In the short period, the monopolist behaves like any other firm. A monopolist will maximize profit or minimize losses by producing that output for which marginal cost (MC) equals to marginal revenue (MR).
Whether a profit or loss is made or not depends upon the relation between price and average total cost (ATC). It may be made clear here that a monopolist does not necessarily makes profit. He may earn super profit or normal profit or even produce at a loss in the short run.
Conditions for the Equilibrium of a Firm under Monopoly:
There are two basic conditions for the equilibrium of a firm under monopoly:
First Order Condition: MC = MR
Second Order Condition: MC curve cuts MR curve from below.
The above conditions are now explain below:
Short Run Equilibrium with Positive or Super Profit:
In the short period, if the demand for the product is high, a monopolist increase the price and the quantity of output. He can increase the output by hiring more labor, using more raw material, increasing working hours etc. However, he cannot change his fixed plant and equipment. In case, the demand for the product falls, he then decreases the use of variable inputs, (like labor, material etc.).
As regards the price, the monopolist is a price maker. There is a greater tendency for the monopolist to have a price which earns positive or super profits. This can only be possible if the price (AR) is higher than average total cost (ATC).
In the short run, positive or super profit earned by the monopolist is now explained with the help of the diagram (16.3) below:
In this diagram, the monopoly firm is in equilibrium at point K where SMC = MR. The short run marginal cost (SMC) curve cuts MR from below. At point K both the equilibrium conditions are fulfilled. As a result, therefore, OE is monopoly price and OB, the monopoly output. At the monopoly output OB, the average total cost OF = BN. The profit per unit is FE. The short run monopoly profit is ETNF. It is represented by the area of shaded rectangle in figure 16.3.
At the output smaller than OB (say at point P) MR > SMC. Therefore, increased output up to B adds more to total receipts than to total costs. In case, the output is increased beyond OB, the MR < SMC. Hence, the increased outputs beyond OB adds more to total cost than to total receipts. This causes profits to decrease. So the best level of output for the monopolist firm is that where SMC curve cuts the MC curve from below.
Short Run Equilibrium with Normal Profit:
There is a false impression regarding the powers of a monopolist. It is said that the monopolistic entrepreneur always earns profits. The fact, however, is that there is no guarantee for the monopolist to earn profit in the short run. If a monopolist firm produces a new commodity and attempts to change the taste pattern of the consumers through advertising campaigns etc., then the firm may operate at normal profit or even produce at a loss minimizing price in the short run (covering variable cost only). The normal profit short run equilibrium of the monopoly firm is explained, in brief, with the help of the diagrams.
In figure (16.4), a firm is in the short run equilibrium at point K, where SMC = MR. The price line is tangent to SAC at point C. The firm charges CB price per unit for units of output OB. The total revenue of the firm is equal to the area OPCB. The total cost of the firm is also equal to the area OPCB. The firm earns only normal profits and continues operating.
Short Run Equilibrium with Losses:
A monopolist also accepts short run losses provided the variable costs of the firm are fully covered. The loss minimizing short run equilibrium analysis is presented graphically.
In this figure (16.5), the best short run level of output is OB units which is given by the point L where MC = MR. A monopolist sells OB units of output at price CB. The total revenue of the firm is equal to OBCF. The total cost of producing OB units is OBHE. The monopoly firm suffers a net loss equal to the area FCHE. If the firm ceases production, it then has to bear to total fixed cost equal to GKHE. The firm in the short run prefers to operate and reduces its losses to FCHE only.