Question

With the aid of a diagram explain how a monopolist determines how much output to produce and what price to charge. (2) Briefly describe price discrimination of the first, second and third degrees. (3) Explain the difference between the demand curve facing a monopoly and the demand curve facing a perfectly competitive firm (4) Explain why under monopoly, price is greater than marginal revenue, while under perfect competition, price is equal to marginal revenue.

Answer 1

1.

A monopolist produces a level of output, that can maximize the profit. Price at that level of the demand, is charged as a price as shown in the following diagram.

The profit maximizing output is identified where the MC = MR and it can be identified by quantity Q in the above diagram. Further, when the line passing through the intersection of MR and MC curve, cuts the demand curve, then price level at that point of demand, is charged as price by the monopolist.

2.

Monopolist applies first, second and third degree of price discrimination in the market. First degree price discrimination takes place when monopolist charges price at the level of price of maximum willingness to pay of the consumers and charges different prices to different consumers.

Second degree price discrimination takes place when monopolist charge different price to different group of consumers on the basis of their consumption level. A person purchasing in bulk, gets a discounted price, but a person purchasing in small amount, will get a higher price.

Third degree price discrimination takes place when monopolist charges different price to different consumers on the basis of their demographic characteristics. For example, a student will be charged a different price to the executive who have the higher paying capacity.

3.

Demand facing a monopoly is downward sloping. It shows different level of elasticity of demand at different price level. In contrast to it, demand curve in perfect competition in perfectly elastic in nature. Here, price remains same, the output can change and price is fixed by the market.

4.

In monopoly, firm is price setter and sets the price at the level of demand that is high. But, in perfect competition, the demand curve is the marginal revenue curved and firm is the price taker, so price is lower in perfect competition. Hence, price is low in perfect competition.