Competitive and Monopoly Firm Graphs

As discussed in previous chapters (for a review see Chapter 2 Graphic Discussion on supply and demand), the market demand curve is negatively sloped - as shown below in graph A. If there is only one firm producing in the market, then the market demand curve is the firm's demand curve. That is, there is only one firm, so all of the market demand is for the one firm. However, if there are many firms in the market, each firm has its own individual demand curve representing the part of market demand that it faces. In the case of a competitive market, each firm is so small relative to the market that it faces a demand curve that is horizontal at the market price. This means that the firm can sell as much as it wants at the market price. The firm is so small that no matter how much it produces, it can sell it all at the market price without influencing the price charged in the market. The competitive firm's demand curve is shown below in graph B. Once price is determined in the market (shown in graph A), the firm's demand curve is horizontal at that price.

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The goal of any firm is to maximize profits. This is done by setting marginal cost equal to marginal revenue. As explained in the textbook, producing at the quantity where MC=MR earns the firm the most profit possible. Therefore, to determine the quantity the firm will sell to maximize profits it is necessary to know marginal revenue and marginal cost for the firm at each level of output (so that the point where MC=MR can be found).

The marginal cost curve was developed in earlier chapters (sometimes called the marginal private cost curve). A marginal cost curve has the basic shape depicted in the graphs below. Marginal revenue (MR) is the additional revenue a firm receives from selling an additional unit of output (remember a marginal value always refers to an additional). The marginal revenue curve for a competitive firm is the same as its demand curve. This is because the competitive firm is so small that it can sell as much as it wants at the market price, without affecting market price. The horizontal demand curve for a competitive firm means that the firm will receive the market price (P*) for any unit of output it sells. The profit maximizing output for a competitive firm is where MC equals MR as shown on the graph below at Q^*.

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For a monopolist, the MR curve is NOT the same as the demand curve. This is because the monopoly firm faces the entire market demand curve, which slopes downward. Therefore, if a monopoly firm wants to sell one more unit of output, it must lower price. It can not sell one more at the market price (consumers are not willing and able to buy any more at the market price, according to the demand curve). Because the monopoly must LOWER price to sell one more, the additional revenue from selling an additional unit of output (the MR) is LESS than price. The MR curve for a monopoly firm lies below the monopoly/market demand curve. The monopoly firm's demand curve and MR curve are shown on the graph below. The profit maximizing level of output is found where MC equals MR. Notice that after the monopoly finds the profit maximizing level of output (Q^*) it will charge the highest price possible (given the demand curve). Once the profit maximizing output is found, price is determined by going up to the demand curve.

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A comparison of the price charged by competitive and monopoly firms shows that monopolies charge a higher price. A comparison of the profit maximizing output for competitive and monopoly firms shows that output will be lower with monopolies. Monopolies produce less and charge more which leads to deadweight welfare loss for society.