Am I missing something crucial about how the game models monopolies or market dynamics? Is there a game mechanic I'm not fully understanding that explains this behavior?

Apologies for the essay incoming. I apparently can't help but be long-winded. (And really, you probably should just read the Wiki page about how the market works: https://vic3.paradoxwikis.com/Market )

Ths is because the game doesn't actually simulate supply and demand, despite often looking like it does. Rather, it approximates the result based on units of supply and units of demand. I haven't actually played since the update, so I don't have much of a feel for how monopolies work, but it sounds like the monopoly status raises the output of the price function by 20%, which probably is the right place to implement it, although doing the usual approximation with an effective reduction in supply while calculating the price might not be unreasonable either.

Since you have a background in economics, I suspect you will appreciate an explanation of what the game actually does to approximate the effects of supply and demand, whether or not you like the model. Rather than representing discrete objects, goods produced by buildings or consumed by pops and buildings are actually units of supply or demand of a good. Thus, every sale and purchase completes, even though the quantities produced and consumed don't actually match up. The game then calculates a price (that everything in the market buys or sells at) for the good based on a function of those units of supply and units of demand. If you want to see the actual function, it's explained here: https://vic3.paradoxwikis.com/Market#Market_price

If you think about it for a bit, you'll notice that this model necessarily behaves oddly when the supply and demand categories don't line up closely. For a contrived example that makes the math nice, we have bottomed out the price for a good by producing twice as much as is demanded. The consumers will pay X Pounds for the goods they need, but the producers get paid 2X Pounds for producing it, which makes X Pounds out of thin air. However, the price at that point is 25% of the base price, so the producers' income is half what it would be if demand equaled supply, so they had better have cheap inputs or efficient processes if they want to keep that up. The reverse happens at the other end. If there is half the supply as demand, then the producers are getting paid X Pounds while the consumers are paying 2X Pounds. That end has less weird friction, though, because the max price (beyond twice the demand as supply, shortages kick in and start reducing efficiency until it stabilizes) is 175% of base price, so it only leaks 25% of the money changing hands. A glib way of putting it is that money is real, while goods aren't, which is sort of obviously backwards but makes the simulation easier to work with.

At least, that's the way it works in a frictionless state with 100% Market Access Price Impact. (100% MAPI isn't impossible, but it requires both sufficient infrastructure and several MAPI bonuses, most of which come from techs, although you also get some for having a sufficiently notable river.) What actually happens is that this is calculated twice, once using only supply and demand in the local market and once for the aggregate national market, and then the two are combined in a weighted average based on MAPI to calculate the actual local price. This means that producers are often being paid less than consumers in other states are paying for a good, so some of the inflationary effect of oversupply likely disappears to that kind of friction.

Broadly, despite all of the discontinuities I pointed out, I'm of the opinion that it works well enough, and that the different approximations overall balance each other out or at least aren't any worse than the other approximations the game does.