Determination of price and quantity supplied by monopolistic firm in the short run
This article describes the process by which a monopoly firm, i.e., a firm that is the only firm selling a particular commodity, selects the quantity to produce and the price to set for the commodity.
Here are some key features of a monopoly firm:
- The firm is a price setter rather than a price taker -- it can choose any price it wants.
- However, for a given price set by the firm, and a given quantity that the firm produces, there is no guarantee that the firm will be able to sell all of what it produces. Thus, instead of being told a market price and trying to optimize the quantity, the firm needs to optimize a (price,quantity) pair based on the market demand curve.
The situation is in sharp contrast to that of determination of quantity supplied by firm in perfectly competitive market.
The situation is similar to determination of quantity supplied by firm in oligopoly. In the latter, however, the firm also has to be concerned about the behavior of competing firms, and the response these firms may show to price changes by the firm. Oligopolistic competition is typically studied using tools of game theory.
More generally, when a firm has market power, it has some leeway in setting prices but, in return, has to explicitly consider the market demand curve it faces. When a firm has monopoly, the leeway in setting prices as well as the importance of the market demand curve are maximal.