Q.(a) Illustrate Price and Output determination under Monopoly.

(a) A monopolist maximises profit where MC = MR and sets price from the demand (AR) curve above that output, so price > MR and super-normal profit is possible. (b) The Loanable Funds Theory determines the interest rate by the demand for and supply of loanable funds.

(a) Price and Output Determination under Monopoly. A monopoly is a market with a single seller of a product having no close substitutes, protected by barriers to entry. The monopolist is a price-maker and faces a downward-sloping demand (AR) curve, with the MR curve lying below the AR curve.

Equilibrium condition. The monopolist maximises profit at the output where:

• MC = MR, and
• MC cuts MR from below.

Price determination. Having chosen the profit-maximising output where MC = MR, the monopolist charges the price given by the AR (demand) curve vertically above that output — this price is higher than MR. Because the demand curve (AR) usually lies above the average cost (AC) curve at that output, the monopolist earns super-normal (excess) profit equal to (AR - AC) x output.

(With diagram, described in words): On a graph with output on the horizontal axis and price/cost on the vertical axis, the downward-sloping AR and the lower MR curves are drawn, along with the U-shaped MC and AC curves. Equilibrium output is at the point where MC intersects MR from below; a vertical line from this output meets the AR curve at the price point (P) and the AC curve at cost point (C); the rectangle between P and C over that output measures the monopoly (super-normal) profit.

(b) Loanable Funds Theory of Interest. This is a neo-classical theory developed by Knut Wicksell, D.H. Robertson and Bertil Ohlin. It holds that the rate of interest is determined by the demand for and the supply of loanable funds (the funds available for lending and borrowing), not merely by savings and investment.

Demand for loanable funds comes from:

1. Investment (I) — firms borrow to buy capital goods.
2. Hoarding (H) — desire to hold idle cash balances.
3. Dissaving — spending in excess of current income (consumption borrowing).

Supply of loanable funds comes from: …