Purely unregulated monopolies, in which a single seller of a unique product can set any price it wishes in an industry, are rare. Regulated monopolies are familiar to most consumers because they encounter them in daily life: gas, water, electric and telephone companies. However, unregulated monopolies are not as common as they are likely to be curbed or banned. They produce less and charge more, resulting in overall reduction of social benefit.
Monopolies, whether regulated or unregulated, can generate profits and losses. To calculate the amount of profit for an unregulated monopolist as a theoretical exercise and basis of comparison to a regulated monopolist, observe these steps.
Find the production level where the monopolist's Marginal Revenue equals Marginal Cost
An unregulated monopolist, like any other business, wants to find the best price/output combination that will maximize its profits. To do this, it will extend production such that marginal revenue, or the extra revenue from the sale of one additional unit, equals marginal cost, or the extra cost of one additional sale.
A marginal revenue curve is a straight line that originates from the same point on the vertical axis as the (straight line) demand curve, except with double the slope.
Find the point of intersection of the marginal revenue curve and the marginal cost curve. This is the point where MR=MC. This point designates the profit-maximizing output level of the monopolist's good.
Determine the price on the market demand curve that corresponds with that profit-maximizing production level
Now that you have the intersection point of MR and MC and profit-maximizing production level as determined above, find the corresponding point on the demand curve that matches that level of output. This point will indicate the price at which the unregulated monopolist maximizes profits.
The demand curve shows the relationship between the price of the monopolist's good and the amount demanded. The corresponding point on this curve will be the price and output that the unregulated monopolist will be making a positive or above-normal profit.
The area under the demand curve -- limited by the profit-making price and the profit-making output and bounded by the average cost curve -- will be the amount of profit for the unregulated monopolist.
Because of barriers to entry in the marketplace and, therefore, the absence of competition, an unregulated monopolist's above-normal profits could continue into the future.
Account for monopoly markup on marginal cost
An unregulated monopolist, unlike a competitive firm, will charge more than marginal cost for the good or service. Depending on how elastic or inelastic demand is -- or how sensitive or insensitive demand is to price -- the unregulated monopolist will increase its markup accordingly.
To calculate the amount of profit for the unregulated monopolist, factor in the elasticity of demand. Elasticity affects the size of the markup, which in turn affects profits.
Profit would decrease in response to a relatively flatter elastic demand curve. While a steeper inelastic demand curve would result in a larger markup.
- Regulation changes the profit profile for a monopolist by forcing the monopolist to become more efficient; in doing so, however, the monopolist incurs greater costs. Subsidies and price discrimination, or the selective offering of lower prices to certain customers while charging other customers higher prices, could offset some of a monopolist's profit loss caused by regulation.
- graph bars image by Tomislav from Fotolia.com