Monopoly profit maximizing price and quantity relationship

monopoly profit maximizing price and quantity relationship

The relationship between the price that you set for your output and the quantity consumers are willing to buy can be specified with a demand curve. Typically. A monopolist is free to set prices or production quantities, but not both When I say "high" here, I am speaking in relationship to the competitive market equilibrium. set whatever price (or quantity) they want, which level will maximize profits?. The Profit Maximization Rule is that if a firm chooses to maximize its profits, words, they used the rule Marginal Revenue = Total Cost/quantity.

Key Concepts and Summary[ edit ] A monopolist is not a price taker, because when it decides what quantity to produce, it also determines the market price. For a monopolist, total revenue is relatively low at low quantities of output, because not much is being sold. Total revenue is also relatively low at very high quantities of output, because a very high quantity will sell only at a low price.

Thus, total revenue for a monopolist will start low, rise, and then decline.

Monopoly Graph Review and Practice- Micro 4.7

The marginal revenue for a monopolist from selling additional units will decline. Each additional unit sold by a monopolist will push down the overall market price, and as more units are sold, this lower price applies to more and more units. If that price is above average cost, the monopolist earns positive profits.

Monopolists are not productively efficient, because they do not produce at the minimum of the average cost curve. As a result, monopolists produce less, at a higher average cost, and charge a higher price than would a combination of firms in a perfectly competitive industry.

Monopolists also may lack incentives for innovation, because they need not fear entry. How much output should the firm supply?

monopoly profit maximizing price and quantity relationship

If price falls below AVC, the firm will not be able to earn enough revenues even to cover its variable costs. In such a case, it will suffer a smaller loss if it shuts down and produces no output. If it shuts down, it only loses its fixed costs. Imagine a monopolist could charge a different price to every customer based on how much he or she were willing to pay.

Profit Maximization

How would this affect monopoly profits? However, there would be no consumer surplus since each buyer is paying exactly what they think the product is worth. Therefore, the monopolist would be earning the maximum possible profits. Review Questions[ edit ] How is the demand curve perceived by a perfectly competitive firm different from the demand curve perceived by a monopolist?

How does the demand curve perceived by a monopolist compare with the market demand curve? Is a monopolist a price taker? What is the usual shape of a total revenue curve for a monopolist?

What is the usual shape of a marginal revenue curve for a monopolist? How can a monopolist identify the profit-maximizing level of output if it knows its total revenue and total cost curves? How can a monopolist identify the profit-maximizing level of output if it knows its marginal revenue and marginal costs?

When a monopolist identifies its profit-maximizing quantity of output, how does it decide what price to charge? Is a monopolist allocatively efficient? Why or why not? How does the quantity produced and price charged by a monopolist compare to that of a perfectly competitive firm? Critical Thinking Questions[ edit ] Imagine that you are managing a small firm and thinking about entering the market of a monopolist.

Market Power and Monopoly

Before you go ahead and challenge the monopolist, what possibility should you consider for how the monopolist might react? If a monopoly firm is earning profits, how much would you expect these profits to be diminished by entry in the long run?

Draw the new demand curve. What happens to the marginal revenue as a result of the increase in demand? What happens to the marginal cost curve?

Identify the new profit-maximizing quantity and price. A monopoly leads to the following: A lower quantity of goods produced and consumed than in a competitive market. A higher price than the equilibrium price in a competitive market.

A higher profit for the firm. In a monopoly, a firm will typically make greater than zero economic profit remember that term?

In a competitive market, it is the act of competition that drives prices towards the equilibrium price and quantity at which the marginal firm makes zero economic profits - they are earning just enough money to cover their costs of production and to pay their owners a return that is sufficient to cover their risks.

monopoly profit maximizing price and quantity relationship

If firms in an industry are making positive economic profits, then other firms have an incentive to enter the market to try and deliver these positive profits to their owners. Generally, this extra market entry is enough to increase production and decrease equilibrium price to the point where zero economic profits are seen.

In a monopoly, these competitive pressures are absent.

monopoly profit maximizing price and quantity relationship

A firm is able to earn positive economic profits, and because they are a monopoly, other firms are unable to enter their market and drive down price. This leads to an increase in the size of the producer surplus and a decrease in the size of the consumer surplus. As a disinterested economist, we might say "who cares? That is, should we care who gets the wealth, as long as wealth is being generated?

That would be a "normative" statement. However, since we are concerned with maximizing the aggregate wealth of a society, we can ask the positive question "does a monopoly decrease total wealth generated? It is quite easy to answer this question with a supply and demand diagram. But first, consider how a monopoly works. We may have a single seller, and this seller may be able to choose his price, but he cannot control the demand curve.

Remember, the demand curve is defined by the marginal utility of consumption, a measure of how much happiness the consumers get from consuming.

So, the monopolist faces a demand curve he or she cannot change. So what a monopolist can do is choose just where the supply curve intersects the demand curve. He can choose any combination of price or quantity that exists along the demand curve. If he picks a high quantity, then he chooses a low price, or vice-versa. He cannot have a high price and high quantity. When I say "high" here, I am speaking in relationship to the competitive market equilibrium.

So, a monopoly producer will typically restrict output to some quantity below the market equilibrium. This is illustrated on the following supply and demand diagram, where Q m refers to the quantity produced by the monopolist.

To find out what price we see in this market, draw the line up from Q m until it intersects the demand curve.

Market Power and Monopoly | E B F Introduction to Energy and Earth Sciences Economics

This gives us the monopoly price, P m. These profits are illustrated in Figure as the shaded rectangle labeled abcd. While you usually think of monopolists as earning positive economic profits, this is not always the case. Absence of a monopoly supply curve. In Figurethere is no representation of the monopolist's supply curve. In fact, the monopolist's supply schedule cannot be depicted as a supply curve that is independent of the market demand curve.

Whereas a perfectly competitive firm's supply curve is equal to a portion of its marginal cost curve, the monopolist's supply decisions do not depend on marginal cost alone. The monopolist looks at both the marginal cost and the marginal revenue that it receives at each price level. In order to determine marginal revenue, the monopolist must know market demand.