Question

Draw a graph that shows a monopolist earning a profit. Be sure your graph includes the monopolist's demand, marginal revenue, average total cost, and marginal cost curves. Be sure to indicate the profit-maximizing level of output and price.

Short answer

To illustrate a monopolist earning a profit via a graph: First, draw the demand curve (downward sloping) and the marginal revenue curve (below the demand curve, also downward sloping). Then, draw the average total cost (U-shaped) and the marginal cost (cuts the ATC at the lowest point) curves. The monopolist's profit-maximizing output and price is where the MC intersects the MR. That vertical line up to the demand curve indicates the profit-maximizing price. The total profit can be shown as the shaded area between the ATC and the demand curve, from the origin to the profit-maximizing quantity.

Step-by-step solution

Draw the Axes

Begin by drawing the graph's two axes. The horizontal axis (X-axis) represents the monopolist's quantity of output, while the vertical axis (Y-axis) shows price and costs.

Draw the Demand Curve

Next, draw the demand curve, which slopes downward from left to right. This high-to-low slope indicates that as price decreases, demand increases, and vice versa.

Draw the Marginal Revenue Curve

Now draw the marginal revenue curve, which is below demand curve and also slopes downward; it represents the additional revenue that the monopolist gains due to a one-unit increase in output.

Draw the Average Total Cost and Marginal Cost Curves

Further down, draw the Average Total Cost (ATC) curve which typically has a U-shape. It represents the cost of each good manufactured. Draw the Marginal Cost (MC) curve that cuts the ATC at its lowest point. It also typically has a U-shape and represents the extra cost incurred in producing each additional unit of output.

Identify the Monopolist's Profit-Maximizing Output and Price

The point where the MC intersects the MR is the monopolist's profit maximizing output. Draw a vertical line from this point up to the demand curve to locate the profit-maximizing price.

Highlight the Area of Profit

The monopolist's total profit is represented by the shaded area between the ATC and the demand curve, from the origin to the profit-maximizing quantity.

Key concepts

Demand Curve

The demand curve is a fundamental element of our monopoly profit graph. It visualizes the relationship between the price of a good and the quantity demanded by consumers. In a monopoly scenario, the demand curve is typically downward sloping. As the price decreases, more consumers are willing to purchase the product, hence, increasing demand.

In graphing this, the demand curve is usually positioned as a straight line, descending from left to right. This slope signifies the inverse relationship between price and quantity demanded. When drawing it, remember:

• The curve shows the highest price consumers will pay for each quantity.
• It’s unique to each market and reflects consumer preferences.

Understanding the demand curve is crucial, as it directly influences the monopolist's pricing decisions and potential profits.

Marginal Revenue

Marginal revenue refers to the additional income a firm earns from selling one more unit of a product. In a monopoly, marginal revenue plays a pivotal role because it helps determine the profit-maximizing level of output.

Unlike in competitive markets, the marginal revenue curve for a monopoly lies below the demand curve and also slopes downward. It indicates that as the monopolist increases sales, the revenue gained from each additional unit declines. This occurs because to sell more, a monopolist must lower the price for all units, not just the extra ones.

Key points about the marginal revenue curve:

• It helps identify the optimal output where maximum profit occurs.
• The intersection with the marginal cost curve signals the profit-maximizing output.
• It's steeper than the demand curve, reflecting how price cuts impact total revenue.

By analyzing this curve, monopolists can determine how changes in production affect revenue and strategize accordingly.

Average Total Cost

The average total cost (ATC) curve is crucial for assessing a monopoly's expenses. It depicts the cost per unit of output on average, combining all fixed and variable costs. Typically, the ATC curve has a U-shape due to the behavior of economies of scale.

As output increases, the average cost initially decreases, then starts to rise. This is because spreading fixed costs over more units reduces per unit costs, but after a point, variable costs rise with increased production.

• The lowest point on the ATC curve indicates the most cost-effective level of output.
• It intersects with the marginal cost at this lowest point, implying optimal efficiency in production.

Understanding where the ATC intersects other curves is essential for gauging when production is profitable. It helps identify the points where costs and revenues align in favor of the monopolist.

Marginal Cost

The marginal cost (MC) curve represents the cost of producing one additional unit of a good. In monopoly analysis, this curve is an important guide for making production decisions.

Like the ATC curve, the MC curve typically has a U-shape. Initially, as production ramps up, the cost per additional unit falls. After reaching a certain point, it begins to rise as resources become more strained.

Key insights from the marginal cost curve include:

• It's critical to identifying profit-maximization: the intersection with marginal revenue marks this golden point.
• The curve helps determine the optimal scale of production, controlling cost increases.
• Meeting the demand efficiently while minimizing cost is crucial for maximum profits.

In a monopoly, understanding the MC curve ensures appropriate pricing strategies are set to align production costs with consumer demand.