Question

a) How does a firm operating under monopoly market structure determine profit maximizing output and price?

b) Explain why an increase in price above the profit maximising price implies that a reduction in profits for the monopolist.   

Answer 1

Ans.
a) A monopolist maximizes its profit at the level of output where marginal revenue (MR) equals marginal cost (MC). This output is represented by Q in the diagram. The price level corresponding to this output level is given by the demand curve curve and is P.
b) A monopolist produces on inelastic portion of the demand curve at profit maximizing level. So, even a 1% increase in price above the profit maximizing level will lead to more than 1% decrease in quantity. So, total revenue which is the product of price anf quantity of the good will fall and as a result profits will also fall.

Price MC P Demand MR Q Quantity

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