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?
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
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.
- Monopolistic competition – where the short run equilibrium is different to the long run equilibrium
- Monopoly – advantages and disadvantages.