Question 28 — Monopoly: Meaning and Equilibrium of Firm in Short Run and Long Run

Introduction

In the study of market structures, monopoly represents one extreme, opposite to perfect competition. Under monopoly there is single-seller dominance; the monopolist controls the entire supply of the commodity and hence has significant control over price and output. The analysis of equilibrium of a monopolist is a core part of the Panjab University B.Com (Sem I) syllabus as presented in “Microeconomics” by T.R. Jain & V.K. Ohri.

This answer first explains the meaning and features of monopoly, then develops the revenue and cost framework for monopoly, and finally discusses the short-run and long-run equilibrium of the monopolist with clear conditions, diagrams and examination-oriented interpretation.

I. Meaning and Essential Features of Monopoly

1. Meaning of Monopoly

The term monopoly is derived from the Greek words “mono” meaning “single” and “poly” meaning “seller”. Thus monopoly is a market situation in which there is a single seller of a commodity having no close substitutes.

2. Essential Features of Monopoly

1. Single seller and many buyers: In the industry there is only one firm, which is the monopolist. However, the number of buyers is large.
2. No close substitute: The product sold by the monopolist does not have close substitutes. Therefore consumers have little choice; they must buy from the monopolist or go without.
3. Restriction on entry: Barriers to entry of new firms (legal, technical, financial, or strategic) prevent competition. This allows the monopolist to enjoy supernormal profits even in the long run.
4. Full control over supply: The monopolist controls total supply of the commodity and thus has substantial control over price. However, he cannot fix both price and quantity independently; he must respect the demand curve.
5. Price maker, not price taker: Unlike a competitive firm, the monopolist is a price-maker. By choosing output, he indirectly determines price from the demand curve.
6. Firm and industry are identical: Since there is only one firm producing the commodity, the monopoly firm itself constitutes the whole industry.
7. Downward sloping demand curve: The monopolist faces the entire market demand curve for his product, which slopes downward from left to right. To sell more, he must reduce price.

3. Sources of Monopoly Power (Brief)

• Legal monopoly (e.g., patents, copyrights, government franchises).
• Natural monopoly (control over scarce resources, network utilities).
• Technical monopoly (superior technology, large economies of scale).
• Strategic monopoly (branding, aggressive tactics, mergers and acquisitions).

II. Revenue and Cost Conditions under Monopoly

For equilibrium analysis we use AR, MR, AC and MC curves. Under monopoly the revenue curves have a characteristic shape:

1. Average Revenue (AR) and Marginal Revenue (MR)

• The monopolist’s Average Revenue (AR) curve is the market demand curve. It slopes downward: to sell more units, the monopolist must reduce price.
• The Marginal Revenue (MR) curve lies below the AR curve and also slopes downward. This is because to sell an additional unit the monopolist must reduce price not only on the last unit but on all previous units.
• Consequently, for all positive outputs, MR < AR. MR may become zero and then negative at higher outputs.

2. Cost Curves

On the cost side, the monopolist faces the usual U-shaped Average Cost (AC) and Marginal Cost (MC) curves:

• AC falls initially due to economies of scale and then rises due to diseconomies.
• MC falls initially, reaches a minimum earlier than AC, and then rises.
• MC intersects AC at AC’s minimum point.

Since the monopolist is also a profit-maximising producer, the basic equilibrium condition for a monopolist is the same as for any firm: MR = MC.

III. Short-run Equilibrium of a Monopolist

1. Assumptions

• Time period is short; some factors of production are fixed.
• The monopolist cannot freely alter scale of plant in the short run.
• Demand and technology are given.

2. Determination of Short-run Equilibrium Output and Price

In the short run the monopolist chooses that level of output where:

• MR = MC, and
• MC cuts MR from below.

Once equilibrium output Q* is found from MR = MC, the monopolist charges the highest price that consumers are willing to pay for that quantity, as given by the AR (demand) curve. Thus price P* is read vertically above Q* on the AR curve.

3. Profit Possibilities in the Short Run

In the short run, depending on the position of the AC curve relative to price P*, the monopolist may:

1. Earn supernormal profits: If at Q*, P* > AC, the monopolist earns supernormal profit equal to (P* − AC) × Q* (shown by the shaded rectangle in the diagram).
2. Earn only normal profit: If at Q*, P* = AC, the monopolist earns normal profit (included in cost) but no supernormal profit.
3. Incur losses but continue production: If at Q*, P* < AC but P* > AVC, the monopolist incurs losses but will still continue production in the short run because he covers his variable costs and part of fixed costs.
4. Shutdown position: If price falls below minimum AVC, the monopolist will shut down in the short run, as even variable costs are not covered.

IV. Long-run Equilibrium of a Monopolist

1. Nature of Long Run for Monopolist

In the long run:

• All factors of production are variable.
• The monopolist can adjust the scale of plant (choose the most efficient plant size).
• However, entry of new firms is still blocked. Therefore, long-run supernormal profit is possible and in fact typical.

2. Conditions of Long-run Equilibrium

The monopolist’s long-run equilibrium requires:

1. Profit maximisation condition: MR = LMC (long-run marginal cost) and LMC cuts MR from below.
2. Least-cost condition for chosen output: The monopolist selects that plant (short-run AC curve) which is tangent to the long-run average cost (LAC) at the equilibrium output. This ensures production at the least possible cost for that chosen level of output.

Unlike perfect competition, there is no requirement that price equals minimum LAC. Hence there is no obligation for the monopolist to operate at the minimum point of LAC.

3. Diagram: Long-run Equilibrium of a Monopolist

4. Important Features of Long-run Monopoly Equilibrium

• The monopolist is in equilibrium at output Q_LR where MR = LMC and LMC is rising.
• Price is given by the AR curve at this output and is usually greater than LAC; hence the monopolist earns supernormal profit even in the long run.
• There is no automatic tendency for long-run monopoly profits to be driven to normal levels because entry of new firms is blocked.
• The monopolist does not normally produce at the minimum point of LAC. Hence monopoly is productively inefficient compared with perfect competition.

V. Monopoly Equilibrium vs. Perfect Competition (Brief Comparison)

To highlight the economic significance of monopoly equilibrium, it is useful to contrast it with perfect competition:

Conclusion

To conclude, monopoly is a market structure characterised by a single seller, absence of close substitutes and barriers to entry. The monopolist faces a downward sloping demand (AR) curve and a corresponding MR curve lying below it. In both short run and long run, the monopolist attains equilibrium where MR = MC, but unlike a competitive firm he typically produces at an output where P > MC and earns supernormal profits. In the long run he can adjust his scale of plant, but the absence of entry ensures that supernormal profits are not competed away. This results in restricted output, higher prices and some degree of inefficiency compared to perfect competition—features that are central to the traditional theory of monopoly as prescribed for B.Com (Sem I), Panjab University.