MONOPOLY, MARGINAL REVENUE AND DEMAND ELASTICITY: The price elasticity of the demand curve facing a monopoly firm determines if the marginal revenue received by the monopoly is positive (elastic demand) or negative (inelastic demand). This relationship is important for the profit-maximizing production decision that involves equality between marginal revenue and marginal cost. It implies that a monopoly can only maximize profit in the elastic range of the demand curve.The relation between the price elasticity of demand and the marginal revenue curve indicates that a monopoly is only able to maximize profit by producing a quantity of output that falls in the elastic range of the demand curve. A monopoly cannot maximize profit in the inelastic range of demand because this involves negative marginal revenue, and by virtue of the profit-maximizing equality between marginal revenue and marginal cost, it requires negative marginal cost, which is just not a realistic possibility. The connection between marginal revenue and elasticity works like this:
A Look at the Curves
The top panel in the exhibit presents a hump-shaped total revenue curve (TR). It is hump-shaped because Feet-First Pharmaceutical does not charge the same price for each quantity sold. As a monopoly, it must lower the price to sell more output. The bottom panel then presents the average revenue curve (AR), which is also the market demand curve and the demand curve facing Feet-First Pharmaceutical, and the marginal revenue curve (MR), which indicates the extra revenue received for selling each extra ounce of Amblathan-Plus. Now consider the price elasticity of the average revenue (demand) curve. A straight-line demand curve such as this one has different ranges of elasticity.
The key question is how these elasticity alternatives relate to marginal revenue and total revenue.
The Monopoly DreamTo see why this conclusion is so important, consider how it appears to contradict what would seem to be dream of any aspiring monopoly.To achieve monopoly status, a firm must supply a good that has no close substitutes. Buyers must be forced to buy from the monopoly if they buy the good at all. However, the availability of substitutes is a key determinant of demand elasticity.
Are these aspiring monopolies misguided? Should they be searching for goods with elastic demand? Are they unaware of the relation between elasticity and marginal revenue? Do they not know that they can never maximize profit if they produce a good with inelastic demand? A Profitable JourneyThe monopoly dream is not as misguided as it might first appear. The key is the phrase "profit maximization." Profit is MAXIMIZED when marginal revenue is positive and demand is elastic. In other words, when profit is maximized there is no way to INCREASE profit by doing something like increasing the price.While profit maximization means profit can go no higher, the lack of profit maximization only means profit has NOT reached its peak. It does not mean profit is lacking. It does not mean that a monopoly firm is earning NO profit or incurring an economic loss. The lack of profit maximization ONLY means that the monopoly can take steps to increase profit. It can increase profit by doing something like increasing the price. If a monopoly faces an inelastic demand curve, increasing the price is exactly what it can do. If the price of a good with inelastic demand is increased, then total revenue and profit also increase. Today the price is $1. Tomorrow the price is $2, and profit increases. The next day the price is $3, and profit increases again. When prices rise so too does profit. As long as demand is inelastic, then profit keeps rising. A "maximum" is not reached. Is this is such a bad thing for the monopoly? Not being AT THE MAXIMUM, but ONLY being able to increase profit is not really all that bad. Few firms would turn down the opportunity to be the sole provider of an inelastic product. Sure they might never MAXIMIZE their profit, that is, reach a nice stable equilibrium. But they can increase profit day after day, month after month, year after year, by raising prices. The "problem" is that profit can always go higher. In the analysis of profit-maximization production, a monopoly NEVER selects an output level in the inelastic range of this demand curve. Feet-First Pharmaceutical NEVER willingly produces more than 10.5 ounces of Amblathan-Plus. Doing so requires that Feet-First Pharmaceutical operate with a quantity that generates negative marginal revenue. If Feet-First Pharmaceutical found itself doing something like selling 15 ounces of Amblathan-Plus, then it undoubtedly raises the price, which reduces the quantity, which then increases total revenue, and which INCREASES profit. It continues this course until the quantity decreases enough to enter the elastic portion of the demand curve. Only there is Feet-First Pharmaceutical be able to MAXIMIZE profit. However, up to that time, profit merely INCREASES. Not such a bad thing for the monopoly. Check Out These Related Terms... | monopoly, sources | monopoly, efficiency | monopoly, realism | monopoly, problems | monopoly and perfect competition | monopoly, demand | Or For A Little Background... | monopoly | monopoly characteristics | average revenue | marginal revenue | demand | demand curve | elasticity | elasticity and demand slope | elasticity determinants | price elasticity of demand | demand elasticity and total expenditure | And For Further Study... | monopoly, short-run production analysis | price discrimination | perfect competition | oligopoly | monopolistic competition | barriers to entry | average revenue, monopoly | average revenue curve, monopoly | marginal revenue, monopoly | marginal revenue curve, monopoly | Recommended Citation: MONOPOLY, MARGINAL REVENUE AND DEMAND ELASTICITY, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: November 30, 2024]. |
