What you'll learn

• What a pure monopoly is and why its assumptions matter.
• How to compare short-run and long-run equilibrium in monopoly and perfect competition.
• Why monopoly can create costs such as higher prices and inefficiency.
• How to evaluate possible benefits, including economies of scale, natural monopoly, price discrimination, and international competitiveness.

The building blocks first

Before monopoly diagrams make sense, you need a few cost and revenue terms.

A profit-maximising firm chooses the output where marginal revenue equals marginal cost: $MR=MC$. It then reads the price from the AR, or demand, curve.

Normal profit is the minimum profit needed to keep the entrepreneur in the market. It is included in costs. Supernormal profit is profit above normal profit.

Short run means at least one factor of production is fixed, and the number of firms in the market may not adjust fully. Long run means all factors are variable and, where there are no barriers, firms can enter or leave the market.

What is monopoly?

A monopoly has market power, meaning it can influence price rather than simply accepting the market price. It is therefore a price maker.

The key assumptions are important:

• One firm supplies the market: the firm faces the whole market demand curve.
• No close substitutes: consumers cannot easily switch away, so demand is often less price elastic.
• High barriers to entry: new firms cannot easily compete away supernormal profits.
• Profit maximisation: the usual diagram assumes the firm sets output where $MR=MC$.

Barriers to entry include patents, licences, ownership of essential resources, strong brands, network effects, high fixed costs, data advantages, and economies of scale.

In UK competition policy, a firm with 25% market share may be treated as having monopoly power. For this Eduqas topic, however, you should understand the stricter model of pure monopoly.

Perfect competition versus monopoly

The diagram below compares the firm’s equilibrium in perfect competition and monopoly in both the short run and the long run.

Perfect competition

In perfect competition, there are many small firms, identical products, perfect information, and no barriers to entry or exit. Each firm is a price taker, so its AR and MR curves are horizontal at the market price.

In the short run, a firm can make supernormal profit if price is above average cost.

In the long run, supernormal profit attracts new entrants. Market supply rises, price falls, and profits are competed away. The long-run equilibrium has:

• Normal profit only
• Allocative efficiency, where price equals marginal cost
• Productive efficiency, where the firm produces at minimum average cost

Monopoly

A monopoly faces a downward-sloping AR curve because it must lower price to sell more output. Its MR curve lies below AR because extra sales reduce revenue on existing units as well as adding revenue from the new unit.

A monopolist produces where $MR=MC$, but the price is above marginal cost. This means monopoly is usually allocatively inefficient.

In the long run, barriers to entry mean supernormal profit can persist. Unlike perfect competition, there is no automatic process forcing price down to average cost.

What shifts the curves?

In monopoly diagrams, changes in demand shift both AR and MR.

Demand may shift right if incomes rise, the firm advertises successfully, population increases, or network effects strengthen. A network effect exists when a product becomes more valuable as more people use it, such as a digital platform.

Demand may become more inelastic if substitutes disappear, switching costs rise, or brand loyalty increases. Switching costs are the costs or inconvenience consumers face when changing supplier.

Cost curves shift when wages, energy prices, raw material prices, taxes, technology, or regulation change. For example, global supply-chain shocks or higher energy costs can raise MC and AC.

The costs of monopoly

Monopoly can reduce economic welfare. Consumer surplus is the extra benefit consumers receive when they pay less than the maximum they were willing to pay. Producer surplus is the extra benefit producers receive when price is above the minimum they would accept.

The welfare diagram shows how monopoly can restrict output below the competitive level, raise price, and create a deadweight loss, which is welfare lost because mutually beneficial trades do not happen.

Main costs include:

• Higher prices and lower output than under a competitive benchmark.
• Allocative inefficiency, because $P>MC$.
• Productive inefficiency, because the monopolist may not produce at minimum AC.
• X-inefficiency, where weak competitive pressure allows costs to drift above the lowest possible level.
• Less choice and quality pressure for consumers.

If a monopoly is not contestable, the threat of entry is weak. This can allow high prices, poor service, and slower innovation. However, if a monopoly is highly contestable, even a single firm may keep prices lower because it fears potential entry.

Possible benefits of monopoly

Monopoly is not always bad. Your evaluation should consider whether the benefits outweigh the costs.

Economies of scale occur when long-run average cost falls as output rises. Examples include water networks, rail infrastructure, energy grids, and broadband networks. It may be wasteful to duplicate pipes, tracks, or cables.

In these cases, monopoly may produce at lower average cost than several competing firms. The issue is that regulation may be needed to make sure cost savings are passed on to consumers. UK regulators such as Ofwat and Ofgem are relevant AO2 examples.

Monopoly profits can also support dynamic efficiency, meaning innovation over time through new products, better processes, or research and development. Joseph Schumpeter argued that the prospect of monopoly profit can encourage innovation, especially in industries such as pharmaceuticals or technology.

Price discrimination

A monopolist may price discriminate if it has market power, can separate consumers into groups, can prevent resale, and faces groups with different price elasticity of demand.

Price discrimination can be harmful if it allows the firm to capture more consumer surplus. But it can also increase output if lower-price consumers are served who would otherwise be excluded.

Monopoly and international competitiveness

Large monopoly or near-monopoly firms may have enough scale to compete internationally. They can spread fixed costs across large output, fund research and development, and build strong global brands.

This can support export performance and productivity. For example, large pharmaceutical or aerospace firms may need major upfront R&D spending before earning returns.

However, a protected domestic monopoly may become complacent. If it faces little foreign competition, it may develop high costs and weak incentives to innovate. Brexit trade frictions or import barriers can reduce contestability in some UK markets, while global competition can increase pressure on monopolists to improve.

How to evaluate monopoly

A strong judgement depends on the market context.

Ask yourself:

• Are economies of scale so large that competition would raise average costs?
• Is the monopoly regulated effectively?
• Is the market contestable?
• Are supernormal profits reinvested into innovation, or simply kept by shareholders?
• Are consumers vulnerable, such as households buying water, energy, or rail services?
• Is the monopoly improving international competitiveness, or weakening it through inefficiency?