All right, econ friends, welcome back. In our previous video, we took a look at monopoly, some definitions, and took a look at that critical role, that barriers to entry play in allowing monopolies to emerge and sustain. In this video, we're going to take our next step in our process, and we're going to take a look at the monopolist's profit-maximizing decisions. Now, as you recall, profit... which is equal to total revenue minus total cost, is also equal to Q times P minus ATC.
So we know that we've got a couple of really key variables that we need to identify, P and Q and ATC. When we did perfect competition, we learned some steps and some rules to determine profit maximizing output levels. We're going to do the same things here. Okay, so we're going to take the same process, extend it to monopoly.
There's going to be one small little tweak, and you'll see it now. Okay, so in terms of its output and its pricing decisions, in terms of its output and pricing decisions, in other words, in terms of its profit maximization decisions, an important thing to bear in mind is that the monopolist, unlike the perfect competitor. is not a price taker, okay?
We had said in our last set of videos that perfect competition was a price taker, okay? We had said that perfect competition, they were a price taker. And you recall that that meant that their demand curve was perfectly horizontal, perfectly elastic. The monopolist, however, is not a price taker. Rather, I want you to think of the monopolist more as what we're going to call a price maker.
The monopolist is a price maker. They have market power. And as a result, they have some control over the price that they charge.
So this is really important to understand. It's a big difference between PC and monopoly. The monopolist is a price maker. Another thing to bear in mind is this. Since by definition, the monopolist is the only seller in the market, the monopolist is the entire market.
And as a result, the monopolist demand curve is the same as the market demand curve. This means that the monopolist demand curve is downward sloping. PC firms demand curve, remember, perfectly elastic, perfectly horizontal. Not the case anymore.
Because of market power and the structure of this industry, the monopolist demand curve is downward sloping. Really important. Another important thing and a direct takeaway from this idea of the downward sloping demand curve is that the monopolies.
marginal revenue curve is going to lie under its demand curve. So we're going to have a downward sloping demand curve. We're also going to have a downward sloping marginal revenue curve, which will fall under the demand curve.
You see a little example here. I give you in panel A some demand. and marginal revenue data.
You can see here that as P goes down, the quantity demanded goes up. So we have a regular demand schedule and some simple number crunching. And I put some practice questions on this in Brightspace for you, but some simple number crunching. If I'm given P and I'm given Q, then it's very easy to calculate total revenue by multiplying.
So you multiply P times Q and you get total revenue. And then once you have total revenue, you guys now know how to calculate marginal values. The marginal revenue would be the change in total revenue by the change in output.
And if you notice, you're going to see when you compare the demand and the marginal revenue curves, that the marginal revenue meets the demand at the first point. And for every point after. Demand will be downward sloping and marginal revenue will be downward sloping.
and under it. It's just simple math. It's the nature of being a price maker. Downward sloping demand curve, marginal revenue underneath it. With that in mind, we're ready to then jump into the big rule.
Just like the PC guy does, the monopolist follows the profit maximizing rule. It first determines its output level, and it does that by setting its marginal revenue equal to its marginal cost. In other words, we're going to follow the old MR equals MC rule, which by now you should have committed to memory. So step one, we know a downward demand curve and a downward MR underneath it. Step two, determine our output level by setting MR equal to MC.
Step three, next, we're going to determine price. Price is determined from the demand curve. So what we're going to do is we're going to go to the demand curve. Specifically, we're going to go directly above the point where MR equaled MC. So you're going to do MR equals MC to get your Q.
You'll do that dotted line all the way up to the demand curve and then go left to get your P. At this point now, we have Q, we have P, and then finally we determine ATC and we're set. Okay. This right here, nice simple example.
Let's take a quick look through it. I'll use red for some contrast. You see that we have a downward sloping demand curve here, and we have the MR curve downward sloping and underneath it. Critically, MR, really important. You see that we have our Nike swoosh MC curve and our U-shaped ATC curve.
So we have the same cost structures and the same cost curve shapes as before. Now we're just layering those on the demand and MR for the monopolist. Okay.
Critically, MR is here and MC is here. So step one, we're going to find where MR equals MC. That's that point. You're going to drop a line straight down and this is going to give you. your Q.
So MR equals MC, drop a line straight down, that's your Q. You're then going to extend that line up, up, up until you hit the demand curve right there. So you're going to take that MR equals MC, you're going to extend it up, hit the demand curve, and then you're going to go left. And this will give you your price.
Quantity, done. Price, done. Final step, you go to where this Q line that we called it, the quantity line, to where it hits the ATC curve. You go left, and there's your ATC. And now you're set.
You can solve this in a couple of ways. You know that you could determine that this, let me go to a little bit of a thicker. that this big box here is total revenue and that this box here is total cost.
And therefore, this leftover box is total revenue. That's one way to solve it. Or you can just remember our formula. Profit is equal to Q times P minus ATC.
Well, this distance here is P minus ATC. And this distance here is quantity. And therefore, this shaded box is profit.
Okay. Simple steps. Downward sloping demand in MR. Hit MR equal to MC and drop a line down for Q. Take that line up to the demand curve and to the left for price.
Take that line to the ATC curve and left for ATC. And now you're set. Good stuff.
Okay. So there we have. This graph here would be, just so we can label it, a monopolist making profit.
Okay, final thing I want you to take away from this discussion, just because you're a monopolist does not guarantee a profit. A monopolist can take on losses. So let's quickly graph out a monopolist facing a loss.
We'll go to red for some contrast. Okay, same basic idea. We're going to have the downward sloping demand curve.
So here's demand and the downward sloping MR curve underneath it. There's MR. We're going to have our Nike swoosh MC curve. There's MC and our U shape ATC.
There's ATC. Step one, find MR equals MC. Here's MC. Here's MR. Here's where they meet.
Take a line straight down and you've got your quantity. It's a really bad Q. Let's try that one again.
There we go. MR equals MC. Take it straight down.
There's your Q. Q, done. Take this Q line up, up, up, up to the demand curve. Go left. There's your price.
Price is done. Note that right now, if you chose. you'd be able to calculate total revenue, which is going to be the area of this box.
Third and final step, extend that Q line up, up, up to the ATC curve. Go left, and there's your ATC. And now you're done. Okay. Notice that the analysis is all the same, but as you guys know, the difference between profit and loss.
is simply the relationship between the ATC curve and the price. Over here, let's clean this a little bit. Over here, you see very clearly that the price is greater than ATC profit. Down here, we have the exact same graph.
We have the exact same setup. We have the exact same steps. It's just that at the conclusion, we see that price is less than ATC, and that's a loss.
So at this point, my friends, you understand not just what a monopoly is, but how to use the monopoly graph, determine the demand curve, determine the MR curve, and follow your step-by-step-by-step analysis to calculate monopoly profits or losses. Good job, and I'll see you next time.