A monopolist is currently producing at quantity Q* where MR = MC, charging price P* = $20 with MC = $8. A consultant advises raising the price to $25 to capture more profit per unit. Why is this advice likely wrong?
AMonopolists are legally required to keep prices within a regulated range of MC
BRaising price above the MR = MC point reduces total profit because the revenue lost from selling fewer units exceeds the gain from a higher price per unit
CHigher prices always reduce total revenue for any firm with a downward-sloping demand curve
DThe consultant is correct — monopolists always maximize profit by charging the highest possible price
The profit-maximizing rule is MR = MC, not 'maximize the markup.' At Q* (where MR = MC), the monopolist has already pushed output to the point where the marginal profit from an additional unit is zero. Raising price further means selling fewer units than Q* — each of those lost sales had MR > MC (positive marginal profit), so eliminating them reduces total profit. Option D is the classic misconception: charging the highest possible price typically means selling zero units.
Question 2 Multiple Choice
A pharmaceutical firm with a patented drug (few substitutes) and a commodity grain producer both behave as price-setters. Which firm can sustain a larger markup, and why?
AThe grain producer — commodity markets are larger and more profitable
BThe pharmaceutical firm — inelastic demand means consumers are less price-sensitive, so a large markup loses relatively few sales
CBoth face the same markup constraint since both apply the MR = MC rule
DThe pharmaceutical firm — it faces a steeper demand curve, which always implies higher marginal revenue
The Lerner Index L = (P − MC)/P = −1/ε shows that markup depends on demand elasticity. With inelastic demand (small |ε|), raising price loses few sales, so the markup can be large. The pharmaceutical firm with no substitutes faces very inelastic demand. The grain producer faces elastic demand (buyers can easily switch to another supplier), so a large markup would cause severe sales losses. This is the direct empirical prediction of monopoly theory.
Question 3 True / False
The deadweight loss from monopoly pricing represents value destroyed by the monopolist's output restriction — it belongs to neither the monopolist nor consumers.
TTrue
FFalse
Answer: True
Deadweight loss consists of units between Q* (monopoly output) and Q_c (competitive output) where demand exceeds MC — buyers value these units more than they cost to produce — but they go unproduced because the monopolist has restricted output. This value is not captured by the firm as profit, nor is it received by consumers as surplus; it simply does not exist. The monopolist's profit itself is a transfer from consumers to the firm, not a social loss. The DWL is the pure social cost of monopoly.
Question 4 True / False
A monopolist maximizes profit by maximizing the markup (P − MC) per unit, since a larger markup means more profit on nearly every unit sold.
TTrue
FFalse
Answer: False
Profit maximization requires MR = MC, not maximum markup. The markup and profit-maximizing quantity are jointly determined by demand and cost conditions. Setting an extreme markup means very few units sold — total profit (markup × quantity) can be far below the MR = MC optimum. A monopolist could technically charge $1 million per unit but sell zero. Maximum markup and maximum profit are generally different outcomes.
Question 5 Short Answer
Why is a monopolist's marginal revenue less than its price, and how does this difference drive the MR = MC profit-maximizing rule?
Think about your answer, then reveal below.
Model answer: A monopolist faces a downward-sloping demand curve, so to sell one more unit it must lower the price on all units sold. The revenue gained from the extra unit equals P, but the firm loses (the price reduction) multiplied by (all previous units sold). MR = P + Q·(dP/dQ) < P because dP/dQ < 0 for downward-sloping demand. For linear demand, MR has the same intercept but twice the slope. Profit is maximized where MR = MC: if MR > MC, producing more adds profit; if MR < MC, producing more destroys profit. The optimal Q* is where these exactly balance.
This infra-marginal effect is the fundamental reason monopoly pricing differs from competitive pricing. A competitive firm takes price as given (faces a horizontal demand curve) so MR = P. The monopolist internalizes the price effect of its own output decision, which depresses MR below P and drives the wedge P > MC at the optimum — the source of both the monopoly markup and the deadweight loss.