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Profit Maximization Under Monopolistic Competition: Choosing The Profit-Maximizing Output and Price
Profit Maximization Under Monopolistic Competition: Choosing The Profit-Maximizing Output and Price
Profit Maximization Under Monopolistic Competition: Choosing The Profit-Maximizing Output and Price
The monopolistically competitive firm decides on its profit-maximizing quantity and price
in much the same way as a monopolist. A monopolistic competitor, like a monopolist,
faces a downward-sloping demand curve, and so it will choose some combination of
price and quantity along its perceived demand curve.
Figure 1. How a Monopolistic Competitor Chooses its Profit Maximizing Output and Price. To maximize
profits, the Authentic Chinese Pizza shop would choose a quantity where marginal revenue equals marginal
cost, or Q where MR = MC. Here it would choose a quantity of 40 and a price of $16.
The combinations of price and quantity at each point on the demand curve can be
multiplied to calculate the total revenue that the firm would receive, which is shown in
the third column of Table 1. The fourth column, marginal revenue, is calculated as the
change in total revenue divided by the change in quantity. The final columns of Table 1
show total cost, marginal cost, and average cost. As always, marginal cost is calculated
by dividing the change in total cost by the change in quantity, while average cost is
calculated by dividing total cost by quantity. The following example shows how these
firms calculate how much of its product to supply at what price.
TRY IT
Calculating Profits
Margina
Total
Quantit Pric l Total Margina Averag
Revenu
y e Revenu Cost l Cost e Cost
e
e
$1,02
70 $10 $700 –$2 $18 $14.57
0
$1,28
80 $8 $640 –$6 $26 $16
0
Alternatively, we can compute profit as total revenue minus total cost. Total revenue is
price times quantity or $16.00 x 40 = $640. This is the area of the rectangle that starts at
the origin, goes up to a price of $16, goes over to the demand curve, down to the
quantity of 40 and back to the origin. Total cost is average cost times quantity or $14.50
x 40 = $580. This is the area of the rectangle that starts at the origin, goes up the
vertical axis to an average cost of $14.50, goes over to the average cost curve, down to
the quantity of 40 and back to the origin. Profit is the difference between the two areas,
$640 – $580 = $60. This is shown graphically as the area of the rectangle on top of total
cost, or the price minus average cost, times quantity. Note that if the firm was earning
zero economic profits, the rectangles of total revenue and total cost would be the same
—there would be no profit rectangle. The break-even point occurs where the demand
curve intersects with average cost, so P = AC. Note also that if the firm was making a
loss, the negative profit (i.e. loss) would be the rectangle on top of total revenue.