Monopoly

·     A few firms dominating the market. Actual monopolies (only one firm in the market) are very rare.

Monopoly Equilibrium

The profit maximisation point is Q1 and P1, where MR=MC. The equilibrium quantity is Q1, however the equilibrium price is not P1. Instead the firm charges P3 since P3 is the maximum price the monopolist firm can charge while succeeding at selling quantity Q1.

Therefore the total revenue gained by the firm is rectangular area P3XQ1O. The total costs the firm incurs is the rectangular area P2YQ1O. The supernormal profits that the monopoly firm makes is P3XQ1O - P2YQ1O (total revenue minus total costs), which equals P3XYP2. This profit is the monopoly profit that the firm makes.

The monopoly IS the industry and therefore there is no separate market demand and supply diagram (like with perfect competition, see here and here). They get combined and put together because the market is the monopoly. AR is downward sloping because if they set a large price, following the law of demand, the number of units they will sell will fall and vice versa.

This diagram is the long run equilibrium and the short run equilibrium. Barriers of entry prevent new firms entering the market, thus monopoly profits are sustained in the long run as well. Firms want to be monopolies because monopoly firms sustain supernormal profits in the long run.

Efficiency

For a monopolistic market, the firm is…

·     NOT allocatively efficient. The firm does not produce above quantity Q1. Price does NOT equal MC.

·     Not productively efficient because it is not producing at its cost minimising point (the lowest point on the AC curve).

Benefits of a monopoly:

·     Market can benefit from economies of scale due to lower ACs.

·     Supernormal profits can be used for R&D.

This model, like perfect competition, can be used to compare real life markets with.

Word of the Day

Positive Output Gap

Occurs when an economy is producing above its trend rate of growth. The economy is said to be in a boom. Please see the economic cycle for more about positive and negative output gaps.