Microeconomics Assignment: Firm Behavior and Organization of Industry

This assignment analyzes key microeconomic concepts related to firm behavior and market structures. The student's solution explores profit maximization in monopolies and perfectly competitive firms, emphasizing the MR=MC rule and explaining why price differs between the two. It addresses conditions under which firms make losses, and when they continue to operate despite them. The assignment further explains the occurrence of deadweight loss in monopolies compared to perfect competition, along with the conditions leading to a lower monopoly price. Finally, it examines excess capacity in monopolistic competition and its impact on consumer prices. The assignment demonstrates understanding of market dynamics, including supply, demand, and pricing strategies within different competitive environments.

Running head: MICROECONOMICS
Microeconomics
Name of the Student
Name of the University
Student ID

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Table of Contents
Answer 1....................................................................................................................................2
Answer 2....................................................................................................................................2
Answer 3....................................................................................................................................3
Answer 4....................................................................................................................................3
References..................................................................................................................................5

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Answer 1
Monopolies and perfectly competitive firms both maximize where MR=MC because
marginal cost gives the amount of cost a firm would incur by producing one more unit and
marginal revenue gives the amount of revenue the firm would earn by selling one more unit
of product. Thus, if MR>MC, could earn more by producing and if MR<MC a firm would
makes losses by producing (Varian, 2014). Therefore, profit is maximized for both monopoly
and perfectly competitive firm at MR=MC. However, even if the profit maximizing condition
is same for both type of firm, price charged by monopoly firm is higher than price charged by
perfectly competitive firm because in perfect competition MR curve is horizontal as there are
infinite number of firms in perfect competition (Azevedo & Gottlieb, 2017). Hence, if
perfectly competitive firm charges price above MC then MR becomes zero as other firm
would charge a lower price as takes entire demand. Thus, in perfect competition price equals
MC. On the other hand, in monopoly MR is downward sloping and lies below demand curve
as it is steeper than the demand curve, thus charging a higher price would only decrease the
quantity demanded. Thus, the monopoly firm produces at MR=MC but charges the price
given by the demand curve which is higher than MC. Thus, price in monopoly is higher than
MC.
Answer 2
Monopolies and perfectly competitive firms would make losses even after operating
at MR=MC, when the when price of the product is below average total cost. However, both
the firms would continue to produce even after making losses if certain conditions are met.
Suppose, the firms are producing below average total cost but above average variable cost,
then the firms might continue to operate, as it would cover entire variable cost and some part
of the fixed cost (Balakrishnan, Labro & Soderstrom, 2014). The firm would also continue to

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operate in the short run with losses if they are hopeful to make profit in the long run.
However, if the price falls below average variable cost then the firms will shut down, as they
cannot cover any of the costs by operating.
Answer 3
Monopoly and perfectly competitive firms both maximize profit at MR=MC but in
case of monopoly deadweight loss occurs unlike perfect condition. This happens due to the
structure of the market and shape of the MR curve. In perfect competition, there are infinite
firms and MR curve is horizontal and signifies the demand of the market and price charged at
P=MC. Thus, both quantity and price is determined at the point where D=MR=MC and if any
firm tries to charge more price then the firm has to exit as others would charge low price
(Pindyck & Rubinfeld, 2014). On the other hand, in the case of monopoly firm, MR curve is
steeper than demand curve and lies below it. Therefore, in case of monopoly output at
MR=MC is less than output at MC=D (market demand). Thus, in monopoly, output supplied
is low and price charged is higher as price is given by the demand curve, which is higher than
MC. Thus, consumer has to pay higher price for lower quantity. Thus, to earn supernormal
profit a loss in surplus occurs from both social welfare and consumer surplus loss, which the
producer could not appropriate too, and thus the loss is termed as deadweight loss (Aggrawal
et al., 2014).
The price of a monopoly firm could be lower than the price of a perfectly competitive
firm if the price charged by the monopoly firm equals its MC, since MR=MC in monopoly
occurs below demand curve, which is not the case with perfectly competitive firm.
Answer 4
Considering a condition where excess capacity is present in monopolistic competition
as there are many firms. Now, the question arises that if the existence of large number of

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firms would lead to a reduction in price that the consumers have to pay (Parenti, Ushchev &
Thisse, 2017). The answer to this question is no as in monopolistic competition MR curve is
downward sloping unlike horizontal MR curve in perfect competition. Thus, in monopolistic
competition firms cannot operate at the minimum point of long run average cost curve, which
gives optimum output and no excess capacity because MR curve in monopolistic competition
does not meet long run average cost curve at tangents. Thus, price will not be lower for
consumers even when there are many firms.
However, according to Chamberlain’s theory in long run excess capacity do not exists in any
of the market structure.

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References
Aggrawal, D., Anand, A., Singh, O., & Singh, J. (2014). Profit maximization by virtue of
price & warranty length optimization. The Journal of High Technology Management
Research, 25(1), 1-8.
Azevedo, E. M., & Gottlieb, D. (2017). Perfect competition in markets with adverse
selection. Econometrica, 85(1), 67-105.
Balakrishnan, R., Labro, E., & Soderstrom, N. S. (2014). Cost structure and sticky
costs. Journal of management accounting research, 26(2), 91-116.
Parenti, M., Ushchev, P., & Thisse, J. F. (2017). Toward a theory of monopolistic
competition. Journal of Economic Theory, 167, 86-115.
Pindyck, R., & Rubinfeld, D. (2014). Microeconomics GE. Pearson Australia Pty Limited.
Varian, H. R. (2014). Intermediate microeconomics with calculus: a modern approach. WW
Norton & Company.