Monopoly Profit - Persistence

Persistence

In the absence of barriers to entry and collusion in a market, the existence of a monopoly, and therefore monopoly profit, cannot persist in the long run. (Note that a barrier can be caused by increasing returns to scale — a bigger firm can produce more cheaply. If the most efficient size firm serves the whole market, we have a "natural monopoly," and no other firms will "rush" to enter.) Normally, when economic profit exists within an industry, economic agents rush to form new firms in the industry in an effort to obtain at least a portion of the existing economic profit. As new firms enter the industry, they increase the supply of the product available in the Market, and these new firms are forced to charge a lower price to entice consumers to buy the additional supply these new firms are supplying (they compete for customers). Since consumers will flock toward the lowest price (in search of a bargain), older firms within the industry actually face losing their existing customers to the new firms entering the industry, and are therefore forced to lower their prices to match the lower prices set by the new firms. New firms will continue to enter the industry until the price of the product is lowered to the point that it is the same as the average economic cost of producing the product, and all of the economic profit disappears. When this happens, economic agents outside of the industry find no advantage to entering the industry, supply of the product stops increasing, and the price charged for the product stabilizes. Essentially, a competitive situation always leads to an equilibrium solution".

Normally, a firm that introduces a brand new product can initially secure a monopoly for a short while. At this stage, the initial price the consumer must pay for the product is high, and the demand for, as well as the available of the product in the market, will be limited. In the long run, however, when the profitability of the product is well established, the number of firms that produce this product will increase until the available supply of the product eventually becomes relatively large, the price of the product shrinks down to the level of the average "Economic cost" of producing the product. When this finally occurs, all monopoly associated with producing and selling the product disappears, and the initial monopoly turns into a (perfectly) competitive industry.

When consumers have full information about the prices available in the market and the quality of the products sold by the various firms, there cannot be a persistent monopolistic situation in the absence of barriers to entry and collusion. Various barriers to entry include patent rights and monopolization of a natural resource needed to produce a product. The American firm Alcoa Aluminum is a historical example of a monopoly due to natural resource control; their control of "practically every source of bauxite in the United States" (bauxite is used to produced aluminum) was one key reason that "Alcoa was, for a long time, the sole producer of aluminum in the United States."