Transcript mr price
Measuring the Effect of Monopoly: Consumer and Producer Surplus Consumer Net benefit buyers enjoy A profitSurplus: maximizing monopoly will always from purchasing and consuming the good. P WHAT IF the monopoly produce a quantity Height firm acts as though it and of Market Demand Curve: Reflects the benefit a buyer enjoys consuming a specific unit of the good. were a firm in a perfectly chargefrom a price Consumer Surplus: The benefit each buyer enjoys from competitive industry? that lies on the market demand curve. consuming the good less what each buyer must pay for A Dead Marginal Revenue (MR): the good. “S” weight loss PM = 1.50 TheBeneath marginal Area therevenue Demandcurve Curvelies Lying MC Above thethe Price: Reflects all thecurve. net benefits B below market demand C buyers enjoy, the consumer surplus, from P = 1.25 MR < Price C E purchasing and consuming the good. D D Producer Surplus: The net benefit sellers MC = 1.00 enjoy from producing and selling the good F Height of Market Supply Curve: The seller’s MR opportunity cost of providing a specific unit of the good. Producer Surplus: What each seller receives from the sale of the good less the opportunity cost each seller incurs by providing it. Q 50 75 Area above the Supply Curve Lying beneath the Who does monopoly Price: Reflects all the net benefit sellers enjoy, the hurt? Consumers producer surplus, from producing and selling the good. help? The monopoly firm Competition Monopoly Change What as Ba & whole. Consumer Surplus A+B+C A about society Lose Lose C Producer Surplus Total Surplus D+E+F A+B+C+D+E+F B+D+F A+B+D+F Gain B & Lose E Lose C & Lose E Connecting the Pareto approach to efficiency with consumer and producer surplus Question: How did we argue that P monopoly was inefficient? We chose an individual, Joe, who Did not by a hamburger when the price was $1.50, the monopoly price. But would be a hamburger at a PM = 1.50 price of $1.40, a value above Mary’s marginal cost. We then devised a special (secret) deal that made both Joe and Mary better MC = 1.00 off which did not affect anyone else. Question: What were the critical aspects in choosing Joe: Price Marginal Cost The dead weight loss represent all the Joes who are around. All those who can make special deals with Mary help the two of them and do no hurt anyone else. Dead weight loss MC D 50 Joe 75 Q Question: Where on the market demand curve would you “place” Joe? Answer: Joe is in the dead weight loss (excess burden) region. A Multi-Plant Monopoly Claim: To maximize profits, two conditions must be satisfied when a firm has two plants: Marginal costs of each plant must be equal: MCA = MCB Marginal revenue must equal each plant’s marginal cost: MR = MCA = MCB MCA MCB MCA 100 100 80 80 60 60 40 40 20 20 MCB Total Production Q = 75 Question: Is it possible for the firm to produce 75 units more cheaply by transferring productions from on plant to the other? qA 50 100 qA = 50 MCA = $60 Plant A produces 1 fewer unit Plant A’s total costs decrease by $60 qB 50 100 150 200 qB = 25 MCB = $30 Plant A produces 1 more unit Plant B’s total costs increase by $30 Profits will Firm’s total costs decrease by $30 rise by $30. MC = Change in total cost resulting from a one unit change in production Intuition: We can reduce the firm’s total costs without reducing the total quantity of output produced by shifting production from the high marginal cost plant to the low marginal cost plant. Question: Can this go on indefinitely? A Multi-Plant Monopoly Claim: To maximize profits, two conditions must be satisfied when a firm has two plants: Marginal costs of each plant must be equal: MCA = MCB Marginal revenue must equal each plant’s marginal cost: MR = MCA = MCB MCA MCB MCA 100 100 80 80 60 60 40 40 20 20 MCB Total Production Q = 75 Question: Is it possible for the firm to produce 75 units more cheaply by transferring productions from on plant to the other? qA 50 100 qA = 25 50 MCA = $40 $60 qB 50 qB = 50 25 100 150 200 MCB = $40 $30 As production is transferred from Plant A to Plant B MCA decreases MCB increases Until they are equal MC = Change in total cost resulting from a one unit change in production Intuition: We can reduce the firm’s total costs without reducing the total quantity of output produced by shifting production from the high marginal cost plant to the low marginal cost plant. Question: Can this go on indefinitely? A Multi-Plant Monopoly Claim: To maximize profits, two conditions must be satisfied when a firm has two plants: Marginal costs of each plant must be equal: MCA = MCB Marginal revenue must equal each plant’s marginal cost: MR = MCA = MCB MCA MCB MCA MCB 100 100 100 80 80 80 60 60 60 40 40 40 20 20 20 qA 50 100 qA = 25 MCA = $40 D MR Q qB 50 qB = 50 100 150 200 MCB = $40 50 100 150 200 200 qA + qB = Q = 75 MR = $90 MC = Change in total cost resulting MR = Change in total revenue resulting from a one unit change in production from a one unit change in production Profit = TR TC Produce 1 Up by $50 Up by $90 Up by $40 more unit To maximize profit: MR = MC A Multi-Plant Monopoly To maximize profits, two conditions must be satisfied when a firm has two plants: Marginal costs of each plant must be equal: MCA = MCB Marginal revenue must equal each plant’s marginal cost: MR = MCA = MCB MCA MCB MCA MCB 100 100 100 80 80 80 60 60 60 40 40 40 20 20 20 qA 50 100 qA = 50 MCA = 60 D MR Q qB 50 100 150 200 qB = 100 MCB = 60 Claim: To maximize profit: qA = 50 and qB = 100 50 100 150 200 200 qA + qB = = 150 MR = 60 P = 90 Question: What price will the monopoly charge? Answer: A monopoly produces a quantity and charges a price that lies on the market demand curve. Review: Efficiency and the Two Polar Cases of Market Structure Perfectly Competitive Industry Monopoly A large number of small firms One large firm A single firm’s production decision Monopoly produces a quantity and charges a price does not significantly affect the price. that lies on the market demand curve. MR curve horizontal: MR curve lies beneath the market demand curve: MR = Price MR < Price or Profit Maximization or Price = MR Price > MR MR = MC Price = MR = MC Price > MR = MC Price = MC Price > MC Consumers base decisions Consumers base decisions on accurate information on misleading information Efficient Inefficient Perfectly Competitive Industry Oligopoly Monopoly A large number of small firms A few moderately sized firms One large firm Efficient Question: Efficient or Inefficient? Inefficient Oligopoly Challenge of Oligopoly: While it is straightforward to predict the price and quantity in a perfectly competitive market or a monopoly it is more difficult to do so in an oligopoly. Project: Explaining OPEC’s Vacillating Behavior in 1993 In late September, the members of OPEC negotiated quotas to restrict the quantity of oil produced. The agreement was applauded by OPEC oil ministers. Shortly thereafter, oil prices promptly rose. The increase in oil prices proved to be short lived, however. OPEC members violated their agreement within two weeks of consummating it. Within a few weeks, the price of oil fell. Conflicting Interests of an Oligopolies and Cartels: Collective versus Individual It is in the collective interests of the firms in an industry to establish a cartel to maximize their joint profits. It is in their collective interests to collude by reducing production below the competitive level; by do so they can act like a monopoly to maximize the joint profits of the entire industry by restricting production below the competitive level. On the other hand, if a cartel is established it may be in the individual interests of each firm to cheat on the cartel agreement to maximize its individual profit. If the cartel agreement is in place, it may be in the individual interests of a firm to produce more than the agreement allows thereby pushing production toward the competitive level. Strategy: Begin with a multi-plant monopoly and then “convert” it to an oligopoly. A Multi-Plant Monopoly To maximize profits, two conditions must be satisfied when a firm has two plants: Marginal costs of each plant must be equal: MCA = MCB Marginal revenue must equal each plant’s marginal cost: MR = MCA = MCB MCA MCB MCA MCB 100 100 100 80 80 80 60 60 60 40 40 40 20 20 20 qA 50 100 qA = 50 MCA = $60 D MR Q qB 50 100 150 200 qB = 100 MCB = $60 50 100 150 200 200 qA + qB = = 150 MR = $60 Marginal Revenue for the Monopoly Slope of Demand Curve = Rise Run = 20 100 = .20 P = $90 Marginal Revenue for the Monopoly Tomorrow Today Tomorrow: Today: Slope of Demand Curve = .20 To clear the market the quantity demanded must increase by 1 unit. The price must fall by .20, from $90.00 to $89.80. Quantity Price 151 $89.80 150 $90.00 Quantity Price 151 89.80 150 Total Revenue = Price Quantity 89.80151 89.80(1 + 150) = 89.80 + 90.00 89.80150 90.00150 Marginal Revenue = 89.80 + 89.80150 90.00150 = 89.80 + (89.80 90.00)150 = 89.80 + (.20)150 TR tends to rise by 89.80, TR tends to fall by 30.00, the price, as a consequence as a consequence of the of the additional unit sold. lower price. Output Effect Price Effect MR = 89.80 30.00 = $59.80 $60 Convert the Multi-Plant Monopoly into an Oligopoly To maximize profits, two conditions must be satisfied when a firm has two plants: Marginal costs of each plant must be equal: MCA = MCB Marginal revenue must equal each plant’s marginal cost: MR = MCA = MCB MCA MCB MCA MCB 100 100 100 80 80 80 60 60 60 40 40 40 20 20 20 qA 50 100 qA = 50 MCA = $60 D MR Q qB 50 100 150 200 qB = 100 MCB = $60 50 100 150 200 200 qA + qB = = 150 MR = $60 Owner retires and gives Plant A to his son Adam and Plant B to his daughter Beth Adam’s Firm Beth’s Firm Total Production qA = 50 qB = 100 Q = 150 P = $90 MCA = $60 MCB = $60 P = $90 Scenario 1: No Retaliation – Does Adam have an incentive to cheat if Beth does not retaliate? Quantity Slope of Demand Curve = .20 Adam Beth Joint Price To clear the market the quantity demanded must increase by 1 unit. Tomorrow 51 100 151 89.80 Today 50 100 150 90.00 The price must fall by .20, from $90.00 to $89.80. MCA = $60.00 Adam’s Adam’s Quantity Price Total Revenue = Price Quantity Tomorrow: Today: 51 50 Question: What does Adam’s marginal revenue (MRA) equal? Does Adam have an incentive to cheat if Beth does not retaliate? Yes 89.80 89.8051 89.80(1 + 50) = 89.80 + 90.00 89.8050 90.0050 Adam’s Marginal Revenue = 89.80 + 89.8050 90.0050 = 89.80 + (89.80 90.00)50 = 89.80 + (.20)50 TR tends to rise by 89.80, TR tends to fall by 10.00, the price, as a consequence as a consequence of the of the additional unit sold. lower price. Output Effect Price Effect MRA = Adam’s Marginal Revenue = 89.80 10.00 = $79.80 Adam produces one more unit of output and Beth does not retaliate: qA: 50 51 qB = 100 P: $90.00 $89.80 qA: 50 51 Increased by 1 Adam’s Profit MRA = $79.80 MR = Change in total revenue resulting from a one unit change in production Adam’s Profit Up by $19.80 = Beth’s Profit MCA = $60.00 MC = Change in total cost resulting from a one unit change in production TR TC Produce 1 more unit Up by $79.80 Up by $60.00 qB = 100: Unchanged P: $90.00 $89.80 Down by $.20 Beth’s Profit Down by $20.00 TR TC Down by $20.00 Unchanged = Production unchanged: 100 units $.20 100 Question: What happens to their joint profit? Question: Down by $.20 Beth produces one more unit of output and Adam does not retaliate: qB: 100 101 qB = 50 P: $90.00 $89.80 qB: 50 51 Increased by 1 Beth’s Profit MRA = $69.80 MR = Change in total revenue resulting from a one unit change in production Beth’s Profit Up by $9.80 = MCA = $60.00 MC = Change in total cost resulting from a one unit change in production TR TC Produce 1 more unit Up by $69.80 Up by $60.00 Adam’s Profit qA = 50: Unchanged P: $90.00 $89.80 Down by $.20 Adam’s Profit Down by $10.00 TR TC Down by $10.00 Unchanged = Production unchanged: 50 units $.20 50 Question: What happens to their joint profit? Question: Down by $.20 Summary Adam’s Marginal Revenue = 89.80 + Adam: MRA = $79.80 MCA = $60 = 89.80 + = 89.80 + When Adam producers 1 more unit his profit rises by approximately $19.80 TR tends to rise by 89.80, the price, as a consequence Question: Who has the of the additional unit sold. greater incentive to cheat? Adam has a greater incentive Output Effect to cheat. Why? Adam’s MR is greater. Why? MRA = 89.80 Adam’s price effect is smaller. Why? Beth’s Marginal Revenue = 89.80 + Adam is the smaller producer. = 89.80 + Conclusion: The smaller = 89.80 + producer has a greater incentive to cheat. TR tends to rise by 89.80, the price, as a consequence Beth: MRB = $69.80 MCB = $60 of the additional unit sold. When Beth producers 1 more unit her profit rises Output Effect by approximately $9.80. MRB = 89.80 89.8050 90.0050 (89.80 90.00)50 (.20)50 TR tends to fall by 10.00, as a consequence of the lower price. Price Effect 10.00 = 79.80 89.80100 90.00100 (89.80 90.00)100 (.20)100 TR tends to fall by 20.00, as a consequence of the lower price. Price Effect 20.00 = 69.80