Consider the following dialogue between Hilary, an Economics student, and Edison
ID: 1145873 • Letter: C
Question
Consider the following dialogue between Hilary, an Economics student, and Edison, a teaching assistant in her class HILARY: Hi, Edison, could you boost my intuition about the new material on monopoly, regulation, and antitrust, by giving me an example a "real world" monopoly? EDISON: Consider a public utility company, say, a local electric company, which is the only provider of electricity. You must purchase electricity from it as there are virtually no close substitutes for electricity. Significant barriers to entry exist due to vast economies of scale associated with generating electricity, or a government license to sell electricity makes it difficult or impossible for other firms to enter this market. In addition, an unregulated public utility company can set its own price that can lead to positive economic profits. These are the characteristics of a monopoly. HILARY: Why is the demand curve facing a perfectly competitive firm perfectly elastic (or horizontal), while the demand curve facing a monopoly is downward sloping? EDISON: A perfectly competitive firm is a price taker-it takes the market price as given and has no control over that price. Demand is nonexistent at any price above the market price. There is no incentive to sell below the market price because the perfectly competitive firm can sell as many units as it can possibly produce at the market price. Therefore, a perfectly competitive firm faces a perfectly elastic demand curve at the market price. On the other hand, a monopolist is the only supplier of a product. Everyone in the market who wishes to purchase the product has only the monopoly to buy from. Therefore, the monopoly faces a downward-sloping market demand curve, which reflects the law of demand: the greater price the lower the quantity and the other way around. However, the monopoly wishes to determine the profit-maximizing quantity. We can apply the same basic principles of marginal revenue and marginal cost that we applied to a perfectly competitive firm. However, there is an important difference between a perfectly competitive firm's marginal revenue and a monopoly's marginal revenue. Can you tell me what is that difference, Hilary?Explanation / Answer
1) Hillary- For perfectly competitive firm, marginal revenue is always equal to market price and is expresed graphically by horizontal line or parallel to Y axis. For monopoly Marginal revenue is half of market price and is expressed graphically by downward sloping marginal revenue curve and alope of MR=twice slope of AR or demand curve.and MR lies below the demand curve.
2) No because economic profit can also be zero in monopoly at profit max. Output. It can be, but not definitely.
3)Monopoly always produces an inefficient outcome because monopoly always produces at a point where MR=MCand perfectly competitive firm produces at a point where AR=MC and in monopoly AR is never equal to MR. Thus there is always a DWL in monopoly.And monopoli is inefficient in its product.