Transcript Handout for Lecture on Ch 5.4 & 6

Chapter 5
REVENUE
• Revenue curves when price varies with
output (downward-sloping demand curve)
– average revenue (AR)
– marginal revenue (MR)
– total revenue (TR)
– revenue curves and price elasticity of demand
Revenues for a firm facing a downward sloping
demand curve
Q (units)
P (£)
TR (£)
AR (£)
1
8
8
8
2
7
14
7
3
6
18
6
4
5
20
5
5
4
20
4
6
3
18
3
7
2
14
2
REVENUE
• Revenue curves when price varies with
output (downward-sloping demand curve)
– average revenue (AR)
TR P.Q
AR 

P
Q
Q
• 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
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 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
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
Profit maximising under monopoly
£
MC
AC
AR
MR
O
Q
Profit maximising under monopoly
£
AR
AC
..and
profits?
MC
AC
a
b
AR
MR
O
Qm
Q
Profit maximising under monopoly
£
MC
AC
AR
MR
O
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
– economies of scale
Natural Monopoly
£
LRAC
MC
O
Q
Industry Demand Curve
£
Pmax
DD
If two firms in the
industry (A Duopoly)
the demand curve for
each is D1
At prices above Pmax
competitor gets all the
business
D
O
Q
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
Suppose a regulator set the price at P3 (Average Cost Pricing). How
would this effect the behaviour of the monopolists?
£
MC ( = supply)perfect competition
MCmonopoly
AC
P2
P1
P3
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?)