Shut-down point of firms

It is assumed that price is greater than Average Variable Cost (AVC) in all three cases such that there is no shut-
down of firms.

The shut-down price is P1 where is P=AVC. At any price below P1, the firm will not produce as it cannot cover
Variable Cost (VC) per unit.
Thus, MC curve above the P1 becomes the short-run supply curve. (Line ABC)
Fixed costs (FC) do not need to be covered in the short-run but in the in long run. Thus, MC curve above the
minimum AC curve becomes the long-run supply curve. (Line BC only)
In the long run, firms will not continue production below price P 2.

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MONOPOLY
A monopoly is a market situation in which there is a single seller for a commodity having no substitutes. A
(pure) monopoly is just one firm in an industry with very high barriers to entry. Since there is only one firm in
the industry, the firm can be referred to as the industry itself.
Pure monopoly controls 100% market share.
Dominant monopoly controls at least 40% market share.
A legal monopoly controls at least 25% market share. (According to Fair Trading Act 1973 in UK)
Examples of monopoly:
1. Microsoft Windows (1990)- Operating systems and web browsers
2. Mauritius Telecom & Orange (2009)- Internet connection
3. MCB Ltd (2016)- controls more than 50% of market share

 On the revenue side, AR is falling and MR falls twice as much as AR. For e.g
Price 10 9 8 7 6 5 4
Output 1 2 3 4 5 6 7
TR 10 18 24 28 30 30 28
AR 10 9 8 7 6 5 4
MR - 8 6 4 2 0 -2

 On the cost side, AC is U-shaped because of EOS and diseconomies of scale (in the long run)

Characteristics of monopoly
(a) Price maker
Monopolist can set the price by changing price or output but not both simultaneously because it is
constrained by the demand curve. Thus, the monopolist become the price maker and its power depends on
the elasticity of the product.
(b) Strong barriers to entry
It refers to any force that prevents new firms to enter an industry. They may be:
(i) Natural- EOS & cost advantages related to uniqueness and location
(ii) Legal- Grants, patents & parliamentary acts protecting nationalised industries.
(iii)Artificial barriers- Copyrights, trademarks, branding, price limit, advertising & predatory pricing.
(c) No substitutes
Monopoly control supplies of raw materials (inputs) and outlets (outputs) of production preventing new
firms to enter the industry such that the product is unique and no other substitute in the market.
(d) The firm (monopoly) is the industry
In theory, a monopoly is when there is only one firm in the industry such that the firm becomes the industry
and faces the whole market demand curve (AR). There is 100% market concentration.
(e) Profit-maximising firm
Monopoly aims at maximising profit by producing at output where MR=MC and produces the output at the
lowest possible costs.

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SHORT RUN EQUILIBRIUM (Monopoly)

LONG RUN EQUILIBRIUM (Monopoly)

In the long run, abnormal profits persist because of barriers to entry. Being the only seller, the monopoly
charges the maximum price to earn abnormal profits.

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Natural monopoly
A natural monopoly is a market situation where a monopolist has a huge cost advantage due to to sole
ownership of a resource such that it is difficult for competitors to duplicate these installations.

This is where a single supplier has substantial cost advantages such that competing producers would raise costs
and where duplication will produce an inefficient use of resources. For e.g railways, piped water supplies and
electricity.

Falling LRAC indicates continuing EOS.

Private monopoly would provide output OQ1 where MR=LRMC and earn abnormal profit as shown above.
Public monopoly (State-owned Enterprises) will behave as a competitive firm. It will not restrict output to its
consumers. It would produce where P(AR)=LRMC (allocative efficiency) but this is a loss-making position.
The government will subsidies the public monopoly as it provides an essential public service. For e.g CWA
Loss-making to be financed by either:
1. Subsidies by government
2. Using average-cost pricing
3. “two-part tariff”- A fixed fee to be paid monthly + MC pricing in order to cover losses

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ADVANTAGES (Monopoly)

1. Monopoly operate on a large scale & benefit from EOS e.g financial EOS to cause a fall in cost of
production & lower prices. They can supply larger quantities at lower prices.
2. Monopoly have financial resources to compete with MNC & can afford to spend on R&D to innovate &
produce better & wider variety of products. This raises SOL of people such that they will be better off.

Perfect competition price = Ppc

Perfect competition output = Qpc

Consumer surplus = aPpcB

Monopoly price = Pm

Monopoly output = Qm

New consumer surplus = aPmk

Net welfare gain = BLK

The impact of large scale production to monopolies compared to perfect competition made it benefit from EOS
to lower AC such that they can afford to sell at lower prices.

3. Monopolies can eliminate wasteful competition e.g water supplier installs only one network of pipes. They
can then benefit from large scale production and EOS. Moreover, monopolies are huge companies which
offer its workers a greater job security relative to other small local firms and they are less likely to close
down. Furthermore, they can make abnormal profits in the long run and have greater certainty of profits
such that they can plan for future investment and further expansion.
4. Monopoly know that their supernormal profit is protected & feel safe to invest in R&D such that consumers
might get better quality products. Moreover, they perform price discrimination such that they can lower
price to those who cannot afford the high price such that it offers a more equitable distribution of the
product.
5. Huge profits made by monopoly generate huge corporate taxes to government that can use the tax revenue
to raise social welfare services e.g pensions and improve infrastructures to improve peoples' SOL.

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DISADVANTAGES (Monopoly)

1. Monopoly has always been feared to exploit consumers by either restricting output or charging higher prices
to consumers but not both simultaneously because it is constrained by the demand curve. This occurs due to
high barriers to entry as cost advantages related to the uniqueness of products, trademarks and patents.
2. Compared to perfect competition, monopolies tend to sell smaller quantities of output and charge the
maximum price to obtain the maximum profits. They try to convert all consumer surplus into producer
surplus as shown below:

Perfect competition price = Ppc

Perfect competition output = Qpc

Consumer surplus = acPpc

Monopoly price = Pm

Monopoly output = Qm

New consumer surplus = aePm

Net welfare gain = edc

Both consumers & producers lose as there is allocative inefficiency and area P mPpcXe is transferred to producer
surplus.

3. Monopolies have less incentive to innovate as the product is relatively inelastic leading to low R&D and
poor quality products with no substitutes (XED =0). It is referred to as X-inefficiency where the costs are
above those experienced in more competitive markets.
4. Monopolies may lead to inefficiencies in terms of resource allocation. It aims at profit maximisation rather
than social welfare. for e.g they may cause externalities e.g pollution and deplete natural resources affecting
future generations.
5. Monopolies may practice limit pricing where firms deliberately lower prices and abandon a policy of profit
maximisation to stop new firms entering a market. As competition disappears, they turned into active
monopolies that exploit consumers. This is against the principle of free trade and competition that lead
consumer exploitation in the long run.

Conclusion
It can be noted that monopoly, left on its own, will try to convert all consumer surplus into its own leading to
consumer exploitation but at the same time, if the monopoly invest on R&D with their consistent abnormal
profits, consumers can be better off with respect to better quality products at lower prices relative to perfect
competition. Thus, monopolies should not be ended but mended through government intervention for a win-win
situation.

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