ECON 101: Chap 9.2 - How a Monopoly Chooses Output and Price

Perceived demand for a perfect competitor

A firm in a perfectly competitive market faces a horizontal (perfectly elastic) demand.

• flat shape means that the firm can sell either a low quantity or a high quantity at the same price

Perceived demand for a perfect monopolist

A monopoly faces a downward-sloping demand

• monopolist’s demand curve is the same as the market demand curve, which for the most part is downward-sloping.

• if a monopolist chooses a high level of output, it can charge only a relatively low price

• has the same inverse relationship of demand curve

Total Revenue and Total Cost Graph for Monopoly

• price depends on quantity

• the total revenue decreases when the quantity increases

• profits will be highest at the quantity of output where Toal revenue is most above total cost

• TR = P(Q) x Q

Monopoly Formula Sheet

5 needed to be remembered (slide 9)

Graph - Marginal Revenue and Marginal Cost Curves

• Marginal revenue decreases as firm sells additional units of output

• marginal cost increases

Profit-maximizing

• to produce at the quantity where MR = MC

• if monopoly produces a lower quantity, then MR > MC and firm can make higher profits by expanding output

• if firm produces a greater quantity, then MC > MR, firm can make higher profits by reducing its quantity of output

• if price charged is above average cost, then firm is earning positive profits

How a Profit-Maximizing Monopoly Decides Price - Step 1

• monopoly chooses the profit-maximizing level of output, by choosing the quantity where MR = MC

How a profit-maximizing monopoly decides price - step 2 (Slide 14)

• monopoly decides how much to charge for output level Q1 by drawing a line straight up from Q1 to point T on its perceived demand curve

• the monopoly will charge a price (p1)

How a profit-maximizing monopoly decides price - step 3

• the monopoly identifies its profits: Total revenue will be quantity 1 multiplied by price 1

• total cost will be Q1 multiplied by average cost of producing Q1, which point S shows on the average cost curve to be P2

• profits will be the total revenue rectangle - total cost rectangletepS

Steps in Short form

1. identify Quantity - MR = MC

2. Look at the demand curve to see what price to charge for Q1

3. identify profit

Marginal Revenue Curve Vs Demand Curve

• always place marginal revenue curve below the demand curve

• when monopoly wants to increase quantity by one very small unit, it lowers the market price by just a little for all units solds

• extra revenue is equal to market price minus the small change in price times the whole quantity, which makes it lower than the price