Question

Explain and show why marginal revenue of a monopoly is different than in a competitive market? Show how that leads a monopoly to produce less of the good than a competitive and sells that good at a higher price?

Answer 1

In a compettitive market we have the case where all firms are price takers and so we have P=AR=MR. So AR and MR are equal in a competitive set up and so the demand curve is horizontal. For a monopoly we have MR<P and so the demand curve or the AR curve is downward sloping and the MR curve is downward sloping and is always below the AR curve. So in a monopoly case, marginal revenue declines with increasing quantity, while it is flat under perfect competition. A competitive firm will produce where P=MC and so this will be the competitive output given by qc below in the first diagram. In a monopoly case, production will be where MC=MR and the price will be determined by the corresponding point on the AR curve given by Pm below. The monopoly price will thus be higher than the competitive price as shown below, and hence the monopoly quantity will be less than the competitive quantity. This is given in the diagram below.