Question

Monopolies can sometimes find themselves in difficult financial situations that lead to losses. Suppose Mr. Burns’ power company has a monopoly for providing electricity in Springfield. His costs of upkeep are so high that he is consistently losing money.

Show this outcome in a completely labeled graph. Clearly identify all parts of your graph, including the best price and output for the firm as well as the losses.

Now, answer the following:

What happens to the market output when Mr. Burns raises the price he charges?

Will this stop his losses? Why or why not?

Answer 1

(a) In following graph, D, MR, MC & ATC are demand, marginal revenue, marginal cost and average total costs respectively. Monopolist maximizes profit (or minimizes loss) by producing at a level where MR intersects MC at point 'e', with equilibrium price P0 and quantity Q0. Since firm is making a loss, it indicates that ATC lies above Demand curve, resulting in a loss equal to area P0ABC.

(b) If Mr.burns raises the price of the product the demand for the electricity will decrease. People will demand lesser amount at a higher price and the quantity output will fall.

(c) Yes, this will stop his loses because Mr.Burn is charging higher which can cover all the cost of production and return a profit. As he is operating a monopoly and there is no substitute for his product people will have to buy at the higher cost.