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Monopolist optimizing price: Marginal revenue

AP.MICRO:
PRD‑3 (EU)
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PRD‑3.B (LO)
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PRD‑3.B.5 (EK)
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PRD‑3.B.6 (EK)
A monopolist's marginal revenue curve is always less than its demand curve. We explore why using a numerical example in this video.  Created by Sal Khan.

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  • male robot hal style avatar for user Tao Cheng
    isn't MR just like elasticity??
    (17 votes)
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    • male robot donald style avatar for user Niels B
      In a way, yes. You could say that the elasticity of demand determines the slope of the MR-curve. The MR-curve is the expected revenue, so the quantity demanded times the price paid for it summed up and given per extra unit.

      The elasticity curve determines the quantity demanded for every price change, whilst the MR-curve visualizes it per quantity change (extra unit).
      (13 votes)
  • leaf green style avatar for user juufa72
    There are many calculus videos on this site, which one specifically should I watch to do through calculus what Sal did algebraically?
    (7 votes)
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    • male robot donald style avatar for user Niels B
      Exactly, as Jan said.

      Make use of the FOC (First-order-condition) which is the derivative equals 0.
      You know the demand function is P = 6 - Q and the TR = P * Q.

      Substitute P in the TR-formula, gives you TR = (6 - Q) * Q
      TR = -Q^2 + 6Q

      Now use the FOC... TR' = -2Q + 6 = 0
      -2Q = -6
      2Q = 6
      Q = 3
      (9 votes)
  • blobby green style avatar for user Iyinsoyemi
    what is the relationship between shortrun and monopoly
    (3 votes)
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    • primosaur seedling style avatar for user Cameron
      There is no distinction between short run and long run with monopolies. So long as the firm remains the only producer in the market and the market does not experience any shifts, the supply, demand, and optimum production quantity will remain the same.
      (7 votes)
  • leaf green style avatar for user Qing Hui Yu
    So that the total revenue = the area under the demand curve = integral of the demand curve,
    and marginal revenue = the inst. slope of total revenue curve = derivative of the TR curve
    does it mean that the MR curve = the demand curve?
    (3 votes)
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  • aqualine seed style avatar for user K B
    @ Why the MR has twice slope of demand in the case of monopolist alone ? Why it is not valid for competitive market ? If it is due to some equilibrium price, surely in case of monopoly too, we can have supply curve (cost curve) & can have some equilibrium price.
    (3 votes)
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  • aqualine tree style avatar for user Lufti Fauzi
    I understand how sal gets the MR but it makes no sense to me about the result
    when Q=1 MR=4 TR=5 then the next incremental unit should add TR by 4 than why the TR when Q=2 is 8 , It's so hard to believe for me
    (2 votes)
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    • aqualine ultimate style avatar for user Stefan van der Waal
      When Q=1 and MR=4 the TR increases by 4 times as much as a very, very small change in quantity. For example: an increase in Q from 1 to 1.001 will increase the total revenue by approximately 4 * 0.001 = ~0.004, making the TR 5 + ~0.004 = ~5.004.

      However, and here it goes wrong with your thinking, when I want to add a little bit more quantity the marginal revenue is no longer 4. It's now slightly lower (at Q=1.001 the MR is 3.998). That decrease in marginal revenue will continue. By the time Q=2, MR dropped to 2.

      Because the MR-curve is a straight line it's safe to say the average MR in between Q=1 and Q=2 is (4 + 2) / 2 = 3, which makes the new TR 5 + 3 * 1 (the change in quantity) = 8.
      (2 votes)
  • blobby green style avatar for user mandrell.bethany
    I have checked several sources and I am just very stuck: if you have a firm that is a monopoly what would cause it to stop production? I know that it stops production when marginal revenue is less than marginal cost, but if you are neglecting cost, what else would cause a monopoly to stop production?
    (2 votes)
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    • starky ultimate style avatar for user Geoff Ball
      A firm doesn't stop production when MR < MC (it will just produce less). The condition you're referring to—the shutdown condition—is when price is less than average variable cost.

      Since a monopoly is the only producer of a good in a market, it's difficult to think of non-cost reasons why they would stop producing. I keep thinking of examples, but they're all cost-related. Maybe barriers to entry (such as a patent) go away, and new entrants drive the original firm out of business. Alternatively, this good might be replaced by another, decreasing demand so much that the firm drops out of production altogether.
      (2 votes)
  • blobby green style avatar for user Christopher Bair
    I am studying in China and not great at Mandarin yet so I'm struggling through some classes.
    I have a question "A producer of oil lamps estimates the following demand function for its product:
    Q=120,000 - 10,000P
    where Q is the quantity demanded per year and P is the price per lamp. Fixed costs are $12,000 and variable costs are $1.50 per lamp."
    I need to write an equation for the total revenue function in terms of Q
    Specify the marginal revenue function.
    Write an equation for the total cost function in terms of Q
    Specify the marginal cost function.
    Write an equation for total profits in terms of Q. At what level are total profits maximized? What price will be charged? what are total profits at this output level?
    Check answers by equating the MR and MC functions, and solve for Q

    Can someone help me out?
    (2 votes)
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  • blobby green style avatar for user Rahul Shivaram
    I was wondering this about the algebra:

    If the area function (integral) underneath the demand (AR) curve is the total revenue TR curve and the derivative (gradient function) is MR curve then why are they different? Surely integrating the AR -> TR then differentiating it should produce the AR again?

    Very confused, would appreciate an explanation perhaps algebraically?
    (1 vote)
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    • starky ultimate style avatar for user Geoff Ball
      Total revenue is not the area under the demand (AR) curve. Total revenue is the price times the quantity. TR would be the integral of the MR function (in which case, I'm guessing the rest of your question will now make more sense—integrating MR -> TR and then differentiating it will produce MR again).
      (3 votes)
  • aqualine seed style avatar for user Kvitrev
    doesn't make any sence. If I'm a monopolist it means that I can set any price for my goods as long as market doesn't have any substitute for it. On your graph for oranges the demand curve goes down as a price goes up. So I can sell 1 thousand of oranges for 6$ and 2 for 5$ and so on. But if we are talking about electricity for example this demand curve wouldn't go down in any case because electricity is a necessity and there are no available substitutes for it. People would be pissed of but they will still pay for their bills. Or there is difference between elastic and inelastic goods?
    (1 vote)
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Video transcript

>>Now that we figured out the total revenue given any quantity, and we've also been able to express it algebraically, I want to think about what the marginal revenue is at any one of these points. To think about marginal revenue, marginal revenue is just how much does our total revenue change, given some change in our quantity. Then later, we can use that so that we can optimize the profit for our monopoly over here. I'm going to try to do it without calculus. It actually would be very straightforward to do it with calculus because we're essentially just trying to find the slope at any point along this curve, but I'll try to do it algebraically and maybe it will even give you a little intuition for what we end up doing eventually in calculus. The first thing I want to do is essentially find the slope, the slope right over here. The best way to find the slope right over here is say how much does my total revenue change if I have a very small change in quantity? If I have a very small change in quantity, how much does my total revenue change? Let me think about it this way. The other ones I will be able to approximate a little bit easier. Let's think of it this way. If my quantity is 0, my total revenue is 0. That one's easy. If I increase my quantity very, very, very, very little, so let's just make it 0.001, what is going to be my total revenue? We could think about it in terms of this curve right over here, or we could just use this expression, which we derived from price times quantity, and we will get, I'll get my calculator out, if our quantity is .001, our total revenue is going to be negative ... Let me turn the calculator on. Total revenue is going to be -.001², squared, so that's that part, plus 6 times .001, 6 times .001. That's going to be our total revenue. It's going to be 0.005999. It's 0.00599. Now we can figure out or get a pretty good approximation for that marginal revenue right at that point. Our change in quantity is .001, so our ΔQ, this right over here is 0.001. That's our change in quantity, and our change in revenue is 0.00599, and so we just have to divide. We just have to divide .005999, that top one, our change in total revenue divided by our change in quantity, divided by .001. We get 5.99999. If you try it with even smaller numbers, if you tried this with .00000001, you'll get 5-point, and you'll get even more 9s going on. The closer that you get, the smaller your change in, and this is what you essentially do in calculus. You try to find a super small change right over here. This is essentially going to be 6. Our marginal revenue at this point is essentially going to be 6. What I want to do is I'm going to plot marginal revenue here on our demand curve as well or on this axis where we've already plotted our demand curve. When our quantity is 0, our marginal revenue, if we just barely increase quantity, the incremental total revenue we get is going to be 6. I'll just plot it. I'll just plot it right over there. That makes sense. The marginal benefit in the market is 6, right at that point. If we were to just sell a drop of orange juice or I guess we're selling oranges in this case, not juice, but if we were to sell a millionth of a pound of oranges, we would get the equivalent of roughly $6 per pound for that millionth of a pound because that's the marginal benefit for that very first incremental chunk of orange out there in the market, so it makes complete sense. Now let's think about the slope at these other points. These, I'm going to approximate. I could do it this way, but I'll just approximate it. I'll just approximate it by using other points. If I want to find the slope right over here, when our quantity is equal to 1, the slope would look like, the slope would look like that. I'm going to approximate it by finding the slope between these two points. I am going to approximate it, and actually, it's going to be a very good approximation. I'll do it later with calculus to show that it is a very good approximation. But I'm going to approximate it by the slope between these two points. Between those two points, our change in quantity is 2, and our change in total revenue is 8. Our change in total revenue is 8. When we produced 2, or 2,000 pounds, our total revenue was $8,000. So we have a change in total revenue of 8, or 8,000, I guess we could say, divided by a change in quantity of 2,000, so our marginal revenue at this point is 8 divided by 2, or 8,000 divided by 2,000, which is $4 per pound. When our quantity is 1, our marginal revenue is $4 per pound. It is $4 per pound, just like that. Now, let's think about the marginal revenue when our quantity is 2. To do that, I'm going to find the slope between these two points. We really want to find the slope of that line, but it looks like the slope between these two points is a pretty good approximation. It's actually almost an exact number because of the way that this is just a parabola, so we can actually do this. But anyway, this is fairly straightforward. Once again, our change in quantity is 2, and our change in total revenue, our change in total revenue is, we're going from 5 to 9, which is 4. This was 9 right over here from the last video. Or you could say it's $4,000 divided by 2,000 pounds gives you $2 per pound. Our marginal revenue right over here, if we have quantity of 2, is $2 per pound. Right at that point, for that incremental millionth of an ounce that we're going to sell them oranges, we're getting the equivalent of $2 a pound of increased total revenue from doing that. Let's just do one more point here, and I think you'll see why I'm only going to do one more point. If we try to go up here, and we try to figure out what is the marginal revenue or if we essentially say what is the slope there, how much do we get an increase in revenue if we just barely increase our quantity, and this is actually easier to look at. This is a maximum point right over here, in the calculus terms. The slope up there is 0. We can even see that by approximating the slope between the slope between these two points. We have some change in quantity, but we have no change in total revenue, so right at that point. Right over here, the slope is barely positive. Right at that point, the slope is 0, and then right past it, it becomes barely negative. But right at that point, our marginal revenue is 0. When our quantity is 3,000 pounds, our marginal revenue is 0. Then after that, our marginal revenue gets negative. Over here, our marginal revenue gets more and more negative. But something very interesting happens. When we plot our marginal revenue curve, or our line, in this case, we are getting a line, we are getting a line, we are getting a line that is twice as steep, twice as steep as our demand curve. This is actually generalizable. If we have a linear demand curve like this, it can be defined as a line, then your marginal revenue curve for the monopolist will also be a linear downward-sloping curve or downward-sloping line, and it will have twice the slope. This slope over here was -1. This slope over here is -2. For every increase in quantity, the price goes down by 2; increase in quantity, price goes down by 2; increase in quantity, price goes down by 2. This is marginal revenue. Let's remind our self, we've been doing all of this algebra and all of this math here, what is marginal revenue telling us? This was the demand curve. It tells us for any given price what quantity is demanded or for any given quantity, what is the incremental marginal benefit, or I guess what's the price at which they could sell that quantity. From that, we were able to figure out the total revenue as a function of quantity, and from that total revenue, we were able to say, well, look, if at any of these quantities, if we were to increase a little bit more, if we were to increase quantity a little bit more, how much is our revenue increasing? Obviously, we want to keep increasing quantity while our revenue is ... while the marginal revenue we get is larger than our marginal cost. I'll take that up in the next video.