a perfectly competitive equilibrium results in a larger quantity being sold at a lower price.

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