Market Power: Monopoly
Market Power: Monopoly
Market Power: Monopoly
Chapter 11
Topics to be Discussed
2
P = LMC = LRAC
Normal profits or zero economic profits in the long
run
Large number of buyers and sellers
Homogenous product
Perfect information
Firm is a price taker
P0 P0
D = MR = P
Q0 Q q0 Q
Monopoly
1. One seller - many buyers
2. One product (no good substitutes)
3. Barriers to entry
4. Price Maker
With Monopoly,
Initial Revenue (at p1): A+C Q Q+1 Quantity, Q
Revenue with one more unit: A+B Units per year
Marginal Revenue: B – C = p2 – C
A B
P=6-Q
$ per 7
unit of
output
6
2
Marginal
1 Revenue
0 1 2 3 4 5 6 7 Output
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Monopoly
16
Observations
1. To increase sales the price must fall
2. MR < P
3. Compared to perfect competition
No change in price to change sales
MR = P
TR = PQ = P(Q)*Q
MR = (d/dQ)P(Q)*Q = P(Q) + P'(Q)*Q
$ per
unit of
output MC
P1
P*
Lost
Profit from AC
producing
too little
P2
and selling
at too high
a price
D = AR
Lost
Profit from
producing too
MR much and
selling at too
Q1 Q* Q2 Quantity low a price
Cost C (Q ) 50 Q 2
C
MC 2Q
Q
Demand : P (Q ) 40 Q
R(Q ) P (Q )Q 40Q Q 2
R
MR 40 2Q
Q
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Monopoly: An Example
22
MC MR P (Q ) 40 Q
2Q 40 2Q P (Q ) 40 10
4Q 40 P (Q ) 30
Q 10
$ C
r' R
400
c’
200 r
Profits
150
100
50
c
0 5 10 15 20 Quantity
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Example of Profit Maximization
25
$/Q
40 MC Profit = (P - AC) x Q
= ($30 - $15)(10) =
$150
P=30
Profit
AC
20
AR
AC=15
10
MR
0 5 10 15 20 Quantity
©2005 Pearson Education, Inc.
Exercise
26
24 Perfectly elastic
Elastic, e < –1
Δ MR = – 2 Δ p = –1
ΔQ = 1 Δ Q = 1
e= –1
12
Demand ( p = 24 – Q)
Perfectly
inelastic
0 12 24
MR = 24 – 2Q Q , Units per day
TR = P(Q)*Q
R ( PQ)
1. MR
Q Q
Thus
P
2. MR P Q
Q
Q P
P P
P Q
3. E d P Q
Q
P
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A Rule of Thumb for Pricing
33
4. Q
P
1
P Q Ed
1
5. MR P P
E
d
Remember: Ed is a negative number.
If demand is inelastic, so that -1 < Ed < 0, then MR < 0.
If demand is unit elastic, so that ed = -1, then MR = 0.
If demand is elastic, so that ed < -1, then MR > 0.
is maximized where MR MC
P P 1 MC
E D
P MC 1
P ED
MC
P
1 1 E D
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Measuring Monopoly Power
35
MC P* MC
P*
P*-MC
D
P*-MC
MR
D
MR
Q* Quantity Q* Quantity
(a) Competition
p, $ per
unit
D2 D1
Q1 Q2 Q, Units per year
$/Q
MC Shift in demand
leads to change in
quantity but same
price
P1 = P2
D2
MR2
D1
MR1
Q1 Q2 Quantity
Demand
MR
0 Q m =6 Q c= 8 12 24
Q , Units per day
(MC+t)/[1 + 1/ed]
if MC is constant, then the price will increase by more than the
amount of the tax. This is because for any demand that is less
than perfectly elastic, 1/[1 + 1/ed] > 1.
If MC is an increasing curve, then the price will not necessarily
$/Q
Increase in P:
P1
P0 to P1 > tax
P
P0 MC + tax
t D = AR
MC
MR
Q1 Q0 Quantity
1
e MC (before tax)
p 2 = 20
A 2 t =$ 8
B C e
1
p 1 = 18
E F
D Result: Taxing a monopolist
increases the deadweight
loss of monopoly.
8
G
Demand
MR
0 Q 2 =4 Q 1 =6 12 24
Q , Units per day
QT = Q1 + Q2 is total output
Profit is then:
( PQT ) C1
0
Q1 Q1 Q1
MR MC 1 0
MR MC 1
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The Multi-plant Firm
53
$/Q
MC1 MC2
MCT
P*
MC=MR* D = AR
MR
Q1 Q2 QT Quantity
p, ¢per
daily dose Patents may be necessary to
143.0
stimulate innovation
A ≈ $0.44
million
em
75.0
Demand
B ≈ $0.88 million
C ≈ $0.44 million
ec MC = AVC
7.5
Pm MC
P1
P2 = P C
AC
P3
P4
AR
AnyIfprice
left alone,
below Pa4 monopolist
results
Ifthe
price
For
Ifinprice is
outputlowered
levels
is lowered
firm
produces incurring
Q to to
PCPoutput
above
a loss. 3 output
QP1 , .
m and charges m
decreases andmaximum
the original
increases to its aaverage
shortage
and
Q exists.
C and
marginal
there revenue
is no curves
deadweight apply.
loss. Qm Q1 Q3 Qc Q’3 Quantity
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Price Regulation: An Illustration
70
p, $ per unit MC
24
Market demand Since the government
e Regulated demand
regulation sets the maximum
A
18
B
m
C
price that the monopolist can
e
16
E
o charge at P = 16, the regulated
D MR curve (MRr) is now the
MR
r
horizontal line at P = 16 (for
MR
0<Q<8) and then the old MR
curve for Q>8.
A B
e Regulated demand
p1 D 1
p2
C However, if the regulated
e2
price is set too low, then
E there will be a shortage.
MR
MR r
Excess demand
Qm Qr QC Quantity