Under certain exceptional cases, the cost of additional units of output, i.e., marginal cost (MC) may be equal to zero. With constant value ‘zero’ of marginal cost, the value of average cost is also constant and is equal to zero.
Its graph coincides with the X-axis. With zero cost of production, the monopolist has only to decide at which output, the total revenue will be maximum. And total revenue is maximum at the output level at which marginal revenue is equal to zero.
Further, with zero marginal cost, the condition of profit maximisation, i.e., the equality of marginal cost (MC) and marginal revenue (MR) can be achieved, where the latter is also equal to zero.
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Fig. 14.6 shows the equilibrium of the monopolist, where marginal cost is equal to zero. ‘E’ is the point of monopolist equilibrium, where MC cuts MR from below. The equilibrium price and the
equilibrium quantities at this equilibrium are OP and OQ respectively. Here, total revenue and hence total profits (area OPBE in Fig. 14.6) of the monopolist are maximum. Beyond OQ level of output, MR becomes negative and total revenue starts declining.
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It is important to note that the monopolist will never produce the output at any level, where MR is negative. If he does so, his total revenue will fall as output increases. He can increase total revenue by reducing the output.
In other words, the monopolist can earn larger profits by restricting the output. Further, since MC cannot be negative, equality of MC and MR (equilibrium condition) cannot be achieved, where MR is negative.
We know from the relationship among average revenue (AR), marginal revenue (MR) and elasticity of demand that when marginal revenue is negative, elasticity of demand is less than one. Therefore, no rational monopolist will produce on that portion of the demand curve, where MR is negative, i.e., the elasticity of demand is less than one. That is why no monopolist ever operates on the inelastic portion of the average revenue curve or the demand curve.
With the positive marginal costs (which is most usually the case), the monopolist fixes his level of output for which MR is also positive, i.e., total revenue rises with increase in the level of output. In other words, the equilibrium will always lie, where elasticity of demand is greater than one.
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In Fig. 14.6, if the price is fixed at point ‘B’ (middle point of the demand curve), where the elasticity of demand is equal to one, the MC (whether straight line or U-shaped) curve will pass through the MR curve at zero point. Here, both the MC and the MR are zero. It is a rare possibility.
Further, below the middle point ‘B’ of the demand curve, elasticity of demand is less than one. If the price is fixed in this inelastic portion of the demand curve, both the MC and the MR assume negative values, as the point of intersection between them is below point ‘Q’ on the MR curve in Fig. 14.6.
However, MC can never be negative. Given positive costs, MC curve must cut the MR curve from below at a point, where both the MC and the MR are positive. The equilibrium in this case will be established at a point above ‘Q’ on the MR curve in the figure and the price will be fixed in the elastic portion of the demand curve, i.e., above the middle point of the AR curve in Fig. 14.6.