Profit Maximization in a Monopoly – Study Questions and Answers

Profit Maximization Diagram

Question 2

a) Monopoly. Assume you are managing a large telecommunications company that is the sole provider of telecommunication services in your country.

  1. Use appropriate diagrammatic analysis to identify the profit maximisation scenario for a monopoly company such as yours.
  2. What other strategic factors should you consider before deciding to adopt the
    profit maximisation strategy illustrated in your diagram? (10 marks)

b) Benefit Cost Analysis. Discuss the major differences between a public sector benefit cost analysis and a private sector capital budgeting investment appraisal.


Question 2a: Monopoly

1. Profit maximization scenario

A monopoly like the large telecommunications company is a business that has no competition in the market. Profit maximization for a monopoly is mainly a revenue maximization scenario (Samuelson, 2001). As shown in the figure below, the profit maximizing point is the point where marginal revenue is equal to the marginal cost.

Profit Maximization Diagram

A monopolist maintains its output at the upper price limits where the price maximizing equilibrium occurs at MR=MC (Samuelson, 2001). This upper range of prices leads the monopolist to set prices at the point where demand is elastic. This also leads to an abnormal profit which represents profit that is higher than the normal profit.

2. Other strategic factors that can be considered before adopting the profit maximization strategy

One of the factors that can be considered is the perception of the consumer about the price and value of the product. Consumers may choose to buy the product based on the value they receive from using the product (Samuelson, 2001). Consumers are not willing to pay high prices if they do not benefit from the product. A monopoly can also consider other marketing objectives of the organisation apart from profit maximization. Such objectives may include survival due to changing consumer wants, or setting barriers of entry.

Question 2b: Benefit Cost Analysis

Cost benefit analysis is mainly used in the public sector while capital budgeting investment appraisal is mainly used by the private sector. Cost benefit analysis in the public sector is used due to the rising public investment. It involves comparison among various public investments in terms of costs and benefits. In this case, the benefits and costs of each alternative are analysed, and the project with the highest positive difference between benefits and costs is selected (Feldstein, 2007). In other words, the public sector investment alternative with more benefits than costs is selected. The benefits that may be analysed include health, safety, equality and ethical outcome of the investment while costs include pollution, injuries and ill-health caused to the public by the public investment. Therefore, the cost benefit analysis includes both economic and social benefits and costs.

On the other hand, capital budgeting involves economic factors in terms of capital expenditure used on a particular private project and its resultant income from the project. In this case, the monetary costs of each investment alternative are added up and subtracted from the income. The project with higher positive difference between revenue and costs is chosen (Feldstein, 2007). Some capital investment appraisal methods include Accounting Rate of Return, Investment Rate of Return, Net Present Value, Payback period, Weighted Average Cost of Capital and Adjusted Present Value.

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