Question

The monopoly will then produce Qe. But here is the drawback: ________.

Answer 1

A monopoly determines its profit-maximizing output and price by equating marginal revenue with marginal cost and charging the corresponding price from the demand curve. The drawback is that monopolies produce less and charge more than competitive markets, creating a deadweight loss to society. In oligopolies, individual firms' temptation to increase production can lead to reduced prices and profits.

Step-by-step explanation:

The question relates to how a profit-maximizing monopoly determines its quantity and price level to maximize profits. The process involves three steps:

1. The monopoly selects the profit-maximizing level of output, Q₁, where marginal revenue (MR) equals marginal cost (MC).
2. It then decides the price to charge for Q₁ by finding the corresponding point on the demand curve, which gives price (P₁).
3. Finally, the monopoly calculates its profit by subtracting total cost from total revenue, represented by a shaded area in a figure.

The 'drawback' hinted at in the student's question likely refers to inefficiencies or potential social welfare losses associated with monopoly pricing. Monopolies tend to produce less quantity (Qe) and charge a higher price (P₁) than would occur in a perfectly competitive market, leading to a deadweight loss to society. This result stems from the fact that the monopoly's price is higher than the marginal cost of production, which prevents some consumers, who value the product more than the marginal cost, from purchasing it.

Additionally, The Prisoner's Dilemma illustrates how individual oligopolists, even knowing that acting collectively as a monopoly benefits them all, could succumb to temptation and increase their quantity, thereby reducing market prices and potential profits. This behavior can lead to a situation where oligopolists earn zero economic profits, akin to perfect competitors.