The blue triangle shows the net loss of consumer and producer surplus to society.But, some of the consumer surplus is captured by firms (from setting higher price). Monopoly also causes a fall in producer surplus (less is sold).In a monopoly, the output will be QM and PM – causing a fall in consumer surplus.In a competitive market, the output will be at Pc and Qc.With less competition, a monopoly has fewer incentives to cut costs and therefore will be x-inefficient.By producing at Qm, the monopoly is productively inefficient (not lowest point on AC curve).Monopolies set a price greater than MC which is allocatively inefficient.However in the long-run in monopoly prices and profits can remain high.Therefore, in the long-run in competitive markets, prices will fall and profits will fall.In competitive markets barriers to entry and low – so new firms can enter the market causing lower profit.In monopolies, there are barriers to entry – which prevent new firms from entering the market.In the short run, firms in competitive markets and monopolies could make supernormal profit. 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.ĭifference between monopoly and competitive markets in the long-run.This diagram shows how a monopoly is able to make supernormal profits because the price (AR) is greater than AC.Profit maximisation occurs where MR=MC.The diagram for a monopoly is generally considered to be the same in the short run as well as the long run. At the fair return price, there is less deadweight loss than an unregulated monopoly and the firm breaks even.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? If forced to earn economic losses, the firm will eventually exit the market so the government must provide the firm with a lump sum subsidy (equal to its loss) to eliminate deadweight loss.Ī fair return price is one which enforces a price ceiling where economic profits are zero (P=ATC). The socially optimal price is allocatively efficient and creates no deadweight loss where price equals marginal cost, but the firm may suffer economic losses at this price. Governments will often regulate natural monopolies by imposing price ceilings which may be more efficient than the unregulated price. So, the natural monopoly may actually benefit consumers. If electric service was not a monopoly and consumers had multiple choices regarding who to purchase electricity from, the costs of production would be dramatically higher (as multiple sets of cables and wires would need to be strung) and price would likely be higher as a result. The most expensive part of providing homes in a city with electricity is putting up wires and cables all over town to carry the electricity. Electricity providers are a prime example of natural monopolies. These businesses usually have extremely high start-up costs but have a very low marginal cost of production. Natural Monopolies and Regulation: A natural monopoly is an industry which captures economies of scale at the allocatively efficient quantity resulting in much lower average costs when there is a large single provider. But since they do not produce the allocatively efficient quantity (where P=MC), they create deadweight loss and are inefficient. Surplus and deadweight loss: Single price monopolies have both consumer and producer surplus. High barriers to entry are the driving force behind giving firms monopoly power.Įfficiency: No, Monopolies price above marginal cost and do not produce at the lowest average cost so they are not allocatively or productively efficient and they have deadweight loss.Įconomies of Scale: Monopolies usually capture economies of scale because the profit maximizing quantity is on the downward sloping portion of their long-run average total cost curve. Long-run Profit: Due to the high barriers to entry, economic profit is possible in the long run.Ībility to Impact Price: Monopoly power gives firms the ability to charge higher prices than would be charged in a competitive market. These actions will increase the firm’s ATC and erode some economic profits. Monopolies may engage in rent seeking behavior (working to pass voter initiatives, lobbying politicians, etc), to maintain a monopoly. Product Difference: The product is unique.īarriers to Entry: High barriers which prevent any competitors from entering. There are no close substitutes and no competitors. Profit/loss is determined by the gap between the ATC and the firm’s demand curve at the profit maximizing quantity (MR=MC).Temporarily shut down when price falls below Average Variable Cost (AVC) at the profit maximizing quantity.
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