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Monopoly and natural monopoly
Edexcel IAL Economics · WEC13 Business behaviour
A pure monopoly is a single seller with no close substitutes. Monopolies can charge higher prices and restrict output, but they may also bring economies of scale and innovation.
Assumptions and sources of power
- One firm supplies the whole market (pure monopoly). In practice, a firm with a very large market share may behave like a monopolist; here we use the theoretical model.
- No close substitutes.
- High barriers to entry: legal (patents, licences), control of an essential resource, economies of scale, brand loyalty, sunk costs.
- The firm is a price maker and aims to maximise profit.
Profit-maximising equilibrium
The monopolist faces the downward-sloping market demand curve (AR), with MR below it. It produces where MC = MR, and charges the price on the AR curve above that output. Because barriers block entry, supernormal profit can persist in the long run.
Diagram in words: AR and MR sloping down, MR steeper; U-shaped AC; MC cutting MR from below at Qm; go up to AR for price Pm; the rectangle between Pm and AC at Qm is supernormal profit. Compared with a competitive industry (output where MC meets AR), price is higher and output lower, and there is a deadweight welfare loss triangle between AR and MC from Qm to the competitive output.
Costs and benefits
Costs: higher price and lower output than in competition; allocatively inefficient (P > MC) and productively inefficient (not at minimum AC); possible X-inefficiency; less choice; transfer of consumer surplus to the firm.
Benefits: economies of scale may make costs lower than many small firms could achieve; supernormal profit funds research (dynamic efficiency); a strong domestic firm can compete internationally; profits can cross-subsidise loss-making services.
Natural monopoly
A natural monopoly exists when economies of scale are so large relative to market demand that one firm can supply the whole market at a lower average cost than two or more firms. Typical examples: water pipes, electricity grids, rail track. The LRAC is still falling where it meets the demand curve. Duplicating the network would waste resources, so governments usually regulate or own natural monopolies rather than break them up.
Worked example
A monopolist faces demand P = 100 - Q (so MR = 100 - 2Q) and constant MC = AC = $20. Find price, output and profit, and compare with the competitive outcome.
- MR = MC: 100 - 2Q = 20, so Qm = 40; Pm = 100 - 40 = $60.
- Profit = (60 - 20) x 40 = $1600.
- Competitive output is where P = MC: 100 - Q = 20, so Qc = 80, Pc = $20.
- Deadweight loss = 0.5 x (60 - 20) x (80 - 40) = $800.
Answer: Monopoly: Q = 40, P = $60, profit $1600; competition: Q = 80, P = $20; deadweight loss $800.
Check yourself
- A monopolist faces demand P = 120 - 2Q, so MR = 120 - 4Q. MC = AC = $40. Find the profit-maximising output.
Show answer
20 units. 120 - 4Q = 40, so Q = 20.
- For the same monopolist (P = 120 - 2Q, MC = AC = $40), find the price.
Show answer
$80. Q = 20, so P = 120 - 40 = $80.
- For the same monopolist, find supernormal profit.
Show answer
$800. (80 - 40) x 20 = $800.
- For the same market, the competitive output is where P = MC (Q = 40). Find the deadweight welfare loss of monopoly.
Show answer
$400. Triangle: 0.5 x (80 - 40) x (40 - 20) = $400.
- Why can a monopolist earn supernormal profit in the long run?
- It produces at minimum average cost
- Its demand curve is horizontal
- Barriers to entry stop new firms entering
- It sets price equal to marginal cost
Show answer
Barriers to entry stop new firms entering. Without entry, profit is not competed away.
- A natural monopoly exists when
- one firm can supply the whole market at lower average cost than several firms
- the firm owns natural resources
- the government owns the firm
- there are no fixed costs
Show answer
one firm can supply the whole market at lower average cost than several firms. Huge economies of scale relative to demand.
- Compared with perfect competition, a profit-maximising monopoly is
- allocatively efficient
- always productively efficient
- allocatively inefficient, because P > MC
- always X-efficient
Show answer
allocatively inefficient, because P > MC. Price is set on AR above MC at the MC = MR output.
Sources
Last updated 8 November 2026. Spotted a mistake? Tell us.