Monopoly versus Perfect Competition

PITFALLS: IS THERE A MONOPOLY SUPPLY CURVE?

PITFALLS

IS THERE A MONOPOLY SUPPLY CURVE?
Given how a monopolist applies its optimal output rule, you might be tempted to ask what this implies for the supply curve of a monopolist. But this is a meaningless question: monopolists don’t have supply curves.
Remember that a supply curve shows the quantity that producers are willing to supply for any given market price. A monopolist, however, does not take the price as given; it chooses a profit-maximizing quantity, taking into account its own ability to influence the price.

When Cecil Rhodes consolidated many independent diamond producers into De Beers, he converted a perfectly competitive industry into a monopoly. We can now use our analysis to see the effects of such a consolidation.

Let’s look again at Figure 13-6 and ask how this same market would work if, instead of being a monopoly, the industry were perfectly competitive. We will continue to assume that there is no fixed cost and that marginal cost is constant, so average total cost and marginal cost are equal.

If the diamond industry consists of many perfectly competitive firms, each of those producers takes the market price as given. That is, each producer acts as if its marginal revenue is equal to the market price. So each firm within the industry uses the price-taking firm’s optimal output rule:

In Figure 13-6, this would correspond to producing at C, where the price per diamond, PC, is $200, equal to the marginal cost of production. So the profit-maximizing output of an industry under perfect competition, QC, is 16 diamonds.

But does the perfectly competitive industry earn any profits at C? No: the price of $200 is equal to the average total cost per diamond. So there are no economic profits for this industry when it produces at the perfectly competitive output level.

We’ve already seen that once the industry is consolidated into a monopoly, the result is very different. The monopolist’s calculation of marginal revenue takes the price effect into account, so that marginal revenue is less than the price. That is,

As we’ve already seen, the monopolist produces less than the competitive industry—8 diamonds rather than 16. The price under monopoly is $600, compared with only $200 under perfect competition. The monopolist earns a positive profit, but the competitive industry does not.

So, just as we suggested earlier, we see that compared with a competitive industry, a monopolist does the following: