Monopoly Profit Maximization

11 Key excerpts on "Monopoly Profit Maximization"

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  Microeconomics

  Theory and Applications

  • Edgar K. Browning, Mark A. Zupan(Authors)
  • 2019(Publication Date)
  • Wiley

    (Publisher)

  • Explain why a monopolist’s profit-maximizing output is where marginal revenue equals marginal cost. Describe why the extent to which a monopolist’s price exceeds marginal cost is larger the more inelastic the demand faced by the monopolist. • Explain several important implications of monopoly analysis such as that the shutdown condition applies to monopolies as well as to firms operating in perfectly competitive environments. • Outline the potential sources of monopoly power: absolute cost advantages, economies of scale, product differentiation, and regulatory barriers. • Explore the efficiency effects of monopoly from static and dynamic perspectives. • Provide an overview of public policy toward monopoly. 280 Chapter Eleven • Monopoly • The Monopolist’s Demand and Marginal Revenue Curves A monopoly faces the market demand curve for its product because it is, by definition, the only seller of the product. Thus, a monopoly’s demand curve slopes downward. This con- trasts sharply with the horizontal demand curve faced by a competitive firm. While a com- petitive firm is a price taker, a monopoly is a price maker. A monopoly supplies the total market and can choose any price along the market demand curve it wants. Since the monopoly faces a downward-sloping demand curve, if it raises price, the amount it sells will fall. Much of the analysis of monopoly and the difference in output and price between a monopoly and a competitive industry stems from this difference in the demand curves. Let’s consider the costars of Modern Family, a popular series on television in recent years. Let’s assume that the Modern Family costars face the demand curve depicted in Figure 11.1, are interested in maximizing profit, and must charge the same price for each new show pro- duced per month.

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  Principles of Economics in a Nutshell

  • Lorenzo Garbo, Dorene Isenberg, Nicholas Reksten(Authors)
  • 2020(Publication Date)
  • Routledge

    (Publisher)

  Draw a market and a single firm’s costs diagram next to each other, as done earlier in this section. Construct it so that the market is in its long-run equilibrium (the intersection of market demand and supply determines a price that is equal to the minimum AC). Profits, therefore, are zero for all the existing firms. Then, imagine that a successful social media campaign increases the market demand for the product. Show on your diagram the shift in the demand, the new equilibrium price, and what happens in the short-run to the existing firms.

    4.9

  Profit maximization in monopoly

  A monopoly is literally the opposite market structure of perfect competition: only one firm produces the product, and no close substitutes of the product exist. How do monopolies come into being? Some of the reasons for which an industry may become a monopoly are:

  • Legal barriers to entry: no other firm can enter the market because of municipal laws (e.g., water), product or process patents, copyright, and so on.
  • Economies of scale (a.k.a. increasing returns to scale): if the technology is such that the efficiency of the firm increases with its size, then the average cost must be decreasing all along. That is, the more a firm produces the lower its average cost is, and thus the lower the price the firm can charge. The largest firm can kick every other firm out of business!
  • Exclusive ownership of essential resources for production (e.g., De Beers and diamonds in South Africa).

  The big difference between monopoly and perfect competition is that the demand for the product of the monopolist is downward sloping rather than perfectly horizontal. In a monopoly, the firm alone faces the whole market demand of the product, and thus the price of the product completely depends on how many units of the product the firm brings to the market. This implies that the market price is under the complete control of the monopolist: we say that a monopolist is a price-maker

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  Economics of Information Technology and the Media

  • Linda Low(Author)
  • 2000(Publication Date)
  • WSPC

    (Publisher)

  Profit after tax may be distinguished from gross profit, since tax is paid to the government. Profit maximisation (ie, to make the largest profit possible) is the conventional goal of a firm, although other goals such as sales maximisation (a strategy of high volume sales to generate profitability) may be pursued. Profit maximisation is synonymous with cost minimisation. The economist's concept of profit is different from that of the accountant, as accounting profit is measured in actual dollars based on the firm's earnings and expenditures. Economists also consider the opportunity cost of allocating resources to produce a particular good in lieu of the next best alternative. As such, normal or zero profit (see chapter 3) is the minimum level of profit needed to encourage a firm to continue operations. Excess or supernormal profit, such as that enjoyed by monopolies, implies a sustained rate of return (before taxes on sales or invested capital) exceeding that of similar products or industries operating under similar conditions in terms of production, 40—ECONOMICS OF IT AND THE MEDIA distribution and risks. In the long run, excess profits hold for approximately five to ten years. The decision to stay in the industry while earning normal profits, or to fix the rate of return for excess profits, depends on the market structure and can be rather arbitrary. There is a need to distinguish between the concepts of average and marginal cost and revenue at the firm or industry levels. An industry is made up of all the firms that produce the same product (eg, the electronic industry). An individual firm can be privately owned (eg, a sole proprietorship incorporated but unlisted, or a private limited if listed on the stock market), or state-owned and formed to organise the factors of production in order to produce goods and services for the market. A distinction must be made between the long run and the short run.

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  Management Economics: An Accelerated Approach

  An Accelerated Approach

  • William G. Forgang, Karl W. Einolf(Authors)
  • 2015(Publication Date)
  • Routledge

    (Publisher)

  This chapter described the microeconomic environments in which firms operate. The process by which managers make decisions—including how to determine price, calculate production needs, and implement a marketing plan—depends heavily on the microeconomic structure of the industry. Each of the four market structures—monopoly, oligopoly, monopolistic competition, and perfect competition—were described to help managers understand how dependent they are on these economic environments. To maximize profit, increase market share, and effectively compete, managers must understand their firm’s strategic position in its industry.

  Review Terms

  Average cost pricing	Monopolistic competition
  Best response	Monopoly
  Coordination game	Nash equilibrium
  Cost-efficient	Natural monopoly
  Dominant strategy	Oligopoly
  Game theory	Perfect competition
  Marginal cost	Prisoner's dilemma
  Marginal profit	Product differentiation
  Marginal revenue	Revenue and profit sharing
  Minimax technique

  Discussion Questions

  1. A spreadsheet software package such as Microsoft Excel can be used to quickly determine a monopolist’s profit-maximizing price and quantity. Figure 6.9 shows an Excel spreadsheet using the demand function in Table 6.2 and the cost function in Table 6.4 . The spreadsheet calculates the quantity demanded, revenue, cost, and profit for any price that is entered into cell B2. A price of $34 is entered into cell B2 as an example. The functions used in each of the cells are displayed in Table 6.19 .

  Figure 6.9 Excel Spreadsheet

  Table 6.19 Excel Functions in Figure 6.9

  Cell	Function
  A2	= 20 − 0.5*B2
  B2	= 34
  C2	= A2*B2
  D2	= 26 + 12*A2
  E2	= C2 − D2

  Microsoft Excel has a Solver tool that searches for the price that maximizes the firm’s profit. The Solver is under the “Tools” menu on the Excel menu. (If the Solver option does not immediately appear, select Tools/Add-ins and bring the Solver tool into the computer’s memory.) The Solver dialogue box is displayed in Figure 6.10 . The target cell, E2, isging cell B2. When the Solve button is selected, Excel will find the price that maximizes the firm’s profit. The results are shown in Figure 6.11 .

  Figure 6.10 Excel Solver Dialogue Box

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  Microeconomic Foundations I

  Choice and Competitive Markets

  • David M. Kreps(Author)
  • 2012(Publication Date)
  • Princeton University Press

    (Publisher)

  It is impossible to do justice to this literature here, without expanding this chapter unreasonably and, in any case, some of the answers require pieces of economics that we haven’t yet studied. So I’ll plead simply that profit maximization is a modeling assumption, one with which economists are comfortable not as a law of nature but as an approximation to reality. Having said that, three specific points are worth making, albeit briefly. •   Profit maximization as an objective function for firms is a lot more specific than utility maximization for consumers. When we assume that a consumer maximizes her utility, we leave it up to the consumer how she feels about apples versus oranges. But, once prices are given, the trade-offs facing a firm are fixed if the firm maximizes profit. (On the other hand, the choice set of a consumer is fixed once prices are fixed and the consumer’s income is given. For firms, the production-possibility set Z gives a lot of latitude to the modeler.) •   Accounting earnings or income is not economic profit. Accounting income does not include any return on capital equipment. •   The arguments in the literature for profit maximization when there is a division between managers and owners of the firm turn to some extent on a contention that managers act on behalf of the firm’s owners, who prefer profit maximization. Why managers do this is usually the issue being studied in the literature. But it is worth noting that the assertion that owners prefer profit maximization is very bound up in the assumption that the firm has no impact on prices

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  Microeconomics

  • David Besanko, Ronald Braeutigam(Authors)
  • 2020(Publication Date)
  • Wiley

    (Publisher)

  CHAPTER 11 MONOPOLY AND MONOPSONY 474 The profit-maximization condition in equation (11.1) is a general one, applying to both monopolists and perfectly competitive firms. As we showed in Chapter 9, in a perfectly competitive market, a price-taking firm maximizes profit by producing a quantity at which marginal cost equals marginal revenue (MC = MR), and as we have just shown, the profit-maximizing monopolist must do the same. A CLOSER LOOK AT MARGINAL REVENUE: MARGINAL UNITS AND INFRAMARGINAL UNITS As we also showed in Chapter 9, for a price-taking firm, marginal revenue equals the market price. For a monopolist, however, marginal revenue is not equal to market price. To see why, let’s take another look at the demand curve D for our monopolist, in Figure 11.3. Suppose the monopolist initially produces 2 million ounces, charging a price of $10 per ounce. The total revenue it gets at this price is 2 million × $10, which corresponds to area I + area II. Now suppose the monopolist contemplates producing a larger output, 5 million ounces. To sell this quantity, it must lower its price to $7 per ounce, as dictated by the market demand curve. The monopolist’s total revenue is now equal to area II + area III. Thus, the change in the monopolist’s revenue when it increases output from 2 million ounces to 5 million ounces is area III minus area I. Let’s interpret what each of these areas means: • Area III represents the additional revenue the monopolist gets from the addi- tional 3 million ounces of output it sells when it lowers its price to $7: $7 × (5 − 2) million = $21 million. The extra 3 million ounces are called the mar- ginal units. • Area I represents the revenue the monopolist sacrifices on the 2 million ounces it could have sold at the higher price of $10: ($10 − $7) × 2 million = $6 million. These 2 million ounces are called the inframarginal units.

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  Economics

  A Contemporary Introduction

  • William A. McEachern(Author)
  • 2016(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Chapter 9 Monopoly 207 equilibrium price appears on the demand curve, no single curve traces points showing unique combinations of both the price and quantity supplied. Because no curve reflects combinations of price and quantity supplied, there is no monopolist supply curve. 9-3c Long-Run Profit Maximization For perfectly competitive firms, the distinction between the short run and the long run is important because entry and exit of firms can occur in the long run, erasing any econom- ic profit or loss. For the monopolist, the distinction between the short run and long run is less relevant. If a monopoly is insulated from competition by high barriers that block new entry, economic profit can persist into the long run. Yet short-run profit is no guarantee of long-run profit. For example, suppose the monopoly relies on a patent. Patents last only so long and even while a product is under patent, the monopolist often must defend it in court (patent litigation has nearly doubled in the last decade). On the other hand, a monopolist may be able to erase a loss (most firms lose money initially) or increase profit in the long run by adjusting the scale of the firm or by advertising to increase demand. A monopolist unable to erase a loss will, in the long run, leave the market. 9-3d “Available for a Limited Time Only” Given the law of diminishing marginal utility, some firms selling a unique product may limit availability to increase its marginal value to the consumer. For example, McDonald’s makes its McRib sandwich “available for a limited time only,” usually in the fall. The same holds for KFC’s Double Down sandwich. And Disney has movies in its vault (such as Cinderella, Dumbo, and Peter Pan) that appear in theaters from time to time for limited periods. Thus, suppliers sometimes limit availability to enhance product appeal.

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  Microeconomics

  A Contemporary Introduction

  • William A. McEachern(Author)
  • 2016(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  Total Revenue Minus Total Cost The profit-maximizing monopolist employs the same decision rule as the competitive firm. The monopolist supplies the quantity at which total revenue exceeds total cost by the greatest amount. Economic profit appears in column (8) of Exhibit 5. As you can price maker A firm with some power to set the price because the demand curve for its output slopes downward; a firm with market power EXHIBIT 5 Short-Run Costs and Revenue for a Monopolist (1) Diamonds per Day ( Q ) (2) Price ( p ) (3) Total Revenue ( TR 5 p 3 Q ) (4) Marginal Revenue ( MR 5 D TR / D Q ) (5) Total Cost ( TC ) (6) Marginal Cost ( MC 5 D TC / D Q ) (7) Average Total Cost ( ATC 5 TC / Q ) (8) Total Profit or Loss ( 5 TR 2 TC ) 0 $ 7,750 0 ____ $ 15,000 ____ ____ $ 2 15,000 1 7,500 $ 7,500 $ 7,500 19,750 $ 4,750 $ 19,750 2 12,250 2 7,250 14,500 7,000 23,500 3,750 11,750 2 9,000 3 7,000 21,000 6,500 26,500 3,000 8,833 2 5,500 4 6,750 27,000 6,000 29,000 2,500 7,250 2 2,000 5 6,500 32,500 5,500 31,000 2,000 6,200 1,500 6 6,250 37,500 5,000 32,500 1,500 5,417 5,000 7 6,000 42,000 4,500 33,750 1,250 4,821 8,250 8 5,750 46,000 4,000 35,250 1,500 4,406 10,750 9 5,500 49,500 3,500 37,250 2,000 4,139 12,250 10 5,250 52,500 3,000 40,000 2,750 4,000 12,500 11 5,000 55,000 2,500 43,250 3,250 3,932 11,750 12 4,750 57,000 2,000 48,000 4,750 4,000 9,000 13 4,500 58,500 1,500 54,500 6,500 4,192 4,000 14 4,250 59,500 1,000 64,000 9,500 4,571 2 4,500 15 4,000 60,000 500 77,500 13,500 5,167 2 17,500 16 3,750 60,000 0 96,000 18,500 6,000 2 36,000 17 3,500 59,500 2 500 121,000 25,000 7,118 2 61,500 Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience.

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  Economics

  A Beginner's Guide

  • James Forder(Author)
  • 2016(Publication Date)
  • Oneworld Publications

    (Publisher)

  diagram 7 . That shows the price times the quantity, which is total revenue, minus the average cost times the quantity, which of course is total cost. So it shows total revenue minus total cost, which is profit.

   

  Diagram 7  Profit

  There is, of course, nothing forcing the firm to maximize profit (unless the maximum profit achievable is zero). Alternatives might be a careless attitude to customer relations or lax cost control, for example. Simply ignoring the phone is an alternative to maximizing profit, as is appointing incompetent family members to senior positions. Or, for that matter, engaging in activities exhibiting ‘corporate social responsibility’ may reduce profit, but nevertheless be thought desirable.

  So far so good. That is an economic model. It is not a refined model, and it has plenty of clear limitations and various little gaps in the logic. Never mind. As with the earlier discussion of the used-car market, the question is whether the model provides useful insight and, as usual, the best thing is to carry on and find out.

  Amongst the insights arising from considering this model, first of all there is the point that profit maximization arises where marginal cost is the same as marginal revenue. That point is much more general than the model, of course, and comes up, with slight variations, again and again in economics. Another point is that profit-maximizing price is always higher than marginal cost. In diagram 6 that is apparent from the fact that the demand curve is always above the marginal revenue curve. The quantity to be sold is determined by the intersection of MC and MR – that is, q1 in diagram 6 . But there, marginal cost is c1 , so quantity is q1 and the price at which that quantity can be sold is p1 . That is important because it has the unfortunate consequence that there are consumers who would be willing to pay a price which is greater than the marginal cost of production – c1 – but less than p1 who end up not buying the product. In that sense there is a way in which the system has failed – both the consumer and the producer could be made better off if there were extra production up to q2

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  Industrial Organization

  Contemporary Theory and Empirical Applications

  • Lynne Pepall, Dan Richards, George Norman(Authors)
  • 2013(Publication Date)
  • Wiley

    (Publisher)

  That is, quality increases cannot indefinitely expand the quantity demanded at a given price. 160 Monopoly Power in Theory and Practice which implies that the marginal cost of increasing product quality is 10z (see Appendix 5). 9 We can now write the firm’s profit to be: π(Q, z) = P (Q, z)Q − F (z) = z(50 − Q)Q − 5z 2 (7.27) Consider first the profit-maximizing choice of output. This turns out to be very simple in this case. As usual, marginal revenue has the same intercept as the demand function but twice the slope. So with the demand function P = 50z − zQ we know that marginal revenue is MR = 50z − 2zQ = z(50 − 2Q). Equating this with marginal cost gives the profit-maximizing output condition: z(50 − 2Q) = 0. Hence, the profit-maximizing output is: Q ∗ = 50/2 = 25. In this simple example, the monopolist’s quantity choice is independent of the quality choice. The profit-maximizing output remains constant at Q ∗ = 25 no matter the choice of quality. Going back to the demand function, the profit-maximizing price is given by P ∗ = z(50 − Q ∗ ) so that the optimal price is: P ∗ = 25z. Unlike output, the profit- maximizing price is affected by the choice of quality. Moreover, the quality choice also affects the firm’s design costs. A higher quality design z permits the monopolist to raise price and earn more revenue but it also raises the firm’s costs. This is the tradeoff that the monopolist must evaluate. To choose the profit-maximizing quality the monopolist must compare the additional revenue resulting from an increase in z with the increase in design cost that the higher quality requires. Because the quantity sold is constant at Q ∗ = 25, the additional revenue of an increase in quality is just this output level times the difference in price that can be charged following the rise in quality.

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  Study Guide for Essentials of Economics

  • J. R. Clark(Author)
  • 2014(Publication Date)
  • Academic Press

    (Publisher)

  some firms would leave the industry for opportunities where economic profits exist c. firms would more than likely be earning accounting profits d. all of the above would be true. 7. In the case of natural monopoly, if the producing firm were broken into several smaller competing firms, which of the following could be expected to occur? a. Each of the smaller firms would have higher per unit production costs. b. Prices paid by the consumer would fall as a result of competition in the industry. c. Each of the smaller firms would be able to take advantage of economies of scale. d. none of the above 8. The perfect competitor maximizes profit by producing where marginal cost equals price. The monopolist differs from this behavior in that: a. in a monopoly, price is higher than marginal revenue b. the monopolist sets output by MR = MC and then charges the highest price consumers are willing to pay for that amount of output. c. Both a and b are correct. d. None of the above are correct. 114 Chapter Thirteen SECTION THREE Vocabulary Self-Test 1. '. is characterized by rivalry between firms, each trying to provide a better deal to buyers when price, quality, and product information are considered. 2. A large number of firms that produce a homogeneous product in an industry with ease of entry and exit characterizes the model of . 3. A product of one firm that is no different from the product of every other firm in the industry is . 4. are obstacles that prevent potential rival firms from freely entering an industry. 5. Sellers facing a horizontal demand curve are , who must adopt the market price in order to sell their product. 6. The change in total revenue derived from the sale of one additional unit of a product is 7. The temporary closing of a business with the intent to reopen in the future is a , during which fixed costs are still incurred. 8. is the permanent exit of a firm from the market; it is characterized by the sale of the firm's assets.

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