Monopoly Pricing and Output

1. Monopoly Pricing and Output We study the pricing and output decision of the monopoly firm.

2. Price and output decision for the monopolist in the short run The amount of output the monopolist should sell in the short run is the amount where MR = MC(as long as P>AVC), just as in the case of the competitive firm. The price charged would then be the price on the demand curve above the quantity where MR = MC.

3. Logic of MR = MC rule $ The Q = b is the Q where MR = MC. But look at Q = a. At that point, Q could be increased and more would be added to revenue than to cost and thus profit would rise. We know this because the MR > MC for these Q. MC D Q a b c MR Now let’s look at a Q greater than where MR = MC, like at point c. More has been added to cost than to revenue and thus profit would fall. We know this because MC > MR at this Q.

4. What price? $ MC At Q*, where MR = MC, P* is the price on the demand curve consumers are willing to pay for Q* and thus this is the price charged by the monopolist. P* D Q Q* MR

5. Qualification $ ATC Note that the ATC is above the demand curve, so the firm will lose money. In the short run, the question is whether the firm should shutdown or continue to operate. Let’s go to the next screen and say more about this. MC AVC1 AVC1 P* AVC2 AVC2 D Q* MR

6. continue If the real AVC is AVC1, then the firm should not follow the MR = MC rule. At this level of output, P < AVC. It should not operate at all and lose less money by not operating than if it tried to operate. The situation is that only some of the variable costs are being covered and none of the fixed costs are being covered. The firm should not operate and only lose its fixed cost.

7. continue 2 If the real AVC is AVC2, then the firm should operate, even though there is still a loss. The P > AVC, and this means the revenue from operating covers all of the variable costs and some of the fixed costs. This is better than not operating and losing all the fixed costs. Note that in the long run if ATC > P (at the Q where MR = MC) the monopoly will continue to lose money and should in that case cease operating.

8. Quiz 1 – not a real quiz $ MC Is this monopoly firm earning a profit? If so, draw in the graph the rectangle that represents the profit. ATC P* D Q* MR

9. Quiz 2 not a real quiz $ ATC MC Is it possible for a monopoly to lose money? Indicate in the graph how much this monopoly is losing by indicating the loss rectangle. AVC P* D Q* MR