Question

Both competitive market firms and monopoly market firms use the same marginal cost equals marginal revenue rule to select profit maximizing output, but economists argue that the profit maximizing behavior of competitive firms leads to a socially efficient allocation of resources but that the profit maximizing behavior of a monopoly leads to an inefficient allocation of resources. Explain.

Answer 1

Perfectly competitive firm are price taker. So they charge price as market price. So at every level of output price are same. So, price equals marginal revenue.so perfectly competitive firm faces horizontal demand curve.

So they produce where price =MR =MC.

So it is socially efficient quantity.

But, monopolist are price maker so they face downward sloping demand curve. Marginal revenue curve is below the demand curve. Monopolist maximise its profit by producing where MR equals MC. So price > MR=MC.

Socially efficient quantity is when price =MC.

So perfectly competitive firm produce where price =MR =MC and thus, it is socially efficient.

But monopoly produce where price >MC. So, it is not socially efficient.