Monopoly diagram short run and long run

Readers Question Explain with the help of diagrams the equilibrium of a firm having monopoly power in the market in the short-run and long-run?

monopoly-diagram-2017

The diagram for a monopoly is generally considered to be the same in the short run as well as the long run.

  • Profit maximisation occurs where MR=MC. Therefore the equilibrium is at Qm, Pm.
  • This diagram shows how a monopoly is able to make supernormal profits because the price (AR) is greater than AC.
  • Usually, supernormal profit attracts new firms to enter the market, but there are barriers to entry in monopoly, and this enables the monopoly to keep supernormal profits.

Efficiency and monopoly

  • Monopolies set a price greater than MC which is allocatively inefficient.
  • By producing at Qm, the monopoly is productively inefficient (not lowest point on AC curve)
  • With less competition, a monopoly has fewer incentives to cut costs and therefore will be x-inefficient.

Welfare loss to society

  • In a competitive market, the output will be at Pc and Qc. (normal profit)
  • In a monopoly, output will be QM and PM – causing a fall in consumer surplus.
  • Monopoly also causes a fall in producer surplus (less is sold). But, some of the consumer surplus is captured by firms (from setting higher price).
  • The blue triangle shows the net loss of consumer and producer surplus to society.

Long run average costs
economiesofscale

It is assumed monopolies have a degree of economies of scale, which enables them to benefit from lower long run average costs.

In a competitive market, firms may produce quantity Q2 and have average costs of AC2. A monopoly can produce more and have lower average costs. This enables efficiency of scale.

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