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ANT371H1 Study Guide - Unita, Marginal Cost, Simple Algebra

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Holly Wardlow

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3. Profit Under a Monopoly
Under a monopoly a producer has full control over how many units of a product will reach
market. Since market demand and selling price are related by a demand relation, the monopolist
can also control the price at which the commodity sells. Under a free enterprise system it is
assumed that the monopolist will attempt to maximize his or her profit. How many units should
the monopolist produce?
Let R(x) be the revenue associated with the sale of xunits; C(x) the cost to the
monopolist of producing xunits. Then profit is defined to be P(x) , with P(x) = R(x)C(x) .
In Figure 1 typical revenue and cost curves are shown, and the profit zone is shaded in.
Figure 1
Now P0(x) = R0(x)C0(x) , and P0(x) = 0 if and only if R0(x) = C0(x) . So as long as
P00(x)<0 , the profit will be maximized at the production level for which marginal revenue
equals marginal cost. In Figure 1 this optimal production level is denoted by x0; it is the point
where the tangents to the revenue and cost curves are parallel.
Note that the values of price and volume for optimal profit do not depend on the overhead
cost, but if the overhead cost is too high no positive profit may be possible for any realistic
This can be seen in Figure 1 where we have called the overhead cost C0. Increasing C0
may eventually place the entire cost curve above the revenue curve so that there would be no
profitable region.
Example 1. A publisher estimates the cost of producing and selling xcopies of a new science
fiction book will be, in dollars,
C(x) = 10,000 + 5x .

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The demand of the book at price pdollars is
x= 4,000 200p .
Find the most profitable sale price.
Solution. Solving the demand relation for p, we find
p= 20 x
200 dollars .
Hence total revenue is
R(x) = 20xx2
and profit is
P(x) = 20xx2
200 5x10,000 .
For maximum value,
P0(x) = 15 x
100 = 0
x= 1500 .
Observe that
P00(x) = 1
100 <0 for all x ,
so that a true maximum value has been found. The price is then p= 201500
200 = 12.50 (dollars)
and the maximum profit is
P(1500) = 15(1500) (1500)2
200 10,000
= 1,250 (dollars) .
Example 2. A Case Study of Taxation on a Monopoly
In this example we shall construct a simple model to analyse taxation on a monopoly. We
assume that the cost and demand curves for a certain product are both linear, and that a tax
of tdollars per unit is levied on the producer for every unit produced.
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