Transcript Slide 1
Chapter 10 Monopoly 10/1 © 2009 Pearson Education Canada Monopoly A firm is a monopoly if no other firm produces the same good or a close substitute for it. The degree to which goods are substitutes is measured by the cross price elasticity of demand. 10/2 © 2009 Pearson Education Canada The Monopolist’s Revenue Function A monopolist faces a downward sloping market demand curve. To sell additional units the monopolist must lower its price. p=D(y). Since all units must sell for the same price, p=average revenue (AR). Total revenue is output times price: TR(y)=y(D)(y) 10/3 © 2009 Pearson Education Canada The Monopolist’s Revenue Function Marginal revenue MR(y) is the rate at which total revenue changes with changes in output. Since the monopolist must reduce price to sell additional units of output, for any positive output, MR is less than price. As Δp approaches zero, MR is equal to (p) plus quantity (y) multiplied by the slope of the demand curve. 10/4 © 2009 Pearson Education Canada Figure 10.1 The monopolist’s marginal revenue 10/5 © 2009 Pearson Education Canada Marginal Revenue and Price Elasticity of Demand Price elasticity of demand (E) at a point (y, p) on the demand curve is: E=p/(y x slope of demand curve) Rearranging: MR(y)=p(1-1/lEl) Marginal revenue is positive if demand is price elastic and is negative if demand is price inelastic. 10/6 © 2009 Pearson Education Canada Figure 10.2 A linear demand function and the associated total and marginal revenue functions 10/7 © 2009 Pearson Education Canada From Figure 10.2 Linear demand curve: P=a-by TR=P*y, Therefore: TR(y)=ay-by2 MR(y)=a-2by The demand curve intersects the quantity axis at a/b. The MR curve intersects the quantity axis at a/2b. 10/8 © 2009 Pearson Education Canada From Figure 10.2 1. 2. 3. 10/9 When TR function has a positive slope, MR is positive. When the TR function is at its maximum, MR is zero. When TR function has a negative slope slope, MR is negative. © 2009 Pearson Education Canada Maximizing Profit Maximize profit by choosing output (y*) where MC intersects MR (from below). From the demand curve, find the price (p*) that corresponds with the profit maximizing y. 10/10 © 2009 Pearson Education Canada Figure 10.3 Maximizing monopoly profit 10/11 © 2009 Pearson Education Canada Figure 10.4 The inefficiency of monopoly 10/12 © 2009 Pearson Education Canada The Inefficiency of Monopoly Because p* exceeds MC in equilibrium, some potential gains from trade are not realized, representing market failure. Efficiency criterion requires producing output to the point where p=MC. The monopoly equilibrium is therefore not Pareto-optimal. A deadweight loss occurs because at equilibrium, there exists unrealized gains from trade, signalling unrealized monopoly profit. 10/13 © 2009 Pearson Education Canada Sources of Monopoly Government Franchise Patent Monopoly Resource Based Monopoly Technological (Natural) Monopoly Monopoly by Good Management 10/14 © 2009 Pearson Education Canada Figure 10.5 Natural monopoly 10/15 © 2009 Pearson Education Canada Regulatory Responses to a Natural Monopoly Average Cost Pricing: Forcing the monopoly to produce a level of output where p=AC. This regulation will fail to minimize production costs. 10/16 © 2009 Pearson Education Canada Figure 10.6 Average cost pricing 10/17 © 2009 Pearson Education Canada Regulatory Responses to a Natural Monopoly Rate of Return Regulation: Aimed at limiting the rate of return on invested capital. Under this regulation, the firm will choose an input bundle that is not cost minimizing, choosing too much capital and too little labour. 10/18 © 2009 Pearson Education Canada Figure 10.7 Rate-of-return regulation 10/19 © 2009 Pearson Education Canada Patent Policy Appropriability Problem: Many inventions with social value are not pursued because inventors do not have the private incentives to pursue them (they are not able to capture the social benefits). 10/20 © 2009 Pearson Education Canada Figure 10.8 The inducement to develop 10/21 © 2009 Pearson Education Canada Optimal Patent Policy At the optimal patent period, the marginal social benefit of increasing the patent period is equal to the marginal social cost. The optimal patent policy maximizes aggregate social value less aggregate social costs. 10/22 © 2009 Pearson Education Canada