If marginal cost exceeds marginal revenue, a profit-maximizing monopolist will:
a. restrict output to increase the price even higher.
b. attempt to maintain this position because it is consistent with profit maximization.
c. raise price and expand output to increase profit.
d. lower price and expand output to increase profit.
The correct answer and explanation is :
The correct answer is d. lower price and expand output to increase profit.
Explanation:
In the context of a monopolist’s profit-maximizing behavior, marginal cost (MC) and marginal revenue (MR) play crucial roles in determining the optimal output level. The monopolist maximizes profit by producing the quantity of output where marginal revenue equals marginal cost (MR = MC). This is the condition for profit maximization because when MR > MC, the firm can increase its profit by expanding output, and when MR < MC, the firm can increase its profit by reducing output.
Here’s a detailed breakdown of why the correct answer is d. lower price and expand output to increase profit:
- When marginal cost (MC) exceeds marginal revenue (MR): This situation implies that the monopolist is currently producing at a point where the cost of producing one more unit (MC) is greater than the revenue generated from selling that additional unit (MR). In this scenario, the monopolist is not maximizing profits because the cost of producing extra units is higher than the revenue it brings in.
- What the monopolist should do: To restore profit maximization, the monopolist needs to adjust its behavior. Since MC > MR, the monopolist should reduce output, which, in turn, should also lead to a price reduction. By lowering the price and increasing output, the monopolist will eventually reach a point where MR = MC, which maximizes profit. This price reduction and output increase are a way to return to the optimal production level.
- Why not other options?
- Option a (restrict output to increase the price even higher): This would only be relevant if MR were greater than MC. In this case, restricting output further would exacerbate the problem by reducing revenues and increasing costs.
- Option b (attempt to maintain this position): If a monopolist were to maintain a situation where MC > MR, it would be making losses, not maximizing profits.
- Option c (raise price and expand output to increase profit): This is contradictory because if MC > MR, raising prices while expanding output would only worsen the inefficiency.
Therefore, the monopolist should lower price and expand output to move towards the point where MR = MC, restoring profit maximization.