Question

How is the demand curve perceived by a perfectly competitive firm different from the demand curve perceived by a monopolist?

Short answer

The demand curve perceived by a perfectly competitive firm is perfectly elastic (horizontal) due to its inability to influence market price, while the demand curve perceived by a monopolist is downward-sloping, reflecting its market power and ability to set prices. This difference results from the distinct market structures and respective degrees of market power held by the firms. In perfect competition, firms are price-takers, whereas monopolists hold significant control over prices and face a trade-off between price and quantity demanded.

Step-by-step solution

1. Understanding Perfect Competition and Monopoly

Perfect competition is a market structure where there are a large number of firms producing identical products or services, and no single firm has the power to influence the market price. In a monopoly, however, there is only one firm in the market, which has significant market power and can set the price of its product or service.

2. Defining the Demand Curve

The demand curve is a graphical representation of the relationship between the price of a good or service and the quantity demanded by consumers at different price levels. It illustrates the decrease in quantity demanded as the price increases, or vice versa, and helps firms in making pricing and production decisions.

3. Demand Curve in Perfect Competition

In a perfectly competitive market, firms are price-takers, meaning that they have no control over the market price and must accept the price determined by the market forces of demand and supply. The demand curve perceived by a perfectly competitive firm is perfectly elastic or horizontal, indicating that consumers are willing to purchase any quantity at the market price. This implies that the firm can sell as much or as little as it wants at the prevailing market price, without affecting the price at all. Mathematically, the elasticity of demand would be infinite.

4. Demand Curve in Monopoly

In a monopolistic market, there is only one firm in the market with significant market power, which allows it to set the price of its product or service. The demand curve perceived by a monopolist is the market demand curve, which is usually downward-sloping. This implies that the monopolist can charge higher prices and sell less quantity, or vice versa. The monopolist must decide on the price to charge to maximize profits while considering the trade-off between price and quantity demanded. In this case, the elasticity of demand will be a finite value, which depends on the consumers' preferences and the presence of substitute products.

5. Comparing the Demand Curves

The main difference between the demand curve perceived by a perfectly competitive firm and the demand curve perceived by a monopolist is in their elasticity and slope. While the perfectly competitive firm's demand curve is perfectly elastic or horizontal, the monopolistic firm's demand curve is downward-sloping, reflecting the control over price the firm has in the market. This difference in demand curves is a direct result of the different market structures and the degree of market power held by the firms in these market environments.