ThealgebraofProfitMaximizationinaMonopoly

Letssupposethatwearefacingthefollowingtwoequationsforourmonopolist.
Demand:P=100Q
Supply:P=4+3Q
Weknowfromourpastdiscussionsthatthemarketwilllooklikethis:

Iveidentifiedthecompetitivemarketequilibrium,howeveritreallywontdoanythingforusexcept
calculateresourcemisallocation.Whatweneedinthisexample(sincethisisamonopoly)isthe
marginalrevenuecurve.Withourstraightlinedemandcurve,wearesimplyfindingthelinethathas
thesameinterceptandaslopethatistwiceassteep.Basically,ourP=100QtransformsintoP=
1002Q.Theproofforthisislistedattheend.Ifyouarenotversedincalculus,thenIsuggest
ignoringtheproofandtakingmywordforit.
NowthatweknowMRisP=1002Q,wecanaddittoourgraph.


Wenowhavethedistastefultaskoffiguringoutwhataandbarenumerically.Thisshouldseem
familiar;infact,wedidthistofindtheequilibriumquantityandprice.
Weareagainsettingtwoequationsequaltooneanother.Thistimewellusesupplyandournewly
discoveredmarginalrevenueequation.Mathematically,thisisidentical(inproceduralterms)towhat
wedidtofindtheequilibrium.Economically,whatweredoingissettingMR=MC(sincesupplyis
marginalcost,didyouforgetthat?).TheQwefindwillbetheprofitmaximizingpointofproductionfor
amonopolist.
P=1002QandP=4+3Q
1002Q=4+3Q

Setthemequaltoeachother

96=5Q

Usealgebra:subtract4fromandadd2Qtobothsides

19.2=Q

Dividebothsidesby5.

Sorryforthedecimal;ithappens.NowthatweknowQ,wecantakethatandputitintoeitherthe
supplyequationorthemarginalrevenueequation.Eitherway,youshouldgetthesameresult.
IntoMarginalRevenue

IntoSupply

P=1002(19.2)

P=4+3(19.2)

P=10038.4

P=4+57.6

P=61.6

P=61.6

Voila!Letsputthatintothegraph.


Onelaststepwiththeequations.Togetthepriceamonopolistcharges,weneedapointonthe
demandcurve.Specifically,weneedthepointondemandthatcorrespondstotheprofitmaximizing
quantity(orinourexample19.2).Amonopolistisnotgoingtosimplycharge$61.60or$76.Whynot?
Becauseamonopolistisnotstupid!Themonopolistisgoingtochargeashighofapriceashe/shecan
get,whichcorrespondstoapointonthedemandcurve(rememberthatdemandismeasuring
reservationprice,orthehighestamountoneiswillingtopay).
Hmmmwhattodowhattodo.Iknow!IknowthatthequantityIaminterestedinis19.2,yes?So,if
IhaveaQandImlookingforaPthatisbasedondemand,ImerelyneedtoputthatQintothedemand
equation.Likeso
P=100Q

MakesureyouareusingDandnotMR!

P=100(19.2)
P=80.8
Sopointcis80.8.Letsgetthatonthegraph.


Nowwehaveallthenumbersweneedtoanalyzethemonopoly.Wecannowfind:
MonopolyQuantity
MonopolyPrice
Markup
ResourceMisallocation
DeadweightLoss

Intheend,youshouldgetsomethingthatlookslikethis(ifyouretryingtofigureoutthesefivethings).
Letmegiveyousomehints.
MonopolyQuantity:whereMR=MC,thisisthequantitythatmaximizesthemonopolistsprofit
MonopolyPrice:Theamountamonopolistcharges,shouldbereadoffthedemandcurve
Markup:PriceMarginalCost,givesasenseofhowmuchmarketpoweramonopolisthas
ResourceMisallocation:Deviationfromequilibrium
DeadweightLoss:Costtosocietyofthepresenceofamonopoly

(Answeronnextpage,dontscrollaheaduntilyouvetrieditonyourown.)

Heresthekey:

MonopolyPrice:$80.80
MonopolyQuantity:19.2
Markup:$80.80$61.60=$19.20
ResourceMisallocation:4.8toofew
DeadweightLoss:($19.20)*(4.8)*(0.5)=$46.08

Getit?Here,tryanotherone.Illgiveyoutheequations.Youfindthefivethingswejustidentified
basedontheseequations.Thenextpageistheanswerkey.DONTLOOKUNTILYOUVETRIED!!You
onlylearnbymakingmistakes.

Demand:
P=403Q
Supply:
P=3Q

(P.S.Icantguaranteeanyoftheseareniceevennumbers.Ijustmadethemuponthespot.)

Well?

ProofofMR

Forthoseofyouwhohavesomecalculusbehindyouandwishtoseewhyweareabletosimplydouble
theslope,herewego.

Sincewearedealingwithamonopoly,thedemandcurveisacollectionofprice/quantitycombinations
thatweareabletosell.BecauseitislistedasP=mQ+b,itsdefinedasaprice.

So,ifwewereinterestedinatotalrevenuefunction,wewouldsimplybemultiplyingpricetimes
quantity.

TR=P*Q

ButweknowwhatPis.Wecansubstituteourequation.Justtodoanexample,Illusetheequation
fromthefirstexampleonthisstudysheet.

Puttingthatin,wesee:
100

Thisbecomes:

100

WhileItrytoshyawayfromusingthisterminologyinaprinciplesclass,thefactthatyouhavecomethis
farmeansyoureinterested.Themarginalisthefirstderivativeofthetotal.So,ifIwanttofindthe
marginalrevenuecurve,Icansimplytakethefirstderivativeofthetotalwithrespecttoquantity.Here
goes.
100

Andthatsit!TheresmyMRfunction.
Wanttoseeitagain?Great,Illshowyou.Takethesecondequation.

40 3

40
3

40

Workseverytime!Infact,thenicethingaboutthismethodisitworksforanyfunctionnomatterhow
crazyyouwanttomakedemand.
ItevenworksforthePerfectCompetitioncasewedid.TheTRfunctionforperfectcompetitionissimply
P*Q.SincewearerestrictedtosellingatPe,itsnomorecomplicatedthanPe*Q.Workingourmagic

RememberhowtheMRcurveincompetitionwassimplyahorizontallineatmarketequilibriumprice?
Thatswhatthisis!!Beautiful!