Introduction to Monopoly
1. The Monopolist’s Demand Curve and Marginal Revenue
a. Recall: Optimal output rule: a profit-maximizing firm produces the quantity of output at
which the marginal cost of producing the last unit of output equals marginal revenue
(the change in total revenue generated by the last unit of output) or MR=MC at the
profit-maximizing quantity of output.
b. Monopolies decisions about price and quantity of output differ from perfectly
competitive industries due to differences in the demand curves faced by monopolists
and perfectly competitive firms.
i. A monopolists is sole supplier of a good.
ii. Its demand curve is simply the market demand curve and it slopes downward.
1. Downward slope creates a wedge between the price of the good and
the marginal revenue of the good.
iii. When a monopolists decides to increase production there are two opposing
effects on revenue:
1. Quantity effect: one more unit is sold, increasing total revenue by the
price at which the unit is sold.
a. At low levels of output, the quantity effect is stronger than the
prices effect.
2. Price effect: in order to sell that last unit, the monopolist must cut the
market price on all units sold. This will decrease total revenue.
a. At high levels of output, the price effect is stronger than the
quantity effect.
iv. Marginal revenue curve is always below demand curve. This is because of the
price effect. This means that a monopolist’s marginal revenue from selling an
additional unit is always less than the price the monopolist receives for that
unit. The price effect is what causes the wedge between MR and demand.
1. This wedge exists for any firm that possesses market power.
c. Having market power means that the firm faces a downward-sloping demand curve.
i. As a result there will always be a price effect from an increase in output for a
firm with market power that charges every customer the same price.
2. Monopolist’s profit-maximizing output and price
a. Maximizing profit
i. To maximize profit, the monopolist compares marginal costs with marginal
revenue.
1. If MR exceeds MC a monopolist will increase profit by producing more.
2. If MR is less than MC a monopolist will increase profit by producing less.
ii. Monopolist’s optimal output rule: MR=MC at the monopolist’s profitmaximizing quantity of output.
b. Price
i. A monopolist’s revenue is influenced by the price effect, so that marginal
revenue is less than the price.
1. P is greater than MR=MC at the monopolist’s profit-maximizing quantity
of output