Monopoly

A monopolist is a producer who supplies the complete market for a good or service. Barriers to entry prevent new firms from entering the market. Barriers to entry could be patents, legal protections, or financial disincentives such as economies of scale.

Since a monopolist is the sole provider, the firm’s marginal cost curve (which is the firm’s supply curve) becomes the industry supply curve. There is also no difference between the market and individual demand curves for a monopolist, since there is only one firm.

The monopolist faces a downward sloping demand curve, which is the same as its average revenue curve. When average revenue is decreasing, marginal revenue must by definition be less than average revenue. The monopolist follows the same profit maximization rule as anyone else: Produce until MR=MC. But since AR (the demand curve) is greater than MC at this quantity, the monopolist earns above normal profits. This is a short run equilibrium position. However, there are no new firms to enter the profit and drive down the above normal profit in the long run. The only change in the long run is that the monopolist will adjust plant size so that LRMC=MR. But the monopolist will only act to increase profit, so the above normal profit is the same or higher in the long run.

Economic efficiency, which requires that the ratio of MU/MC be equal for all goods, will not exist when monopoly conditions exist. The ratio of MU/P will still be equal for all goods because of utility maximizing consumer behavior. However, the monopolist sets P=AR and MR=MC where AR>MR, hence P>MC. The ratio MU/MC for the monopolistic good will be higher than for other goods.