Question

1. What is marginal revenue?

2. What is marginal cost?

3. Why is a monopolist's marginal revenue less than the price it charges for its product? d) Explain why marginal revenue and marginal cost are important determinants of a monopolist's profit maximizing price and output. As part of your answer, explain the process in a monopolistic market at an output below the profit maximizing output, and at the output above, and why the profit maximizing output is eventually chosen.

Answer 1

A> Marginal revenue is the increase in revenue due to an increase in one unit lof output.

B> Marginal cost is the increase in cost due to an increase in one unit of output.

C> Since the demand curve faced by a monopolist is downward sloping, the MR curve falls faster than the average revenue. Thus, at the same price level, MR is lower than AR. Thus, the price must be higher than the MR.

D> Since they are the only seller of the market, they are the price maker. So, they want to have as much profit as possible. Suppose, MR<MC, we can increase our profit if we produce less since that last output caused a loss to us as it takes more money to make it than the money we make by selling it. In a similar way, if MC<MR, we can increase our profit if we increase output. For the next output, we will gain some more money from selling than from making it. Thus, we will reach an optimal equilibrium when MC=MR.