Question

Explain the conditions of equilibrium under monopoly. How does a monopolist attain equilibrium under different cost conditions in the long run?

Answer 1

A monopolist reaches long-run equilibrium by maximizing profits at the point where marginal revenue (MR) equals marginal cost (MC) and the price is at least as high as the average cost (AC). This ensures that the final unit produced contributes equally to both revenue and cost. Monopolists can maintain supernormal profits in the long run due to significant barriers to entry that prevent new competitors from entering the market.

Long-Run Equilibrium Conditions Under Monopoly:

1. MR = MC: The monopolist selects the output level where marginal revenue is equal to marginal cost, maximizing overall profit.
2. MC must intersect MR from below: For profit maximization, the MC curve should intersect the MR curve from below, ensuring that the firm is operating on the rising part of the MC curve.
3. Price (AR) ≥ AC: The selling price must be at least equal to the average cost to avoid losses and ensure long-term sustainability.
4. Barriers to Entry: Monopolists can sustain supernormal profits over the long run due to high barriers to entry, which protect their market position from potential competitors.

Equilibrium Under Different Cost Conditions:

• Constant Costs: If the long-run average cost (LAC) is constant, the equilibrium occurs where MC = MR, with the price matching the LAC, allowing normal profits.
• Increasing Costs: With rising LAC, the monopolist will still produce where MC = MR, but the price will exceed the LAC, resulting in supernormal profits.
• Decreasing Costs: If LAC decreases, the firm will again set output where MC = MR, but with prices higher than LAC, leading to substantial supernormal profits due to economies of scale.