An Explanation of the Equilibrium of a Monopolist Monopoly An Explanation of the Equilibrium of a Monopolist

Conditions / Assumptions Only one firm in the industry. There are barriers to entry. Firm aims to make maximum profits. The firm can determine either price or quantity, but not both.

How Monopolies Arise and Barriers to Entry Legislation Mergers and takeovers Sole ownership of a factor of production Economies of scale Cartels Brand loyalty Patents /copyright

Average Revenue AR curve. Because the firm is the industry it will have a normal downward sloping demand or AR curve. To increase sales the firm must decrease price. AR P1 Q1 Price Quantity P2 Q1

Marginal Revenue When AR is decreasing then : MR is decreasing MR is less than AR MR decreases at a faster rate than AR. For example: Quantity AR (€) TR (€) MR (€) 1 20  2 19 38 18 3 54 16 4 17 68 14 5 80 12

AR and MR Curves Combined Now superimpose the MR curve onto the diagram. Note that the gap between the curves gets wider as price decreases. Price Quantity AR MR

AC and MC Cost Curves Now superimpose typical AC and MC curves on to the revenue curves. When doing this ensure that the MC curve cuts the AC curve at AC’s lowest point. AR MR Quantity Price MC AC AC MC

Long Run Equilibrium Quantity The firm aims to make maximum profit. Thus it will produce the quantity where MR = MC so long as MC > MR after that, i.e. in our example, 120. AC MC AR MR Quantity Price 120

Long Run Equilibrium Price To get the price (AR) for 120 draw a line from 120 on the quantity axis up to the AR curve and across to the price axis. In our example this gives a price (AR) of €15. AC MC AR MR Quantity Price 120 €15

Long Run Equilibrium Profit level Profit level is the difference between AR and AC. As already seen, AR is €15. The AC is €7. As AR > AC the firm is earning supernormal profit (SNP). AC MC AR MR Quantity Price 120 €15 €7

Advantages of Monopoly Monopolists sometimes benefit from the economies of scale and so may be able to sell the product at a lower price than other forms of competition. Production under conditions of monopoly may avoid wasteful duplication of resources. For example, in other forms of competition each firm may have specialised machinery that is under-used: with large-scale production in monopoly only one specialised machine is needed and it is fully utilised.

Advantages of Monopoly A monopolist may be less vulnerable to changes in the level of demand in the market. As it is earning SNPs it may be able to afford to decrease price to maintain the same level of sales. A smaller firm earning only NPs may not be able to afford to do so. Therefore, employment may be more secure in monopoly.

Disadvantages of Monopoly Due to lack of competition a monopolist seldom, if ever, produces at the lowest point on the AC curve. This causes a waste of economic resources. A monopolist earns SNPs, which indicates that the consumer is being exploited. Consumers have no choice of products as there is no other producer of a similar product. There is no incentive to be innovative as there is no competition. A monopolist may be able to practise price discrimination and thus further exploit the consumer.