So when we think about increasing the quantity sold by one unit, marginal revenue is affected in two ways. Now the firm receives less for the first 2 units. A monopoly maximizes profit by. But the firm seeks to maximize profit, not total revenue. The profit-maximizing price and output are given by point E on the demand curve. This quantity is easy to identify graphically, where MR and MC intersect. total … Total profit is found by multiplying the firm’s output, Qm, by profit per unit, so total profit equals Qm(Pm – ATCm)—the area of the shaded rectangle in Figure 10.7 “Computing Monopoly Profit”. Horizontal demand curve: P = AR = MR buyers will buy ALL that firm can sell at the going market price. Its price is given by the point on the demand curve that corresponds to this quantity. Questions over how to define the market continue today. the firm can increase profit by producing more units. Graphically, start from the profit maximizing quantity in Figure 3, which is 5 units of output. This is straightforward if you remember that a firm’s demand curve shows the maximum price a firm can charge to sell any quantity of output. Again, we use the “midpoint” convention. The profit-maximizing number of seats sold per game is thus the quantity at which marginal revenue is zero, provided a team’s stadium is large enough to hold that quantity of fans. The marginal revenue curve for the monopoly firm lies below its demand curve. C) … On the other hand, a competitive firm experiences horizontal demand curve … Step 1. Its total revenue is thus $21. Explain the relationship between price and marginal revenue when a firm faces a downward-sloping demand curve. Draw a vertical line up to the demand curve. The flat shape means that the firm can sell either a low quantity (Ql) or a high quantity (Qh) at exactly the same price (P). It will continue to raise its price until it is in the elastic portion of its demand curve. Apply the marginal decision rule to explain how a monopoly maximizes profit. It sells this output at price Pm. All cartels are inherently reliant on a. a horizontal demand curve. As always, we follow the convention of plotting marginal values at the midpoints of the intervals. The elastic range of the demand curve corresponds to the range over which the total revenue curve is rising in Panel (b) of Figure 10.4 “Demand, Elasticity, and Total Revenue”. Figure 4. To determine the profit-maximizing output, we note the quantity at which the firm’s marginal revenue and marginal cost curves intersect (Qm in Figure 10.6 “The Monopoly Solution”). Determine from the demand curve the price at which that output can be sold. As always, firms seek to maximize economic profit, and costs are measured in the economic sense of opportunity cost. Table 2 expands Table 1 using the figures on total costs and total revenues from the HealthPill example to calculate marginal revenue and marginal cost. The profit-maximizing choice for the monopoly will be to produce at the quantity where marginal revenue is equal to marginal cost: that is, MR = MC. Using the “midpoint” convention, the profit-maximizing level of output is 2.5 million trips per year. In other words, marginal revenue is negative. Figure 10.4 Demand, Elasticity, and Total Revenue. Of course, the firm could choose a point at which demand is unit price elastic. Neither is the monopoly firm guaranteed a profit. 18) 19)The marginal revenue curve for a single-price monopoly A)lies below its demand curve. The firm could earn a higher profit by raising price and reducing output. Figure 10.3 “Perfect Competition Versus Monopoly”, Figure 10.4 “Demand, Elasticity, and Total Revenue”, Figure 10.5 “Demand and Marginal Revenue”, Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License. Total Revenue and Total Cost for the HealthPill Monopoly. Thus, the shape of total revenue isn’t clear. This monopoly faces a typical U-shaped average cost curve and upward-sloping marginal cost curve, as shown in Figure 3. Total revenue, plotted in Panel (b), is maximized at $25, when the quantity sold is 5 units and the price is $5. The demand curve is important in understanding marginal revenue because it shows how much a producer has to lower his price to sell one more of an item. Let’s explore this using the data in Table 1, which shows points along the demand curve (quantity demanded and price), and then calculates total revenue by multiplying price times quantity. In order to increase the quantity sold, it must cut the price. TYPE: M DIFFICULTY:1 SECTION: 16.4 208. Market demand curve are downward sloping according to … The monopoly firm may choose its price and output, but it is restricted to a combination of price and output that lies on the demand curve. At an output of 5, marginal revenue is 400 and marginal cost is 400, so producing this unit still means overall profits are unchanged. Select the output level at which the marginal revenue and marginal cost curves intersect. B)is horizontal. D)maximize revenue, not profits. e. a U-shaped curve. Because it is the only supplier in the industry, the monopolist faces the downward-sloping market demand curve alone. A monopolistically competitive firm does not face a horizontal demand curve. The profit-maximizing level of output is not the same as the revenue-maximizing level of output, which should make sense, because profits take costs into account and revenues do not. Still, arguments over whether substitutes are close or not close can be controversial. Question 11 2 A monopoly sees the demand curve as demand curve as while a perfectly competitive firm perceives its upward-sloping; flat downward-sloping; horizontal horizontal; upward-sloping flat; downward-sloping Question 12 Profits for a monopoly will be highest at the point where total costs are most above the demand curve. The monopolist can either choose a point like R with a low price (Pl) and high quantity (Qh), or a point like S with a high price (Ph) and a low quantity (Ql), or some intermediate point. It could not, for example, charge price P1 and sell quantity Q3. However, a monopolist can sell a larger quantity and see a decline in total revenue, since in order to sell more output, the monopolist must cut the price. The marginal cost curve is like those we derived earlier; it falls over the range of output in which the firm experiences increasing marginal returns, then rises as the firm experiences diminishing marginal returns. True, Microsoft in the 1990s had a dominant share of the software for computer operating systems, but in the total market for all computer software and services, including everything from games to scientific programs, the Microsoft share was only about 16% in 2000. Total revenue for each quantity equals the quantity times the price at which that quantity is demanded. We read up from Qm to the demand curve to find the price Pm at which the firm can sell Qm units per period. Because a sports team’s costs do not vary significantly with the number of fans who attend a given game, the economists assumed that marginal cost is zero. To be a price setter, a firm must face a downward-sloping demand curve. Once it determines that quantity, however, the price at which it can sell that output is found from the demand curve. In Panel (a), the equilibrium price for a perfectly competitive firm is determined by the intersection of the demand and supply curves. To maximize profit or minimize losses, a monopoly firm produces the quantity at which marginal cost equals marginal revenue. But the price at which the firm sells 3 units is $7. The demand curve has a portion above the AC curve, so positive profits are possible. b. identical to the marginal revenue curve. The marginal revenue curve is given by P=10−2Q, which is twice as steep as the demand curve. How a Profit-Maximizing Monopoly Chooses Output and Price. In contrast, a monopoly perceives demand for its product in a market where the monopoly is the only producer. The demand curve in Figure 10.5 “Demand and Marginal Revenue” is given by the equation Q=10−P, which can be written P=10−Q. Marginal profit is the profitability of each additional unit sold. If it wants to increase its output to Q2 units—and sell that quantity—it must reduce its price to P2. The monopoly firm’s total revenue curve is given in Panel (b). And, assuming that the production of an additional unit has some cost, a firm would not produce the extra unit if it has zero marginal revenue. For example, at an output of 4 in Figure 3, marginal revenue is 600 and marginal cost is 250, so producing this unit will clearly add to overall profits. The marginal revenue and demand curves in Figure 10.5 “Demand and Marginal Revenue” follow these rules. If you find it counterintuitive that producing where marginal revenue equals marginal cost will maximize profits, working through the numbers will help. Suppose that the monopoly was making positive economic profits, and attracted a competitor into the industry. If its stadium holds only Qc fans, for example, the team will sell that many tickets at price Pc; its marginal revenue is positive at that quantity. Because the monopolist is the only firm in the market, its demand curve is the same as the market demand curve, which is, unlike that for a perfectly competitive firm, downward-sloping. The challenge for the monopolist is to choose the combination of price and quantity that maximizes profits. Finally, recall that the midpoint of a linear demand curve is the point at which demand becomes unit price elastic. If a monopoly firm faces a linear demand curve, its marginal revenue curve is also linear, lies below the demand curve, and bisects any horizontal line drawn from the vertical axis to the demand curve. At a price of 0, the quantity demanded is 10; the marginal revenue curve passes through 5 units at this point. In the HealthPill example in Figure 2, the highest profit will occur at the quantity where total revenue is the farthest above total cost. Low levels of output bring in relatively little total revenue, because the quantity is low. Chapter 1: Economics: The Study of Choice, Chapter 2: Confronting Scarcity: Choices in Production, 2.3 Applications of the Production Possibilities Model, Chapter 4: Applications of Demand and Supply, 4.2 Government Intervention in Market Prices: Price Floors and Price Ceilings, Chapter 5: Elasticity: A Measure of Response, 5.2 Responsiveness of Demand to Other Factors, Chapter 6: Markets, Maximizers, and Efficiency, Chapter 7: The Analysis of Consumer Choice, 7.3 Indifference Curve Analysis: An Alternative Approach to Understanding Consumer Choice, 8.1 Production Choices and Costs: The Short Run, 8.2 Production Choices and Costs: The Long Run, Chapter 9: Competitive Markets for Goods and Services, 9.2 Output Determination in the Short Run, Chapter 11: The World of Imperfect Competition, 11.1 Monopolistic Competition: Competition Among Many, 11.2 Oligopoly: Competition Among the Few, 11.3 Extensions of Imperfect Competition: Advertising and Price Discrimination, Chapter 12: Wages and Employment in Perfect Competition, Chapter 13: Interest Rates and the Markets for Capital and Natural Resources, Chapter 14: Imperfectly Competitive Markets for Factors of Production, 14.1 Price-Setting Buyers: The Case of Monopsony, Chapter 15: Public Finance and Public Choice, 15.1 The Role of Government in a Market Economy, Chapter 16: Antitrust Policy and Business Regulation, 16.1 Antitrust Laws and Their Interpretation, 16.2 Antitrust and Competitiveness in a Global Economy, 16.3 Regulation: Protecting People from the Market, Chapter 18: The Economics of the Environment, 18.1 Maximizing the Net Benefits of Pollution, Chapter 19: Inequality, Poverty, and Discrimination, Chapter 20: Macroeconomics: The Big Picture, 20.1 Growth of Real GDP and Business Cycles, Chapter 21: Measuring Total Output and Income, Chapter 22: Aggregate Demand and Aggregate Supply, 22.2 Aggregate Demand and Aggregate Supply: The Long Run and the Short Run, 22.3 Recessionary and Inflationary Gaps and Long-Run Macroeconomic Equilibrium, 23.2 Growth and the Long-Run Aggregate Supply Curve, Chapter 24: The Nature and Creation of Money, 24.2 The Banking System and Money Creation, Chapter 25: Financial Markets and the Economy, 25.1 The Bond and Foreign Exchange Markets, 25.2 Demand, Supply, and Equilibrium in the Money Market, 26.1 Monetary Policy in the United States, 26.2 Problems and Controversies of Monetary Policy, 26.3 Monetary Policy and the Equation of Exchange, 27.2 The Use of Fiscal Policy to Stabilize the Economy, Chapter 28: Consumption and the Aggregate Expenditures Model, 28.1 Determining the Level of Consumption, 28.3 Aggregate Expenditures and Aggregate Demand, Chapter 29: Investment and Economic Activity, Chapter 30: Net Exports and International Finance, 30.1 The International Sector: An Introduction, 31.2 Explaining Inflation–Unemployment Relationships, 31.3 Inflation and Unemployment in the Long Run, Chapter 32: A Brief History of Macroeconomic Thought and Policy, 32.1 The Great Depression and Keynesian Economics, 32.2 Keynesian Economics in the 1960s and 1970s, 32.3. That fact complicates the relationship between the monopoly’s demand curve and its marginal revenue. Once we have determined the monopoly firm’s price and output, we can determine its economic profit by adding the firm’s average total cost curve to the graph showing demand, marginal revenue, and marginal cost, as shown in Figure 10.7 “Computing Monopoly Profit”. For a perfect competitor, each additional unit sold brought a positive marginal revenue, because marginal revenue was equal to the given market price. It is easier to see the profit maximizing level of output by using the marginal approach, to which we turn next. A firm’s elasticity of demand with respect to price has important implications for assessing the impact of a price change on total revenue. It cannot just “charge whatever it wants.” And if it charges “all the market will bear,” it will sell either 0 or, at most, 1 unit of output. Suppose the firm in Figure 10.4 “Demand, Elasticity, and Total Revenue” sells 2 units at a price of $8 per unit. It may choose to produce any quantity. Demand Curves Perceived by A Perfectly Competitive Firm and by A Monopoly The demand curve in Panel (a) of Figure 10.4 “Demand, Elasticity, and Total Revenue” shows ranges of values of the price elasticity of demand. A small town in the country may have only one gas station: is this gas station a “monopoly,” or does it compete with gas stations that might be five, 10, or 50 miles away? A horizontal demand curve is used to represent a market where consumers have a choice between a large group offering a nearly identical product. It may seem counterintuitive that marginal revenue could ever be zero or negative: after all, doesn’t an increase in quantity sold always mean more revenue? The demand facing monopoly can be compared with the demand facing a perfectly competitive firm. A solution that maximizes total revenue will not maximize profit unless marginal cost is zero. As the quantity sold becomes higher, at some point the drop in price is proportionally more than the increase in greater quantity of sales, causing a situation where more sales bring in less revenue. DuPont countered that even though it had a 75% market share in cellophane, it had less than a 20% share of the “flexible packaging materials,” which includes all other moisture-proof papers, films, and foils. It could, at the same time, reduce its total cost. The second firm would cause the demand facing each of the two firms to be cut in half. In the long run, it will stay in business only if it can cover all of its costs. Economic theory thus predicts that the marginal revenue for teams that consistently sell out their games will be positive, and the marginal revenue for other teams will be zero. Total profit is given by the area of the shaded rectangle ATCmPmEF. Marginal Revenue and Marginal Cost for the HealthPill Monopoly. Also, the price elasticity of demand can be different at different points on a firm’s demand curve. Consider a monopoly firm, comfortably surrounded by barriers to entry so that it need not fear competition from other producers. Remember that, similarly, marginal revenue is the change in total revenue from selling a small amount of additional output. Price discrimination allows a monopolist to increase its profit by charging higher prices for identical goods to those who are willing or able to pay more. The company will charge a toll of $0.85. If the monopoly produces a lower quantity, then MR > MC at those levels of output, and the firm can make higher profits by expanding output. The Nature of Demand and Marginal Revenue Curves under Monopoly! However, the monopolist is not seeking to maximize revenue, but instead to earn the highest possible profit. But, unlike the perfectly competitive firm, which can sell all it wants at the going market price, a monopolist can sell a greater quantity only by cutting its price. An example for the hypothetical HealthPill firm is shown in Figure 2. A)face downward sloping demand curves. Raising price means reducing output; a reduction in output would reduce total cost. For a monopoly like HealthPill, marginal revenue decreases as it sells additional units of output. Beyond 5 units, total revenue begins to decline. Thus, the monopoly can tell from the marginal revenue and marginal cost that of the choices in the table, the profit-maximizing level of output is 5. d. is more inelastic than the demand curve for the product. However, expanding output from 5 to 6 would involve a marginal revenue of 200 and a marginal cost of 850, so that sixth unit would actually reduce profits. The firm’s profit per unit is thus Pm – ATCm. They regard hockey teams as monopoly firms and use the monopoly model to examine the team’s behavior. For a quantity of 5, the corresponding price on the demand curve is $800. Four economists at the University of Vancouver have what they think is the answer for one group of teams: professional hockey teams set admission prices at levels that maximize their profits. The demand curve is downward sloping because the monopolist can sell greater output only by reducing the price of units of output. c. below the marginal revenue curve. We have said that monopolistic competition is an amalgam of perfect competition and monopoly. However, in the case of a monopoly , this is not true since a monopolist must reduce the price of his product to achieve higher sales. If demand is price elastic, a price reduction increases total revenue. Panel (a) shows the determination of equilibrium price and output in a perfectly competitive market. To sell quantity Q3 it would have to reduce the price to P3. Contrast the situation shown in Panel (a) with the one faced by the monopoly firm in Panel (b). Love of the city? The Monopolist’s Marginal Revenue Curve versus Demand Curve. Duluoz cats – face off – CC BY-NC-ND 2.0. They found that teams that don’t typically sell out their games operate at a quantity at which marginal revenue is about zero, and that teams with sellouts have positive marginal revenue. The marginal revenue curve lies below the demand curve, and it bisects any horizontal line drawn from the vertical axis to the demand curve. Thus, a profit-maximizing monopoly should follow the rule of producing up to the quantity where marginal revenue is equal to marginal cost—that is, MR = MC. The monopoly firm maximizes profit by producing an output Qm at point G, where the marginal revenue and marginal cost curves intersect. If the firm is operating in the inelastic range of its demand curve, then it is not maximizing profits. Marginal revenue is less than price for the monopoly firm. In 1956, after years of legal appeals, the U.S. Supreme Court held that the broader market definition was more appropriate, and the case against DuPont was dismissed. Monopoly: P & Q decisions in SR Demand curve for the firm is the market demand curve Number of buyers in the market (the population) is same as customer base of Since a monopolist faces a downward sloping demand curve, the only way it can sell more output is by reducing its price. It is important to understand the nature of the demand curve facing a monopolist. This is what makes a perfectly competitive firm a price taker. The marginal revenue curve for a monopolist always lies beneath the market demand curve. 19) When the demand curve is linear, as in Figure 10.5 “Demand and Marginal Revenue”, the marginal revenue curve can be placed according to the following rules: the marginal revenue curve is always below the demand curve and the marginal revenue curve will bisect any horizontal line drawn between the vertical axis and the demand curve. Because a monopolist must cut the price of every unit in order to increase sales, total revenue does not always increase as output rises. Similarly, marginal cost is the additional cost the firm incurs from producing and selling one more (or a few more) units of output. (Graphically, MR and demand have the same vertical axis.) For firms with more market control, especially monopoly, the average revenue curve is negatively-sloped. If, instead, we charge a lower price (on all the units that we sell), we would sell Q2. The economists’ statistical results were consistent with the theory. A monopoly has a negatively sloped demand curve, not a perfectly inelastic curve. The maximizing solution occurs where marginal revenue equals marginal cost. Tip: For a straight-line demand curve, the marginal revenue curve equals price at the lowest level of output. D)coincides with its demand curve. Maintenance costs constitute the variable costs associated with building the road. Second, all the previous units, which could have been sold at the higher price, now sell for less. But what defines the “market”? A firm would not produce an additional unit of output with negative marginal revenue. The demand curve for the output produced by a perfectly competitive firm is perfectly elastic, it is horizontal at the going market price. Did you have an idea for improving this content? While a monopolist can charge any price for its product, that price is nonetheless constrained by demand for the firm’s product. The horizontal demand curve means that, from the viewpoint of the perfectly competitive firm, it could sell either a relatively low quantity like Ql or a relatively high quantity like Qh at the market price P. Figure 1. Marginal revenue is positive in the elastic range of a demand curve, negative in the inelastic range, and zero where demand is unit price elastic. Stadium size and the demand curve facing a team might prevent the team from selling the profit-maximizing quantity of tickets. It is straightforward to calculate profits of given numbers for total revenue and total cost. Total revenue rises to $21. Total revenue falls as the firm sells additional units over the inelastic range of the demand curve. In this example, maximum profit occurs at 5 units of output. B) horizontal and below the the demand curve. The market supply curve is found simply by summing the supply curves of individual firms. Profit-maximizing behavior is always based on the marginal decision rule: Additional units of a good should be produced as long as the marginal revenue of an additional unit exceeds the marginal cost. Finally, total profit is the sum of marginal profits. Remember, we define marginal cost as the change in total cost from producing a small amount of additional output. Three common misconceptions about monopoly are: As Figure 10.6 “The Monopoly Solution” shows, once the monopoly firm decides on the number of units of output that will maximize profit, the price at which it can sell that many units is found by “reading off” the demand curve the price associated with that many units. Recall that marginal revenue is the additional revenue the firm receives from selling one more (or a few more) units of output. In the next chapter, we will look at cases in which firms charge different prices to different customers.). Figure 10.3 “Perfect Competition Versus Monopoly” compares the demand situations faced by a monopoly and a perfectly competitive firm. However, because a monopoly faces no competition, its situation and its decision process will differ from that of a perfectly competitive firm. To see why the marginal revenue of the third unit is less than its price, we need to examine more carefully how the sale of that unit affects the firm’s revenues. In this example, total revenue is highest at a quantity of 6 or 7. The reason for the difference is that each perfectly competitive firm perceives the demand for its products in a market that includes many other firms; in effect, the demand curve perceived by a perfectly competitive firm is a tiny slice of the entire market demand curve. 2. We define it as marginal revenue minus marginal cost. It must "take" whatever price is set in the overall market. Modification, adaptation, and original content. Once the monopolist identifies the profit maximizing quantity of output, the next step is to determine the corresponding price. Suppose, for example, that the monopoly firm represented in Figure 10.4 “Demand, Elasticity, and Total Revenue” is charging $3 and selling 7 units. To put it another way, the marginal revenue curve will be twice as steep as the demand curve. To apply that rule to a monopoly firm, we must first investigate the special relationship between demand and marginal revenue for a monopoly. A monopolist can determine its profit-maximizing price and quantity by analyzing the marginal revenue and marginal costs of producing an extra unit. Where marginal revenue is negative, demand is price inelastic. Notice that marginal revenue is zero at a quantity of 7, and turns negative at quantities higher than 7. Marginal revenue is also horizontal because the increase in revenue from producing one more unit of output is equal to the price of the good meaning it remains constant, thus horizontal. Monopoly Price and Its Relationship to Elasticity of Demand: The monopoly firm can set its price, but is restricted to price and output combinations that lie on its demand curve. How does marginal revenue compare to price? Setting the price too high will result in a low quantity sold, and will not bring in much revenue. As a result, the marginal cost of the second unit will be: Step 3. As a result, the marginal revenue of the second unit will be: Table 3 below repeats the marginal cost and marginal revenue data from Table 2, and adds two more columns. The demand curve facing a monopoly is vertical inelastic horizontal elastic The deadweight loss associated with a monopoly is due to: None of the other answers O Net loss in consumer surplus and producer surplus due to monopoly pricing strategy O Socially unproductive expenditures to obtain a monopoly Lost consumer surplus due to monopoly pricing If the gains from monopoly … A perfectly competitive firm acts as a price taker.
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