Introductory Economics

Determination of Long-run Price

• In the long-run, the monopolist will be in equilibrium at a point where his long-run marginal cost is equal to marginal revenue (LMC = MR). In the long run because of sufficiently long period at the disposal of the monopoly firm, all costs can be varied and supply can be increased in response to increase in demand. In the short run, equilibrium price can be more than, equal to or less than the average cost but in long-run, price (AR) is generally more than the long-run average cost. If price is less than long-run average cost, the monopolist would like to close down the unit rather than suffer the loss. In the long-run, a monopolist generally earns super normal profit. It is due to the fact that unlike perfect competition no firm can enter into the market. Thus even when a monopolist earns super normal profit in the long-run, no other producer can enter the market in the hope of sharing whatever super normal profit potential exists. Therefore super normal profits are not eliminated even in the long-run.
• Lack of entry into the industry as well as lack of substitutes in the market, means that the monopolist does not have to have an optimum size plant in the long-run or have to use it at optimum capacity. The size of his plant and the degree of utilisation of any given plant size depend entirely on the market demand. Under some market conditions, optimum capacity will be reached. Under others, the monopolist may produce sub-optimally and certain conditions may lead even to over utilisation. It will all depend on the market demand. In Fig. 5 the long-run equilibrium of the monopolist is explained, when the market size does not permit the monopolist to expand to the minimum size of LAC which is the usual case.
• In this figure, point E indicates the equilibrium of the monopolist. At point E, MR = LMC and LMC curve cuts MR curve from below, hence OM is the equilibrium output and OP (= AM) is the equilibrium price. BM is the long-run average cost. Price (average revenue) AM being more than long-run average cost BM (AR > LAC) the monopolist will get super-normal profits. Accordingly the monopolist earns AM - BM = AB super normal profit per unit. His total super-normal profit will equal to APBN.