Question

5. Monopoly outcome versus competition outcome

Consider the daily market for hot dogs in a small city. Suppose that this market is in long-run competitive equilibrium with many hot dog stands in the city, each one selling the same kind of hot dogs. Therefore, each vendor is a price taker and possesses no market power.

The following graph shows the demand (D) and supply (S = MC) curves in the market for hot dogs.

Place the block point (plus symbol) on the graph to indicate the market price and quantity that will result from competition.

Assume that one of the hot dog vendors successfully lobbies the city council to obtain the exclusive right to sell hot dogs within the city limits. This firm buys up all the rest of the hot dog vendors in the city and operates as a monopoly. Assume that this change doesn't affect demand and that the new monopoly's marginal cost curve corresponds exactly to the supply curve on the previous graph. Under this assumption, the following graph shows the demand (D), marginal revenue (MR), and marginal cost (MC) curves for the monopoly firm.

Answer 1

Under perfect competition, the firm would be facing a given price and it would have equated price equal to its rising marginal cost function to determine the optimum level of output. The market demand and supply are equated against each other rto determine the price and market quantity. However, when the demand is downward sloping, the firm would again equate marginal cost MC = marginal revenue MR. This is a monopoly firm.

From the graph, we see that a perfectly competitive market produces 30 hot dogs for a price of $3.5 per hot dog. A monopoly produces 20 hot dogs at a price of $4 per hot dog.

We infer that price is generally higher in monopoly and quantity is generally lower in a monopoly.

Monopoly Competitive Market 5.0 5.0 4,5 4.0 4.5 4.0 3.5 3.0 2 5 Monopoly Outcome MC PC Outcome s-MC Deadweight Loss 3.5 3.0 2.5 2.0 1.5 2.0 1.0 MR 05 0 10 20 30 40 50607080 90 1 QUANTITY (Hot dogs) o 10 20 30 40 50 60 70 80 90 100 QUANTITY (Hot dogs)