A Monopoly is a market structure where a single seller controls the entire supply of a product that has no close substitutes. The monopolist is the price maker, meaning it has full control over the price of its product. However, it cannot fix both price and quantity — it must choose one, as both are determined by market demand.
Price Determination under Monopoly:
Under monopoly, the demand curve for the firm’s product is downward sloping, meaning the monopolist can sell more only by lowering the price.
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The Average Revenue (AR) curve represents the market demand curve.
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The Marginal Revenue (MR) curve lies below the AR curve because the monopolist must reduce price on all units to sell additional units.
Thus, the monopolist chooses a price-output combination where profits are maximized.
Output Determination by the Monopolist:
The monopolist aims to maximize profit, and the equilibrium output is determined by the condition:
MR = MC
At this point:
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If MR > MC, the firm can increase profit by producing more.
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If MR < MC, the firm reduces output to avoid loss.
The monopolist is in equilibrium where MR = MC, and the MC curve cuts MR from below.
After finding the equilibrium output, the monopolist determines the price by going up to the AR (demand) curve corresponding to that output level.
Short-Run Equilibrium of a Monopolist:
In the short run, a monopolist can earn:
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Supernormal (abnormal) profits, if AR > AC.
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Normal profit, if AR = AC.
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Loss, if AR < AC (but continues operating if AR ≥ AVC).
Because there are barriers to entry, no new firms can enter to compete, allowing the monopolist to sustain profits.
Long-Run Equilibrium of a Monopolist:
In the long run, the monopolist can adjust all factors of production.
Since entry of new firms is blocked, the monopolist can continue to earn supernormal profits indefinitely.
The equilibrium condition remains:
MR = MC
and price is determined from the AR curve at that output level.
However, in the long run, the monopolist may adopt new technologies or reduce costs to maintain profits.
Price and Output Relationship:
Under monopoly:
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The price is higher, and
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The output is lower
than under perfect competition.
This is because the monopolist restricts output to raise the price and maximize profit, leading to allocative inefficiency.