Question

2) Merkel, Inc. has a monopoly in producing coconut oil. a) Draw a graph to show the profit maximization by Merkel, Inc. Label the profit maximizing quantity, QM. Show that Merkel, Inc. is earning negative economic profit [that is, economic loss]. Label the loss either by shading or by using the letters to define the area. Make sure all the curves, axes and lines are labeled appropriately. b) Suppose that the coconut oil is produced in a perfectly competitive market. Use the graph you drew for part a) to show the profit maximizing quantity [label it Qc] produced by the perfectly competitive industry. c) Compare the competitive price with the monopoly price. Does the competitive industry earn loss or the profit situation is different now? Explain. d) Use the profit situation [loss or economic profit as drawn] to explain the long run adjustment by the firms in perfect competition.

Answer 1

The following is the graph of monopolist earning losses -

The colored region is loss by the monopolist, P* and Q* are equilibrium price and output respectively.

b) The following figure shows Pc as perfect competition price and Qc as output -

In perefect competition MR is demand curve and firm produces output where MR meets AC and also puts price at the coresponding level.

c) See that price in nomopoly market is more than price in competitive market.

d) As the firms in perfect compeition are earning losses (as ATC is above MR at equilibirum output), firms will start leaving the market. This will increase the demand for each firm and hence MR curve will move upward. This leaving of firm will continue until the MR curves of all firms get equal to ATC firm at equilibrium output. Thus, in long run, fewer producers will be there earining normal profit.