Short response question > Monopoly

1. Explain the level of output at which a monopoly firm will produce

There are main theories of Monopoly: A firm is a monopolist when it's the only firm producing the product and is therefore the industry. For a monopolist, there exist barriers to entry, which stop new firms from entering the industry and maintain the monopoly. As a consequence of barriers to entry the monopolist may be able to make abnormal profits in the long run. However, it is important to know how much monopoly power a firm has. The strength will really depend upon how many competing substitutes are available.

The demand curve of a monopolistic firm is downward sloping, since it is the industry demand curve. Even though a monopoly firm can control their output and their price of the product, it can't control both at the same time. This means that for a monopoly firm the law of demand still is important. The law of demand says that as the price of a product falls, the quantity demanded of the product will increase; ceteris paribus. So in order to sell more of their product they have to lower their price. This affects the output. When a firm sets a high price for their product, the demand is less and therefore the output is less. However when the monopoly firm lowers their price to p1, the quantity demanded for their product increases to q1. Therefore the output increases as well. Hence a monopolist can't charge whatever price they like and still sell their product. Nevertheless a monopoly firm's goal is to maximize their profits and they maximize their profit by producing at the level of output where the marginal cost is equal to marginal revenue.

2. Using a diagram, explain the concept of a natural monopoly

A firm is a natural monopoly when there are only enough economies of scale available in the market to support one firm's abnormal profits. Economies of scale are any decreases in long-run average cost when a firm alters all of its factors of production in order to increase its scale of output.

The monopoly firm has the demand curve of D1. Because of the economies of scale the LRAC is shaped and positioned as it is. Therefore the monopolist can make abnormal profits between q1 and q2. This is because the average revenue is greater than the average cost for the range of output. However, when another firm enters the industry the demand from the monopolist would decrease and the curve D1 would shift to the left, D2. When the firms produce at the demand curve D2, they will have huge losses and won't be able to make normal profits because the LRAC would be above the AR and every level of output. However a monopolist will only gain abnormal profit when it is able to assure all of the demand of its product. So an industry is monopoly because the market will only support one firm.

3. Using appropriate diagrams, explain whether a monopoly is likely to be more efficient or less efficient than a firm in perfect competition.

Monopoly is more likely to be less efficient than a firm in perfect competition. The power of the monopoly plays a big role, since monopolists can use an anti-competitive behavior to keep their monopoly power. Competitive behavior is when they use their image, sales, advertisement or special offers to keep the customers attracted.

A monopoly firm produces productively and allocatively inefficient, as shown in the diagram on the left. A monopolist would probably produce at q1. However the most efficient point to produce as a monopolist is at q where MR=MC. Therefore the monopoly may restrict output and charge a higher price than in perfect competition. So the high profits of monopolists are considered unfair. However, the dimension of the profits depends on the power of the monopoly. So overall, a monopolist can charge a higher price for a lower level of output. Since some monopolists can act against public interest. Hence, the government has laws and policies to limit monopoly power.
Compared to the monopoly, the perfect competitive market produces most allocative and proactively efficient where MC=AR. Therefore all the profit-maximizing firms in the perfect competition produce efficient at the point q on the right diagram.