Profits for the monopolist, like any firm, will be equal to total revenues minus total costs. The pattern of costs for the monopoly can be analyzed within the same framework as the costs of a perfectly competitive firm —that is, by using total cost, fixed cost, variable cost, marginal cost, average cost, and average variable cost. However, because a monopoly faces no competition, its situation and its decision process will differ from that of a perfectly competitive firm.
A perfectly competitive firm acts as a price taker. The demand curve it perceives appears in Figure 1 a. The horizontal demand curve means that, from the viewpoint of the perfectly competitive firm, it could sell either a relatively low quantity like Ql or a relatively high quantity like Qh at the market price P. Figure 1. The flat shape means that the firm can sell either a low quantity Ql or a high quantity Qh at exactly the same price P.
Thus, if the monopolist chooses a high level of output Qh , it can charge only a relatively low price Pl ; conversely, if the monopolist chooses a low level of output Ql , it can then charge a higher price Ph. The challenge for the monopolist is to choose the combination of price and quantity that maximizes profits. A monopoly is a firm that sells all or nearly all of the goods and services in a given market. In , after years of legal appeals, the U.
Supreme Court held that the broader market definition was more appropriate, and the case against DuPont was dismissed. Questions over how to define the market continue today. The Greyhound bus company may have a near-monopoly on the market for intercity bus transportation, but it is only a small share of the market for intercity transportation if that market includes private cars, airplanes, and railroad service.
DeBeers has a monopoly in diamonds, but it is a much smaller share of the total market for precious gemstones and an even smaller share of the total market for jewelry. In general, if a firm produces a product without close substitutes, then the firm can be considered a monopoly producer in a single market.
But if buyers have a range of similar—even if not identical—options available from other firms, then the firm is not a monopoly. Still, arguments over whether substitutes are close or not close can be controversial.
No monopolist, even one that is thoroughly protected by high barriers to entry, can require consumers to purchase its product. Because the monopolist is the only firm in the market, its demand curve is the same as the market demand curve, which is, unlike that for a perfectly competitive firm, downward-sloping.
Figure 1 illustrates this situation. The monopolist can either choose a point like R with a low price Pl and high quantity Qh , or a point like S with a high price Ph and a low quantity Ql , or some intermediate point. Setting the price too high will result in a low quantity sold, and will not bring in much revenue. Conversely, setting the price too low may result in a high quantity sold, but because of the low price, it will not bring in much revenue either.
The challenge for the monopolist is to strike a profit-maximizing balance between the price it charges and the quantity that it sells. The demand curve as perceived by a perfectly competitive firm is not the overall market demand curve for that product. The reason for the difference is that each perfectly competitive firm perceives the demand for its products in a market that includes many other firms; in effect, the demand curve perceived by a perfectly competitive firm is a tiny slice of the entire market demand curve.
In contrast, a monopoly perceives demand for its product in a market where the monopoly is the only producer. In order to determine profits for a monopolist, we need to first identify total revenues and total costs. An example for the hypothetical HealthPill firm is shown in Figure 2. The economy is one of the major political arenas after all.
Many have filed for bankruptcy, with an Revenue maximisation Revenue maximisation is a theoretical objective of a firm which attempts to sell at a price which achieves the greatest sales revenue. Business Economics. Nikolay Krylovskiy T Explaining The K-Shaped Economic Recovery from Covid Explaining The K-Shaped Economic Recovery from Covid A K-shaped recovery exists post-recession where various segments of the economy recover at their own rates or levels, as opposed to a uniform recovery where each industry takes the same Supreme Court held that the broader market definition was more appropriate, and the case against DuPont was dismissed.
Questions over how to define the market continue today. The Greyhound bus company may have a near-monopoly on the market for intercity bus transportation, but it is only a small share of the market for intercity transportation if that market includes private cars, airplanes, and railroad service.
DeBeers has a monopoly in diamonds, but it is a much smaller share of the total market for precious gemstones and an even smaller share of the total market for jewelry. In general, if a firm produces a product without close substitutes, then the firm can be considered a monopoly producer in a single market.
But if buyers have a range of similar—even if not identical—options available from other firms, then the firm is not a monopoly. Still, arguments over whether substitutes are close or not close can be controversial. No monopolist, even one that is thoroughly protected by high barriers to entry, can require consumers to purchase its product.
Because the monopolist is the only firm in the market, its demand curve is the same as the market demand curve, which is, unlike that for a perfectly competitive firm, downward-sloping. Figure 1 illustrates this situation. The monopolist can either choose a point like R with a low price Pl and high quantity Qh , or a point like S with a high price Ph and a low quantity Ql , or some intermediate point.
Setting the price too high will result in a low quantity sold, and will not bring in much revenue. Conversely, setting the price too low may result in a high quantity sold, but because of the low price, it will not bring in much revenue either.
The challenge for the monopolist is to strike a profit-maximizing balance between the price it charges and the quantity that it sells. See the following Clear it Up feature for the answer to this question. The demand curve as perceived by a perfectly competitive firm is not the overall market demand curve for that product. The reason for the difference is that each perfectly competitive firm perceives the demand for its products in a market that includes many other firms; in effect, the demand curve perceived by a perfectly competitive firm is a tiny slice of the entire market demand curve.
In contrast, a monopoly perceives demand for its product in a market where the monopoly is the only producer. Profits for a monopolist can be illustrated with a graph of total revenues and total costs, as shown with the example of the hypothetical HealthPill firm in Figure 2. The total cost curve has its typical shape; that is, total costs rise and the curve grows steeper as output increases.
To calculate total revenue for a monopolist, start with the demand curve perceived by the monopolist. Table 2 shows quantities along the demand curve and the price at each quantity demanded, and then calculates total revenue by multiplying price times quantity at each level of output.
In this example, the output is given as 1, 2, 3, 4, and so on, for the sake of simplicity. If you prefer a dash of greater realism, you can imagine that these output levels and the corresponding prices are measured per 1, or 10, pills.
As the figure illustrates, total revenue for a monopolist rises, flattens out, and then falls. In this example, total revenue is highest at a quantity of 6 or 7. Clearly, the total revenue for a monopolist is not a straight upward-sloping line, in the way that total revenue was for a perfectly competitive firm.
The different total revenue pattern for a monopolist occurs because the quantity that a monopolist chooses to produce affects the market price, which was not true for a perfectly competitive firm.
If the monopolist charges a very high price, then quantity demanded drops, and so total revenue is very low. If the monopolist charges a very low price, then, even if quantity demanded is very high, total revenue will not add up to much. At some intermediate level, total revenue will be highest.
However, the monopolist is not seeking to maximize revenue, but instead to earn the highest possible profit.
Profits are calculated in the final row of the table. In the HealthPill example in Figure 2 , the highest profit will occur at the quantity where total revenue is the farthest above total cost. Of the choices given in the table, the highest profits occur at an output of 4, where profit is In the real world, a monopolist often does not have enough information to analyze its entire total revenues or total costs curves; after all, the firm does not know exactly what would happen if it were to alter production dramatically.
But a monopolist often has fairly reliable information about how changing output by small or moderate amounts will affect its marginal revenues and marginal costs, because it has had experience with such changes over time and because modest changes are easier to extrapolate from current experience.
A monopolist can use information on marginal revenue and marginal cost to seek out the profit-maximizing combination of quantity and price. The first four columns of Table 3 use the numbers on total cost from the HealthPill example in the previous exhibit and calculate marginal cost and average cost.
This monopoly faces a typical upward-sloping marginal cost curve, as shown in Figure 3. The second four columns of Table 3 use the total revenue information from the previous exhibit and calculate marginal revenue. Notice that marginal revenue is zero at a quantity of 7, and turns negative at quantities higher than 7. It may seem counterintuitive that marginal revenue could ever be zero or negative: after all, does an increase in quantity sold not always mean more revenue?
For a perfect competitor, each additional unit sold brought a positive marginal revenue, because marginal revenue was equal to the given market price. But a monopolist can sell a larger quantity and see a decline in total revenue.
When a monopolist increases sales by one unit, it gains some marginal revenue from selling that extra unit, but also loses some marginal revenue because every other unit must now be sold at a lower price. As the quantity sold becomes higher, the drop in price affects a greater quantity of sales, eventually causing a situation where more sales cause marginal revenue to be negative.
A monopolist can determine its profit-maximizing price and quantity by analyzing the marginal revenue and marginal costs of producing an extra unit. If the marginal revenue exceeds the marginal cost, then the firm should produce the extra unit. For example, at an output of 3 in Figure 3 , marginal revenue is and marginal cost is , so producing this unit will clearly add to overall profits. At an output of 4, marginal revenue is and marginal cost is , so producing this unit still means overall profits are unchanged.
However, expanding output from 4 to 5 would involve a marginal revenue of and a marginal cost of , so that fifth unit would actually reduce profits.
Alternatively, we can compute profit as total revenue minus total cost. This is shown graphically as the area of the rectangle on top of total cost, or the price minus average cost, times quantity. Note that if the firm was earning zero economic profits, the rectangles of total revenue and total cost would be the same — there would be no profit rectangle.
Note also that if the firm was making a loss, the negative profit i. Practice until you feel comfortable doing the questions. Privacy Policy. Skip to main content. Module Monopolistic Competition and Oligopoly. Search for:. How a Monopolistic Competitor Determines How Much to Produce and at What Price The process by which a monopolistic competitor chooses its profit-maximizing quantity and price resembles closely how a monopoly makes these decisions process. Two scenarios are possible: If the firm is producing at a quantity of output where marginal revenue exceeds marginal cost, then the firm should keep expanding production, because each marginal unit is adding to profit by bringing in more revenue than its cost.
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