Monopoly Profit Maximization: Chapter 15-3

Monopoly Profit Maximization
Chapter 15-3
A Model of Monopoly
How much should the monopolistic firm

choose to produce if it wants to
maximize profit?
The Monopolists Price and
Output Numerically
The first thing to remember is that
marginal revenue is the change in
total revenue that occurs as a firm
changes its output.
TR=P x Q
MR = Change in Total Revenue/ change in output
Another way to say it is:

how much does your Total Revenue changes as you increase output
Output Numerically
When a monopolist increases output, it
lowers the price on all previous units.
As a result, a monopolists marginal
revenue is always below its price.
Output Numerically
In order to maximize profit, a
monopolist produces the output level
at which marginal cost equals
marginal revenue.
Producing at an output level where

MR > MC or where MR < MC will
yield lower profits.
Profit Maximizing Level of
Output
The goal of the monopolistic firm is to maximize profits,
the difference between total revenue and total cost
The monopoly maximizes profit when marginal revenue
equals marginal cost
Marginal revenue (MR) is the change in
total revenue associated with a change in
quantity
Marginal cost (MC) is the change in total cost associated
with a change in quantity
15-6
Profit Maximizing Level of
Output
The profit-maximizing condition of a monopolistic firm is:
MR = MC
For a monopolistic firm, MR < P

A monopolistic firm maximizes total profit, not profit per unit
If MR > MC,
The monopoly can increase profit by increasing output
If MR < MC,
The monopoly can increase profit by
decreasing its output 15-7
Profit Maximization for a Monopolist
Output Price TR MR TC MC ATC Profit

0 36 0 47 47
1 33 33 33 48 1 48.00 15
2 30 60 27 50 2 25.00 10
3 27 81 21 54 4 18.00 27
4 24 96 15 62 8 15.50 34
5 21 105 9 78 16 15.60 27
6 18 108 3 102 24 17.00 6
7 15 105 3 142 40 20.29 37
8 12 96 9 196 56 24.75 102
9 9 81 15 278 80 30.89 197
Output Graphically
The marginal revenue curve is a
graphical measure of the change in
revenue that occurs in response to a
change in price.
It tells us the additional revenue the
firm will get by expanding output.
MR = MC Determines the Profit-
Maximizing Output**
If MR > MC, the monopolist gains profit
by increasing output.
If MR < MC, the monopolist gains profit
by decreasing output.
If MC = MR, the monopolist is
maximizing profit.
The Price a Monopolist Will
Charge
The MR = MC condition determines the
quantity a monopolist produces.
The monopolist will charge the
maximum price consumers are willing to
pay for that quantity.
That price is found on the demand
curve.
The Price a Monopolist Will
Charge
To determine the profit-maximizing
price (where MC = MR), first find the
profit maximizing output.
Determining the Monopolists
Price and Output
Price MC
Monopolist
$36 price
30
24
18
12
6 D
0
6 1 2 3 4 5 6 7 8 9 10
12 MR
Profits and Monopoly
Draw the firm's marginal revenue curve.
Determine the output the monopolist
will produce by the intersection of the
MC and MR curves.
Determine the price the monopolist will
charge for that output.
Determine the average cost at that level
of output.
Determine the monopolist's profit (loss)
by subtracting average total cost from
average revenue (P) at that level of
output and multiply by the chosen
output.
The monopolist will make a profit if
price exceeds average total cost.
The monopolist will make a normal return
if price equal average total cost.
The monopolist will incur a loss if price is
less than average total cost.
A Monopolist Making a Profit
A monopolist can make a profit.
A Monopolist Making a Profit
Price MC
ATC
PM A
Profit
CM B
MR D
0 QM Quantity
A Monopolist Breaking Even
A monopolist can break even.
A Monopolist Breaking Even
Price MC
ATC
PM
MR D
0 QM Quantity
A Monopolist Making a Loss
A monopolist can make a loss.
A Monopolist Making a Loss
Price MC ATC
CM B
Loss A
PM
MR D
0 QM Quantity
Profit Maximization
The monopoly firm will not set the price
arbitrarily high, the profit-maximizing price
still corresponds to the point where
MR=MC.
The monopoly firms market power will

allow the firm to achieve above-normal
profits.
Profit Maximization
Monopolistic Profit
Maximization Table The profit-
P TR MR TC MC ATC Profit maximizing
Q
($) ($) ($) ($) ($) ($) ($) condition is:
0 36 0 47 --- -47 MR = MR
33 1
1 33 33 48 48.00 -15
27 2 If MC < MR,
2 30 60 50 25.00 10 increase
21 4 production
3 27 81 54 18.00 27
15 8 Profit maximizing
4 24 96 62 15.50 34
9 16 quantity is where
5 21 105 78 15.60 27 MC = MR
3 54
6 18 108 102 17.00 6 If MC > MR,
-3 40 decrease
7 15 105 142 20.29 -37 production
-9 56
8 12 96 198 24.75 -102
-15 80
9 9 81 278 30.89 -197
15-26
Monopolistic Profit Maximization
Graph
P Marginal revenue is not constant
MC as Q increases because:
revenue increases as the
monopolist sells more
D at Qprofit max
revenue decreases because the
monopolist must lower the price
P= to sell more
$24
Find output where
MC = MR, this is the profit
MC = MR maximizing Q
D
MR
Q Find how much consumers
4 = Qprofit max will pay where the profit max
Q intersects demand, this is
the monopolist price
15-27
Monopoly Profit and Loss
A monopolist will suspend operations in the
short run if its price does not exceed the average
variable cost at the quantity the firm produces.
A monopolist will shut down permanently if
revenue is not likely to equal or exceed all costs
in the long run.
In contrast, however, if a monopolist makes a
profit, barriers to entry will keep other firms out
of the industry.
Monopoly Myths
1. A monopolist can charge any price it
wants and will reap unseemly profits by
continually increasing the price.
2. A monopolist is not sensitive to

customers.
3. A monopolist cannot make a loss.

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Monopoly Profit Maximization

How much should the monopolistic firm

MR = Change in Total Revenue/ change in output

Another way to say it is:

Producing at an output level where

For a monopolistic firm, MR < P

Output Price TR MR TC MC ATC Profit

The monopoly firms market power will

2. A monopolist is not sensitive to

3. A monopolist cannot make a loss.

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