Monopoly: Meaning, Features and Equilibrium

Monopoly is the market form at the opposite end of the spectrum from perfect competition: a single seller controls the entire supply of a commodity that has no close substitute, so the firm and the industry are one and the same. The monopolist's essential features are: sole seller, no close substitute, price maker (not a price taker), and the survival of monopoly depends on barriers that prevent new firms from entering — natural barriers (control over a scarce raw material), legal barriers (a patent, licence or government franchise), or economic barriers (very large economies of scale that make entry unprofitable for a newcomer).

Because the monopolist faces the entire downward-sloping market demand curve, to sell one more unit it must lower the price on all units sold, not just the marginal one. This means marginal revenue is always below average revenue (price) at every output level except the first unit — the two curves start together but MR falls away faster than AR.

Equilibrium. Like every profit-maximising firm, a monopolist produces where marginal cost equals marginal revenue, $MC = MR$, and then reads the price it can charge for that output off its AR (demand) curve — the price is always above marginal cost. Because there is no free entry to compete away abnormal profit, a monopolist can go on earning super-normal profit even in the long run — there is no long-run tendency towards normal profit as there is under perfect competition.

A useful way to see the mark-up over cost is through the elasticity of demand $e_d$ facing the monopolist:

$P = \frac{MC}{1 - \dfrac{1}{|e_d|}}$ …