Question

• Assume Acme Corporation is a typical monopoly:
  • Construct a graph illustrating Acme's average and marginal cost curves and the demand curve facing it. Identify profit maximizing output and price, total revenues, total costs, and total profits.
  • Assume the economy moves into a recession and the demand for Acme's product falls. On the same graph, show the effect of the recession on equilibrium price, output, and profits.

Your response should be one graph and at least 75 words (1 paragraph) that includes an explanation for the graph.

There were many answers to this one, but I had a hard time understanding the handwriting. Could you please make the response as clear as possible, I've been struggling with this question for a while, especially with the graph.

And where are all the numbers coming from if none where provided?

Answer 1

In the case of a monopoly, the optimum level of output to be produced is at the level where marginal revenue of the firm is equal to marginal cost of the firm. This is depicted in the diagram below:

In the diagram above, DD represents the demand curve and MR represents the marginal revenue curve of the monopolist. The equilibrium occurs at point E where MR = MC and Qm is the equilibrium amount of quantity produced and Pm is the equilibrium price level. At this level, the total revenue of the firm = P_mA QmO and total cost of the firm is =ATC * Q = BCOQm. Thus, profits of the firm =total revenue - total cost of the firm represented by red shaded area.

Due to recession, demand for the good will fall as overall income decreases in the economy. This will also shift the MR curve downwards and thus new equilibrium occurs at point E' where Qm' is the new equilibrium level of quantity and Pm' is the new equilibrium price level of the monopolist and both have reduced as compared to the initial case. Also the profits represented by area CDC'Pm' have also decreased because of recession.

Thus, recession has led to decline in equilibrium price, quantity and profits of the monopolist.