Assuming no economies of scale and identical costs, if the firms in a purely competitive industry were replaced by a profit-maximizing monopolist, the likely result would be a(n):
A) increase in both price and output.
B) unchanged price and reduced output.
C) increase in price and unchanged output.
D) increase in price and reduced output.
The correct answer and explanation is :
The correct answer is:
D) increase in price and reduced output.
Explanation:
In a purely competitive industry, numerous firms produce identical products, leading to a market equilibrium where price equals marginal cost (P = MC). Firms are price takers, meaning they cannot set prices above the market level due to competition. The result is an efficient allocation of resources, maximizing consumer and producer surplus.
If a profit-maximizing monopolist replaces these competitive firms, the market structure changes from perfect competition to monopoly. Unlike competitive firms, a monopolist is a price maker and faces a downward-sloping demand curve, meaning it must lower the price to sell additional units.
To maximize profits, the monopolist produces where marginal revenue (MR) = marginal cost (MC) rather than where price (P) = MC as in perfect competition. Because the monopolist must lower prices to sell more output, MR is always less than price (MR < P). As a result, the monopolist restricts output to maximize profit, leading to lower output than under perfect competition.
With reduced output, scarcity in the market increases, driving up the price. Thus, consumers face higher prices and reduced quantities, leading to a deadweight loss, which represents the loss of total economic welfare.
Since the problem states there are no economies of scale and identical costs, the monopolist cannot offset inefficiencies by reducing costs. Instead, it simply reduces output to maximize profits at the expense of consumer welfare.
Therefore, the correct answer is D) increase in price and reduced output, as monopoly leads to restricted supply and higher prices compared to a purely competitive market.