Use the diagram below to answer the questions that follow. (b)(i) Which of the curves represents the monopoly demand curve? (ii) What is the point on the di...

Answer Details

Reading the diagram. The vertical axis is Price and the horizontal axis is Quantity. Four curves are shown: MC (marginal cost, rising), AC (average cost, U-shaped), AR (average revenue, the downward-sloping curve ending at the right), and MR (marginal revenue, the steeper dashed line that lies below AR). Point a sits on the AR curve at the price level \(P_1\); point b sits on the AC curve at the cost level \(C\); point d is where MC cuts MR. The output \(q_1\) is marked on the quantity axis directly below points a and b.

(b)(i) The monopoly demand curve. The curve labelled AR (average revenue) is the monopoly's demand curve. For any firm, price equals average revenue \(\left(AR=\dfrac{TR}{Q}=\dfrac{P\times Q}{Q}=P\right)\), so the AR curve shows the price buyers will pay at each quantity, which is exactly the demand curve. It slopes downward because a monopolist must lower price to sell more.

(b)(ii) The point on the diagram (equilibrium point). The firm maximises profit where marginal cost equals marginal revenue, that is at point d, where the MC curve cuts the MR curve. This fixes the profit-maximising output at \(q_1\). Rising vertically from \(q_1\) to the demand (AR) curve gives point a, from which the price \(P_1\) is read off.

(b)(iii) Equilibrium price and quantity.

• Equilibrium quantity \(= q_1\) (read below points a and b, where \(MC=MR\)).
• Equilibrium price \(= P_1\) (read on the AR curve at point a, vertically above \(q_1\)).

(b)(iv) Area of monopoly (abnormal) profit. Profit per unit is price minus average cost, \((P_1-C)\), and this is earned on \(q_1\) units. On the diagram this is the shaded rectangle \(P_1\,a\,b\,C\), bounded above by the price line \(P_1\) through a, below by the cost line \(C\) through b, on the right by the output \(q_1\), and on the left by the price axis.

(c) Numerical value of the monopoly profit. Using the given data, price \(P_1=5\) Naira, quantity \(q_1=50\) units and average cost \(C=2\) Naira:

The monopolist therefore earns a supernormal (abnormal) profit of 150 Naira, represented by the rectangle \(P_1\,a\,b\,C\).