Question

How does the quantity produced and price charged by a monopolist compare to that of a perfectly competitive firm?

Short answer

In conclusion, a monopolist produces a lower quantity and charges a higher price for its product compared to a firm operating in a perfectly competitive market. This outcome results from the market power that monopolists hold, allowing them to restrict output and set prices above their marginal costs to maximize profits.

Step-by-step solution

Understand Monopoly and Perfectly Competitive Market

A monopolist is a single seller in a market with no close substitutes available for its product. A monopolist has significant control over the price of its product and faces a downward-sloping demand curve. On the other hand, a perfectly competitive market is characterized by a large number of sellers and buyers, where products are virtually identical, and no single producer or consumer can influence the market price. In a perfectly competitive market, firms face a horizontal demand curve, i.e., they are price takers.

Analyze Supply and Demand Conditions of both Market Structures

In a monopoly, because the monopolist is the sole seller of the product, it faces the entire market's demand curve. To maximize its profits, a monopolist chooses the quantity at which the marginal cost (MC) equals the marginal revenue (MR). Furthermore, the monopolist can then set the price for the product based on the market demand curve at that quantity. In a perfectly competitive market, each firm faces a horizontal demand curve, or perfectly elastic demand, at the prevailing market price. In the long run, a firm in a perfectly competitive market will produce where its MC equals the market price, which corresponds to the point where each firm's MR also equals the MC.

Compare Quantity Produced

In a monopolist market, the quantity produced is lower than the quantity produced in a perfectly competitive market. Due to market power, the monopolist restricts output, producing at a point where MC equals MR, but this quantity is lower than what would be produced if the market were perfectly competitive. To illustrate, let the demand curve be given by \(Q_D = a - bP\) and the monopolist's marginal cost is constant \(MC = c\). The monopolist's marginal revenue curve equals \(MR = a - 2bQ\). Equating MC and MR, we find the monopolist's output level \(Q_M = \frac{a - c}{2b}\). In a perfectly competitive market, firms set their quantity such that price equals MC, so \(P = c\). Plugging this price back into the demand curve, we find the competitive output level \(Q_C = \frac{a - c}{b}\). Since \(Q_C > Q_M\), monopolists produce lower quantities than perfectly competitive firms.

Compare Price Charged

In a monopolist market, the price charged is higher than in a perfectly competitive market. Having control over the price, a monopolist sets the price based on the market demand curve at the chosen quantity to maximize profits. This price is usually greater than the marginal cost of production, which allows the monopolist to earn above-normal profits. On the other hand, in a perfectly competitive market, each firm is a price taker, and thus the price equals the marginal cost, which is the lowest possible price that allows the firms to cover their costs and earn normal (zero economic) profits. Using the above example, a monopolist charges price \(P_M = a - bQ_M = c + \frac{a - c}{2}\), while a competitive firm charges price \(P_C = c\). Clearly, \(P_M > P_C\), so monopolists charge higher prices than perfectly competitive firms. In conclusion, a monopolist produces a lower quantity and charges a higher price for its product compared to a firm operating in a perfectly competitive market. This outcome results from the market power that monopolists hold, allowing them to restrict output and set prices above their marginal costs to maximize profits.