Overview
This lecture explains how monopolists use cost curves to determine the profit-maximizing output, price, and profit, with step-by-step methods and an applied example.
Monopolist Profit Maximization Process
- In monopoly, the demand curve is downward sloping and marginal revenue (MR) lies below it.
- For a linear demand curve, the MR curve starts at the same point but has double the slope (twice as steep).
- To maximize profit, a monopolist produces up to the quantity where MR equals marginal cost (MC).
- If MR > MC, the monopolist should increase output; if MC > MR, decrease output.
- The quantity where MR = MC gives the profit-maximizing output, not the price.
Determining Monopoly Price and Profit
- Price is determined by going up from the profit-maximizing quantity to the demand curve (reflects willingness to pay).
- Profit is calculated as total revenue minus total cost: (Price × Quantity) – (Average Total Cost × Quantity).
- Alternatively, profit can be found as (Price – Average Total Cost) × Quantity, representing the area of a rectangle between curves.
Example: Epipen Monopoly
- For the Epipen example, output is maximized where MR = MC at 175 units.
- Price for 175 units is found on the demand curve, which is $600 per unit.
- Average total cost at 175 units is $400; total profit is (600 – 400) × 175 = $35,000.
Key Terms & Definitions
- Marginal Revenue (MR) — The additional revenue from selling one more unit.
- Marginal Cost (MC) — The additional cost of producing one more unit.
- Demand Curve — A graph showing quantity demanded at various prices.
- Average Total Cost (ATC) — Total cost divided by the number of units produced.
- Profit Maximizing Output — The quantity where MR equals MC.
Action Items / Next Steps
- Review these 3-step methods for homework and exam problems.
- Prepare for the next lecture on efficiency.
- Apply the process to similar monopoly examples in assignments.