The barriers to entry in one form or the other allow the profits of a monopolist to continue even in the long-run. In the long-run, the monopolist has time to expand his plant or to use his existing plant at any level, which will maximise his profits.
However, the monopolist need not reach for an optimal scale of plant where the long-run average cost is minimum. With entry blocked, he need not even use his existing plant at an optimal capacity. The size of plant and the extent of utilisation of existing plant of a monopolist depend upon the size of the market demand (i.e., quantity of demand in the market) and long-run average costs.
Image Source: crawfordsworld.com
ADVERTISEMENTS:
Accordingly, he may remain at sub-optimal scale (falling part of his LAC) or surpass the optimal scale (expand beyond the minimum LAC) or reach the optimal scale (minimum point of LAC). Since, long-run equilibrium also implies short-run equilibrium, hence, MR = LMC = SMC.
Fig. 14.5 depicts the most usual case, where the size of the market is too small to permit the monopolist to expand his output upto the minimum point of the LAC. In this case, the monopolist is operating not only with the plant of sub-optimal size, but also is under utilising the given plant.
Here, the economies of scale are not fully exhausted. The firm reaches equilibrium at point ‘E’, where LMC as well as SMC curve cut MR curve from below. The firm decides to use the plant size represented by cost curves SAC and SMC. OP is the profit maximising price and OQ is the profit maximising output.
ADVERTISEMENTS:
The plant used in this case is less than sub-optimal, since short run average cost (curve is tangent to long-run average cost (LAC) curve at its falling apart at point ‘C’, which is to the left of the minimum point ‘F’ of LAC curve. The monopolist can push down the long-run average cost to a minimum and also achieve the optimum size of the plant.
But, on account of limited market demand, it will not be in the interest of the firm to produce more than OQ quantity of output. Further, even this sub-optimal sized plant SAC is underutilized and is operated at point ‘C’, while full capacity utilisation would have taken place at point ‘G’ (the minimum point of SAC).
This implies that there is an excess capacity of QQ, as shown in Fig. 14.5. Even with limited market demand, the monopolist earns profit shown by shaded area DPBC in this figure.
Unlike perfect competition, the monopolist need not always operate at the optimal capacity (i.e., minimum point of the LAC curve in the long run), even when he earns only normal profits in the extreme possibility. But, he will not remain in the business, if he suffers losses in the long run. Actually, no firm under any market form will stay to produce in the long run, if it incurs losses.