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Chapter 9: Monopoly: 9-3a Profit Maximization Book Title: Micro ECON Printed By: Ashley Rader ([email protected]) © 2019 Cengage, Cengage Learning, Inc.

9-3a Profit Maximization Exhibit 9.5 repeats revenue schedules from Exhibits 9.3 and 9.4 and also includes a shortrun cost schedule similar to those already introduced in the two previous chapters. Please take a little time now to become familiar with this table. Then ask yourself this question: Which price-quantity combination should De Beers select to maximize profit? As was the case with perfect competition, the monopolist can approach profit maximization in two ways —the total approach and the marginal approach.

Exhibit 9.5

Short-Run Costs and Revenue for a Monopolist

(2)

(1)

Diamonds Price per Day

(3) Total

(4) Marginal

(5) Total

Revenue

Revenue

Cost (TC)

(6) Marginal Cost

(7) Average

(8) To

Total Cost

Profit

(p)

Loss

(Q) 0

$7,750

   0

  —

$15,000

   —

   —

$−1

1

7,500

$ 7,500

$7,500

19,750

$ 4,750

$19,750

−1

2

7,250

14,500

7,000

23,500

 3,750

11,750

 −

3

7,000

21,000

6,500

26,500

 3,000

 8,833

 −

4

6,750

27,000

6,000

29,000

 2,500

 7,250

−

5

6,500

32,500

5,500

31,000

 2,000

 6,200

 

6

6,250

37,500

5,000

32,500

 1,500

 5,417

 

7

6,000

42,000

4,500

33,750

 1,250

 4,821

 

8

5,750

46,000

4,000

35,250

 1,500

 4,406

1

9

5,500

49,500

3,500

37,250

 2,000

 4,139

1

10

5,250

52,500

3,000

40,000

2,750

4,000

12

11

5,000

55,000

2,500

43,250

3,250

3,932

1

12

4,750

57,000

2,000

48,000

4,750

4,000

13

4,500

58,500

1,500

54,500

6,500

4,192

14

4,250

59,500

1,000

64,000

9,500

4,571

−

15

4,000

60,000

500

77,500

13,500

5,167

−1

16

3,750

60,000

  0

96,000

18,500

6,000

−3

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(2)

(1)

Diamonds Price per Day

(3) Total

(4) Marginal

(5) Total

Revenue

Revenue

Cost (TC)

(6) Marginal Cost

(7) Average

(8) To

Total Cost

Profit Loss

(p)

(Q) 17

3,500

59,500

−500

121,0000

25,000

7,118

−6

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 9.5. As you can see, maximum profit is $12,500 per day, which occurs at 10 diamonds per day. At that quantity, total revenue is $52,500 and total cost is $40,000. Marginal Revenue Equals Marginal Cost De Beers, as a profit-maximizing monopolist, increases output if doing so adds more to total revenue than to total cost. So De Beers expands output as long as marginal revenue, shown in column (4) of Exhibit 9.5, exceeds marginal cost, shown in column (6). But De Beers stops short of producing where marginal cost exceeds marginal revenue. Again, profit is maximized at $12,500 when 10 diamonds per day are sold. For the 10th diamond, marginal revenue is $3,000 and marginal cost is $2,750. As you can see, if output exceeds 10 diamonds per day, marginal cost exceeds marginal revenue. An 11th diamond’s marginal cost of $3,250 exceeds its marginal revenue of $2,500. For simplicity, we say that the profitmaximizing output occurs where marginal revenue equals marginal cost, which, you will recall, is the golden rule of profit maximization. Graphical Solution The revenue and cost schedules in

“The profit-maximizing output occurs Exhibit 9.5 are graphed in Exhibit 9.6, where marginal revenue equals with per-unit cost and revenue curves in marginal cost.” panel (a) and total cost and revenue curves in panel (b). The intersection of the two marginal curves at point e in panel (a) indicates that profit is maximized when 10 diamonds are sold. At that quantity, we move up to the demand curve to find the profit-maximizing price of $5,250. Average total cost of $4,000 is identified by

point b. The average profit per diamond equals the price of $5,250 minus the average total cost of $4,000. Economic profit is the average profit per unit of $1,250 multiplied by the 10 diamonds sold, for a total profit of $12,500 per day, as identified by the blue-shaded rectangle. So the profit-maximizing rate of output is found where the marginal cost curve intersects the marginal revenue curve. Exhibit 9.6

Monopoly Costs and Revenue Profit is maximized by producing where marginal cost equals marginal revenue, which is point e in panel (a). A profit-maximizing monopolist supplies 10 diamonds per day and charges $5,250 per diamond. Total profit, shown by the blue rectangle https://ng.cengage.com/static/nb/ui/evo/index.html?deploymentId=583265219313318568251256031&eISBN=9781337914413&id=678781618&nbId=1… 2/4

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in panel (a), is $12,500, the profit per unit multiplied by the number of units sold. In panel (b), profit is maximized by producing where total revenue exceeds total cost by the greatest amount, which occurs at an output rate of 10 diamonds per day. Maximum profit is total revenue ($52,500) minus total cost ($40,000), or $12,500. In panel (a) profit is measured by an area and in panel (b) by a vertical distance. That’s because panel (a) measures cost, revenue, and profit per unit of output while panel (b) measures them as totals at each level of output.

In panel (b), the firm’s profit or loss is measured by the vertical distance between the total revenue and total cost curves. De Beers expands output if the increase in total revenue from selling another diamond exceeds the increase in total cost. The profit-maximizing firm produces where total revenue exceeds total cost by the greatest amount. Again, profit is maximized where De Beers sells 10 diamonds per day. Total profit in panel (b) is measured by the vertical distance between the two total curves; in panel (a), total profit is measured by the shaded area formed by multiplying average profit per unit by the number of units sold.

De Beers sells more diamonds as long as the marginal revenue of increasing quantity outweighs the marginal cost.

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One common myth about monopolies is that they charge the highest price possible. But the monopolist is interested in maximizing profit, not price. What the monopolist can charge is limited by consumer demand. De Beers, for example, could charge $7,500, but selling only one diamond a day would result in a big loss. Indeed, De Beers could charge $7,750 or more but would sell no diamonds. So charging the highest possible price is not consistent with maximizing profit. A monopolist may be able to set the price, but the quantity demanded at that price is determined by consumers. Even the most powerful monopolist must obey the law of demand. Chapter 9: Monopoly: 9-3a Profit Maximization Book Title: Micro ECON Printed By: Ashley Rader ([email protected]) © 2019 Cengage, Cengage Learning, Inc. © 2020 Cengage Learning Inc. All rights reserved. No part of this work may by reproduced or used in any form or by any means - graphic, electronic, or mechanical, or in any other manner - without the written permission of the copyright holder.

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