Question

Compare how perfectly competitive firms choose their profit maximizing quantity with how monopolies choose their profit maximizing quantity? Explain why a monopoly can make economic losses. Will the monopoly exit the industry if it is making economic losses?

Answer 1

Comparison between profit maximisng quantity of perfect competiton and monopoly -:

• In perfect competition, average revenue = marginal revenue. equilibrium quantity is set at the point where marginal revenue=marginal and price is set at average revenue . But since average revenue is equal to marginal revenue , so we can say that profit maximising quantity in perfect competition is set at the point where Price=Marginal cost.
• In a monopoly, both average revenue curve and marginal revenue curve are different and rapidly falling . Average revenue curve is higher then marginal revenue curve as the rate of fall in marginal revenue is more than average revenue. Profit maximising quantity is set at the point where marginal revenue=marginal cost and price is set on average revenue curve. Here prices > marginal cost.

In the diagram , profit maximising quantity is set at the point where P=MC=MR UNDER PERFECT COMPETITION.

Under Monopoly, profit maximising quantity(Q*) is set at point where MR=MC . Price is set at AR higher than Marginal cost.

• A monopoly can earn economic losses when Price< Average cost or AR<AC. It is shown in the following figure -:

the shaded region is the economic loss region for a monopolist when AR<AC OR P<AC.

• The monopoly firm will not exit the market if it is making economic losses because in the long run it will only make super normal profits as it has the market power to adjust the prices and charge them higher . This is so because monopoly is a single seller firm in the market. There are no substitutes for its product being single seller , so it exercises market power to charge prices over and above the marginal cost. In the long run , average cost is reduced due to economies of scale and hence the firm will earn supernormal profits in long run.