Profit Maximization

Profit Maximization in a Monopoly

2 Key Assumptions of a Monopoly:

• Price Setter - a monopoly is when there is only one firm in the industry that has a lot of market power, which means they have a lot of influence over the prices they set (opposite of perfect competition where each firm is a price taker and has no market power).
• High Barriers to Entry - it is difficult for new firms to enter the market Example: Government doesn't allow new firms to enter or patents for a new medicine.

Profit Maximization

• If Marginal Revenue (MR) > Marginal Cost (MC) , the firm should

  increase

  ---

  output
• If Marginal Revenue (MR) < Marginal Cost (MC) , the firm should

  decrease

  ---

  output
• When MR = MC , profit is

  maximized

  ---

Marginal Revenue

• When Total Revenue (TR) is decreasing, the Marginal Revenue (MR) is

  negative

  ---

• When TR is increasing, the MR is

  positive

  ---

• When TR is at its maximum, MR is equal to

  0

  ---

  . In the diagram above this is at an output of

  25

  ---

  .

Steps to Find Profit for a Monopoly

1. Make MR = MC to find profit maximizing output. In the diagram below this is at an output of

   20

   ---

2. Plug that output in the demand to find the price. This is at a price of

   $80

   ---

3. Plug that same output in the ATC. This is at a cost of

   $70

   ---

4. Find profit using the formula Profit = (P - ATC) * Q =

   (80 - 70) * 20 = $200

   ---

Example: Profit Maximization