Question

A student argues, “If a monopoly firm finds a way of producing a good at lower cost, it will not lower its price. Because it is a monopolist, it will keep the price and the quantity the same and just increase its profit.” Do you agree? Use a graph to illustrate your answer.

Answer 1

A monopoly is a single seller in a market and the entire supply of a product is controlled by the single seller. No close substitutes are available for the product and as such the monopoly firm does not face any competition from the rivals. Thus the firm always tries to maximize its profit by restricting output and charging a high price. The advantage of cost reduction does not pass to the hands of consumers in the form of lower price. The advantage of cost reduction will be retained by the monopoly firm itself and it will continue to charge a high price as usual by creating artificial scarcity. P MC1 P. ATC1 ATC2 P P D Q MR Q Suppose the monopoly firm initially choose to produce a quantity Q where it's marginal cost equal to marginal revenue. The firm charging a price P which is higher than the marginal cost. While producing a quantity equal to Q, the firm incurs a cost equal to P1. Thus the total area of profit is equal to P1 PR S. Suppose some cost advantage arise in the firm which shifts the ATC curve down from ATC1 to ATC2. But the firm will charge the same price P and produce the same quantity Q and enlarge its area of profit from PI P R S to P2 P R T. In short a monopoly firm does not transfer the advantage of cost reduction to the consumers in the form of low price and increased quantity.