Economics

Assignment No.1

Name: Aleem Hasan

Class: BBA-2K11-A

Q: Explain why each of the following statements is false. Write the

correct statement, draw the graph and justify your answer.
(a) A Monopolist maximizes profits when MC=P
Correct Statement- A monopolist maximizes profits when MC=MR

Explanation- A monopolist will find its maximum-profit position where MC=MR, that is, where the last
unit it sells brings in extra revenue just equal to its extra cost. This relationship is called the marginal
principle and this principle is shown graphically by the intersection of the MR and MC curves or by the
equality of the slopes of the total revenue and total cost curves. A monopolist has to find the production
point where marginal cost ‘MC’ is equal to the marginal revenue ‘MR’. The price of goods is independent
of this relationship.

Increasing output would lead to a lower level of profits so the profit maximizing firm should cut back on
output. Clearly the best profit comes at the point where MR=MC and not at MC=P

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 (b) The higher the price elasticity of demand, the higher is a
monopolist’s price above its MC.
Correct Statement- The lower the price elasticity of demand, the higher is a monopolist’s
price above its MC.

Explanation- We are considering 2 possibilities a company’s demand schedule in the short run and its
demand schedule in the long run. If a company changes its price in the short run it will not affect its
demand curve but in the long run it will cause the demand curve to shift. A monopolistic company’s prices
are inelastic so even if prices are above the marginal cost consumers will still buy the goods produced by
the firm. But in cases where prices are elastic the raise in price of a company’s products will cause the
consumers to switch to other goods causing the firm a loss. The graphs below show that if the price
elasticity is low, the gap between price and marginal cost is bigger. For monopolist’s inelasticity, marginal
cost is low as the quantity demanded and supplied is low. A monopolist can increase prices without the
fear of losing large share of its consumer base. Hence, the gap between price and marginal cost is large.

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 (c)Monopolists ignore the marginal principle.
Correct Statement- Monopolists ignore the economic efficiency principle and that the
marginal principle is one of the central lessons of economics.

Explanation- The marginal principle states that people will maximize their incomes or profits or
satisfactions by counting only the marginal costs and marginal benefits of a decision. Monopolists use
the marginal principle to judge the amount of output they should produce to get the maximum
profit. Hence, monopolists cannot ignore the marginal principle as it comes in handy in many situations.
 If marginal revenue is greater than marginal cost, the monopolist should increase
output.
 If marginal revenue is less than marginal cost, the monopolist should decrease
output.
The marginal principle of equating marginal cost and marginal revenue is the rule for profit maximization.
When MR>MC the firm should continue to increase outputs but when MR<MC increasing output would
lower profits. So the company should decrease outputs to increase prices and hence, maximize profits.
When deciding about investing in companies forget about past gains and losses and decide only on the
basis of marginal returns and costs. On the contrary, Monopolists ignore the Efficiency Principle
rather than the marginal principle.