Economics » Monopoly » How a Profit-Maximizing Monopoly Chooses Output and Price

Total Cost and Total Revenue For a Monopolist

Total Cost and Total Revenue for a Monopolist

Profits for a monopolist can be illustrated with a graph of total revenues and total costs, as shown with the example of the hypothetical HealthPill firm in this figure. The total cost curve has its typical shape; that is, total costs rise and the curve grows steeper as output increases.

Total Revenue and Total Cost for the HealthPill Monopoly

The graph shows total cost as an upward-sloping line and total revenue as a curve that rises then falls. The two curves intersect at two different points.

Total revenue for the monopoly firm called HealthPill first rises, then falls. Low levels of output bring in relatively little total revenue, because the quantity is low. High levels of output bring in relatively less revenue, because the high quantity pushes down the market price. The total cost curve is upward-sloping. Profits will be highest at the quantity of output where total revenue is most above total cost. Of the choices in this table, the highest profits happen at an output of 4. The profit-maximizing level of output is not the same as the revenue-maximizing level of output, which should make sense, because profits take costs into account and revenues do not.

Total Costs and Total Revenues of HealthPill

QuantityTotal CostQuantityPriceTotal RevenueProfit = Total Revenue – Total Cost

To calculate total revenue for a monopolist, start with the demand curve perceived by the monopolist. This table shows quantities along the demand curve and the price at each quantity demanded, and then calculates total revenue by multiplying price times quantity at each level of output. (In this example, the output is given as 1, 2, 3, 4, and so on, for the sake of simplicity. If you prefer a dash of greater realism, you can imagine that these output levels and the corresponding prices are measured per 1,000 or 10,000 pills.) As the figure illustrates, total revenue for a monopolist rises, flattens out, and then falls. In this example, total revenue is highest at a quantity of 6 or 7.

Clearly, the total revenue for a monopolist is not a straight upward-sloping line, in the way that total revenue was for a perfectly competitive firm. The different total revenue pattern for a monopolist occurs because the quantity that a monopolist chooses to produce affects the market price, which was not true for a perfectly competitive firm. If the monopolist charges a very high price, then quantity demanded drops, and so total revenue is very low. If the monopolist charges a very low price, then, even if quantity demanded is very high, total revenue will not add up to much. At some intermediate level, total revenue will be highest.

However, the monopolist is not seeking to maximize revenue, but instead to earn the highest possible profit. Profits are calculated in the final row of the table. In the HealthPill example in this figure, the highest profit will occur at the quantity where total revenue is the farthest above total cost. Of the choices given in the table, the highest profits occur at an output of 4, where profit is 800.

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