How does a monopoly determine the level of output that maximizes profit?

• A. By producing at the highest possible output level
• B. By producing where marginal cost equals marginal revenue
• C. By producing where price equals marginal cost
• D. By producing where average total cost equals marginal cost

Answer: (B)

Verified step by step guidance

1. Understand that a monopoly maximizes profit by choosing the quantity of output where the additional revenue from selling one more unit (marginal revenue, MR) equals the additional cost of producing that unit (marginal cost, MC).
2. Recall that marginal revenue (MR) is the change in total revenue from selling one more unit, and marginal cost (MC) is the change in total cost from producing one more unit.
3. Set up the condition for profit maximization: \(\text{MR} = \text{MC}\). This is because producing beyond this point would add more to cost than to revenue, reducing profit.
4. Note that in a monopoly, marginal revenue is less than price due to the downward-sloping demand curve, so the profit-maximizing output is not where price equals marginal cost.
5. Once the profit-maximizing quantity is found by solving \(\text{MR} = \text{MC}\), the monopoly sets the price based on the demand curve at that quantity.