Both competitive firms and monopolies produce at the level where marginal cost equals marginal revenue. Then, other things remaining the same, why is price lower in a competitive market than in a monopoly?

Question

What will be an ideal response?

Answer 1

In both market structures, firms produce the level of output such that marginal cost equals marginal revenue. A firm in a perfectly competitive market faces a perfectly elastic demand curve. As a result, marginal revenue for a competitive firm is equal to price. Therefore when a competitive firm equates marginal revenue and marginal cost it also equates price and marginal cost. For a monopolist, however, marginal revenue is less than marginal cost. A monopolist faces a downward sloping market demand curve. As a consequence a monopolist must reduce price in order to sell an additional unit of its product. Therefore, for a monopolist, marginal revenue is less than price; the difference between price and marginal revenue is the effect of reducing price in order to sell more output. As a result, when a monopolist equates marginal revenue and marginal cost price will be greater than marginal cost (since price is greater than marginal revenue).