Total profit is maximized where marginal revenue equals marginal cost. In this example, maximum profit occurs at 5 units of output. It is straightforward to calculate profits of given numbers for total revenue and total cost. Figure shows the data for these curves. Figure illustrates the three-step process where a monopolist: selects the profit-maximizing quantity to produce; decides what price to charge; determines total revenue, total cost, and profit.
The firm can use the points on the demand curve D to calculate total revenue, and then, based on total revenue, calculate its marginal revenue curve.
The monopolist will charge what the market is willing to pay. A dotted line drawn straight up from the profit-maximizing quantity to the demand curve shows the profit-maximizing price which, in Figure , is? This price is above the average cost curve, which shows that the firm is earning profits. Total revenue is the overall shaded box, where the width of the box is the quantity sold and the height is the price.
In Figure , this is 5 x? In Figure , the bottom part of the shaded box, which is shaded more lightly, shows total costs; that is, quantity on the horizontal axis multiplied by average cost on the vertical axis or 5 x?
The larger box of total revenues minus the smaller box of total costs will equal profits, which the darkly shaded box shows. Using the numbers gives? In a perfectly competitive market, the forces of entry would erode this profit in the long run. However, a monopolist is protected by barriers to entry. In fact, one obvious sign of a possible monopoly is when a firm earns profits year after year, while doing more or less the same thing, without ever seeing increased competition eroding those profits.
The marginal revenue curve for a monopolist always lies beneath the market demand curve. To understand why, think about increasing the quantity along the demand curve by one unit, so that you take one step down the demand curve to a slightly higher quantity but a slightly lower price.
A demand curve is not sequential: It is not that first we sell Q 1 at a higher price, and then we sell Q 2 at a lower price. Rather, a demand curve is conditional: If we charge the higher price, we would sell Q 1. If, instead, we charge a lower price on all the units that we sell , we would sell Q 2. When we think about increasing the quantity sold by one unit, marginal revenue is affected in two ways. First, we sell one additional unit at the new market price.
Second, all the previous units, which we sold at the higher price, now sell for less. Because of the lower price on all units sold, the marginal revenue of selling a unit is less than the price of that unit—and the marginal revenue curve is below the demand curve.
Tip : For a straight-line demand curve, MR and demand have the same vertical intercept. As output increases, marginal revenue decreases twice as fast as demand, so that the horizontal intercept of MR is halfway to the horizontal intercept of demand. You can see this in the Figure. The Inefficiency of Monopoly Most people criticize monopolies because they charge too high a price, but what economists object to is that monopolies do not supply enough output to be allocatively efficient.
To understand why a monopoly is inefficient, it is useful to compare it with the benchmark model of perfect competition. Allocative efficiency is an economic concept regarding efficiency at the social or societal level.
It refers to producing the optimal quantity of some output, the quantity where the marginal benefit to society of one more unit just equals the marginal cost.
Following this rule assures allocative efficiency. However, in the case of monopoly, price is always greater than marginal cost at the profit-maximizing level of output, as you can see by looking back at Figure.
Thus, consumers will suffer from a monopoly because it will sell a lower quantity in the market, at a higher price, than would have been the case in a perfectly competitive market. The problem of inefficiency for monopolies often runs even deeper than these issues, and also involves incentives for efficiency over longer periods of time.
There are counterbalancing incentives here. On one side, firms may strive for new inventions and new intellectual property because they want to become monopolies and earn high profits—at least for a few years until the competition catches up. In this way, monopolies may come to exist because of competitive pressures on firms. However, once a barrier to entry is in place, a monopoly that does not need to fear competition can just produce the same old products in the same old way—while still ringing up a healthy rate of profit.
He meant that monopolies may bank their profits and slack off on trying to please their customers. The old joke was that you could have any color phone you wanted, as long as it was black. An explosion of innovation followed.
Services like call waiting, caller ID, three-way calling, voice mail through the phone company, mobile phones, and wireless connections to the internet all became available. Companies offered a wide range of payment plans, as well. It was no longer true that all phones were black. Instead, phones came in a wide variety of shapes and colors.
The end of the telephone monopoly brought lower prices, a greater quantity of services, and also a wave of innovation aimed at attracting and pleasing customers. In the opening case, we presented the East India Company and the Confederate States as a monopoly or near monopoly provider of a good. Regarding the cotton industry, we also know Great Britain remained neutral during the Civil War, taking neither side during the conflict.
Did the monopoly nature of these business have unintended and historical consequences? Might the American Revolution have been deterred, if the East India Company had sailed the tea-bearing ships back to England? Of course, it is not possible to definitively answer these questions. We cannot roll back the clock and try a different scenario.
We can, however, consider the monopoly nature of these businesses and the roles they played and hypothesize about what might have occurred under different circumstances. Perhaps if there had been legal free tea trade, the colonists would have seen things differently.
There was smuggled Dutch tea in the colonial market. If the colonists had been able to freely purchase Dutch tea, they would have paid lower prices and avoided the tax. What about the cotton monopoly? With one in five jobs in Great Britain depending on Southern cotton and the Confederate States as nearly the sole provider of that cotton, why did Great Britain remain neutral during the Civil War?
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.
This gives us the monopoly price, P m. In a competitive market, wealth is the sum of the red, yellow, and blue areas. In the monopoly market, it is just the sum of the yellow and red areas. The blue area is wealth that is lost to society. This area is the Deadweight Loss. This labeled as "DWL" in Figure 5. This is the cost to a society of allowing a monopoly to operate. So, in a monopoly, the producer makes more, the consumer makes less, and the society, added together, is poorer as a result.
In order to find the dead-weight loss, we need to calculate the area of triangle bounded to the equilibrium point and monopolistic quantity Qm.
The consumer surplus will be x 90 x 0. The total wealth generated by this market will be 40, The area of this triangle is x 40 x 0. While a monopoly must be concerned about whether consumers will purchase its products or spend their money on something altogether different, the monopolist need not worry about the actions of other firms.
As a result, a monopoly is not a price taker like a perfectly competitive firm. Rather, it exercises power to choose its market price. Notice in the competitive market, demand is downward sloping, but how does demand behave for the individual firm? In Figure 8. Since the firm cannot deviate from the market price dictated by aggregate supply and demand, they face an elastic demand curve.
If they raise the price, they will sell no units; if they drop the price, they will sell an infinite amount of units. So we know a competitive market faces an elastic demand, what about a single-priced monopoly?
This is distinct from other monopolies in that the firm must charge the same price to all consumers. To explore monopoly, consider the sunglasses market. What do Oakley, Ray-Ban and Persol have in common? They are all owned by the same brand. This is fairly close to a monopoly, as with that high of a market share, Luxottica dominates the market price. Notice that Luxottica is not a single price monopoly, as it practices a form of price discrimination by having multiple brands aimed at different consumers.
Whereas the competitive firm was a small player in the aggregate market, the monopolist dictates both the final price and the quantity. Why did Britain not recognize the Confederacy at that point? Two reasons: The Emancipation Proclamation and new sources of cotton.
Having outlawed slavery throughout the United Kingdom in , it was politically impossible for Great Britain, empty cotton warehouses or not, to recognize, diplomatically, the Confederate States.
In addition, during the two years it took to draw down the stockpiles, Britain expanded cotton imports from India, Egypt, and Brazil. Monopoly sellers often see no threats to their superior marketplace position. In these examples did the power of the monopoly blind the decision makers to other possibilities? But, as they say, the rest is history. 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. 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. Aboukhadijeh, Feross. Accessed July 7, British Parliament. Dattel, E. Accessed July Grogan, David. Accessed March 12, Massachusetts Historical Society. Pelegrin, William. Skip to content Chapter 9. Learning Objectives By the end of this section, you will be able to:. Explain the perceived demand curve for a perfect competitor and a monopoly Analyze a demand curve for a monopoly and determine the output that maximizes profit and revenue Calculate marginal revenue and marginal cost Explain allocative efficiency as it pertains to the efficiency of a monopoly.
What defines the market? What is the difference between perceived demand and market demand? Maximizing Profits If you find it counterintuitive that producing where marginal revenue equals marginal cost will maximize profits, working through the numbers will help. Figure 6. Because the market demand curve is conditional, the marginal revenue curve for a monopolist lies beneath the demand curve. The Rest is History In the opening case, the East India Company and the Confederate States were presented as a monopoly or near monopoly provider of a good.
How much output should the firm supply? Hint : Draw the graph. Imagine a monopolist could charge a different price to every customer based on how much he or she were willing to pay. How would this affect monopoly profits? Review Questions 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? Explain briefly. 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 Imagine that you are managing a small firm and thinking about entering the market of a monopolist.
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