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Homework answers / question archive / Explain why the profit maximizing price and quantity for a price-setting firm (in a market where it can only set one price) will result in an outcome that can be considered Pareto inefficient
Explain why the profit maximizing price and quantity for a price-setting firm (in a market where it can only set one price) will result in an outcome that can be considered Pareto inefficient.
Consider an inverse demand function given by: P = A - Q
Monopoly:
P = A -Q
TR = (A-Q)*Q
TR'(Q) = MR = A - 2Q
MC = c
Equating MR to MC, we get:
A - 2Q = c, or
Qm = (A-c)/2
Pm = (A+c)/2
Perfect Competition:
Equilibrium requires equating price to marginal cost, i.e.
A - Q = c, or
Qc = A- c
Hence, we can see that under monopoly the price charged is higher while quantity produced is lower than under perfect competition. Hence, price and quantity for a price-setting firm will result in an outcome that can be considered Pareto inefficient.
