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Eastern Orthodoxy
Monopoly (Business)

Why is a monopoly price maker but perfectly competition a price taker?


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December 11, 2007 1:06PM

The answer to your question is quite complex, but in a very basic sense a monopoly faces no competitive constraints in the market. Under pure competition a firm can only charge the price that consumers are willing to pay. If you and I both own perfectly competitive coffee shops and I charge $1 for a cup of coffee while you are charging $2, the number of cups of coffee demanded at your shop will decrease while mine increases. I'll increase my supply as a result, and wind up raking in the cash. This will mean that you make a lot less money, and eventually you will have to change your price in order to make profits. In other words, you must TAKE the price that consumers are willing to pay, or they'll just go to other places. On the other hand, if you own the only coffee shop on the planet, you could charge whatever price you like since you control supply. No other firm can pop up and supply coffee at a lower price than yours because all of the coffee in the world comes from you. The bottom line is: a monopolist can set the industry supply curve wherever they please since they control all output, which means supply will intersect demand wherever the monopolist wants it to (which will be at the quantity where marginal revenue equals marginal cost, but that's a different story). This is by no means a complete answer, but I hope it helps.