Chapter 5

REVENUEREVENUE

• 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 Revenues for a firm facing a downward sloping demand curvedemand curve

REVENUEREVENUE

• Revenue curves when price varies with output (downward-sloping demand curve)– average revenue (AR)

PQQP

QTRAR

.

• TR at P=6, Q = 3 is 18TR at P=6, Q = 3 is 18• TR at P=5, Q = 4 is 20TR at P=5, Q = 4 is 20• So MR = 2So MR = 2

• Alternative Story:Alternative Story:• Gain from selling one more unit = 5Gain from selling one more unit = 5• But now have reduced price from 6 to 5 on the first But now have reduced price from 6 to 5 on the first

three units sold.three units sold.• So losing 3*£1=£3 as a resultSo losing 3*£1=£3 as a result• MR = price of extra unit (5) less price reduction on MR = price of extra unit (5) less price reduction on

all units sold previously (3) = 5 – 3 = 2all units sold previously (3) = 5 – 3 = 2

-4

-2

0

2

4

6

8

1 2 3 4 5 6 7

Q(units)

1234567

P =AR(£)8765432

TR(£)

8141820201814

MR(£)

6420

-2-4

AR

MR

AR

, MR

(£)

Quantity

ARAR and and MRMR curves for a firm facing a downward-sloping curves for a firm facing a downward-sloping D D curvecurve

0

4

8

12

16

20

0 1 2 3 4 5 6 7

TRTR curve for a firm facing a downward-sloping curve for a firm facing a downward-sloping DD curve curve

TR

Quantity

TR (£

)

MR

-4

-2

0

2

4

6

8

1 2 3 4 5 6 7

AR

MR

Elasticity = -1Elastic

Inelastic

AR

, MR

(£)

Quantity

ARAR and and MRMR curves for a firm facing a downward-sloping curves for a firm facing a downward-sloping D D curvecurve

£

Q O

AC

MC

MR

AR

Profit maximising under monopolyProfit maximising under monopoly

£

Q O

AC

MC

AR

AC

Qm

MR

AR

a

b

Profit maximising under monopolyProfit maximising under monopoly

..and profits?

£

Q O

AC

MC

MR

AR

Profit maximising under monopolyProfit maximising under monopoly

£

Q O

P0

Qm

a

b

What is the supply curve for the monopolist?What is the supply curve for the monopolist?

P1

The Supply Curve is a unique relationship between Price and

Quantity

Here we found that monopolist will

supply the same amount at two different prices

So no Supply Curve

MONOPOLYMONOPOLY

• 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 MonopolyNatural Monopoly£

O Q

LRAC

Long –Run average cost curve is downward sloping

When will this occur?

If there are large Fixed Costs and small MC

MC

£

Q O

MC

Q1

MR

AR = D

P1

Equilibrium of industry under perfect competition and monopoly:Equilibrium of industry under perfect competition and monopoly: with the same with the same MCMC curve curve

MONOPOLYMONOPOLY

• 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 MonopolyNatural Monopoly£

O Q

LRAC

MC

Industry Demand CurveIndustry Demand Curve£

O Q

D

If two firms in the industry (A Duopoly) the demand curve for

each is D1

Pmax

At prices above Pmax competitor gets all the

businessDD

An alternative version of the story is to examine an An alternative version of the story is to examine an industry where the cost curve an individual firm industry where the cost curve an individual firm

faces falls as the scale of production rises.faces falls as the scale of production rises.

SO now we are going to examine the Equilibrium of SO now we are going to examine the Equilibrium of industry under perfect competition and monopoly:industry under perfect competition and monopoly:

with with different different MCMC curvescurves

£

Q O

MC ( = supply)perfect competition

MRQ2

MCmonopoly

AR = D

Equilibrium of industry under perfect competition and monopoly:Equilibrium of industry under perfect competition and monopoly:with different with different MCMC curves curves

P2=MR. =MC

£

Q O

MC ( = supply)perfect competition

Q1

MR

P1

P2

Q2

MCmonopoly

P3

AR = D

Suppose a regulator set the price at PSuppose a regulator set the price at P3 3 (Average Cost Pricing). How (Average Cost Pricing). How would this effect the behaviour of the monopolists?would this effect the behaviour of the monopolists?

AC

MONOPOLYMONOPOLY

• 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?)