Monopoly
Economically a monopoly is a market in which a single firm has 100% market share. The firm is the industry. We refer to this as a pure monopoly. Legally a monopoly is defined as a market where a single supplier has a 25% market share, as classified by the competition commission using various methods including percentage of market profits, percentage of total revenue and percentage of quantity produced (measured by mass or units).
In a pure monopoly supernormal profits are earned in both the short and long run. There are high barriers to entry (factors which prevent other firms from joining the industry), consumers have low knowledge and the firm is a price maker as there is no competition.
Economies of scale act as a barrier to entry as new entrants are unable to take advantage of economies of scale so they must charge a higher price. Economies of scale are the reduction in LRATC as output increases. Examples of economies of scale include technical economies of scale (attracting skilled workers), marketing economies of scale (bulk buying) and financial economies of scale (borrowing at a lower interest rate).
In a monopoly demand is inelastic as there are no substitute goods.
The MR curve is lower than the D (= P) curve as to increase the quantity sold the monopolist must lower the cost of their product for all units sold. This means that MR < AR(P) for all P.
TR is maximized when PED = 1.
The monopolist makes a supernormal profit of the shaded region on the above diagram. Profit maximising output occurs where MC = MR as if the output is lower than this then for producing an extra unit of output the MR will be greater than the MC, that is the revenue from producing one extra unit will be greater than the cost of producing that unit. If the output is higher than MC = MR then the cost of producing those extra units is higher than the revenue gained from selling them at the market price. Therefore profit maximising output occurs when MC = MR.
Pm shows the equilibrium price and ACYQmO the normal profits and costs. The shaded area PmXYAC represents the supernormal profits.
In the long run this cost structure remains constant as barriers to entry keep other entrants out of the market the firm will continue to make supernormal profits in the long run.
As there are no firms there is no pressure to lower costs or to lower the price. Monopolies are not productively efficient as they do not produce at the minimum point on the ATC and are not allocatively efficient, as consumer surplus is not maximised. A maximised consumer surplus occurs at P = MC. This condition is not met in a monopoly, where the monopolist overcharges the consumer by XZ (=PmMClast unit).
Also, as there is no competition the monopolist can make an inferior quality good, as there is no substitute. Monopolists also reduce consumer surplus, that is the welfare received by not paid for by the consumer.
Assuming costs of production remain unchanged, and then changing the market structure from a monopoly to perfect competition gives a new equilibrium price and quantity, Pc and Qc. Under perfect competition the MC curve is the supply curve so the equilibrium is determined by the interaction of the supply and demand curves giving a new consumer surplus of QPcC under perfect competition. Therefore PmPcBC is the increase in consumer surplus between a monopoly and perfect competition.
Homework
Revise the term producer surplus and read pp. 24 - 28 of the study guide.
The shaded area, ABPe in the diagram below, represents the producer surplus.
These notes are from a lesson on 14/9/2004 and a homework given in that lesson.
