Q+27+Micro

(a) How does a monopoly maintain supernormal (or abnormal) profit in the long run? (b) Is monopoly always undesirable? a. A monopoly is a market structure where there is only one firm in the industry, so the firm is the industry. There is only one firm that acts as a producer for a good or a service and hence dominates the market. It can easily control the market. A monopoly is created due to a feature of high barriers to entry and exit. Barriers to entry are known as obstacles in the way of potential newcomers to a market, such as economies of scale, product differentiation, and legal protection. Due to these barriers, different types of monopolies can be created such as pure monopoly, legal monopoly (patented), local monopolies (low economies of scale), natural monopolies, etc. There is a complete absence of competition in a monopoly market, making no distinction between the firm and the industry. This gives monopoly the status of price maker. The market power can result in the monopoly making high abnormal profits. Abnormal profit is a level of profit that is greater than that required to ensure that a firm will continue to supply its existing good or service. It is an amount of revenue greater than the total costs of production, including opportunity costs. As seen as the Diagram above, a monopoly enjoys huge ‘abnormal profits’, due to AR being greater than AC. If it were a competitive market with low barriers to entry, the other firms would have been attracted to this industry increasing the supply and thus decreasing the Average Revenue. This entire process would have competed the profits away. However, in a monopoly market, due to high barriers to entry it is not possible for the firms to enter and compete with the monopolies’ abnormal profits. Thus, a monopoly can make an abnormal profit even in the long run.

b.  Monopolies are highly socially undesirable due to many negative consequences. Due to the fact that a monopoly is a single seller in the market, it can charge higher prices, restrict consumer sovereignty, and dominate the market. When compared to the most efficient market, Perfectly Competitive market that is a market structure where there are a very large number of small firms, producing identical products, Monopolies are highly undesirable.  As seen from the Diagram above, a PC firm is productively efficient as ATC = MC, allocatively efficient as the Selling Price = MC, and makes ‘Normal Profits’ in the long run, which is the average revenue needed to cover the total costs of production, including the opportunity costs. In comparison with the PC Market, monopolies are highly undesirable as they produce lesser output for a higher price P. In addition, they convert consumer surplus into abnormal profit, even in the long run. They operate at a high average cost curve ATC, which leads to a high wastage of resources, causing productive inefficiency. The Long Run position for a monopoly is also inefficient as the selling price is greater than the Marginal Cost (P > MC), and AC does not equal to MC (at ‘Quantity Produced’). Furthermore, Demand and Supply are not at equilibrium, this reduces the total welfare in the form of consumer surplus and producer surplus being lost (Dead Weight Loss). Monopolies reduce consumer sovereignty, as they have no variety in choice. Furthermore, Monopolies can become too powerful and meet their unreasonable demands from the government such as receive subsidies to reduce their costs or threaten to close down the industry. However, Monopolies are not all that bad. Monopolies invest heavily in Research and Development and invent products for consumers enhancing their living standards. Eventually, these products get copied saving other firms’ resources. Natural monopolies are socially desirable, as these industries require huge set up costs making it necessary to achieve huge economies of scale. Natural Monopolies can not only set up these industries efficiently, such as basic utilities like water, electricity, transportation etc., but can also provide these essentials at low prices which would not be possible in a PC Market.