Profit Maximization in a Monopoly

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 life-saving 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 life-saving 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