If demand is price elastic, a price reduction increases total revenue. We have learned that price elasticity varies along a linear demand curve in a special way: Demand is price elastic at points in the upper half of the demand curve and price inelastic in the lower half of the demand curve. The demand curve in Panel (a) of Figure 10.4 “Demand, Elasticity, and Total Revenue” shows ranges of values of the price elasticity of demand.
At that point on the demand curve, the price elasticity of demand equals −1. Total revenue, plotted in Panel (b), is maximized at $25, when the quantity sold is 5 units and the price is $5. Total revenue is found by multiplying the price and quantity sold at each price. In order to increase the quantity sold, it must cut the price. Suppose a monopolist faces the downward-sloping demand curve shown in Panel (a). To be a price setter, a firm must face a downward-sloping demand curve.įigure 10.4 Demand, Elasticity, and Total Revenue
It could not, for example, charge price P 1 and sell quantity Q 3. The monopoly firm may choose its price and output, but it is restricted to a combination of price and output that lies on the demand curve. To sell quantity Q 3 it would have to reduce the price to P 3. If it wants to increase its output to Q 2 units-and sell that quantity-it must reduce its price to P 2. Suppose, for example, that a monopoly firm can sell quantity Q 1 units at a price P 1 in Panel (b). But, unlike the perfectly competitive firm, which can sell all it wants at the going market price, a monopolist can sell a greater quantity only by cutting its price. Because it is the only supplier in the industry, the monopolist faces the downward-sloping market demand curve alone. The perfectly competitive firm, by contrast, can sell any quantity it wants at the market price.Ĭontrast the situation shown in Panel (a) with the one faced by the monopoly firm in Panel (b). The monopoly firm can sell additional units only by lowering price. Once it determines that quantity, however, the price at which it can sell that output is found from the demand curve. As a profit maximizer, it determines its profit-maximizing output. In Panel (b) a monopoly faces a downward-sloping market demand curve. A typical firm with marginal cost curve MC is a price taker, choosing to produce quantity q at the equilibrium price P. Panel (a) shows the determination of equilibrium price and output in a perfectly competitive market. Each firm in a perfectly competitive industry faces a horizontal demand curve defined by the market price.įigure 10.3 Perfect Competition Versus Monopoly In the perfectly competitive model, one firm has nothing to do with the determination of the market price. Notice the break in the horizontal axis indicating that the quantity produced by a single firm is a trivially small fraction of the whole. The marginal cost curve, MC, for a single firm is illustrated. Those, in turn, consist of the portions of marginal cost curves that lie above the average variable cost curves. The market supply curve is found simply by summing the supply curves of individual firms.
In Panel (a), the equilibrium price for a perfectly competitive firm is determined by the intersection of the demand and supply curves. Figure 10.3 “Perfect Competition Versus Monopoly” compares the demand situations faced by a monopoly and a perfectly competitive firm. Because a monopoly firm has its market all to itself, it faces the market demand curve.
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