Economics without Tears: A New Approach to an Old Discipline by Ashok Sanjay Guha

Author:Ashok Sanjay Guha [Guha, Ashok Sanjay]
Language: eng
Format: epub
ISBN: 9789385990496
Publisher: Penguin Books Ltd
Published: 2016-11-26T18:30:00+00:00

THE PROFIT-MAXIMIZING MONOPOLIST

Unlike the horizontal demand curve of the perfect competitor, the monopolist’s demand curve slopes downward. He has no rivals whose markets he can invade without reducing his own price significantly. If he is to sell more, he must cut his price. However, his marginal revenue—the increase in revenue achieved by selling one more unit—is less than his price (because he must reduce price not only on the last unit sold but on all the infra-marginal units as well). The MR curve, therefore, must lie below the demand curve and, like it, slope down as well (Fig. 6.1).

Profit maximization requires the marginal cost curve to cut the MR curve from below. At scales of output lower than this intersection, MR > MC, the monopolist adds to his profits by expanding production. At larger scales, MC > MR, so that contraction is profitable. Thus, the monopolist maximizes his profit by equating MC to MR.

Since P > MR, it follows that, in monopoly equilibrium, P > MC. The gap between P and MR, and therefore between P and MC, is inversely related to the price-elasticity of demand. If the elasticity is infinite, the demand curve is horizontal and P = MR = MC; we are in a competitive equilibrium. There is no gap between price and marginal cost, and production is optimal. This represents the case where the seller can sell any amount he wishes at the ruling price. This implies that he does not have to reduce the price of infra-marginal units when he expands production. Therefore, MR = P. On the other hand, if elasticity is less than 1, demand will rise less than proportionately to any fall in price. Recalling Chapter 4, the total consumer expenditure (and therefore sales revenue) will fall: MR will be negative. If elasticity is equal to 1, the rise in demand is proportional to the fall in price, and sales revenue is independent of output so that MR = 0. Thus, if MC is positive, MR = MC can only be achieved where the elasticity of demand is more than 1. Monopoly equilibrium is possible only on the elastic segment of the demand curve.

Unlike the competitive firm, the monopolist has no supply curve. There is no functional relationship between output and the price required to induce it. At any output, the price that the monopolist will charge depends on the elasticity of demand, as explained in the previous paragraph. Different demand conditions will give rise to different supply prices for the same output.

Fig. 6.1: Profit Maximization by a Monopolist

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