9.6 profit maximising output for a monopolist

• A monopolist aims to maximize profit, which means they will choose a level of output (quantity) where their marginal revenue (MR) equals their marginal cost (MC).
• Unlike competitive firms, monopolists are price setters, not price takers. They have the ability to influence the price of the product they are selling because they are the sole producer in the market.
• Marginal Revenue (MR): The additional revenue earned from selling one more unit of output.
• Marginal Cost (MC): The additional cost incurred from producing one more unit of output.
• • Average Cost (AC): The total cost divided by the number of units produced.
• MR = MC: The monopolist maximizes profits by producing the quantity where MR = MC.
• Determine Price from the Demand Curve: Once the monopolist chooses the profit-maximizing output, they look at the demand curve to see the price they can charge for that output level.
• Check Average Cost: The monopolist must ensure that the price they charge covers the average cost (AC) of production. If not, they will operate at a loss.
• • Demand Curve (D): Represents how much quantity consumers will buy at different price levels. The monopolist faces the entire market demand.
• Marginal Revenue (MR): Shows the additional revenue earned from selling one more unit. MR lies below the demand curve because the monopolist must lower the price on all units to sell additional ones.
• TR Curve: Total revenue increases as more units are sold, but it eventually decreases because the monopolist must lower the price significantly to sell more units.
• Demand Curve (DD): Represents market demand. It shows the price consumers are willing to pay for different quantities.
• Marginal Revenue (MR): Lies below the demand curve because the monopolist must lower the price to sell more units.
• Marginal Cost (MC): Represents the additional cost of producing one more unit.
• • Average Cost (AC): The total cost divided by the number of units produced.
• Profit Maximization:

  • The monopolist sets MR = MC to determine the profit-maximizing output, which is Q1.
  • At Q1, the monopolist can charge a price P1, which is determined by the demand curve.
  • The monopolist's profit is the shaded area between P1 (price) and AC1 (average cost) for the quantity Q1.
• Setting MR = MC:

  • To maximize profit, the monopolist produces the quantity Q1 where MR = MC.
  • This is the optimal level of output for a monopolist because any additional output would decrease overall profit.
• Setting Price Based on the Demand Curve:

  • The monopolist uses the demand curve to determine the highest price consumers are willing to pay for Q1 units of output.
  • This price is P1.
• Monopoly Profits:

  • The monopolist’s profit is the difference between the price P1 and the average cost at that output level, multiplied by the quantity produced.
  • Profits are represented by the shaded area on the graph (above AC1 and below P1).
• Price Setting and Market Power:

  Unlike competitive firms that are price takers, a monopolist has market power and can set prices. This is because they are the sole producer in the market and face no competition.

  • The monopolist always sets price (P) above marginal cost (MC) because they have the power to influence the market price.
  • The less elastic the demand curve, the more pricing power the monopolist has. Elasticity refers to how sensitive consumers are to changes in price.
• Elasticity and Marginal Revenue:

  Elasticity of demand plays a significant role in determining the monopolist’s marginal revenue:

  • When demand is inelastic (between 0 and -1), a rise in output reduces total revenue, and MR is negative.
  • When demand is elastic, a rise in output leads to higher total revenue, and MR is positive.
• A monopolist will never produce in the inelastic region of the demand curve because it leads to negative marginal revenue, meaning further production reduces total revenue.
• Profit Maximization:

  • A monopolist maximizes profit by producing where MR = MC and setting the price based on the demand curve.
  • The monopolist earns a profit because it charges a price higher than marginal cost and average cost.
• • Marginal Revenue and Demand:
  • The MR curve always lies below the demand curve because a monopolist must reduce the price on all units sold to sell an additional unit.
  • Maximum profit is made where MR = MC.
• Elasticity:

  • A monopolist will never produce on the inelastic part of the demand curve because this would result in negative marginal revenue.
• 1. Market Power:

  • A monopolist has the ability to set prices above marginal cost due to its market power. This is different from competitive firms that can only charge a price equal to marginal cost.