Question

Using the Google Draw tool, create a marginal revenue and demand for a monopolist graph.

Then answer the following questions:

1. What is the relationship between Marginal Revenue (MR), and Demand (D) for a monopolist?
2. For a non-price discriminating monopolist (a monopolist who charges only one price), if the cost for producing one extra unit of a product where $0, what point on your curve should the monopolist produce? (Hint: think Marginal Benefit/Revenue = Marginal Cost or MB=MC)

Make sure to label each axis and line appropriately.

Answer 1

- In case of a monopoly market structure, the demand that a single producer with the monopoly power faces is equal to the market demand curve. This means, a monopoly firm faces a lower downward sloping demand curve i.e. in order to increase its sales, the firm has to lower its prices not only for the new unit but for all corresponding units.

- Marginal revenue is defined as the change in total revenue, when one more unit of output is produced and sold. Due to the downwards sloping demand curve, any additional unit of output can be sold only by lowering its price of the good. Due to this reason the marginal revenue is below the price and the MR curve lies below the demand curve.

Assuming that for a non-price discriminating monopolist, if the cost of producing additional unit of output is zero (MC =0), then the monopolist is only left with the choice to produce that level of output that maximizes its total revenue. A firms, total revenue is maximum when its marginal revenue is zero.

Refer to the below figure where X-axis represents the quantity and y-axis shows the price. Dm represents the downward sloping demand curve and MR represents the downwards sloping marginal revenue curve that lies below the demand curve. When MC = 0, the MC curve coincides with the X-axis (shown by the red line). The monopolist maximizes its profits and total revenue at point E where MR cuts MC and MR=MC=0. Here, the equilibrium price level is OP and the equilibrium quantity produced is OE and the maximum revenue earned by the firm is given by the area of the box OEBP.

Thus, the point where the monopolist should produce is Point E