Refer To Figure 15-5. A Profit-Maximizing Monopoly’s Profit Is Equal To
When a monopoly operates in a market, it has the ability to set a price higher than the market price, resulting in higher profits. This is because the monopoly has the market power to set prices higher than what competition would allow. However, the monopoly’s goal is to maximize profits, and in order to do so, it must determine the optimal price and output level that yields the highest profits.
Figure 15-5 shows the profit-maximizing price and output combination for a monopoly. The profit maximizing point is determined when the marginal revenue is equal to the marginal cost. The marginal revenue is the extra revenue earned from producing and selling one more unit of output. The marginal cost is the increase in total cost associated with producing and selling one more unit of output. At the profit maximizing point, the marginal revenue is equal to the marginal cost, meaning the extra revenue earned is equal to the increase in total cost.
At the profit maximizing point in Figure 15-5, the equilibrium price is Pmax and the equilibrium output is Qmax. The profit at this point is the shaded area, which is the area under the demand curve (AR) and above the marginal cost curve (MC). This area represents the difference between the total revenue (the area under the demand curve) and the total cost (the area under the marginal cost curve). The profit-maximizing monopoly’s profit is equal to this area.
In conclusion, a monopoly is able to maximize profits by setting the price and output at the profit-maximizing point. The profit at this point is equal to the shaded area in Figure 15-5, which represents the difference between the total revenue and the total cost.