Graphing Exercise: Monopoly

A monopolist is a firm that produces a product for which there are no close substitutes. Whether the source of its unique status is the result of patents, control of a resource, or economies of scale, the monopoly essentially is the industry. The demand for its product is the same as the industry demand, and as such, is downward sloping. To sell additional output, the firm must lower the price. Further, this lower price applies to all units sold, not just the marginal unit. Marginal revenue must then be less than the price. A monopolist searches the demand curve for the price and quantity that maximizes its profits.

The graph shows the demand, marginal revenue, and cost data for a monopolist. It is currently producing 60 units per month and charging a price of $250 each. Its total revenue, cost, and profit are shown in the box. To use the graph, click and drag the green triangle to change the firm's choice of output (and price). Click on the Show Profit/Loss for a graphical illustration of the profit or loss at the chosen output. Dragging up or down on the D label will change the elasticity of the demand curve; click Reset to restore all initial settings.

1		Starting from the initial price and quantity, what happens to the firm's revenue as the firm lowers the price? What combination of quantity and price will maximize the firm's total revenue? Note the value of marginal revenue over this range.
2		What quantity and price will maximize the firm's profits? How much profit is attainable at this choice? Compare marginal revenue and marginal cost at alternative choices.
3		Experiment on your own with different demand conditions. For a given demand curve, what rule for selecting price and output will always provide the firm with the greatest profits?

Graphing Exercise: Monopolistic Competition

Monopolistic competition is characterized by a large number of firms producing goods or services that are differentiated from one another. Entry of new firms into the industry is relatively unrestricted. As a result, the typical firm will earn no economic profit in the long run.

The graph illustrates the demand and cost conditions for a typical firm in a monopolistically competitive industry. Its demand curve is downward sloping to reflect the monopoly power owing to its differentiated product. The firm can raise its price without losing all its sales to rival firms. To use the graph, use the mouse to drag the demand curve; clicking on the Adjust button will illustrate how the market and firm respond to restore long-run equilibrium. The Show Profit button will illustrate any short-run profits available to the firm.

4		Given the initial demand and cost conditions, what output level and price will maximize the firm's profit? What profit level can the firm attain?
5		Suppose demand for the products made by this industry increases. How will this firm respond in the short run? Will its profits increase in the short run?
6		In response to an increase in industry demand, how will this firm respond in the long run? Will its profits increase in the long run?
7		Experiment on your own. How would the firm and industry respond to a decline in demand in both the short and long run? What generalization can you make?