Question

Suppose that the market demand is: P = 10 – Q, so that marginal revenue is: MR = 10 – 2Q.
The marginal cost is: MC = 4 and average cost is: AC = 4.
a. If the market structure is monopoly, determine the profit maximizing price and output for
this monopolist and calculate its economic profit or loss at the profit maximizing output.
b. If the market structure is perfect competition, determine the profit maximizing price and
total output and calculate a typical firm’s profit or loss at the profit maximizing output.
c. Which market structure is more efficient, i.e., monopoly or perfect competition? Why?

Use relevant diagrams to answer the question

Answer 1

a.

For a monopolist firm, profit is maximized at a point where its marginal revenue (MR) equals to marginal cost (MC).

Given, MR = 10 - 2Q and MC = 4.

10 - 2Q = 4

2Q = 6

Q = 3.

Now, if we put Q = 3, in the demand equation, we will get the profit-maximizing price.

P = 10 - Q = 10 - 3 = 7.

Now, to determine whether the firm earns an economic profit or loss, we need to calculate the profit or loss.

Profit = Total Revenue (TR) - Total Cost (TC).

TR = P * Q

TR = 10Q - Q² = (10 * 3) - (3 * 3) = 21.

TC = AC * Q = 4Q = (4 * 3) = 12

So, Profit = 21 - 12 = 9.

So, if the market structure is monopoly, the profit-maximizing price is $7 and output for this monopolist is 3 units and its economic profit at the profit-maximizing output is $9.

b.

For a perfectly competitive firm, profit is maximized at a point where P = MC.

Here, P = 10 - Q and MC = 4.

So, 10 - Q = 4

Q = 6

Now, if we put Q = 6 in the demand function we will get the price.

P = 10 - Q = 10 - 6 = 4

Now, to determine whether the firm earns an economic profit or loss, we need to calculate the profit or loss.

Profit = Total Revenue (TR) - Total Cost (TC).

TR = P * Q

TR = 10Q - Q² = (10 * 6) - (6 * 6) = 24.

TC = AC * Q = 4Q = (4 * 6) = 24

So, Profit = 24 - 24 = 0.

So, If the market structure is perfect competition, the profit-maximizing price is $4 and total output is 6 units and a typical firm earns zero economic profit at the profit-maximizing output.

c.

Perfect competition is more efficient market than a monopolist.

The reason behind this is, the perfectly competitive firm has less market power. That means it cannot influence the market price and quantity at all because of a large number of buyers and sellers.