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Monopoly profit
Monopoly profit is an inflated level of profit due to the monopolistic practices of an enterprise.
Traditional economics state that in a competitive market, no firm can command elevated premiums for the price of goods and services as a result of sufficient competition. In contrast, insufficient competition can provide a producer with disproportionate pricing power. Withholding production to drive prices higher produces additional profit, which is called monopoly profits.
According to classical and neoclassical economic thought, firms in a perfectly competitive market are price takers because no firm can charge a price that is different from the equilibrium price set within the entire industry's perfectly competitive market. Since a competitive market has many competing firms, a customer can buy widgets from any of the competing firms. Because of this tight competition, competing firms in a market each have their own horizontal demand curve that is fixed at a single price established by market equilibrium for the entire industry as a whole. Each firm in a competitive market has buyers for its product as long as the firm charges "no more than" the single price. Since firms cannot control the activities of other firms that produce the same widget sold within the market, a firm that charges a price that is higher than the industry's market equilibrium price would lose business; customers would respond by buying their widgets from other competing firms that charge the lower market equilibrium price, which makes deviation from the market equilibrium price impossible.
Perfect competition is commonly characterized by an idealized situation in which all firms within the industry produce exact comparable goods that are perfect substitutes. With the exception of commodity markets, this idealized situation does not typically exist in many actual markets, but in many cases, there exist similar products that are easily interchangeable because they are close substitutes (for example, butter and margarine). A significant rise in a product's price tends to cause customers to switch from this good to a lower priced close substitute. In some cases, firms that produce differing but similar goods have similar production processes, which makes it relatively easy for one-good firms to switch their manufacturing processes to produce a different but similar good. This would be the case when the cost of changing the firm's manufacturing process to produce the similar good can be somewhat immaterial in relationship to the firm's overall profit and cost. Since consumers tend to replace goods whose prices are high with cheaper close substitutes, and the existence of close substitutes whose manufacturing processes are similar allows a firm producing a low-priced good to easily switch over to producing the other higher priced good, the competition model accurately explains why the existence of different similar goods form competitive forces that deny any single firm the ability to establish a monopoly in their product. This effect is observable in a high profit and production cost industry, such as the car industry, and other industries facing competition from imports.
By contrast, the lack of competition in a market ensures the firm (monopoly) has a downward sloping demand curve. Although raising prices causes the monopoly to lose some business, some sales can be made at higher prices. Although monopolists are constrained by consumer demand, they are not "price takers" because they can influence price through their production decisions. The monopolist can either have a target level of output that will ensure the monopoly price as the given consumer demand in the industry's market reacts to the fixed and limited market supply, or it can set a fixed monopoly price at the onset and adjust output until it can ensure no excess inventories occur at the final output level chosen. At each price, the firm must accept the level of output as determined by the market's consumer demand, and every output quantity is identified with a price that is determined by the market's consumer demand. The price and output are co-determined by consumer demand and the firm's production cost structure.
A firm with monopoly power sets a monopoly price that maximizes the monopoly profit. The most profitable price for the monopoly occurs when output level ensures the marginal cost (MC) equals the marginal revenue (MR) associated with the demand curve. Under normal market conditions for a monopolist, this monopoly price is higher than the marginal (economic) cost of producing the product, indicating that the price paid by the consumer, which is equal to their marginal benefit, is above the firm's MC.
Without barriers to entry and collusion in a market, the existence of a monopoly and monopoly profit cannot persist in the long run. Normally, when economic profit exists within an industry, economic agents form new firms in the industry to obtain at least a portion of the existing economic profit. As new firms enter the industry, they increase the supply of the product available in the market, and they are forced to charge a lower price to entice consumers to buy the additional supply they are supplying as competition. Since consumers flock toward the lowest price (in search of a bargain), older firms within the industry may lose their existing customers to the new firms entering the industry, and are forced to lower their prices to match the prices set by the new firms. New firms continue to enter the industry until the price of the product is lowered to the point that it is the same as the average economic cost of producing the product, and economic profit disappears. When this happens, economic agents outside of the industry find no advantage to entering the industry, supply of the product stops increasing, and the price charged for the product stabilizes.
Normally, a firm that introduces a brand new product can initially secure a monopoly for a short while. At this stage, the initial price the consumer must pay for the product is high, and the demand for, as well as the availability of the product in the market, will be limited. As time passes, when the profitability of the product is well established, the number of firms that produce this product will increase until the available product supply becomes relatively large, and the product's price shrinks down to the level of the average economic cost of producing the product. When this occurs, all monopoly associated with producing and selling the product disappears, and the initial monopoly turns into a (perfectly) competitive industry.
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Monopoly profit
Monopoly profit is an inflated level of profit due to the monopolistic practices of an enterprise.
Traditional economics state that in a competitive market, no firm can command elevated premiums for the price of goods and services as a result of sufficient competition. In contrast, insufficient competition can provide a producer with disproportionate pricing power. Withholding production to drive prices higher produces additional profit, which is called monopoly profits.
According to classical and neoclassical economic thought, firms in a perfectly competitive market are price takers because no firm can charge a price that is different from the equilibrium price set within the entire industry's perfectly competitive market. Since a competitive market has many competing firms, a customer can buy widgets from any of the competing firms. Because of this tight competition, competing firms in a market each have their own horizontal demand curve that is fixed at a single price established by market equilibrium for the entire industry as a whole. Each firm in a competitive market has buyers for its product as long as the firm charges "no more than" the single price. Since firms cannot control the activities of other firms that produce the same widget sold within the market, a firm that charges a price that is higher than the industry's market equilibrium price would lose business; customers would respond by buying their widgets from other competing firms that charge the lower market equilibrium price, which makes deviation from the market equilibrium price impossible.
Perfect competition is commonly characterized by an idealized situation in which all firms within the industry produce exact comparable goods that are perfect substitutes. With the exception of commodity markets, this idealized situation does not typically exist in many actual markets, but in many cases, there exist similar products that are easily interchangeable because they are close substitutes (for example, butter and margarine). A significant rise in a product's price tends to cause customers to switch from this good to a lower priced close substitute. In some cases, firms that produce differing but similar goods have similar production processes, which makes it relatively easy for one-good firms to switch their manufacturing processes to produce a different but similar good. This would be the case when the cost of changing the firm's manufacturing process to produce the similar good can be somewhat immaterial in relationship to the firm's overall profit and cost. Since consumers tend to replace goods whose prices are high with cheaper close substitutes, and the existence of close substitutes whose manufacturing processes are similar allows a firm producing a low-priced good to easily switch over to producing the other higher priced good, the competition model accurately explains why the existence of different similar goods form competitive forces that deny any single firm the ability to establish a monopoly in their product. This effect is observable in a high profit and production cost industry, such as the car industry, and other industries facing competition from imports.
By contrast, the lack of competition in a market ensures the firm (monopoly) has a downward sloping demand curve. Although raising prices causes the monopoly to lose some business, some sales can be made at higher prices. Although monopolists are constrained by consumer demand, they are not "price takers" because they can influence price through their production decisions. The monopolist can either have a target level of output that will ensure the monopoly price as the given consumer demand in the industry's market reacts to the fixed and limited market supply, or it can set a fixed monopoly price at the onset and adjust output until it can ensure no excess inventories occur at the final output level chosen. At each price, the firm must accept the level of output as determined by the market's consumer demand, and every output quantity is identified with a price that is determined by the market's consumer demand. The price and output are co-determined by consumer demand and the firm's production cost structure.
A firm with monopoly power sets a monopoly price that maximizes the monopoly profit. The most profitable price for the monopoly occurs when output level ensures the marginal cost (MC) equals the marginal revenue (MR) associated with the demand curve. Under normal market conditions for a monopolist, this monopoly price is higher than the marginal (economic) cost of producing the product, indicating that the price paid by the consumer, which is equal to their marginal benefit, is above the firm's MC.
Without barriers to entry and collusion in a market, the existence of a monopoly and monopoly profit cannot persist in the long run. Normally, when economic profit exists within an industry, economic agents form new firms in the industry to obtain at least a portion of the existing economic profit. As new firms enter the industry, they increase the supply of the product available in the market, and they are forced to charge a lower price to entice consumers to buy the additional supply they are supplying as competition. Since consumers flock toward the lowest price (in search of a bargain), older firms within the industry may lose their existing customers to the new firms entering the industry, and are forced to lower their prices to match the prices set by the new firms. New firms continue to enter the industry until the price of the product is lowered to the point that it is the same as the average economic cost of producing the product, and economic profit disappears. When this happens, economic agents outside of the industry find no advantage to entering the industry, supply of the product stops increasing, and the price charged for the product stabilizes.
Normally, a firm that introduces a brand new product can initially secure a monopoly for a short while. At this stage, the initial price the consumer must pay for the product is high, and the demand for, as well as the availability of the product in the market, will be limited. As time passes, when the profitability of the product is well established, the number of firms that produce this product will increase until the available product supply becomes relatively large, and the product's price shrinks down to the level of the average economic cost of producing the product. When this occurs, all monopoly associated with producing and selling the product disappears, and the initial monopoly turns into a (perfectly) competitive industry.