Monopoly

Econ 212: Intermediate Microeconomics

John S. Schuler
October 21, 2019

We call a firm a monopoly when it faces a downward sloping demand curve for its product. If the firm
wishes to sell more, it must lower the price. Where will the firm choose to produce? At that point where
M R = M C. Unlike in a competitive firm, price does not automatically equal M R since the price itself is
changing. Recall the the demand curve D expresses price in terms of quantity, that is P = f (Q). We can
derive total revenue simply by multiplying quantity. T R = f (Q) × Q. Seeing how this varies as we add or
subtract from Q gives us marginal revenue. The monopolist finds the quantity where M R = M C.

1 Everywhere Elastic
Price

MR D MC

P∗

Q∗ Quantity
The market power of the monopolist depends on the elasticity of the demand curve. Let’s begin with
a simple case. The demand curve below is everywhere elastic. We have our profit curve Π = T R − T C.
Notice that Π is maximized where MR = MC. This gives us the price the monopolist charges and thus the
quantity.

1
2
Price Everywhere Inelastic

D MC

Quantity

The situation changes if the demand curve is instead everywhere inelastic. Marginal cost or MC is risings
as it usually is. MR is not pictured because it is negative. Notice that the profit, Π is falling. This is to
say that if a demand curve is everywhere inelastic, the firm produces nothing and charges an infinite price
for it. This gives us some intuition for why the monopolist always operates on the elastic portion of the
demand curve. The idea here is that as something costs more and more, less of it demanded but the quantity
demanded never hits 0. In the real world, we cannot consume arbitrarily small quantities of things so this is
only a mathematical approximation.

2
3 Typical Case

Price
MC

MR D

P∗

Q∗ Quantity
Elasticity−1

η −1 = 1
η −1

Quantity

In a more typical, case, the elasticity of the demand curve varies. We have the normal diagram but below
it we have plotted the reciprocal of the elasticity of the demand curve. This means that the dotted line
extending up from the quantity produced where the reciprocal of the elasticity, η −1 = 1 , is the dividing line
between the elastic and inelastic portions of the demand curve. To the left, the demand curve is elastic. To
the left, it is inelastic. The monopolist will always restrict output on the inelastic portion of the demand
curve because MR is negative over this range. This means that T R is decreasing as more is produced.
Once we pass the dotted line where η −1 = 1, MR becomes positive and thus, T R is increasing as more is
produced. To get a full picture of profit, Π, we also need to account for marginal costs, MC. Π is maximized,
as always, where MR = MC.