Mostly summarized from Gregory Mankiw’s
Principles of Economics, 5th
Ed.
PART 5 Firm Behavior
and the Organization of Industry
Chapter
15 of 36 Monopoly
Section
8 of 33
…
Table 1 here
…
Table
1 shows a result important for understanding monopoly behavior:
A monopoly firm's marginal revenue is always less
than the price of its good.
Column
5 shows the monopoly firm's marginal
revenue.
This
is the amount of revenue the firm receives for each
additional unit of output.
When
this firm is producing 3 gallons of water, it receives total revenue of $24.
When
this firm is producing 4 gallons of water, it receives total revenue of $28.
The
marginal revenue of the 4th gallon of water is $4.
…
If this firm raises production of water
from 3 to 4 gallons it will increase total revenue by only $4, from $24 to $28.
This
result even though it will sell the fourth gallon for $7.
Why
does total revenue when selling one more unit go up only $4 and not $7?
For
a monopoly marginal revenue is lower than price because a monopoly faces a downward-sloping
demand curve.
To
increase the total revenue, a monopoly must lower the price it charges to all
customers.
To
sell the fourth gallon of water the price must be lowered from $8 to $7 for all
customers.
…
At price $8, quantity of 3 gallons is sold.
The first three buyers are willing to pay $8 a gallon.
Price is $8 and marginal revenue is $6
moving from 2 gallons to 3 gallons.
Total revenue becomes $24.
At price $7, quantity of 4 gallons is sold.
The first
three buyers are willing to pay $7 a gallon, any price $8 or less.
A new fourth buyer is now willing to pay the lower price of $7 a
gallon.
Price is now $7 and marginal revenue is
$4 moving from 3 gallons to 4.
Total revenue becomes $28.
… …
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