What is the equilibrium condition under monopoly?

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In layman’s language, a Market is a place where the exchange of goods takes place. In other words, a place where the purchase and sale of goods take place is a market. The market is the nervous system of modern economic life where producers and consumers carry out the sale and purchase transactions. The market has a different and wider meaning in Economics, as it does not refer to a specific place. In Economics, a Market is a region where the buyers and sellers do not have to assemble at a specific place for the sale and purchase of goods. Instead, they have to be in contact with each other through any communication means, such as the internet, letter, mail, telephone, etc. 

Market refers to the whole region where buyers and sellers of a commodity are in contact with each other to affect the purchase and sale of the commodity. 

Equilibrium

Producer’s equilibrium states that a firm is at equilibrium when it earns maximum profits. As there is freedom of entry in perfect competition and monopolistic competition, the firms can only earn normal profits in the long run. However, as there is a restriction on the entry and exit under a monopoly market, the firms can earn abnormal profits. Therefore, the long-run equilibrium under perfect competition, monopolistic competition, and monopoly are different. 

Long-run Equilibrium under Perfect Competition

Due to freedom of entry and exit into the perfectly competitive market, the firms earn normal profits in the long run. Therefore, AR and MR under perfect competition are equal, and both coincide in a straight horizontal line and are parallel to the X-axis. 

In the above graph, LMC and LAC are the Long-run Marginal Cost Curve and Long-run Average Cost Curve, respectively. To attain equilibrium, the conditions i) MR = LMC ii) LMC curve cuts the MR curve from below, are fulfilled at point E. Therefore, point E is the equilibrium point of the firm at which it sells equilibrium output OQ at the equilibrium price of OP. Besides this, the LAC of the firm is equal to its AR. Therefore, the firm will only earn normal profits. 

Long-run Equilibrium under Monopolistic Competition

Due to freedom of entry and exit into the monopolistic competition market, the firms earn normal profits in the long run. Also, as the firms under Monopolistic Competition can sell more output by reducing the price of the product, its demand curve or AR curve slopes downward, and because of this, the MR curve also slopes negatively. 

In the above graph, LMC and LAC are the Long-run Marginal Cost Curve and Long-run Average Cost Curve, respectively. To attain equilibrium, the conditions i) MR = LMC ii) LMC curve cuts the MR curve from below, are fulfilled at point E. Therefore, point E is the equilibrium point of the firm at which it sells equilibrium output OQ at the equilibrium price of OP. Besides this, the LAC of the firm is equal to its AR. Therefore, the firm will only earn normal profits. 

Long-run Equilibrium under Monopoly

Due to restrictions on the entry and exit into the monopoly market, the firms earn abnormal profits in the long run. Also, as the firms can sell more outputs by reducing the price of the product, the demand curve or AR curve of the firm slopes downwards, and because of this the MR curve also slopes negatively. 

In the above graph, LMC and LAC are the Long-run Marginal Cost Curve and Long-run Average Cost Curve, respectively. To attain equilibrium, the conditions i) MR = LMC ii) LMC curve cuts the MR curve from below are fulfilled at the OQ output level. If the output of the firm is priced at OP1 and LAC at OP, then it will earn abnormal profits of PBAP1. 

In studying the Short-run equilibrium in a monopoly, its purpose is to maximize profits. Before we discuss the short-run equilibrium in monopoly, let’s learn about the definition and characteristics of a monopoly.

A monopoly is another extreme type of market that exists in the microeconomic theory. As perfect competition itself, a pure monopoly may not exist in real world situation. However, the study of this market model provides us with guidelines and approacheses to study the monopolistic markets.

Characteristics of the monopoly market

1. There is only one seller in the market, but there is a large number of buyers.
2. Supply a unique product and no close substitutes for the product. Thus cross-elasticity of demand between the product of the monopolist and every other product is zero or close to zero.
3. There are strong entry barriers to the industry.
4. Perfect information

The market models which fulfill all these conditions are called a pure monopoly. However, since it is tough to see the markets that satisfy all these conditions, pure monopoly is also a hypothetical market model like perfect competition.

Definition: A monopoly is a market structure in which there is a single seller, selling a unique product. In a monopolistic market, the seller does not face any competition. He is the only seller of the commodity with no close substitute.

Facts which causes a monopoly market

1. Knowledge of raw material ownership or production technology is essential.
2. A product or manufacturing process requires a patent or copyright.
3. Government license required.
4. The imposition of foreign trade barriers to prevent the influences of foreign competitors.
5. When the size of the market does not support more than one supplier.
6. The limited-pricing policy is required to avoid new entrants.

These factors serve as barriers to the entry of new firms.

Demand and Revenue Curves of the Monopolist

As there is only a single seller in the market, the monopolist demand curve is the industry’s demand curve. The monopolist can be known as a price maker. So he can decide either quantity supplied or the price of the commodity.

However, these two decisions are interdependent. When he decides, the market will determine the quantity equilibrium price. When he determines the price, the equilibrium quantity will be determined by the market.

This shows that the monopolist cannot make both the quantity and price he wants to sell independently. And also he can sell more and more of the product to the declining price. That implies the demand curve is downward sloping. So the monopolist does not have a full market as to the competitive firm.

The Equation for the Demand Curve and Revenue Curves

This proves that the demand and MR curves have the same intercept, but the slope of the MR curve is twice the slope of the demand curve.

Cost Curves of the Monopolist

The cost curves of the monopolist are the same as in pure competition. Accordingly, AVC, ATC, and MC are U-shaped, while AFC is a rectangular hyperbola.

Short run Equilibrium in Monopoly

The goal of the monopolist is to maximize profit. Thus, the monopolist’s equilibrium conditions are the same as in the conditions of a competitive firm. Hence, the equilibrium conditions are:

First-order condition MR = MC

Second-order condition, the slope of MR curve < slope of MC curve

The following figure shows the short-run equilibrium of the monopolist which fulfills the above condition.

The equilibrium point is e, at which the MC curve cuts the MR curve from below. At this point, both conditions are fulfilled. So the equilibrium price is P1 and the quantity is X1.

TR = 0P1BX1 and TC = 0ACX1.

Thus, monopolist earns excess/supernormal profit equal to the area of AP1BC. This implies that a monopolist can make an excess profit in the short run.

It can be observed that there is a significant difference between monopoly equilibrium and competitive equilibrium. Although, the equilibrium price under perfect competition equal to MC, the monopoly price is higher than MC. This is because the monopolist faces a downward sloping AR curve, and his MR curve lies below the AR curve. Hence, at the equilibrium MR=MC condition satisfied at a point below the price P (=AR). In the above graph, the equilibrium output is 0 -X1. MR and MC equal to X1 – e. It is less than the Price (=AR) which is equal to X1–B (0–P1)

Monopoly Firm Can Earn Losses in the Short-run

Generally thought that monopolists could earn supernormal profit in the short-run. However, there is no guarantee of excess profit always. If the demand is not adequate to set the price product’s price for his benefit, he will earn losses. For example, in the time of depression, demand is very low. Hence, when the price is less than AC, the firm will earn losses. However, if the price is higher than AVC, he will continue in the short-run. If the losses continue in the long-run he will leave the industry.

The equilibrium price is P1 and the quantity is Q1. The firm earns losses equal to the area of P1GHS. Although P<SAC is higher than AVC, the firm will continue in the short-run.

If the P<AVC as shown below, the firm will leave in the industry.

The demand curve (=AR) lies even below the AVC. The equilibrium price is P2 and the quantity is Q2. The firm losses equal to the fixed cost ABRH plus variable cost equal to the area of P2ABF. Since the losses are greater than the fixed cost it is not rational to further produce. Hence the firm will leave the industry.

Relationship between AR, MR and Price Elasticity

Price elasticity at any point of a demand function can be written as

Real-World Cases of Monopoly

• United Kingdom
  • British Telecom
    • Buildingand maintaining UK telecommunication network
  • Royal Mail
    • Postal distribution network
  • Camelot
    • Operate the UK national network of lottery
  • National Rail
    • Owns, manages and leases the UK railway network
  • National Grid
    • Owns and operates the National Grid high-voltage electricity transmission network in England and Wales
  • London Underground

Questions

1. What is short run equilibrium under monopoly?

2. What are the characteristics of the monopoly market?

3. How monopolist maximize profits in the short run?

4. Can a monopolist incur losses in the short run?

Conclusion

All right then. In this article, we discussed short run equilibrium in monopoly. Did you find this blog post helpful? If so, who could share it with? I’m trying to improve my website’s usability. Is there anything on my site you’re having trouble finding? Let me know by leaving comment.