AP_Krugman_Textbook

To maximize profit, the monopolist compares marginal cost with marginal rev-
enue. If marginal revenue exceeds marginal cost, De Beers increases profit by pro-
ducing more; if marginal revenue is less than marginal cost, De Beers increases
profit by producing less. So the monopolist maximizes its profit by using the opti-
mal output rule:

(61-1) MR=MCat the monopolist’s profit-maximizing quantity of output

The monopolist’s optimal point is shown in Figure 61.3. At A,the marginal cost
curve, MC,crosses the marginal revenue curve, MR.The corresponding output level, 8
diamonds, is the monopolist’s profit-maximizing quantity of output, QM.The price at
which consumers demand 8 diamonds is $600, so the monopolist’s price, PM,is $600—
corresponding to point B.The average total cost of producing each diamond is $200,
so the monopolist earns a profit of $600 −$200=$400 per diamond, and total profit is
8 ×$400=$3,200, as indicated by the shaded area.

Monopoly versus Perfect Competition

When Cecil Rhodes consolidated many independent diamond producers into De Beers,
he converted a perfectly competitive industry into a monopoly. We can now use our
analysis to see the effects of such a consolidation.
Let’s look again at Figure 61.3 and ask how this same market would work if, instead
of being a monopoly, the industry were perfectly competitive. We will continue to as-
sume that there is no fixed cost and that marginal cost is constant, so average total cost
and marginal cost are equal.
If the diamond industry consists of many perfectly competitive firms, each of those
producers takes the market price as given. That is, each producer acts as if its marginal
revenue is equal to the market price. So each firm within the industry uses the price-
taking firm’s optimal output rule:

(61-2) P=MCat the perfectly competitive firm’s profit-maximizing quantity

of output.

In Figure 61.3, this would correspond to producing at C,where the price per dia-
mond,PC,is $200, equal to the marginal cost of production. So the profit-maximizing
output of an industry under perfect competition, QC,is 16 diamonds.
But does the perfectly competitive industry earn any profit at C? No: the price of
$200 is equal to the average total cost per diamond. So there is no economic profit for
this industry when it produces at the perfectly competitive output level.
We’ve already seen that once the industry is consolidated into a monopoly, the re-
sult is very different. The monopolist’s marginal revenue is influenced by the price ef-
fect, so that marginal revenue is less than the price. That is,

(61-3) P> MR=MCat the monopolist’s profit-maximizing quantity of output

As we’ve already seen, the monopolist produces less than the competitive industry—8
diamonds rather than 16. The price under monopoly is $600, compared with only $200
under perfect competition. The monopolist earns a positive profit, but the competitive
industry does not.
So, we can see that compared with a competitive industry, a monopolist does the
following:

■ produces a smaller quantity: QM< QC

■ charges a higher price: PM> PC

■ earns a profit

module 61 Introduction to Monopoly 613

Section 11 Market Structures: Perfect Competition and Monopoly