Profit Maximization in a
Monopoly
Profit Maximization in a Monopoly
• A firm with market power will price
above cost but by how much?
• A firm with no competition still faces a
demand curve—so as it raises its price,
it will sell fewer units
• Higher prices are not always better for a
seller – raise the price too much and the
profits will fall, lower the price and
profits will fall
Profit Maximization in a Monopoly
• To maximize profit:
– A firm should produce until revenue from
an additional sale is equal to the cost of an
additional sale
– MR = MC
• For a smaller firm, revenue = price (MR=P)
• When a firm’s output of a product is large
relative to the entire market’s output of that
product, an increase in the firm’s output will
cause the MP of that product to fall
Profit Maximization in a Monopoly
• So….a firm that produces a large share
of the markets total out of a product,
revenue from the sale of an additional
unit is less than the current market price
(MR < P)
• To calculate the firm’s profit
maximization:
– 1. first need to figure out marginal
revenue
Using Market Power to Max. Profits
• Marginal Revenue is the revenue gain on new
sales plus the revenue loss on previous sales
• Shortcut to find MR:
• If the demand curve is a straight line, then
the revenue curve is a straight line that
begins at the same point on the vertical axis
as the demand curve but with twice the slope
Using Market Power to Max. Profits
Elasticity of Demand
• Consumers with serious diseases are
relatively insensitive to the price of lifesaving pharmaceuticals – will continue to buy
in large quantities even when the price
increases
• When consumers are relatively insensitive to
the price, what type of demand?
Inelastic demand
Elasticity of Demand
• “You can’t take it with you” and “other
people’s money” are two influences on
demand that make the demand curve
more inelastic
• The more inelastic the demand curve,
the more monopolist will raise its price
above MC
Elasticity of Demand
The Costs of Monopoly
• Monopolists gain less from the monopoly
pricing than the consumer loses
• Monopolies are bad because compared with
competition, monopolies reduce total
surplus, the total gains from trade (consumer
surplus plus producer surplus)
The Costs of Monopoly
• Key Point:
– SOME of the consumer surplus has been
transferred to the monopolist as profit.
– But some of the consumer surplus is not
transferred, it goes to neither the
consumer nor to the monopolist, it goes to
no one and is lost
– Deadweight loss
The Costs of Monopoly
Profit Maximization in a
Monopoly Notes
Profit Maximization in a Monopoly
• A firm with market power will price
above cost but by how much?
• A firm with no competition faces a
_____________as it raises it price, it will
sell fewer _________
• Higher prices are not always better for a
seller – raise the price too much and the
profits will ___________, lower the
price and profits will ___________
Profit Maximization in a Monopoly
• To maximize profit:
– A firm should produce until revenue from
an additional sale is equal to the cost of an
additional sale
– ______________________
• For a smaller firm, ___________ (MR=P)
• When a firm’s output of a product is large
relative to the entire market’s output of that
product, an increase in the firm’s output will
cause the MP of that product to fall
Profit Maximization in a Monopoly
• So….a firm that produces a large share
of the markets total output of a product,
revenue from the sale of an additional
unit is less than the current market price
(___________)
• To calculate the firm’s profit
maximization:
– 1. first need to figure out ___________
Using Market Power to Max. Profits
• Marginal Revenue is the revenue gain on new
sales plus the revenue loss on previous sales
• Shortcut to find MR:
Using Market Power to Max. Profits
Elasticity of Demand
• Consumers with serious diseases are
relatively insensitive to the price of lifesaving pharmaceuticals – will continue to buy
in large quantities even when the price
increases
• When consumers are relatively insensitive to
the price, what type of demand?
Elasticity of Demand
• “______________________” and
“______________________” are two
influences on demand that make the
demand curve more inelastic
• The more inelastic the demand curve,
the more monopolist will ________ its
price above MC
Elasticity of Demand
The Costs of Monopoly
• Monopolists ___________from the
monopoly pricing than the consumer ______
• Monopolies are bad because compared with
competition, monopolies reduce
___________, the ___________from trade
(______________________plus
______________________)
The Costs of Monopoly
• Key Point:
– SOME of the consumer surplus has been
transferred to the monopolist as profit.
– But some of the consumer surplus is not
transferred, it goes to neither the
consumer nor to the monopolist, it goes to
no one and is lost
– ______________________
The Costs of Monopoly