Demand Curve
A demand curve illustrates the relationship between the price of a product and the quantity of the product that consumers are willing and able to purchase. In the case of De Beers, the diamond monopoly, the demand curve is downward-sloping. This means as the price of diamonds decreases, the quantity demanded increases. The willingness to pay for each customer—Raquel, Jackie, Joan, Mia, and Sophia—establishes discrete points on this curve, indicating that at higher prices, fewer diamonds would be purchased. This creates a stepwise graphic that, when connected, forms the typical downwards slope.
For a monopolist like De Beers, the demand curve is also the average revenue curve, since it shows the average price (or revenue) at each level of output. However, it's vital to understand that this demand curve does not remain constant; it can shift due to changes in consumer preferences, income, prices of related goods, or any other number of factors affecting demand.
Marginal Revenue
Marginal Revenue (MR) is the additional revenue that a company receives when it sells an additional unit of a product. For De Beers, MR is calculated by the change in total revenue from selling one more diamond. Since De Beers is a monopolist, its MR is always less than the price of the diamond because to sell additional diamonds, it must lower the price, and this lower price applies to all units sold, not just the additional unit. This results in a MR curve that lies below the demand curve and also slopes downward, reflecting the decreasing additional revenue gained from selling each subsequent unit.
Understanding Marginal Revenue
It's crucial to recognize that for non-monopolistic markets, MR typically remains constant as the price does not change with each additional unit sold. However, in monopolistic markets, the MR can change significantly with each additional unit.
Marginal Cost
Marginal Cost (MC) represents the cost of producing one more unit of a good. For De Beers, they have a constant MC of \( \(100 \) per diamond, which means it costs them \( \)100 \) to produce an additional diamond, regardless of how many they have already produced. In the context of profit maximization, De Beers will continue to produce and sell diamonds up to the point where MC equals MR.
Importance in Decision Making
In general, knowing the MC is vital for a firm's decision-making process, as it helps determine at what point producing more units would lead to diminishing returns and potentially losses if the MC exceeds the MR.
Price Effect
When discussing a monopolist, such as De Beers, the price effect refers to the reduction in total revenue due to decreasing the price of a product so more units can be sold. This effect occurs because, in a monopoly, the lowered price affects all units sold, not just the additional ones. In the exercise, if De Beers lowers the price from \( \(200 \) to \( \)100 \), the price effect would be calculated as the difference in price multiplied by the number of diamonds sold before the price was decreased.
The price effect can dampen the monopolist's ability to increase revenue through higher sales volume, as the gain from selling additional units at a lower price may not offset the revenue lost on the units that could have been sold at a higher price.
Quantity Effect
Opposite to the price effect is the quantity effect, which implies the additional revenue generated from the increase in quantity sold due to a price reduction. For De Beers, when they lower the price from \( \(200 \) to \( \)100 \), they will sell more diamonds. The quantity effect is calculated as the new price multiplied by the increase in the number of diamonds sold.
The quantity effect represents the monopolist's potential to generate more revenue through increased sales. Nonetheless, the key for a monopolist like De Beers is to find the balance where the increase in revenue due to the quantity effect is greater than the loss in revenue from the price effect.
Profit Maximization
The goal of profit maximization for a monopolist, such as De Beers, is to find the point where the difference between total revenue and total cost is the greatest. This is typically where the marginal revenue equals the marginal cost. In the exercise, by plotting the MR curve and the horizontal MC line for De Beers, we identify the profit-maximizing quantity where these two curves intersect. Then, we look at the demand curve to find the highest price De Beers can charge for that quantity.
For De Beers, or any monopolist, profit maximization also involves considerations of the price effect and the quantity effect. The firm must make strategic decisions on pricing to ensure it's not lowering prices unnecessarily, which would diminish the revenue from existing customers, while also not pricing too high, which would reduce the quantity sold more than the extra revenue gained from higher prices.
