Monopoly and monopolistic competition

Sample Solution

Monopoly Pricing Strategies: Markup and Profit Maximization

1-) Monopoly Manager Decisions:

A) Markup with price elasticity = 2:

• Given a marginal cost of $100 and a price elasticity of 2, your ideal markup over marginal cost would be 100%.
• Explanation: When price elasticity is 2, a 1% increase in price causes a 2% decrease in quantity demanded. To maximize profit, you need to find the price where the incremental revenue from price increase (marginal revenue) equals the incremental cost of producing another unit (marginal cost). In this case, a 100% markup translates to doubling the price from marginal cost, maximizing profit as the marginal revenue just equals the marginal cost.

B) Markup with price elasticity = 3:

• With a higher price elasticity of 3, a 100% markup would lead to a larger decline in demand and lower overall profit.
• In this case, your optimal markup would be 66.67%.
• Explanation: When demand is more elastic, even a smaller price increase leads to a greater decrease in quantity demanded. Therefore, to reach the point where marginal revenue equals marginal cost, you need a smaller markup compared to a less elastic demand. A 66.67% markup ensures this balance and maximizes profit for a price elasticity of 3.

Full Answer Section

Factors affecting price elasticity:

• Availability of substitutes: If readily available substitutes exist, demand is more elastic, necessitating lower markups.
• Necessity of the product: Essential goods have less elastic demand, allowing for higher markups.
• Time horizon: In the long run, demand tends to be more elastic as consumers have more time to find substitutes.

2-) Marginal Analysis and Profit Maximization:

Marginal analysis involves comparing marginal revenue (MR) and marginal cost (MC) to determine the profit-maximizing quantity for any firm. While the specific calculations differ, the underlying principle applies to monopolies, dominant firms, and monopolistically competitive firms:

• Monopolies: They face a downward-sloping demand curve due to their sole control of the market. Their MR curve lies below the demand curve, and the profit-maximizing quantity is found where MR = MC.
• Dominant Firms: These firms hold a significant market share but face some competition. Their MR curve might not have the same predictable shape as a monopoly, but the principle of maximizing profit by setting output where MR = MC still holds.
• Monopolistically Competitive Firms: In this market structure, firms offer differentiated products with some degree of substitution. Each firm faces a downward-sloping demand curve for its specific product. Similar to monopolies, they achieve profit maximization by setting their output where MR = MC.

Ultimately, regardless of the market structure, understanding marginal revenue and marginal cost and their relationship is crucial for any firm to determine the optimal quantity to produce for maximum profit.

I hope this explanation clarifies the markup strategies for a monopoly manager and the general application of marginal analysis in different market structures. If you have any further questions or want to delve deeper into specific aspects, feel free to ask!