Question

Describe how a monopoly determines its profit-maximizing levels of output and price. Discuss why and how a monopoly may choose to price discriminate.

Answer 1

A profit-maximizing monopoly always produces at the point where it's marginal revenue = Marginal cost. However, monopoly sets its profit-maximizing price higher than it's MC. That is, a monopoly sets its profit-maximizing price at the point where its profit-maximizing quantity lies on the demand curve.

A monopolist has control over pricing and as it is the single firm in the market, therefore it also has control over demand and supply decisions. So, a monopoly often engages in price discrimination in order to earn the maximum profit and gain the market advantage or to capture the market position. Price discrimination is when a monopolist charges different prices from a different group of consumers for the same product it sells.

So, how does a monopoly choose to price discriminate? Monopoly charges different prices according to the level of income of consumers. For example, consumers with higher willingness to pay are charged higher prices while lower income group people are charged lower prices for the same product by the monopoly. While discriminating prices, a monopoly also considers the basis of use of products. For example, an electric supply board, which is a monopoly, charges higher prices for commercial use of electricity but charges a lower price for domestic consumption.