Understand the Marginal Revenue curve and its significance for a monopolist.This is the main reason monopolies are discouraged, if not outlawed, by governments. And as we noted in the previous chapter, the loss in consumer surplus will exceed the profit gain to the monopolist. Unfortunately, consumers do worse at the monopolist’s optimal operation as they pay a higher price and purchase fewer units. The highest profit will result from selling Q M units at a price of P M. However, at this volume, marginal cost is greater than marginal revenue, indicating greater profit by operating at a lower volume at a higher price. The monopolist could afford to function at this same volume and price and may even earn some economic profit. The perfect competition market equilibrium would occur at a volume Q C, with a price P C. If the marginal cost curve for the monopolist were instead the combined marginal cost curves of small firms in perfect competition, the marginal cost curve would correspond to the market supply curve. Since the monopolist has complete control on sales, it will only sell at the quantity where marginal revenue equals marginal cost but will sell at the higher price associated with that quantity on the demand curve, P M, rather than the marginal cost at a quantity of Q M.įigure 7.1 Graph Showing the Optimal Quantity and Price for a Monopolist Relative to the Free Market Equilibrium Price and Quantity Because the condition for optimal seller profit is where marginal revenue equals marginal cost, the monopolist will elect to operate at a quantity where those two quantities are in balance, which will be at volume marked Q M in Figure 7.1 "Graph Showing the Optimal Quantity and Price for a Monopolist Relative to the Free Market Equilibrium Price and Quantity". As we discussed in Chapter 2 "Key Measures and Relationships", when the demand curve is downward sloping, the marginal revenue corresponding to any quantity and price on the demand curve is less than the price (see Figure 7.1 "Graph Showing the Optimal Quantity and Price for a Monopolist Relative to the Free Market Equilibrium Price and Quantity"). If the market demand curve is downward sloping, the monopolist knows that marginal revenue will not equal price. In a monopoly, the demand curve seen by the single selling firm is the entire market demand curve. In the case of flat demand curves, price and marginal revenue are the same, and since a profit-maximizing producer decides whether to increase or decrease production volume by comparing its marginal cost to marginal revenue, in this case the producer in perfect competition will sell more (if it has the capability) up the point where marginal cost equals price. Even though the overall market demand curve decreases with increased sales volume, the single firm in perfect competition has a different perception because it is a small participant in the market and takes prices as given. Recall that in perfect competition, each firm sees the demand curve it faces as a flat line, so it presumes it can sell as much as it wants, up to its production limit, at the prevailing market price. In a monopoly there is only one seller, called a monopolist The one seller that possesses market power. In this section, we will consider the strongest form of seller market power, called a monopoly The strongest form of seller market power a market structure in which there is only one seller with market power. Often, the main deterrent to a highly competitive market is market power possessed by sellers.
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