Monopoly question

1. Explain the level of output at which a monopoly firm will produce.
   

All firms with to receive profits, monopolies included. A monopoly will produce at the profit maximization point, where the marginal cost meets the marginal revenue. If the monopoly's average costs are below the demand curve then the firm will be making abnormal profits. Because the monopoly's demand curve is the same as the industry's demand curve, because the monopoly is the industry it will be a downward sloping demand curve. A monopoly can change its price and level of output, but not both at the same time. If a monopoly wishes to increase its profits it will reduce it output, this way the price will increase.

1. Using a diagram, explain the concept of a natural monopoly.
   

A natural monopoly states that there is only room for one firm because there are not enough economies to scale. The economies of scale set the position of the average total cost curve.

When the revenue is higher than the cost the firm is making abnormal profits. When the first is producing between q1 and q2 the monopoly is earning abnormal profits. If another firm entered the market then the demand would decrease to D2. This way the firm will not be covering its average total cost and earn losses.

So it is more productively efficient for an industry to have one firm with limited economies of scale. If there is only one firm and it produces in the demand satisfying area on the graph then that firm will earn abnormal profits. The government usually helps regulate the monopolies, blocking barriers to entry, making the firms more productively efficient.

1. Using appropriate diagrams, explain whether a monopoly is likely to be more efficient or less efficient than a firm in perfect competition.
   

A monopoly, like all firms will produce at the point where marginal cost is equal to marginal revenue. The price will be set high with low output to increase profits, but the monopoly will not be allocative or productively efficient. With large economies to scale, the marginal cost decreases making it possible for the firm to produce more and charge a higher price.

The monopoly will produce where marginal cost is equal to marginal revenue to maximize its profit. At p1, the price of the good is higher than p2, which is the monopoly's cost; thus the monopoly is earning an abnormal profit marked in green. Allocative efficiency is where marginal cost equals average revenue at q2, but the monopoly is not producing there so it is not allocatively efficient. Productive efficiency is where marginal cost is average cost at q1. However the monopoly is not producing there either so it is not productively efficient.

A perfect competition firm needs to be very efficient both allocative and productive because by raising its price, it leaves the market.