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Monopolist optimizing price: Dead weight loss

AP.MICRO:
PRD‑3 (EU)
,
PRD‑3.B.6 (EK)
The marginal revenue curve for a monopoly differs from that of a perfectly competitive market. A monopolist maximizes profit by producing the quantity at which marginal revenue and marginal cost intersect. This results in a dead weight loss for society, as well as a redistribution of value from consumers to the monopolist. Created by Sal Khan.

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  • leaf green style avatar for user Soren.Debois
    Could someone help me understand why the MR/MC intersection optimizes producer surplus?
    (11 votes)
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    • blobby green style avatar for user jerry.kohn
      Where MR=MC is not so much a matter of optimizing producer surplus as maximizing profit. If the firm were to produce less (where MR>MC)then it would be leaving some potential profits unrealized and if it produced more (where MR<MC), it would be adding more to its costs than it could gain in revenue for each unit produced beyond the MR=MC point. While monopoly tips the balance of producer and consumer surplus in favor of the producer, I am not sure there is an absolute increase in producer surplus compared to a competitive market when considering the dead weight loss involved. Ultimately, government monopolies (and there are no other kind) harm both producer and consumer by slowing technological advances and encouraging wasteful use of economic resources.
      (25 votes)
  • blobby green style avatar for user jackligx
    At , how did he get the consumer surplus and producer surplus. And by the way what is "dead weight cost"? Thanks!
    (9 votes)
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    • primosaur seedling style avatar for user Cameron
      We know that monopolists maximize profits by producing at the quantity (Q) where marginal cost=marginal revenue. They then must charge the price (P) associated with that quantity from the demand curve.

      Consumer Surplus is the area above the price and below the demand curve.

      Produce Surplus is the area below price and above MC up until the given Q.

      Dead weight loss is transactions that would have occurred in a free market. There are less transactions because the monopolist is fixing the quantity produced to sell his product at a higher cost.
      (12 votes)
  • duskpin ultimate style avatar for user tuannb1997
    You say that the aim of a monopoly is to maximize it's PROFIT rather than it's REVENUE. I don't get it because, with the monopoly being the only supplier in the market, they're supposed to be much better off if their Revenue is as high as possible, aren't they ?
    (3 votes)
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  • piceratops seed style avatar for user Shashwat Roy
    Can you please do a video with a practical problem, so we actually know how to calculate dead weight loss when asked in our quizzes/examinations.
    (3 votes)
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    • mr pink red style avatar for user Travis Adler
      Calculating these areas is actually fairly simple and just uses two formulas.
      Area of a triangle: Base x Height / 2
      Area of a rectangle: Base x Height
      From Video:
      Consumer Surplus Triangle = 2 x 3 / 2 = 3 (in thousands)
      Producer Surplus Triangle = 2 x 1 / 2 = 1 ( in thousands)
      Producer Surplus Rectangle = 2 x 2 = 4 (in thousands)
      -Add Producer Surplus together = 1 + 4 = 5 (in thousand)
      Dead Weight Loss Triangle = 2 x 1 / 2 = 1 (in thousands)
      (4 votes)
  • blobby green style avatar for user Zvonimir Franić
    why would monopolists lower the price if raising a qountity,,, consumers dont have a chice then they would accept given price, wouldnt they?
    (1 vote)
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    • piceratops ultimate style avatar for user Gerri Zitrone
      Always remember that the monopolist wants to maximise his profit. And if the prices are too high, the consumers don't buy the product. They may have no choice in the price, but they can decide not to buy the product. The profit from 10 products to a price of 10€ will be higher than the profit from 1 product to the price of 50€ (not considering costs per product in this example).
      (5 votes)
  • blobby green style avatar for user LP
    So is the price still determined by the demand curve or is it determined by the marginal revenue curve? At the end I got a little bit confused when you were showing the producer and consumer surplus.
    (0 votes)
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  • leaf blue style avatar for user Caleb Aaxel
    Is there a deadweight loss if a firm produces the quantity of output at which price equals marginal cost?
    (2 votes)
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    • blobby green style avatar for user Hannah
      Because firms are the price makers in a Monopolistically Competitive Market, they determine the price charged for their product. If they make the price of the product equal the marginal cost of producing the product (MR=MC), it would result in the most efficient output and a maximization of profit. Instead, monopolistic firms charge more than the marginal cost of producing the product. This disenfranchises certain buyers but does not result in an overall loss for the firm because consumers do not have a better option.
      (2 votes)
  • mr pink red style avatar for user Venkata Krishna vardhan.Tanguturi
    why does a monopoly does't have supply curve ?
    (1 vote)
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    • starky tree style avatar for user melanie
      A supply curve says what is supplied at a given price, for example, a seller might say, "when the price increases, I will be willing to sell 10 more". That make sense for a competitive firm, that has to take the price as given, but a monopoly is a price maker.

      The monopolist's decision to produce is based on its costs, and more importantly, the demand for it's good. So, we don't really consider there to be a supply curve for a monopolist.
      (3 votes)
  • blobby green style avatar for user Osama Hussain
    Well if a question asks us to determine the MR of say the 5th unit will we see the MR curve on the 5th unit or will we do it by determining the difference between the TR of the 4th unit and the 5th unit?
    (0 votes)
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    • blobby green style avatar for user Ryan Pierce
      Marginal revenue is the difference between the 4th unit and the 5th unit. So yes, if you want to find out the marginal revenue of the 5th unit, you would subtract Total revenue of the 5th unity by the total revenue of the 4th unit
      (4 votes)
  • leaf green style avatar for user Vasyl Matviichuk
    i wondering whether all these fancy graphs are really necessary to explain relatively straightforward ideas. all this looks unnecessarily complicated to me, especially for people with little math background
    (1 vote)
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Video transcript

Based on what we've done in the last 2 videos we've been able to figure out what the marginal revenue curve looks like for the monopolist year, for the monopolist in the orange market and this is what we got. Right over here, it was a line with a slope twice as steep as the slope of the demand curve, we'll see that's actually generalizable. There's an optional video that I'll do very shortly where I prove it with a little bit of calculus. It's very important to realize that this marginal revenue curve looks very different than the marginal revenue curve if we were dealing with perfect competition. If we were dealing with perfect competition there would be some equilibrium price in the market and all of the competitors would essentially just have to take that price. Let's say that that equilibrium price was $3 per pound then our marginal revenue curve would look like this if we were not a monopolist, if we were one of the many perfect competitors. I guess you could view it that way. Because we would just have to take that price. If we wanted to sell 1000 pounds, each of those pounds we would get $3 per pound and then if we want to sell 1001, we'll just get $3 per pound for the next one. It doesn't change. We're just taking that price. With the monopolist things do change because we are the only producer in the market. The price at which we can get changes depending on what we produce because we are the entire supply for the market and we have this downward sloping marginal revenue curve. Now, with that out of the way, let's think about what will be the optimal quantity for us to produce if we wanted to maximize profit? If we think in pure economic terms, that's what firms try to do. They exist to maximise profit. To do that, we're going to have to think about, and remember, it's not to maximize revenue. To maximize revenue we would have said, "Oh, they should just produce 3000 pounds." It's not about maximizing revenue, it's about maximizing profit. We have to take the cost into consideration. To do that, we'll have to draw a marginal cost curve. Let's say I did the research. Let's say we're the owners of this firm and we have a marginal cost curve that looks something like this. Let's say our marginal cost curve looks like this. It's important to realize, we are the market. We are the only producers here. This isn't just our marginal cost curve. This is a marginal cost curve for the market. Another way to think about it, this is the supply curve for the market. It tells you at any given price how much the market is willing to supply. You could view it as a marginal cost or you could view it as a supply curve and we've talked about it before. You could view a supply curve as a marginal cost curve. If you want the market to produce 1 extra pound, what's the minimum price you would have to give? that is the marginal cost. Now, with this out of the way, let's think about what you would produce. Well, you would definitely want to produce something you definitely start to produce a few pounds right over here because the marginal revenue you're getting is way above your marginal cost. Each incremental pound you're producing right over here, you're getting much more revenue, you're getting $5 or $6 of revenue and it's only costing you a little over a dollar. It's like, "Okay, I'm going to keep producing. "I'm going to keep producing." Over here, you're still, each incremental unit you're getting, you're still getting more revenue than the cost of that incremental unit. That keeps being true all the way until you get to 2000 pounds right over here. At this point right over here you don't want to produce an incremental unit because if you produce one more unit, if you produce that 2001st pound right over here then for that 2001st pound, your cost is going to be slightly higher than the revenue you get in. You will actually take a slight loss on that. Your total profit will start to go down and you don't want to produce less than this because you'll be leaving a little money on the table. You'll be leaving that little incremental pound where the total revenue was just slightly higher, or the marginal revenue on that incremental pound was just slightly higher than your marginal cost on that incremental pound. You will produce right over there. Now, this is interesting because this is a different equilibrium, or I guess we say this is a different price or this is a different price and quantity than we would get if we were dealing with perfect competition. If we were dealing with perfect competition, our equilibrium price and quantity would be where our supply and demand curves intersect. It would be right over here. It would be a price of $3 per pound and a quantity of 3000 pounds. Now, in order to maximize profit, we are intersecting between the marginal revenue curve or our quantity that we want to produce as the monopolist is the intersection between our marginal revenue curve and our marginal cost curve which is right over here. So we can see that there is a dead weight loss. There is a dead weight loss by being a monopoly although it's good for us. It's good for the monopolist, it's not good for a society at least in this example and there's very few where I can imagine it being good but I guess there are a few if you're trying to protect the national industry or something like that. Over here, this is the quantity that we are deciding to produce. The consumer surplus is the area above the price and below the demand curve. This right over here is the consumer surplus. The producer surplus is looking pretty good and this is essentially what we're trying to optimize. Our producer surplus is this whole area. Our producer surplus is this whole area right over here. Producer surplus right over there. But we have a dead weight cost. There's a total surplus that we would have gotten, that society would have gotten if we were dealing with perfect competition, right over here that's now being lost. But as we lose that, we were able to increase the producer surplus and decrease the consumer surplus. Beyond just having this dead weight loss over here, it's also obviously given much more value to the producer, to the monopolist and given much less value to the consumer.