Transcript Handout for lecture 11

Chapter 5 & 6 .2.1
Main Monopoly
REVENUE
• Revenue curves when price varies with
output (downward-sloping demand curve)
– average revenue (AR)
TR P.Q
AR 

P
Q
Q
AR and MR curves for a firm facing a downward-sloping D curve
Q P =AR
(units) (£)
8
1
7
2
6
3
5
4
4
5
3
6
2
7
8
AR, MR (£)
6
4
2
TR MR
(£) (£)
8
6
14
4
18
2
20
0
20
-2
18
-4
14
AR
0
1
2
3
4
5
6
7
-2
-4
MR
Quantity
• TR at P=6, Q = 3 is 18
• TR at P=5, Q = 4 is 20
• So MR = 2
• Alternative Story:
• Gain from selling one more unit = 5
• But now have reduced price from 6 to 5 on the first
three units sold.
• So losing 3*£1=£3 as a result
• MR = price of extra unit (5) less price reduction on
all units sold previously (3) = 5 – 3 = 2
Why is the MR curve below the Demand
Curve
dTR
MR 
dQ
MR 
d[
but TR  P.Q
]
dQ
d [ P.Q]

dQ
d [ P.Q]

dQ
To differentiate P.Q we use the
product rule. Let u=P and v=Q
d [u.v]
dv
du
u
v
dQ
dQ
dQ
Why is the MR curve below the Demand
Curve?
dP
MR  P  Q
dQ
•MR = price of extra unit (5) less price
reduction on all units sold previously (3)
•= 5 – 3 = 2
TR curve for a firm facing a downward-sloping D curve
20
16
TR
TR (£)
12
8
4
0
0
1
2
3
4
Quantity
5
6
MR
7
revenue curves and price elasticity of demand
Consider once again the derivative of the Total
Revenue Function
dTR
dP
 MR  P  Q
dQ
dQ
 Q dP 
MR  P 1 

 P dQ 
revenue curves and price elasticity of demand
 Q dP 
MR  P 1 

 P dQ 



1 
MR  P 1 

 Q dP 
 P dQ 
 1
 P 1  
 
revenue curves and price elasticity of demand
 1
MR  P 1  
 
For Perfect Competition the demand curve
the firm faces is elastic so,
revenue curves and price elasticity of demand
 1
MR  P 1  
 
For a downward sloping demand function, when
Total Revenue is a maximum
 1
MR  P 1    0
 
1
  1

 1
1

0
TR curve for a firm facing a downward-sloping D curve
Elasticity = -1
20
16
TR
TR (£)
12
8
4
0
0
1
2
3
4
Quantity
5
6
7
AR and MR curves for a firm facing a downward-sloping D curve
8
Elastic
Elasticity = -1
AR, MR (£)
6
4
Inelastic
2
AR
0
1
2
3
4
5
6
7
-2
-4
MR
Quantity
MONOPOLY
• Essential Characteristics of the monopolist's
demand curve
– downward sloping
– MR below AR
– AND
– the Monopolist will always be on the elastic
portion of her demand curve
– Why? Surely if Elastic that implies a rise in Q
would result in a rise in Revenue?
– Ans: What is happening to costs!!!!
Profit maximising under monopoly
£
MC
AC
AR
MR
O
Q
What is the supply curve for the monopolist?
£
There isn’t
any
MC
AC
Why not?
AR
AR
MR
O
Qm
Q
What is the supply curve for the monopolist?
£
P0
P1
The Supply Curve is
a unique relationship
between Price and
Quantity
a
b
Here we found that
monopolist will
supply the same
amount at two
different prices
So no Supply Curve
O
Qm
Q
MONOPOLY
• Defining monopoly
• Barriers to entry
– economies of scale
– product differentiation and brand loyalty
– lower costs for an established firm
– ownership or control over key factors
– ownership or control over outlets
– legal restrictions
– mergers and takeovers
– aggressive tactics
– intimidation
• Natural monopoly
Natural Monopoly
£
Long –Run average cost
curve is downward sloping
When will this occur?
If there are large Fixed
Costs and small MC
LRAC
MC
O
Q
Equilibrium of industry under perfect competition and monopoly:
with the same MC curve
£
MC
P1
AR = D
MR
O
Q1
Q
MONOPOLY
• Disadvantages of monopoly
– high prices / low output: short run
– high prices / low output: long run
– lack of incentive to innovate
– X-inefficiency
• Advantages of monopoly
– Yes, if economies of scale are significant
– The case of a Natural Monopoly
Natural Monopoly
£
LRAC
MC
O
Q
Natural Monopoly
£
Dm
With one firm, however,
DD
LRAC
MC
O
Qm
Q
Natural Monopoly
• Here with competition no production at all
• But with monopoly production takes place
that would not otherwise happen.
• There may be supernormal profits, but scale
of production allows lower cost and a
(profitable) market price agents are willing
to pay.
Economies of Scale
An alternative version of the story is to
examine an industry where the cost curve
an individual firm faces falls as the scale of
production rises.
SO now we are going to examine the
Equilibrium of industry under perfect
competition and monopoly:
with different
MC curves
Equilibrium of industry under perfect competition and monopoly:
with different MC curves
£
MC ( = supply)perfect competition
MCmonopoly
P2=MR
. =MC
AR = D
MR
O
Q2
Q
Economies of Scale
• Here with competition high priced
production and low scale
• Monopoly allows economies of scale to be
exploited and hence a lower cost of
production.
• There may be supernormal profits, but
consumers still better off than before:
• Lower Price and Greater Quantity
Note Monopoly is better as long as the new MC curve lies below
point x
£
MC ( = supply)perfect competition
MCmonopoly
P2=MR
. =MC
P1
x
AR = D
MR
O
Q2
Q1
Q
£
Any suggestions as to Price regulator might
choose?
MC ( = supply)perfect competition
MCmonopoly
AC
P2
P1
AR = D
MR
O
Q2
Q1
Q
£
Any suggestions as to Price regulator might
choose?
MC ( = supply)perfect competition
MCmonopoly
AC
P2
P1
AR = D
MR
O
Q2
Q1
Q
MONOPOLY
• Disadvantages of monopoly
– high prices / low output: short run
– high prices / low output: long run
– lack of incentive to innovate
– X-inefficiency
• Advantages of monopoly
– economies of scale
– profits can be used for investment (dodgy!!)
– promise of high profits encourages risk taking (Still a bit
dodgy – what is appropriate risk taking?)
MONOPOLY
• The monopolist's demand curve
– downward sloping
– MR below AR
• Equilibrium price and output
• Limit pricing
PROFIT MAXIMISATION
• Some qualifications
– long-run profit maximisation
– the meaning of profit
• What if a loss is made?
– loss minimising:
still produce where MR = MC
– short-run shut-down point:
P = AVC
– long-run shut-down point:
P = LRAC