Determine optimal pricing policy
- Using the data above, calculate the output the firm will provide.
- Determine the price at this output level.
- Complete the Microsoft Excel Template given below using the data in the problem.
- Check whether your data is consistent with your calculations in question 1. Why or why not?
- Now assume that the state decides to give as many contracts as it can for the same activity, so your firm is now operating in a perfectly competitive market. How will your price and output decisions change? Explain the differences and why these changes happened.
The firm will provide output at a level where the profit-maximization happens. In a monopolistic situation, profit is maximized when marginal revenue (revenue generated from an additional unit of product sold) is equal to the marginal cost (cost of an additional unit of product manufactured).
Therefore, the output quantity for a monopoly firm is computed at the point where
Given that MR= 1400-0.0008Q
MC=derivative of TC wrt Q
TC = 1000Q since there is no fixed cost
MC = d (1000 Q)
= $1000, is constant.
Now, since the output quantity for a monopoly firm is computed at the point where MR=MC
- 1400-0.0008Q = 1000
- 400 = 0.0008Q
- Q =500,000
Thus, the output that the firm will provide is 500,000 units.
The price at the output level of 500,000 units can be given by:
P = 1400 – 0.0004*Q = 1400 – 0.0004 * 500000
= 1400 – 200 = 1200
Thus, the price at this output level is $1200.
Table 1: Data from Excel Template
From the calculations, we see that in monopolistic situation, the profit maximizing point s where MR = MC. That is, when the additional cost of producing a unit of product is equal to the additional revenue generated by the sale of a unit of product. The price point for MR=MC is $1200 (refer Answer 2) and the output level is: 500,000 (refer Answer 1). The data in the above table (Answer 3) also shows that the profits of the company are highest ($100,000,000) at the price point of $1200 and at output level of 500,000. This is also the point where the MR=MC at $1000 each.
Profit-maximization in monopoly happens at 500,000 level of output where Marginal revenue is equal to marginal cost and the price is 1200. Thus, the economic profit (yellow-shaded portion in graph) exists. But in perfectly competitive market, the equilibrium output is at the point where price is equal to marginal cost i.e. at $1000 and thus, the equilibrium output is 1,000,000. And thus, the companies in perfectly competitive market do not enjoy super normal profits but only normal profits.
In monopoly, the price is higher than the average cost as seen in the graph. The price is $1200 while the average cost is $1000. However, in perfectly competitive market, price is equal to marginal cost and thus, both the price and average cost are at $1000 as shown in the graph.
In case of a perfectly competitive market, the price is determined by the industry with large number of firms operating in the industry. A firm has no control over the pricing and it has to accept that price. However, under monopoly, monopolist firm decides the price. In a perfectly competitive market, average revenue (AR) is equal to marginal revenue (MR), whereas under monopoly, average revenue(AR) can be higher than the marginal revenue (MR). This results in the change in Price and output decisions.