Can someone explain how does P and Q in a monopoly compare to P and Q in a Perfectly Competitive Market?
In: Economics
Edit: oops forgot this was ELI5 not ELI16 so:
Imagine we have two people, one called supply and one called demand.
Demand is a simple man. All he wants is chocolate covered almonds. If it’s cheap, he’ll buy lots of chocolate covered almonds. If it’s expensive, he’ll buy less chocolate covered almonds. His want for chocolate almonds stays constant regardless of if it’s a competitive market or a monopoly.
**Perfectly competitive market**
Supply makes and sells chocolate covered almonds. In a perfectly competitive market, he’s pretty simple too. If demand is willing to pay him more, he’ll make more almonds. If demand doesn’t want to pay him as much, he’ll sell less almonds.
So in a perfectly competitive market, price of almonds and quantity of almonds sold is just where supply and demand agree on how many chocolate almonds they’re selling, and how much demand is paying supply for those almonds.
**Monopoly**
Monopoly is a bit different.
Demand still has the same want for chocolate covered almonds, but now supply can sell at any price and demand will have to buy it from them of course, of they sell the almonds at a lower price, demand will want to buy more, and if they sell it at a higher price, demand won’t want to buy as much.
Now supply has to look at some different metrics.
If supply sells more almonds, demand will slowly become sick of eating so much chocolate covered almonds, so supply will have to decrease his prices to convince demand to buy almonds. This is the decreasing marginal revenue with regards to quantity sold.
If supply wants to sell more almonds, he’ll have to work longer to make almonds. However, he notices that as he goes into his 17th straight sleepless hour of almond making, his almond making efficiency has decreased dramaticay. This is the law of diminishing returns at work, and shows itself as increasing marginal cost with regards to quantity sold (it costs supply more to make more almonds after he’s already made a lot of almonds)
So because supply can set the price to whatever he wants and doesn’t need to worry about being out competed, supply just makes almonds until it costs more to make more almonds then he would earn back selling them.
ELI16 version:
In a perfectly competitive market, Qd (Q demand) falls as P rises and Qs (Q supply) rises as P rises. Therefore P* and Q* (market price and market quantity) is located at the intersection of Qd and Qs.
This is because there are hypothetically infinite suppliers in a perfectly competitive market, so individual suppliers have no power to change the market. If a supplier sold at less than P*, they would be sold out quickly and the consumer would move on to buy more expensive options. If a supplier sold at more than P*, no one would buy from them because there are enough less expensive options.
On the other hand, in a monopoly, Qd is the same as in a competitive market, but there isn’t really a Qs since there aren’t multiple suppliers. in this case, P* and Q* is determined by the intersection of MR (marginal revenue) and MC (marginal cost) instead.
This is because in a monopoly, the consumer has no power in determining prices. Marginal Revenue is the instantaneous revenue gained from selling one more unit of product, and Marginal Cost is the instantaneous cost associated with selling one more unit of product. MC(Q) slopes upward based on the law of diminishing returns and MR(Q) slopes downward because consumers pay less wheb there is more supply (based on the Qd curve). As long as MR is higher than MC, it is worth for the supplier to sell more product. When MR is lower than MC, it is worth it for the supplier to sell less products, so the market equilibrium is at the intersection of the two.
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