Question

The first thing to notice about monopoly is that price exceeds the marginal cost of production: PM > MC. The price in a market reflects the value to society of another unit of output. Marginal cost reflects the cost to society of the resources needed to produce an additional unit of output. Since price exceeds marginal cost, the monopolist produces less output than is socially desirable. In effect, society would be willing to pay more for one more unit of output than it would cost to produce the unit. Yet the monopolist refuses to do so because it would reduce the firm’s profits. This is because marginal revenue for a monopolist lies below the demand curve, and thus MR ' MC at this level of output.

What does it mean by Marginal cost reflects the cost to society of the resources needed to produce an additional unit of output?

Answer 1

Marginal cost is the additional cost incurred when the firm decides to produce one more unit of the output. In any market structure, there are certain resources such as labor, capital, raw materials, used in the production process. So when firms produce a given level of output, they draw certain resources from society's pool of resources. For each additional unit of output produced, a definite amount of these resources is taken up / used up and this involves a definite opportunity cost. This opportunity cost is represented by the marginal cost which then explains the cost imposed on the society in terms of a reduction in the total amount of the resources that is needed to produce an additional unit of output.