Question

A potential entrant can produce at the same cost as the monopolist illustrated in the figure below. The monopolist’s demand curve is given by D M, and its average cost curve is AC.

1. What level of output does the monopolist have to produce in order for the entrant to face the residual demand curve, DR?
2. How much profit will the monopolist earn if it commits to the output that generates the residual demand curve, DR?
3. Can the monopolist profitably deter entry by committing to a different level of output? Explain.

Short answer

1. If a horizontal curve is drawn from price$\text{200}$, the monopolist must produce a particular number of goods in order for the entrant to face the residual demand curve,${\text{D}}_{\text{R}}$, until the demand curve,${\text{D}}_{\text{M}}$, reaches$\text{16}$ units.
2. The profit earned by the monopolist is obtained as: $\text{\$320}$.
3. The introduction of new rivals will not be profitable since the entrant's residual demand curve is lower than the average cost curve, therefore producing more or less will result in a loss. The monopolistic firm, on the other hand, will be able to get larger profits by establishing a limited price while producing at a level greater than$\text{16}$ units, because a higher level of production would result in more losses for the entrant.

Step-by-step solution

Defining Business strategy

A defined set of plans, activities, and goals that explains how a company will compete in a certain market, or markets, with a product or a number of goods or services, is known as a business strategy.

Explaining what level of output was produced

The monopolist corporation will charge a price of ${\mathrm{P}}_{\mathrm{L}}\left(200\right)$ to restrict price, which is lower than the initial monopoly price $\left(250\right)$. As a result, the residual demand curve of the entrant begins at ${\mathrm{P}}_{\mathrm{L}}$. If a horizontal curve is formed from price $200$, the monopolist must generate a certain amount of production in order for the entrant to confront the residual demand curve, _{${\mathrm{D}}_{\mathrm{R}}$}, until the demand curve ${\mathrm{D}}_{\mathrm{M}}$ reaches $16$ units.

Therefore, If a horizontal curve is established from price$200$ the monopolist must produce a specific quantity of output for the entrant to face the residual demand curve, _{${\mathrm{D}}_{\mathrm{R}}$}, until the demand curve _{${\mathrm{D}}_{\mathrm{M}}$} reaches $16$ units.

Evaluating the profit

When determining the monopolist’s profit level, keep in mind that profit is calculated as Profit _{$=\mathrm{P}\times \mathrm{Q}$}, where $\mathrm{P}$ is the price and $Q$ is the quantity. It is already know that the best amount of output for the entrant to meet the residual demand curve is $16$, and that the price may be calculated as the difference between ${\mathrm{P}}_{\mathrm{L}}$ and $\text{AC}$, where $\mathrm{P}=\mathrm{AC}$for the entrant. As a result, it remains:

_{$\begin{array}{c}\mathrm{P}={\mathrm{P}}_{\mathrm{L}}-\mathrm{AC}\\ =200-180\\ =\mathrm{\$}20\end{array}$}

Note that$\mathrm{AC}$ is equivalent to$180$ because it is the price at a_$16$-unit manufacturing level.

As a result, the monopolist's profit may be calculated as follows:

_{$\begin{array}{c}\mathrm{Pr}ofi{t}_M=\mathrm{Pr}ice\times Quantity\\ =\$20\times 16\\ =\$320\end{array}$}

Therefore, the profit is:_$\$320$.

Explaining if the monopolist profitably deter entry by committing to a different level of output

As, the entrant's residual demand curve is lower than the average cost curve, new rivals will not be successful because they will lose money whether they produce more or less. The monopolistic firm, on the other hand, will be able to get larger profits by establishing a limit price while producing at a level greater than units, because a higher level of production would result in more losses for the entrant.

Therefore, Due to the entrant's residual demand curve is lower than the average cost curve, new competitors will lose money if they produce more or less. The monopolistic firm, on the other hand, will be able to get larger profits by establishing a limit price while producing at a level greater than units, because a higher level of production would result in more losses for the entrant.