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The Monopoly Model

24 April, 2015 - 11:52

Learning Objectives

  • Explain the relationship between price and marginal revenue when a firm faces a downwardsloping demand curve.
  • Explain the relationship between marginal revenue and elasticity along a linear demand curve.
  • Apply the marginal decision rule to explain how a monopoly maximizes profit.

Analyzing choices is a more complex challenge for a monopoly firm than for a perfectly competitive firm. After all, a competitive firm takes the market price as given and determines its profit-maximizing output. Because a monopoly has its market all to itself, it can determine not only its output but its price as well. What kinds of price and output choices will such a firm make?

We will answer that question in the context of the marginal decision rule: a firm will produce additional units of a good until marginal revenue equals marginal cost. To apply that rule to a monopoly firm, we must first investigate the special relationship between demand and marginal revenue for a monopoly.