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Can you explain the profit-maximising equilibrium of a monopoly vs perfect competition?

Relevant Topics

This question pertains to topics in Microeconomics, such as Monopoly, Perfect Competition, and Profit Maximisation.

Definitions:

Monopoly: A market structure characterised by a single seller, selling a unique product in the market with no close substitutes. In a monopoly market, the seller faces no competition, as he is the sole seller of goods with no close substitute.

Perfect Competition:
A type of market structure where a large number of small firms compete against each other. In this setting, all firms sell identical products and no barriers to entry or exit exist.

Profit Maximising Equilibrium:
This is the point where a firm determines the price and output level that generates the most profit.

Detailed Explanation:

In both a monopoly and perfect competition, firms aim to maximise their profits. However, the way they reach this equilibrium differs due to market structure differences.

In a perfectly competitive market, firms are price takers – they have no power to influence the market price, which is determined by market demand and supply. Each firm produces where its marginal cost (MC) equals the market price (P), i.e., P = MC, and thus also equals marginal revenue (MR). This condition ensures that they are maximising their profit or minimising their losses.

On the contrary, a monopoly, being the sole provider, has market power to set its price. They maximise their profit by producing at a level where marginal cost (MC) equals marginal revenue (MR), i.e., MC = MR. But unlike perfect competition, price (P) is higher than MC. The monopolist charges a price (P) on the demand curve corresponding to this output level. This results in a higher price and lower output compared to perfect competition, leading to supernormal profits.

Recent: 

Perfect Competition - Agricultural Markets: In many agricultural markets, individual farmers (small in relation to the entire market) sell identical products like wheat, corn etc. They accept the prevailing market price, making these markets near perfect competition.

Monopoly - De Beers:
Until the 21st century, De Beers controlled a significant portion of the world's diamond supply, essentially operating as a monopoly. They could influence the market price and maintained high profits.

Summary:

The profit-maximising equilibrium in a monopoly and perfect competition differs mainly due to the market structure. In perfect competition, firms are price takers and maximise profits where P=MC=MR. In contrast, a monopolist, with its price-setting power, maximises profits where MC=MR but charges a price (P) higher than MC, leading to supernormal profits.

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