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IAI Actuarial Core Principles · Business Economics · Profit maximisation under perfect competition and monopoly

A perfectly competitive industry is taken over by a single firm with no change in costs, which are constant returns with identical marginal cost. Which outcome is the most likely, other things equal?

Price rises and output falls. With unchanged costs the monopolist sets marginal revenue equal to marginal cost, giving lower output than the competitive level. Some consumer surplus becomes supernormal profit and some is lost as deadweight loss.

  1. APrice rises and output falls, with consumer surplus transferred partly to the firm and partly lost as deadweight lossCorrect
  2. BPrice falls and output rises because of the monopolist's market power
  3. CPrice and output are unchanged because marginal cost is unchanged
  4. DPrice rises and output rises because the firm earns supernormal profit
  5. Price rises, output is unchanged, and no deadweight loss arises

Explanation

With the same costs, the monopolist restricts output to where MR = MC, which is below the competitive output, and charges a higher price. Part of the lost consumer surplus becomes monopoly profit and part is deadweight loss. Option 3 ignores that MR is below price.

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