Diagram of Monopoly

Monopoly Graph

 A monopolist will seek to maximise profits by setting output where MR = MC

 This will be at output Qm and Price Pm.
 Compared to a competitive market, the monopolist increases price and reduces
output

 Red area = Supernormal Profit (AR-AC) * Q

 Blue area = Deadweight welfare loss (combined loss of producer and consumer
surplus) compared to competitive market

Disadvantages of a Monopoly

 Higher prices Higher price and lower output than under perfect competition. This
leads to a decline in consumer surplus and a deadweight welfare loss
 Allocative inefficiency. A monopoly is allocatively inefficient because in monopoly
the price is greater than MC. P > MC. In a competitive market, the price would be
lower and more consumers would benefit

 Productive inefficiency. A monopoly is productively inefficient because it is not the

lowest point on the AC curve.
 X – Inefficiency. It is argued that a monopoly has less incentive to cut costs
because it doesn’t face competition from other firms. Therefore the AC curve is
higher than it should be.

 Supernormal Profit. A monopolist makes supernormal profit Qm * (AR – AC )

leading to an unequal distribution of income.
 Higher prices to suppliers – A monopoly may use its market power and pay lower
prices to its suppliers. E.g. Supermarkets have been criticised for paying low prices
to farmers.

 Diseconomies of scale – It is possible that if a monopoly gets too big, it may

experience diseconomies of scale. – higher average costs because it gets too big
 Worse products. Lack of competition may also lead to improved product innovation.
 Charge higher prices to suppliers. Monopolies may use their supernormal profits
and monopsony power to pay lower prices to suppliers. For example, supermarkets
squeezing prices paid to farmers.

Advantages of monopoly
1. Economies of scale

If a firm is in a competitive market and produces at Q2, its average costs will be AC2.
A monopoly can increase output to Q1 and benefit from lower long run average costs
(AC1). In industries with high fixed costs, it can be more efficient to have a monopoly
than several small firms.

2. Research and development

The supernormal profit can enable more investment in research and development,
leading to better products.