Question

2. a) How do the demand curves for a perfectly competitive firm, monopolistically competitive firm, and a monopoly firm differ?

b) Briefly explain why monopolists are neither productively nor allocatively efficient. What results from these circumstances?

Answer 1

a) Demand curve for a perfectly competitive firm is perfectly elastic, flat and thus, horizontal while demand curve for monopolistically competitive firm, and a monopoly is downward sloping. The difference arises because firms under competition sell identical goods and have no influence over the price they charge. While firms under monopoly and monopolistic competition sell unique and differentiated goods respectively, and thus can influence the price they charge.

b) Monopolist produce a level of output that is always to the left of the minimum efficient scale on the ATC curve. This shows that it produces an productively inefficient output. Similarly, it produces an allocatively inefficient output when it charges a price above the marginal cost. Since its demand is greater than marginal revenue, and marginal revenue is equal to marginal cost for profit maximization, price is greater than marginal cost resulting in allocative inefficiency.