Question

How does the price set by a monopolist compare with the price under competition? Using the markup equation introduced in the class, be specific about the difference in magnitude between the prices.

Answer 1

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Answer – In order the understand the difference in the price set by a monopolist to the price under competition, we need to understand the market structures of monopoly and perfect competition and the equilibrium conditions in the two markets.

In monopoly, there is a single seller who faces a downward sloping demand and MR curve. The equilibrium output is determined when the profit maximizing condition of MR = MC is satisfied. Let us assume from the below graph that the equilibrium output for the monopolist is Qm. The price that the monopolist will charge for Qm is determined from the downward sloping demand curve faced by the monopolist. Let the optimum price for the monopolist for Qm quantity be Pm.

On the other hand, in perfect competition, there are large number of buyers and sellers. Each seller is a price taker and the individual demand curve is a horizontal straight line. However, the market demand curve, resembles a downward sloping linear straight line. The equilibrium condition in perfect competition is P=MC. Let us assume that the optimum price and quantity in a perfectly competitive industry is Pc and Qc respectively.

We will always see that Qm<Qc and Pm>Pc.

The markup in monopoly is the difference between P and MC. In perfect condition, we know that P = MC. So markup is zero in perfect competition.

Thus, the monopolist charges a much higher price compared to the price under perfect competition. This distortion in a monopolist market from perfect competition gives rise to dead-weight loss in the market.

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