INTRODUCTION TO ECONOMICS

CHAPTER 8 · PERFECT COMPETITION AND PURE MONOPOLY

MATHS 8.1

The Mathematics of Profit

Maximization
and Monopoly Power

A complete, step-by-step teaching guide — from first definitions to the

elasticity-based monopoly pricing rule, with worked examples and practice.

Prepared by
Mr. Farouk Saleh
+201062415129
 Chapter 8 · MATHS 8.1 · Profit Maximization & Monopoly Power

Table of Contents
MATHS 8.1 · Profit Maximization and Monopoly Power
1. Introduction to the Mathematical Model ........................................................................................ 4
1.1 Every symbol used in this document ........................................................................................................4
1.2 Variable, parameter, function, equation....................................................................................................5
2. The Linear Inverse Demand Function............................................................................................ 5
2.1 Reading the parameters a and b ..............................................................................................................5
2.2 A first small example ................................................................................................................................6
3. The Total Cost Function .................................................................................................................. 6
3.1 There is no fixed cost here — and how to add one ..................................................................................7
3.2 A small cost table .....................................................................................................................................7
4. Derivation of Total Revenue ........................................................................................................... 7
4.1 Why revenue is not always rising .............................................................................................................8
5. Construction of the Profit Function ............................................................................................... 8
6. Essential Differentiation Skills ....................................................................................................... 8
6.1 The four rules we need .............................................................................................................................9
6.2 Three tiny practice derivatives ..................................................................................................................9
7. Derivation of Marginal Revenue ..................................................................................................... 9
7.1 Comparing demand and marginal revenue ............................................................................................10
8. Derivation of Marginal Cost .......................................................................................................... 10
9. Why Profit Is Maximized Where MR = MC ................................................................................... 11
10. Deriving the Profit-Maximizing Quantity Q* .............................................................................. 11
10.1 How each parameter moves Q* ...........................................................................................................12
11. First-Order and Second-Order Conditions................................................................................ 12
11.1 First-order condition ..............................................................................................................................12
11.2 Second-order condition ........................................................................................................................12
12. Deriving the Profit-Maximizing Price P* .................................................................................... 13
13. Full Numerical Example from the Screenshots ........................................................................ 13
13.1 Step-by-step solution ............................................................................................................................14
13.2 Summary of results...............................................................................................................................14
14. Monopoly Power and the Price-Cost Markup ........................................................................... 15
15. General Derivation of Marginal Revenue Using Elasticity ...................................................... 15
16. The Monopoly Pricing Rule and the Lerner Index .................................................................... 16
17. Why a Monopolist Never Produces on the Inelastic Part of Demand .................................... 17
18. Elasticity and the Degree of Monopoly Power.......................................................................... 18
19. Graphical Explanation ................................................................................................................. 19
20. Common Student Mistakes ......................................................................................................... 21
21. Fully Worked Examples ............................................................................................................... 22
22. Practice Questions....................................................................................................................... 24
22.A Part A — Foundations and definitions..................................................................................................24
22.B Part B — Derivations and algebra ........................................................................................................24
22.C Part C — Numerical problems .............................................................................................................24
22.D Part D — Elasticity and monopoly power.............................................................................................24
22.E Part E — Conceptual and exam-style ..................................................................................................25
23. Answer Key ................................................................................................................................... 25
24. End-of-Section Summary ............................................................................................................ 27

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 Chapter 8 · MATHS 8.1 · Profit Maximization & Monopoly Power

1. Introduction to the Mathematical Model

This document explains, from the very beginning, the mathematics behind how a single-firm monopoly
chooses how much to produce and what price to charge. It is written for a student of Introduction to
Economics who may not yet feel confident with algebra, functions, derivatives, or elasticity. Every step
is shown in full. Nothing is left for you to “just see”.
The central problem of the monopolist can be stated in one sentence. A monopolist must choose one
level of output, and then charge the highest price that consumers are willing to pay for exactly that
amount of output. The firm cannot pick a high price and a high quantity at the same time, because
customers buy less when the price is higher. The monopolist's goal is to choose the output level that
produces the largest possible economic profit.
Because the firm makes a single decision — how much to produce — the whole model is built around
one decision variable, the quantity of output. Everything else in the model either follows from that choice
or is a fixed feature of the market. To keep the mathematics clear, we first give a name to every quantity
we will use.

1.1 Every symbol used in this document

Before any formula appears, here is the complete list of symbols. Read this table once now, and return
to it whenever a letter is unfamiliar. Consistent notation is used everywhere in this document.

Symbol Meaning Unit / nature

P Price per unit of output money per unit
Q Quantity of output produced and sold units of output
money per unit
a Vertical intercept of the inverse demand curve — the price when Q = 0
(parameter)
Demand-slope parameter — how much price falls when Q rises by
b one unit
positive parameter

TC Total cost of producing Q units money

TR Total revenue = price × quantity money

MR Marginal revenue — extra revenue from one more unit money per unit

MC Marginal cost — extra cost of one more unit money per unit
π Economic profit = total revenue − total cost money
c Constant part of marginal cost in the cost function positive parameter
d How fast marginal cost rises as output increases positive parameter
pure number (no
PED Price elasticity of demand
unit)
Q* The profit-maximizing quantity (the best Q) units of output

P* The price charged at the profit-maximizing quantity money per unit

Exam tip — what the asterisk means

The little star in Q* and P* is not multiplication. It is a label that means “the optimal value” — the
best choice for the firm. So Q* reads as “the profit-maximizing quantity” and P* reads as “the price
at the profit-maximizing quantity.” This notation is used consistently throughout.

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 Chapter 8 · MATHS 8.1 · Profit Maximization & Monopoly Power

1.2 Variable, parameter, function, equation

Four words are used again and again in this model. They are easy to confuse, so we define them clearly.

Definition — four essential words

Variable: a quantity that can change. In this model the decision variable is Q, the output the firm
chooses.
Parameter: a quantity that is fixed for the problem we are solving. Here a, b, c and d are
parameters. They describe the market and the firm's technology, and we treat them as constants
while we choose Q.
Function: a rule that turns an input into exactly one output. “Total revenue is a function of quantity”
means each value of Q gives one value of TR.
Equation: a statement that two expressions are equal, using an “=” sign. We solve equations to
find unknown values, for example to find the Q that makes marginal revenue equal to marginal
cost.
Keep this distinction in mind: when we “differentiate with respect to Q,” we treat a, b, c and d as fixed
numbers, and only Q is allowed to move.

2. The Linear Inverse Demand Function

A demand relationship links the price of a good to the quantity people wish to buy. There are two ways
to write the same relationship, and it is important to see why the monopolist prefers one of them.

Definition — demand function vs inverse demand function

Ordinary demand function: Q = f(P). Quantity is written as depending on price. You put a price
in, you get a quantity out.
Inverse demand function: P = a − bQ. Price is written as depending on quantity. You put a
quantity in, you get the highest price that will still sell exactly that quantity.
The word inverse simply means the roles of the two variables have been swapped: instead of price
explaining quantity, quantity explains price. The monopolist prefers the inverse form because the firm
actually chooses Q first and then reads off the price the market will bear. The inverse demand function
answers exactly the question the monopolist asks: “if I decide to sell this much, what is the most I can
charge?”

2.1 Reading the parameters a and b

We assume both parameters are positive. Each one has a clear meaning.
• a is the intercept. Setting Q = 0 gives P = a. So a is the price at which buyers want zero units —
the highest price the curve reaches. It sits where the demand line meets the vertical (price) axis.
• b is the slope size. Because it is subtracted, every extra unit of Q lowers the price by b. A larger
b means a steeper curve: price falls quickly as output rises. A smaller b means a flatter curve.
Since b is positive and it is subtracted, the demand curve slopes downward: higher quantity always
corresponds to a lower price. This matches the law of demand — to sell more, the firm must accept a
lower price.

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 Chapter 8 · MATHS 8.1 · Profit Maximization & Monopoly Power

2.2 A first small example

Take the demand curve P = 100 − 2Q. Here a = 100 and b = 2. We compute the price for several
quantities by substituting each Q value.

𝑃 = 100 − 2𝑄
the inverse demand curve used throughout this document

Quantity Q Calculation Price P

0 100 − 2(0) 100
10 100 − 2(10) 80
20 100 − 2(20) 60
25 100 − 2(25) 50
40 100 − 2(40) 20
50 100 − 2(50) 0
Notice how the price falls steadily as output rises, and reaches zero at 50 units. This is the key restriction
on a monopolist: it cannot choose a price and a quantity independently. Every quantity has one matching
maximum price on the demand curve, and the firm must respect that link.

Checkpoint
Using P = 100 − 2Q, what price matches Q = 15? Substitute: 100 − 2(15) = 100 − 30 = 70. We will
meet this number again as the profit-maximizing price.

3. The Total Cost Function

The firm also faces costs. The cost function in this model tells us the total cost of producing any chosen
level of output.

𝑇𝐶(𝑄) = 𝑐𝑄 + 𝑑𝑄
total cost as a function of output
This expression has two parts, and each has an economic meaning.
• The term cQ: cost that grows in direct proportion to output. Each extra unit adds a further c to
cost. On its own this part would give a constant marginal cost of c.
• The term dQ2: cost that grows with the square of output. Because Q is squared, this part rises
faster and faster as output increases. It represents the idea that pushing out ever more units
becomes progressively more expensive — machines are strained, overtime is paid, less efficient
inputs are used.
The squared term is the reason costs rise at an increasing rate. Doubling output more than doubles
this part of cost, because 2Q squared is 4 times Q squared. This shape gives an upward-sloping
marginal cost curve, which we derive in Section 8.

3.1 There is no fixed cost here — and how to add one

As written, TC = cQ + dQ2 has no constant term, so total cost is zero when output is zero. There is no
fixed cost. If the firm did have a fixed cost F (rent, insurance, a licence — paid whatever the output), we
would simply add it on:

𝑇𝐶(𝑄) = 𝐹 + 𝑐𝑄 + 𝑑𝑄
the same cost function with a fixed cost F included

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 Chapter 8 · MATHS 8.1 · Profit Maximization & Monopoly Power

Warning — fixed cost and the optimal quantity

A fixed cost changes the amount of profit, but it does not change marginal cost, and therefore
does not change the interior profit-maximizing quantity. The reason is that F is a constant, and the
derivative of a constant is zero — so F disappears from MC. The firm's output decision is driven
by marginal revenue and marginal cost, neither of which contains F. (Fixed cost only matters for
the separate question of whether to operate at all, which we do not analyse here.)

3.2 A small cost table

Using c = 10 and d = 1, so that TC = 10Q + Q2, we tabulate total cost:

Quantity Q 10Q Q² Total cost TC

0 0 0 0
5 50 25 75
10 100 100 200
15 150 225 375
20 200 400 600
Look along the last column: the jumps between rows get larger as output rises (75, then 125, then 175,
then 225). That growing gap is exactly the rising marginal cost produced by the squared term.

4. Derivation of Total Revenue

Total revenue is the money the firm receives from selling its output. It is defined as price multiplied by
quantity.

𝑇𝑅 = 𝑃 × 𝑄

For a monopolist, the price is not a free number: it is fixed by the demand curve once the quantity is
chosen. So we replace P by the inverse demand function P = a − bQ:

𝑇𝑅(𝑄) = (𝑎 − 𝑏𝑄) × 𝑄

Now expand the bracket. We multiply every term inside the bracket by the Q outside, keeping careful
track of signs:

𝑇𝑅(𝑄) = (𝑎)(𝑄) − (𝑏𝑄)(𝑄)

𝑇𝑅(𝑄) = 𝑎𝑄 − 𝑏𝑄

The middle step uses the fact that Q × Q = Q2. So total revenue is a quantity term aQ minus a squared
term bQ2.

Warning — a typo in the source screenshot

The screenshot writes total revenue in a form that reads like “− bQ2 = aQ”, which is a printing slip.
The correct multiplication of (a − bQ) by Q gives aQ − bQ², not −aQ − bQ2. The aQ term must be
positive, because a positive a multiplied by a positive Q is positive; only the bQ2 term is subtracted.
We use the correct expression TR = aQ − bQ² throughout this document.

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4.1 Why revenue is not always rising

Total revenue is a downward-opening parabola: it rises, reaches a peak, then falls. The reason is the
tension between two effects. Selling one more unit increases the number of units sold, which by itself
raises revenue. But to sell that extra unit the monopolist must lower the price along the downward-
sloping demand curve, and the lower price applies to all the units, not just the last one. When output is
low the first effect wins and revenue rises; when output is high the second effect wins and revenue falls.
We will see the exact peak (where marginal revenue is zero) in Sections 7 and 17.

5. Construction of the Profit Function

Economic profit is what remains after subtracting total cost from total revenue. This is the quantity the
monopolist wants to make as large as possible.

𝜋(𝑄) = 𝑇𝑅(𝑄) − 𝑇𝐶(𝑄)

We now substitute the two functions we have built. Total revenue is aQ − bQ² and total cost is cQ + dQ².
Watch the signs carefully when the whole cost expression is subtracted:

𝜋(𝑄) = 𝑎𝑄 − 𝑏𝑄 − (𝑐𝑄 + 𝑑𝑄 )
The minus sign in front of the bracket flips the sign of every term inside it. This is the single most common
place students lose a sign, so we do it slowly:

𝜋(𝑄) = 𝑎𝑄 − 𝑏𝑄 − 𝑐𝑄 − 𝑑𝑄
Now collect like terms. We group the two plain-Q terms together, and the two squared terms together:
• Plain-Q terms: aQ − cQ = (a − c)Q.
• Squared terms: − bQ2 − dQ2 = − (b + d)Q2.

𝜋(𝑄) = (𝑎 − 𝑐)𝑄 − (𝑏 + 𝑑)𝑄

the profit function of the monopolist
This is a compact, tidy formula. Profit depends only on the quantity Q that the firm selects; everything
else is a fixed parameter. Because the coefficient on Q2 is negative (both b and d are positive), this
profit function is a downward-opening parabola with a single highest point — exactly the maximum we
are hunting for.

6. Essential Differentiation Skills

To find the highest point of the profit function, and to define marginal revenue and marginal cost, we
need one tool from calculus: the derivative. This short section teaches exactly the rules we will use, and
nothing more.

Definition — what a derivative is

The derivative of a function measures its instantaneous rate of change — how fast the output
changes as the input changes by a tiny amount. Geometrically it is the slope of the curve at a
point. We write the derivative of y with respect to Q as dy/dQ. In economics, a derivative of a total
quantity gives the matching “marginal” quantity: the derivative of total revenue is marginal revenue,
and the derivative of total cost is marginal cost.

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 Chapter 8 · MATHS 8.1 · Profit Maximization & Monopoly Power

6.1 The four rules we need

• Constant rule: the derivative of a constant is 0. A constant does not change, so its rate of
change is zero. Example: d(7)/dQ = 0.
• Linear rule: the derivative of kQ is k. A straight line through the origin has constant slope k.
Example: d(5Q)/dQ = 5.
• Power rule (for squares): the derivative of kQ2 is 2kQ. You bring the power 2 down to the front
and reduce the power by one. Example: d(3Q2)/dQ = 6Q.
• Sum/difference rule: differentiate a sum or difference term by term. The derivative of a total is
the sum of the derivatives of its parts.

Warning — parameters stay constant

When we differentiate with respect to Q, the letters a, b, c and d behave as ordinary numbers.
They are constants of the problem, so a term like aQ differentiates to a, exactly as 5Q differentiates
to 5.

6.2 Three tiny practice derivatives

Before applying the rules to economics, warm up on three examples.

Function Rule used Derivative

y = 12 constant rule 0
y = 8Q linear rule 8
y = 4Q2 power rule 8Q
2
Now combine them: if y = 100Q − 2Q , then term by term dy/dQ = 100 − 4Q. This is exactly the
calculation we need for marginal revenue in the numerical example.

7. Derivation of Marginal Revenue

Definition — marginal revenue

Marginal revenue is the extra total revenue gained from selling one more unit of output.
Mathematically it is the derivative of total revenue with respect to quantity, MR = dTR/dQ.
We start from the total revenue we derived in Section 4 and differentiate term by term.

𝑇𝑅(𝑄) = 𝑎𝑄 − 𝑏𝑄
𝑑𝑇𝑅
𝑀𝑅(𝑄) =
𝑑𝑄
Differentiating each term:
• The term aQ gives derivative a (linear rule).
• The term −bQ2 gives derivative − 2bQ (power rule).

𝑀𝑅(𝑄) = 𝑎 − 2𝑏𝑄
marginal revenue for linear demand

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 Chapter 8 · MATHS 8.1 · Profit Maximization & Monopoly Power

7.1 Comparing demand and marginal revenue

Line the two curves up next to each other:

𝐷𝑒𝑚𝑎𝑛𝑑: 𝑃 = 𝑎 − 𝑏𝑄
𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑟𝑒𝑣𝑒𝑛𝑢𝑒: 𝑀𝑅 = 𝑎 − 2𝑏𝑄

Both start at the same height a when Q = 0 (same vertical intercept). But the marginal revenue curve
falls twice as steeply, because its slope is −2b against the demand slope of −b. This “twice the slope”
property is exact for any linear demand curve.
The economic reason. To sell one extra unit, the monopolist must lower the price a little. That lower
price is charged not only on the new unit but on every unit already being sold. So the extra revenue
from the last unit is its price minus the revenue lost on all the earlier units. That loss is what makes
marginal revenue fall faster than price, and why MR lies below the demand curve at every positive
quantity.

Exam tip
For a linear demand curve only, there is a shortcut: keep the same intercept and double the slope.
From P = 100 − 2Q you can write MR = 100 − 4Q immediately.

8. Derivation of Marginal Cost

Definition — marginal cost

Marginal cost is the extra total cost of producing one more unit. It is the derivative of total cost
with respect to quantity, MC = dTC/dQ.
Start from the total cost function and differentiate term by term.

𝑇𝐶(𝑄) = 𝑐𝑄 + 𝑑𝑄
𝑑𝑇𝐶
𝑀𝐶(𝑄) =
𝑑𝑄
• The term cQ gives derivative c (linear rule).
• The term dQ2 gives derivative 2dQ (power rule).

𝑀𝐶(𝑄) = 𝑐 + 2𝑑𝑄
marginal cost for the quadratic cost function
Because d is positive, the term 2dQ grows with output, so marginal cost rises as more is produced.
This is the upward-sloping marginal cost curve. The constant c is the marginal cost of the very first unit
(where Q ≈ 0).

Definition — do not confuse three different costs

Total cost TC: all the money spent to make Q units.
Average cost (ATC = TC/Q): cost per unit on average.
Marginal cost MC: the cost of the next single unit. This is the one that matters for the output
decision.

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 Chapter 8 · MATHS 8.1 · Profit Maximization & Monopoly Power

9. Why Profit Is Maximized Where MR = MC

The rule “produce where marginal revenue equals marginal cost” is not a formula to memorise blindly.
It follows from simple, step-by-step reasoning about whether one more unit is worth making.
• If MR > MC: the next unit adds more to revenue than to cost, so it adds to profit. The firm should
produce more.
• If MR < MC: the next unit adds more to cost than to revenue, so it subtracts from profit. The firm
should produce less.
• If MR = MC: the next unit adds nothing to profit either way. There is no gain from changing
output. This balance point is the profit maximum.
The table below applies this reasoning to the numerical model (MR = 100 − 4Q, MC = 10 + 2Q) at
several output levels. The final column states what a profit-seeking firm should do.

Output Q MR = 100 − 4Q MC = 10 + 2Q MR vs MC Correct decision

5 80 20 MR > MC Increase output
10 60 30 MR > MC Increase output

Stay here
15 40 40 MR = MC
(optimum)
20 20 50 MR < MC Decrease output
25 0 60 MR < MC Decrease output
The decisions all point toward Q = 15, where marginal revenue and marginal cost are exactly equal at
40. Below 15 the firm wants to expand; above 15 it wants to contract; at 15 it is content. That is the
profit-maximizing output.

10. Deriving the Profit-Maximizing Quantity Q*

We now solve the condition MR = MC in general, using the parameters, so we obtain a formula that
works for any linear-demand, quadratic-cost monopoly.

𝑎 − 2𝑏𝑄 = 𝑐 + 2𝑑𝑄
set marginal revenue equal to marginal cost
Solve for Q, showing every move. The goal is to collect all the Q terms on one side and everything else
on the other.
Step 1. Move the c to the left and the −2bQ to the right (add 2bQ and subtract c from both sides):

𝑎 − 𝑐 = 2𝑏𝑄 + 2𝑑𝑄

Step 2. On the right, both terms contain Q and a factor of 2. Factor them out:

𝑎 − 𝑐 = 2𝑄(𝑏 + 𝑑)

Step 3. Divide both sides by 2(b + d) to isolate Q:

∗
𝑎 − 𝑐
𝑄 =
2(𝑏 + 𝑑)
the profit-maximizing quantity
We label the solution Q* to show it is the optimal quantity. Because we assumed b > 0 and d > 0, the
denominator is positive. For the quantity to be positive we also need the numerator to be positive, which

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 Chapter 8 · MATHS 8.1 · Profit Maximization & Monopoly Power

means a > c — the price buyers will pay for the first unit must exceed the cost of making it. If nobody
will pay more than it costs, the firm should not produce.

10.1 How each parameter moves Q*

The formula lets us predict the direction of change if a parameter changes, holding the others fixed.

Change Effect on Q* Intuition

Higher a raises Q* buyers value the good more, so more is worth selling
Higher c lowers Q* each unit costs more to make
Higher b lowers Q* demand is steeper; price falls faster as output grows

Higher d lowers Q* marginal cost rises faster with output

If a = c Q* = 0 no gain from the first unit

If a < c formula gives Q* < 0 not feasible; the sensible output is zero

Warning — negative quantities are not real output

If the formula returns a negative number, do not report it as the answer. A firm cannot produce a
negative quantity. The economically meaningful output in that case is the boundary value Q* = 0
(the firm produces nothing), unless the problem adds further conditions.

11. First-Order and Second-Order Conditions

There is a second, equivalent route to the optimum that goes straight through the profit function. It also
lets us confirm that we have found a maximum rather than a minimum.

Definition — four calculus terms in plain language

Stationary point: a quantity where the slope of the function is zero — the curve is momentarily
flat.
First-order condition (FOC): set the first derivative equal to zero to locate a stationary point.
Second-order condition (SOC): check the second derivative to see whether that stationary point
is a peak or a trough.
Concavity: a curve is concave (opens downward, like a hill) when its second derivative is negative.
A hill's top is a maximum.

11.1 First-order condition

Differentiate the profit function π(Q) = (a − c)Q − (b + d)Q² term by term:

𝑑𝜋/𝑑𝑄 = (𝑎 − 𝑐) − 2(𝑏 + 𝑑)𝑄

Set this slope to zero and solve, and you obtain Q* = (a − c) / [2(b + d)] — exactly the same answer as
the MR = MC condition. This is no coincidence: setting dπ/dQ = 0 is the same statement as MR − MC
= 0.

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 Chapter 8 · MATHS 8.1 · Profit Maximization & Monopoly Power

11.2 Second-order condition

Differentiate once more to get the second derivative of profit:

𝑑2 𝜋/𝑑𝑄2 = − 2(𝑏 + 𝑑)

Because b > 0 and d > 0, we have:

− 2(𝑏 + 𝑑) < 0

The second derivative is negative, so the profit function is concave — shaped like a hill. Its single
stationary point is therefore a maximum, not a minimum. We have genuinely found the highest profit,
not the lowest.

12. Deriving the Profit-Maximizing Price P*

Once we know the best quantity Q*, the price follows from the demand curve. This is a crucial point of
logic: the output is chosen using MR = MC, but the price is read off the demand curve, never off the
marginal revenue curve. We substitute Q* into P = a − bQ.

𝑃 ∗ = 𝑎 − 𝑏𝑄 ∗
𝑎 − 𝑐
𝑃∗= 𝑎 − 𝑏
2(𝑏 + 𝑑)

To combine these into one fraction we put everything over the common denominator 2(b + d).
Step 1. Write a as a fraction over the same denominator: a = 2a(b + d) / [2(b + d)]. Then subtract:

2𝑎(𝑏 + 𝑑) − 𝑏(𝑎 − 𝑐)
𝑃∗=
2(𝑏 + 𝑑)

Step 2. Expand the top: 2a(b + d) = 2ab + 2ad, and b(a − c) = ab − bc. Subtracting the second from the
first:

2𝑎𝑏 + 2𝑎𝑑 − 𝑎𝑏 + 𝑏𝑐
𝑃∗=
2(𝑏 + 𝑑)

Step 3. Combine the two ab terms (2ab − ab = ab):

𝑎𝑏 + 𝑏𝑐 + 2𝑎𝑑
𝑃∗=
2(𝑏 + 𝑑)

Step 4. Factor b out of the first two terms of the top (ab + bc = b(a + c)):

𝑏(𝑎 + 𝑐) + 2𝑎𝑑
𝑃∗=
2(𝑏 + 𝑑)
the profit-maximizing price

Exam tip — output first, price second

Always find Q* from MR = MC first, then substitute into the demand curve to get P*. Reading the
price off the MR curve is a classic error that gives a price that is too low.

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13. Full Numerical Example from the Screenshots

We now apply every step to the concrete example given in the source. This is the example to know by
heart, because it ties all the formulas together.

𝑃 = 100 − 2𝑄
𝑇𝐶 = 10𝑄 + 𝑄

Matching these against the general forms P = a − bQ and TC = cQ + dQ², we read off the parameters:

𝑎 = 100, 𝑏 = 2, 𝑐 = 10, 𝑑 = 1

13.1 Step-by-step solution

Total revenue. Multiply price by quantity: TR = (100 − 2Q)Q = 100Q − 2Q2.
Marginal revenue. Differentiate: MR = 100 − 4Q. (Same intercept 100, double the slope.)
Marginal cost. Differentiate the cost function: MC = 10 + 2Q.
Set MR = MC and solve for Q*:

100 − 4𝑄 = 10 + 2𝑄
90 = 6𝑄
90
𝑄 ∗ = = 15
6

Find the price. Substitute Q* = 15 into the demand curve (not the MR curve):

𝑃 ∗ = 100 − 2(15) = 100 − 30 = 70

Now compute the remaining figures the model produces:

𝑇𝑅 = 70 × 15 = 1,050
𝑇𝐶 = 10(15) + (15) = 150 + 225 = 375
𝜋 = 𝑇𝑅 − 𝑇𝐶 = 1,050 − 375 = 675
𝑀𝑅 𝑎𝑡 𝑄 = 15: 100 − 4(15) = 40
𝑀𝐶 𝑎𝑡 𝑄 = 15: 10 + 2(15) = 40
𝑀𝑎𝑟𝑘𝑢𝑝: 𝑃 − 𝑀𝐶 = 70 − 40 = 30

13.2 Summary of results

Quantity Value How it was found
Q* 15 MR = MC
P* 70 demand curve at Q* = 15
MR = MC 40 at the optimum
TR 1,050 P* × Q*

TC 375 10(15) + 15²

Profit π 675 TR − TC
Markup P − MC 30 70 − 40

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 Chapter 8 · MATHS 8.1 · Profit Maximization & Monopoly Power

Why is the price 70 while marginal revenue and marginal cost are only 40? Because the output decision
balances the revenue and cost of the last unit (both 40 at Q = 15), but the price is the amount buyers
are willing to pay for that quantity, read from the demand curve (70). The 30-unit gap between price and
marginal cost is the monopolist's markup, and it is the visible sign of monopoly power.

Accuracy check
Confirm the optimum: at Q = 15, MR = 100 − 60 = 40 and MC = 10 + 30 = 40. They match, so Q =
15 truly solves MR = MC.

14. Monopoly Power and the Price-Cost Markup

Definition — monopoly power

Monopoly power is the ability of a firm to hold its price above marginal cost. A firm in perfect
competition cannot do this — it must accept the market price, and price equals marginal cost. The
bigger the gap between price and marginal cost, the greater the monopoly power.
Several related measures describe how far price sits above cost. They are connected but not identical,
and mixing them up is a common source of confusion.

Measure Definition Value in the example

Price P 70
Marginal cost MC 40
Absolute markup P − MC 30
Proportional markup (Lerner) (P − MC) / P 30/70 ≈ 0.4286
Economic profit (P − ATC) × Q 675

Warning — markup is not the same as profit

A large markup does not guarantee a large total profit, and a firm can have a positive markup yet
make a loss if average cost is high. Absolute markup, proportional markup, and total profit answer
different questions. Keep them apart.
In our example the absolute markup is P − MC = 70 − 40 = 30. The proportional markup expresses
that gap as a share of the price:

𝑃 − 𝑀𝐶 30
= ≈ 0.4286 (42.86%)
𝑃 70

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15. General Derivation of Marginal Revenue Using Elasticity

So far marginal revenue came from a specific linear demand curve. We now derive a completely general
expression that links marginal revenue to the price elasticity of demand, for any demand curve. This is
the key to understanding monopoly power more deeply.
Begin from the general total-revenue function, where price depends on quantity through some inverse
demand function P(Q):

𝑇𝑅(𝑄) = 𝑃(𝑄) × 𝑄

Definition — the product rule, in plain terms

When two things that both change are multiplied, the rate of change of the product is (first × rate
of change of second) + (second × rate of change of first). Here total revenue is price times quantity,
and both move as Q changes.
Applying the product rule to differentiate TR with respect to Q:

𝑑𝑇𝑅
𝑀𝑅(𝑄) =
𝑑𝑄
𝑑𝑃
𝑀𝑅(𝑄) = 𝑃(𝑄) + 𝑄
𝑑𝑄

The first term is the price of the extra unit; the second term is the revenue lost on existing units because
the price had to fall (dP/dQ is negative on a downward-sloping curve). Now factor P out of both terms:

𝑑𝑃 𝑄
𝑀𝑅 = 𝑃 1 +
𝑑𝑄 𝑃

Look closely at the group (dP/dQ)(Q/P). This is familiar from elasticity.

Definition — point price elasticity of demand

Price elasticity of demand measures how responsive quantity is to price: PED = (dQ/dP)(P/Q).
Because quantity and price move in opposite directions on a demand curve, PED is normally a
negative number.
The group in our marginal-revenue expression is the reciprocal of elasticity. A reciprocal is “one divided
by” a number: the reciprocal of PED turns the P/Q and dQ/dP upside down into Q/P and dP/dQ. So:

1 𝑑𝑃 𝑄
=
𝑃𝐸𝐷 𝑑𝑄 𝑃

Substituting this into the marginal-revenue expression gives a clean, general formula:

1
𝑀𝑅 = 𝑃 1 +
𝑃𝐸𝐷

Because PED is negative, the term 1/PED is negative, which correctly makes marginal revenue smaller
than price. To make the formula easier to read, we use the absolute value of elasticity, written |PED|,
which is just its size without the minus sign. Since 1/PED = − 1/|PED| for a negative PED, the formula
becomes:

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 Chapter 8 · MATHS 8.1 · Profit Maximization & Monopoly Power

1
𝑀𝑅 = 𝑃 1 −
|𝑃𝐸𝐷|
marginal revenue in terms of elasticity

Definition — absolute value and reciprocal

Absolute value |x| is the distance of a number from zero, always non-negative: |−3| = 3.
Reciprocal of x is 1/x. The reciprocal of 2 is 0.5; the reciprocal of a large number is close to 0.

16. The Monopoly Pricing Rule and the Lerner Index

We combine the profit-maximizing rule MR = MC with the elasticity form of marginal revenue to obtain
the famous monopoly pricing rule and a direct measure of market power.

𝑀𝑅 = 𝑀𝐶
1
𝑀𝑅 = 𝑃 1 −
|𝑃𝐸𝐷|

Setting the two expressions for MR equal:

1
𝑃 1 − = 𝑀𝐶
|𝑃𝐸𝐷|

Now rearrange, step by step, to isolate the markup as a fraction of price.

Step 1. Multiply out the bracket on the left:

𝑃
𝑃 − = 𝑀𝐶
|𝑃𝐸𝐷|

Step 2. Move MC left and the fraction right:

𝑃
𝑃 − 𝑀𝐶 =
|𝑃𝐸𝐷|

Step 3. Divide both sides by P:

𝑃 − 𝑀𝐶 1
=
𝑃 |𝑃𝐸𝐷|
the monopoly pricing rule

Definition — the Lerner Index

The left-hand side has a name. The Lerner Index is the proportional gap between price and
marginal cost:
𝑃 − 𝑀𝐶
𝐿 =
𝑃
The pricing rule says this equals 1/|PED|. The Lerner Index measures market power directly: it is
0 under perfect competition (price equals marginal cost) and rises toward 1 as demand becomes
less elastic.

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 Chapter 8 · MATHS 8.1 · Profit Maximization & Monopoly Power

Interpreting the range: a value near zero means price is barely above marginal cost, so the firm has
little market power. A larger value means price sits well above marginal cost, indicating stronger power.
In our numerical example L = 30/70 ≈ 0.4286, and correspondingly |PED| at the optimum is 1/0.4286 ≈
2.33.

Warning — limitations of the Lerner Index

The index depends on measuring marginal cost correctly, which is difficult in practice. It is also a
static snapshot: it says nothing about potential competition, entry threats, or innovation over time.
A high Lerner Index is a signal of market power, not a complete verdict on how competitive an
industry is.

17. Why a Monopolist Never Produces on the Inelastic Part of

Demand
The elasticity formula for marginal revenue explains a striking result: a profit-maximizing monopolist
always operates where demand is elastic. We show this by looking at the sign of marginal revenue in
the three elasticity regions.
Elastic demand (quantity is very responsive to price):

|𝑃𝐸𝐷| > 1 ⟹ 𝑀𝑅 > 0

Unit-elastic demand (the borderline case):

|𝑃𝐸𝐷| = 1 ⟹ 𝑀𝑅 = 𝑃(1 − 1) = 0

Inelastic demand (quantity is barely responsive to price):

0 < |𝑃𝐸𝐷| < 1 ⟹ 𝑀𝑅 < 0

When demand is inelastic, marginal revenue is negative: selling one more unit actually reduces total
revenue. Turn that around — producing less and raising the price would increase total revenue, and
normally reduce total cost as well. Both effects raise profit. So no profit-seeking monopolist would ever
stay in the inelastic region; it can always do better by cutting output.
There is also a clean mathematical argument. At the optimum MR = MC, and marginal cost is normally
positive. But in the inelastic region MR is negative. A negative number cannot equal a positive number,
so the optimum cannot lie in the inelastic region. The profit-maximizing output must sit on the elastic
part of the demand curve.

Exam tip
Check the earlier pricing rule: if |PED| were below 1, the bracket [1 − 1/|PED|] would be negative,
forcing a negative price to satisfy the equation — impossible. This is the same result seen from
the pricing-rule side.

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18. Elasticity and the Degree of Monopoly Power

The pricing rule (P − MC) / P = 1 / |PED| tells us directly how elasticity controls the markup. The more
elastic the demand the firm faces, the smaller its feasible markup; the less elastic the demand, the
larger the markup can be. As |PED| grows very large, 1/|PED| approaches zero and price is pushed
down toward marginal cost — the firm behaves almost like a competitive one.
The size of the elasticity the firm faces depends on how easily customers can walk away:
• Close substitutes: if rivals sell similar products, small price rises send buyers elsewhere —
demand is elastic, power is low.
• Consumer switching: the easier and cheaper it is to switch, the more elastic demand becomes.
• Necessity: goods with no substitutes and high need (some medicines) tend to have inelastic
demand and higher potential markups.
• Time: demand is usually more elastic over the long run, as buyers find alternatives.
• Market definition: a firm may be the only seller of a narrowly defined product yet face elastic
demand once close substitutes are counted.
The table converts several elasticity values into the implied proportional markup, using (P − MC)/P =
1/|PED|.

|PED| Markup (P−MC)/P = 1/|PED| As a percentage Interpretation

fairly inelastic — large
1.5 0.6667 66.7%
markup, strong power
2 0.5000 50.0% substantial markup
3 0.3333 33.3% moderate markup
small markup — fairly
5 0.2000 20.0%
competitive
very elastic — price close to
10 0.1000 10.0%
marginal cost
Read the table downward: as demand becomes more elastic (|PED| rising from 1.5 to 10), the markup
shrinks from about two-thirds of price to one-tenth. Being the only seller does not by itself guarantee
unlimited pricing power — what matters is the elasticity of the firm's own demand curve.

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 Chapter 8 · MATHS 8.1 · Profit Maximization & Monopoly Power

19. Graphical Explanation

The diagrams below make the algebra visible. Every figure uses the same numerical example (P = 100
− 2Q, MC = 10 + 2Q) so the numbers line up across all four.

19.1 Output, price, and the markup

Figure 1. Demand, marginal revenue, and marginal cost. Output Q* = 15 is found where MR = MC (both 40). The price
P* = 70 is then read vertically up to the demand curve. The orange arrow is the price–cost markup, P* − MC = 30.

The figure shows the whole decision in one picture. The green MR = MC point fixes the quantity. Moving
straight up from Q* to the blue demand curve fixes the price. The vertical gap between the demand
curve and the marginal-cost curve at Q* is the markup — the visible measure of monopoly power.

19.2 The profit rectangle

Figure 2. Introducing average total cost ATC = 10 + Q. At Q* = 15, ATC = 25. Profit is the shaded rectangle: height (P*
− ATC) = 70 − 25 = 45, width Q* = 15, area = 675.

Profit per unit is the distance between price and average total cost, P* − ATC = 45. Multiplying by the
number of units, Q* = 15, gives total profit 675 — the same figure we computed algebraically in Section
13. The shaded rectangle is that profit.

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19.3 Elasticity regions of demand

Figure 3. The linear demand curve splits at its midpoint (Q = 25, P = 50) into an elastic upper half (|PED| > 1, MR > 0)
and an inelastic lower half (0 < |PED| < 1, MR < 0). Marginal revenue crosses zero exactly at the midpoint.

Above the midpoint demand is elastic and marginal revenue is positive; below it demand is inelastic and
marginal revenue is negative. A monopolist with positive marginal cost sets MR = MC in the elastic
upper region, never in the inelastic lower region.

19.4 Total revenue and elasticity

Figure 4. Total revenue rises while demand is elastic (MR > 0), peaks where MR = 0 at the unit-elastic point (Q = 25,
TR = 1,250), then falls while demand is inelastic (MR < 0).

The peak of total revenue lines up exactly with the point where marginal revenue is zero, which is the
unit-elastic midpoint of demand. This is why moving out of the inelastic region — by producing less —
raises revenue: you climb back up toward the peak.

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 Chapter 8 · MATHS 8.1 · Profit Maximization & Monopoly Power

20. Common Student Mistakes

These are the errors that most often cost marks in exams. Read each one, and check your own working
against it.

Warning — 1. Reading the price off the MR curve

The output Q* is found where MR = MC, but the price must be read from the demand curve, not
from marginal revenue. Substituting Q* into MR gives the height 40, not the price 70. Always put
Q* into P = a − bQ.

Warning — 2. Losing the sign when subtracting total cost

In π = aQ − bQ2 − (cQ + dQ2), the minus in front of the bracket flips both terms inside. Forgetting
to flip the dQ2 term is a very common slip.

Warning — 3. Only halving the intercept, or only doubling the wrong thing
For linear demand, MR keeps the same intercept and doubles the slope: from P = 100 − 2Q the
correct MR is 100 − 4Q, not 50 − 2Q and not 100 − 2Q.

Warning — 4. Treating parameters as if they were the variable

When differentiating with respect to Q, the letters a, b, c, d are constants. The derivative of aQ is
a, not aQ and not 1.

Warning — 5. Confusing marginal cost with average cost

Profit-maximizing output uses MC, the cost of the next unit. Average total cost ATC = TC/Q is only
used later, to measure profit per unit. Do not set MR equal to ATC.

Warning — 6. Forgetting the absolute value in the elasticity formulas

Because PED is negative, keep track of the sign. The clean pricing rule uses |PED|: (P − MC)/P =
1/|PED|. Dropping the absolute value produces a negative markup, which is nonsense.

Warning — 7. Claiming a fixed cost changes the optimal quantity

A fixed cost changes total profit but not marginal cost, so Q* and P* are unchanged. Only the profit
figure moves.

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21. Fully Worked Examples

Eight complete examples, each solved from first principles. Work through them with a pen; then attempt
the practice questions in Section 22.

Worked Example 1 — The complete method on clean numbers

Demand P = 50 − Q, cost TC = 10Q + Q2. Find Q*, P*, profit, and the markup.
Parameters: a = 50, b = 1, c = 10, d = 1.
MR and MC: MR = 50 − 2Q; MC = 10 + 2Q.

50 − 2𝑄 = 10 + 2𝑄 ⟹ 40 = 4𝑄 ⟹ 𝑄 ∗ = 10
𝑃 ∗ = 50 − 10 = 40

Profit: TR = 40×10 = 400; TC = 10(10) + 102 = 200; π = 400 − 200 = 200.

Markup: MC at Q = 10 is 30, so P* − MC = 40 − 30 = 10; Lerner = 10/40 = 0.25.

Worked Example 2 — Different parameters, same method

Demand P = 90 − 2Q, cost TC = 10Q + 3Q2.
Parameters: a = 90, b = 2, c = 10, d = 3. MR = 90 − 4Q, MC = 10 + 6Q.

90 − 4𝑄 = 10 + 6𝑄 ⟹ 80 = 10𝑄 ⟹ 𝑄 ∗ = 8
𝑃 ∗ = 90 − 2(8) = 74

Profit: TR = 74×8 = 592; TC = 10(8) + 3(64) = 272; π = 320. Markup = 74 − 58 = 16.

Worked Example 3 — Using the general Q* and P* formulas directly

For a = 80, b = 4, c = 8, d = 2, use the formulas rather than solving from scratch.

𝑎 − 𝑐 72
𝑄∗= = = 6
2(𝑏 + 𝑑) 12
𝑏(𝑎 + 𝑐) + 2𝑎𝑑 4(88) + 2(80)(2) 672
𝑃∗= = = = 56
2(𝑏 + 𝑑) 12 12

Check against the demand curve: P = 80 − 4(6) = 56. ✓ Profit: TR = 336, TC = 8(6)+2(36) = 120, π =
216.

Worked Example 4 — From price and marginal cost to the Lerner Index
A monopolist charges P* = 50 with MC = 30 at its optimum. Find the markup, the Lerner Index, and the
elasticity.

𝑀𝑎𝑟𝑘𝑢𝑝 = 50 − 30 = 20
50 − 30
𝐿 = = 0.40
50
1 1
|𝑃𝐸𝐷| = = = 2.5
𝐿 0.40

The firm operates on the elastic part of demand (|PED| = 2.5 > 1), as it must.

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Worked Example 5 — Finding elasticity at the optimum

Using Worked Example 1 (P = 50 − Q, so Q* = 10, P* = 40), compute |PED| at the optimum and check
the pricing rule.
The slope of demand is dP/dQ = −1, so dQ/dP = −1. Then:

𝑑𝑄 𝑃 40
𝑃𝐸𝐷 = = (−1) = −4, |𝑃𝐸𝐷| = 4
𝑑𝑃 𝑄 10

Pricing rule check: (P − MC)/P = (40 − 30)/40 = 0.25, and 1/|PED| = 1/4 = 0.25. They agree. ✓

Worked Example 6 — Comparative statics: a rise in demand

Cost is TC = 10Q + Q2. Demand rises from P = 50 − Q to P = 60 − Q (the intercept a rises from 50 to
60). Find the new optimum.

Before (a = 50) After (a = 60)

Q* (50−10)/4 = 10 (60−10)/4 = 12.5
P* 50 − 10 = 40 60 − 12.5 = 47.5
A rise in demand raises both the profit-maximizing quantity and the price, exactly as the Q* formula
predicts (higher a ⟹ higher Q*).

Worked Example 7 — Adding a fixed cost

Demand P = 50 − Q; cost now includes a fixed cost: TC = 100 + 10Q + Q2. Find Q*, P*, and profit.
Marginal cost is still MC = 10 + 2Q (the constant 100 differentiates to 0), so the optimum is unchanged:
Q* = 10, P* = 40. Only profit changes:

𝜋 = 400 − (100 + 100 + 100) = 400 − 300 = 100

Profit falls from 200 to 100 — down by exactly the fixed cost of 100 — but the price and quantity do not
move.

Worked Example 8 — Checking the firm is on the elastic region

For the main example (P = 100 − 2Q, Q* = 15, P* = 70), confirm the optimum lies on the elastic part of
demand.
dP/dQ = −2 ⟹ dQ/dP = −0.5. So:

70
|𝑃𝐸𝐷| = |(−0.5) | = 2.33 > 1
15

Since |PED| exceeds 1, demand is elastic and marginal revenue is positive (MR = 40 > 0). The optimum
is on the elastic region, as theory requires.

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22. Practice Questions

Thirty questions in five parts, from definitions to full exam-style problems. Attempt them without looking
back, then check every answer against the worked solutions in Section 23. Space is deliberately left for
you to write.

22.A Part A — Foundations and definitions

A1. Define the inverse demand function and explain why a monopolist prefers it to the ordinary demand
function.
A2. In P = a − bQ, state precisely what a and b represent and give the sign of each.
A3. State the profit-maximization condition and explain, in words, why producing where MR = MC gives
the largest profit.
A4. Explain the difference between marginal cost and average total cost, and say which one is used to
choose output.
A5. Explain why the marginal-revenue curve lies below the demand curve for a monopolist.
A6. Define the Lerner Index and state its value under perfect competition.

22.B Part B — Derivations and algebra

B1. Starting from TR = (a − bQ)Q, derive the marginal-revenue function, showing every step.
B2. Given TC = cQ + dQ2, derive marginal cost.
B3. Derive Q* = (a − c) / [2(b + d)] from the condition MR = MC.
B4. Using the second derivative of the profit function, show that Q* is a maximum, not a minimum.
B5. Derive the general result MR = P[1 − 1/|PED|], starting from TR = P(Q)Q.
B6. From the pricing rule, show that (P − MC) / P = 1/|PED|.

22.C Part C — Numerical problems

C1. Demand P = 80 − 2Q, cost TC = 20Q + Q2. Find Q*, P*, and profit.
C2. Demand P = 150 − 3Q, cost TC = 30Q + 3Q2. Find Q*, P*, and profit.
C3. Demand P = 200 − 5Q, cost TC = 50Q + 5Q2. Find Q*, P*, and profit.
C4. For the main example (P = 100 − 2Q, TC = 10Q + Q2), compute the absolute markup and the
Lerner Index.
C5. Demand P = 40 − Q, cost TC = 4Q + 2Q2. Find Q*, P*, and profit.
C6. Repeat C5 but add a fixed cost of 50. What are the new Q*, P*, and profit?
C7. Demand P = 100 − 2Q, cost TC = 40 + 10Q + Q2. Find Q*, P*, and profit.
C8. At its optimum a monopolist sets P = 100 with MC = 25. Find the Lerner Index and |PED|.

22.D Part D — Elasticity and monopoly power

D1. If |PED| = 2 at the optimum, what fraction of the price is the markup?
D2. Explain, using marginal revenue, why a monopolist never produces where demand is inelastic.
D3. A firm faces |PED| = 5 at its optimum. Compute the markup fraction and comment on its market
power.
D4. At the profit-maximizing point, MR = 30 and P = 50. Find |PED|.
D5. Explain how the availability of close substitutes affects the elasticity a monopolist faces and hence
its markup.
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 Chapter 8 · MATHS 8.1 · Profit Maximization & Monopoly Power

22.E Part E — Conceptual and exam-style

E1. “A monopolist can charge any price it likes.” Evaluate this statement.
E2. Using the numbers of the main example, explain why the price (70) exceeds marginal cost (40) at
the optimum.
E3. Two firms have the same marginal cost, but firm X faces |PED| = 1.5 and firm Y faces |PED| = 6.
Which has greater monopoly power, and why?
E4. Distinguish clearly between the absolute markup, the proportional markup, and total profit, using
the main example.
E5. A student finds Q* correctly but then reads the price off the MR curve instead of the demand curve.
Explain the error and its numerical consequence in the main example.

23. Answer Key

Full solutions to all thirty practice questions. Where a question is a derivation, the key steps are given;
where it is numerical, every figure is shown.

Part A — Foundations and definitions

A1. The inverse demand function writes price as a function of quantity, P = a − bQ. A monopolist prefers
it because the firm chooses the quantity to produce and then needs the highest price that will sell exactly
that quantity — which is precisely what the inverse form gives.
A2. a is the vertical intercept, the price when Q = 0 (positive). b is the slope size, the fall in price per
extra unit (positive, and subtracted, so demand slopes downward).
A3. The condition is MR = MC. If MR > MC the next unit adds more to revenue than cost, so profit rises
by producing more; if MR < MC the next unit reduces profit; only where MR = MC is there no gain from
changing output, giving the maximum.
A4. MC is the cost of the next single unit; ATC = TC/Q is cost per unit on average. Output is chosen
using MC (via MR = MC), not ATC.
A5. To sell one more unit the monopolist must lower the price on every unit sold, so the extra revenue
from the last unit is its price minus the revenue lost on earlier units. That loss makes MR fall below price
at every positive quantity.
A6. The Lerner Index is L = (P − MC)/P. Under perfect competition P = MC, so L = 0.

Part B — Derivations and algebra

B1. TR = (a − bQ)Q = aQ − bQ2. Differentiate: d(aQ)/dQ = a, d(−bQ2)/dQ = −2bQ. So MR = a − 2bQ.
B2. d(cQ)/dQ = c; d(dQ2)/dQ = 2dQ. So MC = c + 2dQ.
B3. Set a − 2bQ = c + 2dQ. Then a − c = 2bQ + 2dQ = 2Q(b + d). Divide by 2(b + d): Q* = (a − c)/[2(b
+ d)].
B4. From π = (a−c)Q − (b+d)Q2, the first derivative is (a−c) − 2(b+d)Q; setting it to zero gives the same
Q*. The second derivative is −2(b+d) < 0, so the profit function is concave and Q* is a maximum.
B5. TR = P(Q)Q; by the product rule MR = P + Q(dP/dQ) = P[1 + (dP/dQ)(Q/P)]. Since (dP/dQ)(Q/P) =
1/PED, we get MR = P[1 + 1/PED] = P[1 − 1/|PED|].
B6. Set MR = MC: P[1 − 1/|PED|] = MC. Expand: P − P/|PED| = MC. Rearrange: P − MC = P/|PED|.
Divide by P: (P − MC)/P = 1/|PED|.

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 Chapter 8 · MATHS 8.1 · Profit Maximization & Monopoly Power

Part C — Numerical problems

C1. MR = 80 − 4Q, MC = 20 + 2Q. 80 − 4Q = 20 + 2Q ⟹ 60 = 6Q ⟹ Q* = 10. P* = 80 − 2(10) = 60. TR
= 600, TC = 20(10)+100 = 300, π = 300.

C2. MR = 150 − 6Q, MC = 30 + 6Q. 150 − 6Q = 30 + 6Q ⟹ 120 = 12Q ⟹ Q* = 10. P* = 150 − 30 =

120. TR = 1,200, TC = 300 + 300 = 600, π = 600.
C3. MR = 200 − 10Q, MC = 50 + 10Q. 200 − 10Q = 50 + 10Q ⟹ 150 = 20Q ⟹ Q* = 7.5. P* = 200 −
5(7.5) = 162.5. TR = 1,218.75, TC = 375 + 281.25 = 656.25, π = 562.5.
C4. P* = 70, MC = 40. Absolute markup = 30; Lerner = 30/70 ≈ 0.4286 (42.86%).
C5. MR = 40 − 2Q, MC = 4 + 4Q. 40 − 2Q = 4 + 4Q ⟹ 36 = 6Q ⟹ Q* = 6. P* = 40 − 6 = 34. TR = 204,
TC = 4(6)+2(36) = 96, π = 108.
C6. Marginal cost is unchanged, so Q* = 6, P* = 34 as before. Profit falls by the fixed cost: π = 108 −
50 = 58.
C7. Marginal cost is still 10 + 2Q, so Q* = 15, P* = 70. Profit = 675 − 40 = 635.
C8. L = (100 − 25)/100 = 0.75; |PED| = 1/0.75 = 1.333.

Part D — Elasticity and monopoly power

D1. Markup fraction = 1/|PED| = 1/2 = 0.5 (50% of the price).
D2. Where demand is inelastic, MR < 0, so selling more reduces total revenue. Producing less and
raising price raises revenue and lowers cost, both increasing profit. Also, MR < 0 cannot equal a positive
MC, so the optimum cannot lie there.
D3. Markup fraction = 1/5 = 0.2 (20%). The markup is small, so the firm has relatively low monopoly
power despite being a single seller — demand is quite elastic.

D4. Use MR = P[1 − 1/|PED|]: 30 = 50[1 − 1/|PED|] ⟹ 0.6 = 1 − 1/|PED| ⟹ 1/|PED| = 0.4 ⟹ |PED| =
2.5.
D5. More close substitutes make consumers more willing to switch when price rises, raising the elasticity
the firm faces. By (P − MC)/P = 1/|PED|, a higher |PED| means a smaller markup and weaker monopoly
power.

Part E — Conceptual and exam-style

E1. The statement is false as stated. A monopolist is a price-setter but is still bound by the demand
curve: a higher price means a lower quantity sold. It chooses the price–quantity combination on the
demand curve that maximizes profit (MR = MC), not any price it wishes. Its power is limited by the
elasticity of demand.
E2. At Q* = 15 the firm balances the revenue and cost of the last unit (MR = MC = 40). The price,
however, is what buyers will pay for 15 units, read from the demand curve (70). Because MR lies below
price, the price (70) sits above marginal cost (40); the 30 gap is the markup.
E3. Firm X, with the lower elasticity (|PED| = 1.5), has greater monopoly power. Its markup fraction is
1/1.5 ≈ 0.67, versus 1/6 ≈ 0.17 for firm Y. Lower elasticity means customers are less able to switch, so
the firm can hold price further above marginal cost.
E4. Absolute markup = P − MC = 30 (a money amount). Proportional markup = (P − MC)/P = 0.4286 (a
ratio, the Lerner Index). Total profit = (P − ATC)×Q = 675 (a money amount over all units). They answer
different questions and need not move together.
E5. Reading the price off MR gives the height of MR at Q*, which is 40 — equal to marginal cost, not
the market price. The correct price comes from the demand curve, 70. The error understates the price
by 30 and would wrongly suggest zero markup and zero monopoly power.

Mr. Farouk Saleh | +201062415129 | Page 26

 Chapter 8 · MATHS 8.1 · Profit Maximization & Monopoly Power

24. End-of-Section Summary

The whole model, condensed. If you can reproduce this page from memory, you understand the
mathematics of monopoly profit maximization.

Summary — the model in one place

Demand: P = a − bQ Cost: TC = cQ + dQ2
Revenue: TR = aQ − bQ2 Profit: π = (a−c)Q − (b+d)Q2
Margins: MR = a − 2bQ MC = c + 2dQ
Rule: produce where MR = MC, then read P* off the demand curve.
The key formulas:

𝑎 − 𝑐
𝑄∗=
2(𝑏 + 𝑑)
𝑏(𝑎 + 𝑐) + 2𝑎𝑑
𝑃∗=
2(𝑏 + 𝑑)
1
𝑀𝑅 = 𝑃 1 −
|𝑃𝐸𝐷|
𝑃 − 𝑀𝐶 1
= (𝑡ℎ𝑒 𝐿𝑒𝑟𝑛𝑒𝑟 𝐼𝑛𝑑𝑒𝑥)
𝑃 |𝑃𝐸𝐷|

Ten things to remember

1. The monopolist chooses Q, and the demand curve fixes the price.
2. Total revenue is aQ − bQ2 — the aQ term is positive (watch the source typo).
3. For linear demand, MR has the same intercept and double the slope.
4. Marginal cost rises with output because of the dQ2 term.
5. Profit is maximized where MR = MC; the second derivative −2(b+d) < 0 confirms a maximum.
6. Find Q* first, then substitute into the demand curve for P*.
7. A fixed cost changes profit but not Q* or P*.
8. Monopoly power is the gap between price and marginal cost; the Lerner Index measures it.
9. The pricing rule (P−MC)/P = 1/|PED| links markup to elasticity.
10. A monopolist always operates on the elastic part of demand, never the inelastic part.
You now have the complete mathematical toolkit for monopoly profit maximization and monopoly power,
from the first definition to the elasticity-based pricing rule. Return to the worked examples and practice
questions whenever you need to rebuild your confidence with the algebra.

Mr. Farouk Saleh | +201062415129 | Page 27