A second condition is that the monopolist is the sole seller of a product which has no close substitutes.
If there are some other firms which are producing close substitutes for the monopolist’s product, there will be competition between them. In the presence of such competition a firm cannot be said to have monopoly.
Monopoly implies absence of all competition. When a commodity is distinct in its physical properties and recognised by everybody as distinct, then a firm producing such a commodity can be called a monopoly.
To be distinct, the commodity must be a marked gap in a chain of substitutes. Its cross elasticity’s of demand with other commodities must be low.
Joel Dean has called a monopolized product “a product of lasting distinctiveness”. Such a product has no acceptable substitutes; its distinctiveness lasts for many years. Thirdly, the fact that there is one firm under monopoly means that other firms are prohibited to enter the monopolist’s industry.
In other words, strong barriers to the entry of firms exist wherever there is one firm having sole control over the production and sale of a commodity. Lastly, it should be noted that many monopolistic firms sell their products in two or more separate markets.
A firm can have a monopolistic position in one market, but not in another. For example, electric supply companies are monopolists in selling electric power for lighting purposes. The same companies face severe competition as sellers of energy for cooking.
It is important to understand the nature of the demand curve facing a monopolist. The demand curve facing an individual firm under perfect competition is a horizontal straight line, but the demand curve facing the whole industry under perfect competition is downward sloping.
This is so because the demand is of the consumers and the demand curve of consumers for a product usually slopes downwards.
But an individual firm under perfect competition does not face a downward sloping demand curve. This is because an individual firm under perfect competition is one among numerous firms constituting the industry so that it cannot affect the price by varying its individual level of output.
It can sell as much as it likes at the ruling price. But in the case of monopoly one firm constitutes the whole industry. Here, firm and industry are identical. Therefore, the entire demand of the consumers for a product faces the monopolist.
Since the demand curve of the consumers for a product slopes downwards, the monopolist faces a downward sloping demand curve. If he wants to increase the sales of his product, he must lower the price. He can raise the price if he is prepared to sacrifice some sales.
Therefore, a monopolist’s demand curve would be falling. Demand curve facing the monopolist will be his average revenue curve. Thus the average curve of the monopolist slopes downward throughout its length.
Since average revenue curve slopes downward, marginal revenue curve will lie below it. This follows from usual average-marginal relationship. The implication of marginal curve lying below average revenue curve is that the marginal revenue will be less than the price or AR.
Monopolist, like a perfectly’ competitive firm, tries to maximise his profits. The motive of the monopolist is the same as the motive of the perfectly competitive firm—maximisation of profits.
A firm under perfect competition faces a horizontal straight line demand curve and marginal revenue is equal to average revenue (or price) but a monopolist faces a downward sloping demand curve and his MR curve lies below the AR curve.
This is another way of saying that the MR of any quantity is less than its price. The difference in the demand conditions facing the monopolist and the perfectly competitive firm makes all the difference in the results of their equilibrium, even though both work on the basis of the same profit maximisation motive.
Monopoly equilibrium is shown in Fig. 8. AR is the average revenue or demand curve. The demand curve is linear for the sake of convenience. MR is the marginal revenue curve and always lies to the left of the demand curve whether it is linear or not.
As the quantity increases, the height of the MR curve above each quantity shows the addition to total revenue from the quantity. In figure 8, the quantity is OM with a price MP and a marginal revenue MF. Total revenue is the rectangle OMPS.
Total revenue is also the area under the MR curve, OCFM. Since each one describes the same total revenue, the two areas are necessarily equal. Therefore, the two triangles— CSE and EPF—are equal. It can be shown that SE equals EP, so that ? is at the midpoint of the line SP.
Just as in the case of pure competition profit is maximised at the price-output combination where MR=MC. The monopolist will go on producing additional units of output so long as MR exceeds MC.
This is because it is profitable to produce an additional unit if it adds more to revenue than to cost. His profits will be maximum and he will attain equilibrium at the level of output at which MR equals MC.
If he stops short of the level of output at which MR = MC, he will be unnecessarily foregoing some profits which otherwise he could make.
In our figure, MR=MC at OM level of output. The firm will be earning maximum profit and will be in equilibrium when it is producing and selling OM quantity of output.
If he increases his output beyond OM, MR will be less than MC and the monopolist will be incurring loss on the additional units beyond OM and will thus be reducing his total profits by producing more than OM. Thus, he is in equilibrium at OM level of output at which MC=MR.