Monopoly Revenue - Online Tutor, Practice Problems & Exam Prep

In a monopoly, the firm faces a downward sloping demand curve, leading to distinct price and output effects when altering prices. A price decrease results in lower revenue per unit (price effect) but increases total revenue through higher sales volume (output effect). Consequently, marginal revenue is always less than the price. Understanding these dynamics is crucial for grasping market power and revenue generation in monopolistic structures, paralleling concepts in monopolistic competition.

Monopoly Revenue

Alright. So now let's discuss revenue for a monopoly firm including the ideas of average revenue and marginal revenue. Okay. So as we saw, a monopoly faces a downward sloping demand curve, right? Downward sloping unlike what we saw in perfect competition, right? In perfect competition, we saw that the firm faced a flat demand curve, right? There was a flat demand curve in perfect competition for the firm. Here, the firm has a downward sloping demand curve. Okay, so when we have a downward sloping curve, demand curve and we change the price, there's going to be two effects. We're going to talk about the price effect and the output effect. Now we've gone into great detail about this before actually. It was in a video. I think it was called total revenue test and this was back when we were discussing elasticity. We went into detail about this price effect and output effect. So if you want a lot more detail, you can go to that video to review, price effect and output effect, but we're kind of going to discuss the logic here. So let's think about what happens if we decrease the price in a situation where we have this downward sloping demand curve.

Well, we're going to have two effects: price effect and output effect. First let's think about the price effect. If we decrease the price, that means we're going to earn less revenue for each unit we sell, right? Every unit we sell, we're selling at a lower price, so we're going to get less revenue. Compare that to the output effect which these two are always going to be opposite. If the price effect is bringing down revenue, the output effect will be increasing revenue and then opposite, right? So the output effect, well when we've lowered our price, we're going to sell more units, right? At the lower price, so the price effect is that we lowered we have that lower price per unit, but the output effect, well we're going to sell more units, right? So we're going to earn more revenue from the amount of units we sell, but it's going to be at a lower price, okay?

So you can imagine with a price increase, it would be the opposite. The price effect would earn us more revenue because we're selling each unit for more money, but since we increase the price, we're selling less, right? So the output effect would be less in that case. So if you want more details, again go to that video, but the key thing here is that the price effect and the output effect makes it so that the marginal revenue to the monopolist is always going to be less than the price of the good, okay? So that price is going to be greater than marginal revenue, okay? So that's the idea here and one thing I want you to notice, if you guys have already studied monopolistic competition, which is another one of our market structures, everything that we discuss in this video is exactly the same as the video for Monopolistic Competition okay? We're talking about the exact same thing. I literally copy-and-pasted the whole page savage like no, I did not care at all. I just copied everything and just changed our title here from monopolistic competition to monopoly revenue. Okay, so you're going to see that they completely parallel each other and if you haven't studied it yet, well monopolistic competition you're going to see is going to be exactly the same.

Alright, so let's go ahead and in the next video, let's do a little example so I can show you in the table and on the graph what our marginal revenue looks like, how it's always going to be less than the price, and how the curve comes out on the graph. Okay. So let's do that now, in the following video.

Monopoly and Marginal Revenue

Alright, so here we have a market for cable subscriptions. We can imagine we're in a small town where there's only one cable provider for your cable TV, and they have a monopoly over cable subscriptions in this town. Now, in my example, it's simple; it's a small town, we're going to talk about anywhere from 0 to 5 subscribers, but we're just keeping it simple just to keep the math easy, and we're going to reach the same conclusions anyway. One more thing to note, which I mentioned in the previous video—if you've covered monopolistic competition already or any other market structure, it's exactly the same. I'm even using the same example here. No cares given, right? So let's go ahead and dive right in.

We've been given some quantities and prices here, right? And notice that as the quantity increases, the price decreases—this is the law of demand. We have to decrease the price to increase the quantity. So let's go ahead and discuss total revenue, average revenue, and marginal revenue in these cases.

We've got our formulas here. Total revenue, we've discussed before, is price times quantity. So let's do some multiplication here. 0 times 80, right? Total revenue is going to be 0 there. There were no sales. How about when we have 1 subscriber paying 70? Well, that's going to be 70, right? 2 times 60, 120. 3 times 50, that's 150. 4 times 40 is 160 and then 5 times 30 is 150. There, right? So you can see that the total revenue was increasing, increasing to a point and then it decreased again.

Let's talk about average revenue and remember, when we proved that average revenue just equals price. The total revenue divided by quantity, where total revenue is price times quantity. Well, these quantities just go away, and we're left with just price. So we could just double-check here, and we could, well in this case, you can't divide by 0, but we could just test it just in case. So we take our total revenue of 70 divided by our subscribers of 1, and we're going to get 70, right? That is the price also, right? The price was 70, average revenue is 70. How about the next one? 120 divided by 2 gets us 60, right? And 60 again is the price. So there you go, you're going to see that the average revenue is always going to just equal the price: 50, 40, and 30, right? All the way down. Average revenue just equals the price.

Our demand curve is this curve that we've got here, and it's equal to average revenue. Now let's think about our marginal revenue. Marginal revenue is the change in total revenue over change in quantity. In general, this change in quantity is just going to be one; we're just increasing by 1 subscriber each time, so it's really just what is the change in total revenue. So in the first case, we had 0 revenue, and then we went up to 70 revenue when we got our 1st subscriber, so our marginal revenue there was 70. When we added the second subscriber, our revenue was already 70, and we added another 50, to get up to 120. 120 minus 70 is that 50 in marginal revenue. The next one we already had 120 in revenue, and it got us up to 150. So the 150 minus the 120 is another 30 in revenue, and how about the next one? Well, we already had 150, and then we went up to 160. So we got an additional 10 in revenue there, and how about this last one? We were at 160 and we went back down to 150. We lost some marginal revenue there. So we had negative marginal revenue, negative ten marginal revenue. So look at this, marginal revenue is not constant. In perfect competition, marginal revenue was always just the price. Here, since we have a downward-sloping demand curve, our marginal revenue is decreasing.

Let's draw this marginal revenue curve on the graph. So when we had 1 subscriber, a quantity of 1, we were at 70. And then when we had 2 subscribers, marginal revenue was 50. 3 subscribers, we were down at 30, 10, and then it was like negative 10, so it went under the graph there. So if we connect these points right here, something like that, we've now drawn in our marginal revenue curve. The marginal revenue curve is less than the demand curve. It's a different shape and is always going to have more of a slope and come down just under the demand curve.

Now we'll see more examples of marginal revenue, but the key here is that this is unlike perfect competition. In perfect competition, we saw that the marginal revenue equaled the average revenue, equaled the price, and there was that flat demand curve. No longer, right? Now we've got the downward-sloping demand curve and marginal revenue underneath it. This is going to have some implications. Remember, when we were thinking about profit maximizing, marginal revenue equaling marginal cost. We're going to see how this affects what we're going to produce and how we maximize profit. Before we move on, let's go ahead and do some practice problems about this topic, and then we'll go on to discussing profit. Let's do that now.

Which of the following statements is true?

• A. A monopolist's demand curve is more elastic than the market demand curve.
• B. For a monopoly, an increase in the quantity sold will always increase total revenue.
• C. The barriers to market entry in perfect competition are similar to those for a monopoly.
• D. A monopoly's marginal revenue is less than its average revenue.

Here’s what students ask on this topic:

What is the relationship between marginal revenue and price in a monopoly?

In a monopoly, the marginal revenue (MR) is always less than the price of the good. This occurs because the monopolist faces a downward sloping demand curve. When the monopolist lowers the price to sell more units, the price effect (lower revenue per unit) and the output effect (higher revenue from increased sales) come into play. The price effect reduces revenue, while the output effect increases it. However, the net effect is that the additional revenue from selling one more unit (MR) is less than the price at which that unit is sold. This is a key characteristic of monopolistic markets.

How do price effect and output effect influence monopoly revenue?

In a monopoly, the price effect and output effect have opposing influences on revenue. The price effect occurs when a price decrease leads to lower revenue per unit sold, while the output effect happens when the lower price results in higher sales volume, increasing total revenue. When the monopolist decreases the price, the price effect reduces revenue per unit, but the output effect increases total revenue by selling more units. Conversely, a price increase raises revenue per unit (price effect) but reduces the quantity sold (output effect). These effects ensure that marginal revenue is always less than the price.

Why is the demand curve downward sloping for a monopoly?

The demand curve is downward sloping for a monopoly because the monopolist is the sole provider of the good or service in the market. As a result, to sell more units, the monopolist must lower the price, which reflects the law of demand. This contrasts with perfect competition, where firms face a flat demand curve at the market price. The downward sloping demand curve means that the monopolist has to consider the price effect and output effect when setting prices, leading to marginal revenue being less than the price.

How does a monopoly determine the profit-maximizing level of output?

A monopoly determines the profit-maximizing level of output by equating marginal revenue (MR) to marginal cost (MC). The monopolist will produce up to the point where MR = MC. At this level, the cost of producing one more unit equals the revenue gained from selling that unit, maximizing profit. Since MR is always less than the price in a monopoly, the price at the profit-maximizing output is found on the demand curve above the MR = MC point. This ensures the monopolist maximizes profit by balancing additional revenue and cost.

What is the significance of understanding monopoly revenue for microeconomics students?

Understanding monopoly revenue is crucial for microeconomics students because it highlights the unique market power monopolists hold and how they influence prices and output. Unlike in perfect competition, monopolists can set prices above marginal cost, leading to higher profits but also potential inefficiencies and consumer welfare losses. Grasping the concepts of price effect, output effect, and the relationship between marginal revenue and price helps students analyze real-world market structures, regulatory policies, and the economic implications of monopolistic practices.