Econ 101: Introductory Microeconomics

Fall 2008
Discussion Section #10 Handout November 13, 14

Compare and Contrast: Perfect Competition vs. Monopoly

Perfect Competition
▪ firms take the price as given (no control over price)
▪ face a horizontal demand curve
▪ marginal revenue is equal to the market price
▪ firms earn zero economic profits
Monopoly
▪ the firm chooses the price
▪ face the downward sloping market demand curve
▪ set price higher than marginal revenue
▪ firms earn positive economic profits

Finding the Monopolist’s Equilibrium Quantity QM, Price PM and

Profit
Suppose you are given a linear demand function: P = b − mQ, and a marginal cost function.

Step 1: Graph the demand and MC curves.

Step 2: Derive and graph the marginal revenue curve.

The MR curve will have the same vertical intercept as the demand curve.
The slope of the MR curve is: 2m (twice as steep as demand).

Step 3: The monopolist chooses QM where MC = MR (set the two equations equal to each other and solve for QM ).

Step 4: Find PM by plugging QM into the demand equation.

Step 5: Monopolist’s Profit is TR – TC where: TR = QM x PM,

TC = (ATC at QM) x QM.
 Natural Monopoly
Natural monopoly is the case where one firm can produce the total quantity in a market more cheaply than multiple firms.
This situation is typically driven by large fixed costs or economies of scale. Graphically, a natural monopoly arises if the
minimum of the ATC curve is to the right of the point where the demand curve intersects the ATC curve.
 Question 1: Monopolist -- then there was one.
I. A monopolist faces a market demand curve given by P = 105 − 2Q . This monopolist has no fixed costs and faces constant
marginal cost of $5. The marginal revenue curve is given by P = 105 − 4Q.
P
$105 Monopoly

CS

Pm =$55

PS = ProfitM DWL

Pc = $5 MC = ATC = $5
MC=5
MR: P = 105 – 4Q D: P = 105 – 2Q
Qm = 25 105/4 Qc = 50 105/2 Q

a) What is the monopolist’s profit-maximizing production quantity QM?

At the profit maximization point, MR = MC,
105- 4QM = 5  QM = 25

b) What price will the monopolist charge PM?

Plug QM from a) into demand equation,
PM = 105 – QM = 105-2*25 = 55

Now suppose that this market is characterized as perfect competition instead of monopoly. The demand curve is the same as
in the monopoly characterization. Furthermore, all firms have access to the same constant marginal cost technology and
there are no fixed costs.
P
$105 Perfect Competition

D
CS

Pc = $5 MC = ATC = $5
MC=5
D: P = 105 – 2Q
Qc = 50 105/2 Q
c) What is the equilibrium price in the competitive market PC?
Perfect competition implies Pc = MR = MC. Pc = 5.

d) What is the equilibrium quantity demanded in this market QC?

Plug P from c into demand equation, P = 105 – 2Q.
 5 = 105 – 2Qc  2Qc = 100  Qc = 50

Now let’s think about comparing the monopoly and the perfect competition outcomes.

e) Is the total quantity produced and demanded higher or lower in the monopoly case?
Lower

f) Is the equilibrium price higher or lower in the monopoly case?

Higher

g) What is consumer surplus with perfect competition? With monopoly?

1
CS (Perfect Competition): (105 – 5)*50 = 2500;
2
1
CS (Monopoly): (105 – 55)*25 = 625
2
h) Does the monopolist earn a profit? How much?
Yes. Profit for monopolist: π (M) = (PM – P)*QM = (55 – 5)*25 = $1,250

i) What is the deadweight loss due to the monopoly?

1 1
DWL due to monopoly = (PM – P)*(QM – Q) = (55 – 5)*(50 – 25) = 625
2 2
or DWL due to monopoly = CS(PC) – CS(M) – π (M) = 2,500 – 625 – 1,250 = 625

II. Suppose the technology the monopoly uses changed (somehow) and the monopolist now faces a marginal cost given by
MC=Q. The demand function and marginal revenue curve do not change. (A demand curve is P = 105 – 2Q. The marginal
revenue curve is MR = 105 – 4Q. )
P
$105 Monopoly
TR (total revenue)

TC (total cost)
Pm = $63 MC: P = Q

D
PS = ProfitM
$21

TC MR: P = 105 – 4Q D: P = 105 – 2Q MC=5

Qm = 21 105/4 105/2 Q

a) What is the monopolist’s profit-maximizing production quantity QM?

At the profit maximization point, MR = MC,
105 – 4QM = QM,  QM = 21

b) What price will the monopolist charge PM?

Plug QM from a) into demand equation,
PM = 105 – QM = 105 – 2*21= $63

c) Does the monopolist make any profit? How much is the profit?
Total cost is the area underneath the MC curve up to the point of output quantity Qm.
Yes. Profit for monopolist: π (M) = (PM)*QM – TC = (63)*21 – ½ (21)(21) = $1,102.5
 Question 2: Natural Monopolist -- When one is better
a) What is the profit-maximizing quantity and price for this monopolist?
q3, p1

b) Is this efficient?
No, the price is greater than the marginal cost, therefore, it is not
allocatively efficient. In addition, the output is smaller than the
intersection of ATC and MC (it does not show on the graph, but will
be at somewhere far to the right of the Q-axis), therefore, it is not
productively efficient, either.

Suppose the government chooses to regulate this natural monopoly.

There are many ways that this firm could be regulated. The government
could require the monopolist to produce a certain quantity or require the
monopolist to charge a certain price. We consider two alternative price
regulation schemes.

c) The government requires the monopolist to charge a price

equal to marginal cost. How much will the firm produce? Is it efficient?
Is it good for the firm?
q1. This is allocatively efficient from a societal standpoint, but the
firm suffers a loss and can not sustain in the long-run. It’s not
productively efficient.

d) The government requires the monopolist to charge a price at

P2. What is the corresponding quantity the firm will produce? Is it
efficient? Is it good for the firm?
q2. It is not allocatively efficient, but at least the firm breaks even. It
is not productively efficient.