Monopoly
Assumptions/Features
- There is only one producer.
This firm is the entire market supply for the product.There are a number of possible reasons for this, including patents, statutory monopolies and control of raw materials.EG. The ESB has a statutory monopoly in electricity production in Ireland.
- The firm can control price or quantity sold, but not both.
Thefirm faces a downward-sloping Demand/AR curve. As such, it can fix price and let the market decide the quantity sold (the usual), or fix quantity and let the market decide the price. However, it can’t set the price and expect the market to buy exactly as many as it wants it to.
- Entry to the market by other firms is impossible.
No other firm can come into the industry – even if it wants to. This allows the firm to earn Super Normal Profit – even in the long run.
- Perfect Knowledge does not apply
Producers and consumers may not be fully aware of profits and production technologies.
- Profit Maximisation
Each firm will try to maximise profits (by producing where MC = MR)
Monopoly vs Perfect Competition
Perfect Competition is considered the most efficient market because:
(i)The firm produces at the lowest possible Average Cost in the long run.
(ii)In the long run no Super Normal Profit is possible – meaning consumers aren’t being exploited.
(iii)No need for wasteful advertising.
NB: This answer isn’t restricted to monopoly – perfect competition is more efficient than all markets
Monopoly does have one thing in its favour:
(i)The Super Normal Profit allows greater scope for Research and Development work, raising quality.
Employment is likely to be greater in Perfect Competition because:
(i)The monopolist restricts output and sells it at a higher price.
(ii)The MRP curve of labour slopes downwards quicker in Monopoly, because it must lower its price to sell extra output.
However, it is considered better to be employed in a Monopoly market because:
(i)Lack of competition means more stability of employment.
(ii)Some of the Super Normal Profit may be distributed to employees in the form of higher wages and bonuses.
Diagrams
AR/MR Curves
In Monopoly, the average revenue (AR)/demand curve facing the firm is downward-sloping. This is because the firm constitutes the whole industry, and to sell extra units, the firm must lower its price. When AR is falling, the marginal revenue (MR) must be less than AR. This is because the firm must lower its prices even further to sell additional units.
AC/MC Curves
These are as usual, with the U-shaped AC curve, and MC cutting AC at its lowest point.
Equilibrium Output
Because we assume each firm tries to maximise profits, they will produce where MC = MR. This gives the equilibrium quantity, Q. Reading up from this point to the AC curve gives the cost per unit at this point, and similarly reading up to the AR curve gives the revenue per unit.
Profit Levels
The difference between AC and AR is Super Normal Profit. The total Super Normal Profit earned is marked by the shaded rectangle in the graph below. SNP is any profit over and above the minimum profit needed to make it worth the firm’s while staying in the industry.
The Long Run
The SNP earned by the monopolist cannot entice other firms into the industry because it is assumed that there is no freedom of entry. Therefore this situation prevails even in the long run, and the monopolist can continue to enjoy large Super Normal Profit