Chapter 5.4 &6Monopoly
REVENUEREVENUE
• Revenue curves when price varies with output (downward-sloping demand curve)
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
.
REVENUEREVENUE
• Revenue curves when price varies with output (downward-sloping demand curve)– average revenue (AR)
– marginal revenue (MR)
-4
-2
0
2
4
6
8
1 2 3 4 5 6 7
ARAR and and MRMR curves for a firm facing a downward-sloping curves for a firm facing a downward-sloping D D curvecurveQ
(units)1234567
P =AR(£)8765432
D= ARAR
, MR
(£)
Quantity
5
• 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
Revenues for a firm facing a downward sloping Revenues for a firm facing a downward sloping demand curvedemand curve
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
Why is the MR curve below the Demand Why is the MR curve below the Demand CurveCurve
dQdTRMR QPTRbut .
dQQPdMR ].[
Do differentiate P.Q we use the product rule. Let u=P and
v=Q
dQduv
dQdvu
dQvud
].[
dQdPQ
dQdQP
dQQPd
].[
dQdPQP
dQQPd
].[
Why is the MR curve below the Demand Why is the MR curve below the Demand Curve?Curve?
dQdTRMR
dQdPQP
dQQPd
].[
Why is the MR curve below the Demand Why is the MR curve below the Demand Curve?Curve?
MR
•MR = price of extra unit (5) less price MR = price of extra unit (5) less price reduction on all units sold previously (3) reduction on all units sold previously (3)
•= 5 – 3 = 2= 5 – 3 = 2
dQdPQP
-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
REVENUEREVENUE
• Revenue curves when price varies with output (downward-sloping demand curve)– average revenue (AR)
– marginal revenue (MR)
– total revenue (TR)
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
Quantity
TR (£
)
Quantity(units)
1234567
P = AR(£)
8765432
TR(£)
8141820201814
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 (£
)
Quantity(units)
1234567
P = AR(£)
8765432
TR(£)
8141820201814
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
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
-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
MONOPOLYMONOPOLY
• Essential Characteristics of the monopolist's demand curve– downward sloping– MR below AR
£
Q O
MR
AR
Profit maximising under monopolyProfit maximising under monopoly
MONOPOLYMONOPOLY
• The monopolist's demand curve– downward sloping– MR below AR
• Equilibrium price and output
£
Q O
AC
MC
MR
AR
Profit maximising under monopolyProfit maximising under monopoly
Profit maximising under monopolyProfit maximising under monopoly£
Q O
MC
Qm
MR
MR=MC rule still applies
Determines Qm
£
Q O
MC
AR
Qm
MR
AR
a
Profit maximising under monopolyProfit maximising under monopoly
Given MR=MC, we
then find Price at Qm
£
Q O
AC
MC
AR
AC
Qm
MR
AR
a
b
Profit maximising under monopolyProfit maximising under monopoly
..and profits?
£
Q O
AC
MC
AR
Qm
MR
AR
What is the supply curve for the monopolist?What is the supply curve for the monopolist?There isn’t
any
Why not?
£
Q O Qm
What is the supply curve for the monopolist?What is the supply curve for the monopolist?The Supply Curve is a unique relationship between Price and
Quantity
£
Q O
AC
MC
P0
Qm
MR0
AR1
a
b
What is the supply curve for the monopolist?What is the supply curve for the monopolist?
But here not unique
P1
MR1
AR0
£
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
£
Q O Qm
What is the supply curve for the monopolist?What is the supply curve for the monopolist?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
MONOPOLYMONOPOLY
• Defining monopoly• Barriers to entry• Natural monopoly
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
MONOPOLYMONOPOLY
• Disadvantages of monopoly– high prices / low output: short run
£
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
£
Q O
MC
Q1
MR
P1
P2
Q2
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
AR = D
£
Q O
MC ( = supply under perfect competition)
Q1
MR
P1
P2
Q2
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
AR = D
MONOPOLYMONOPOLY
• Disadvantages of monopoly– high prices / low output: short run– high prices / low output: long run (Profits not
eliminated)
MONOPOLYMONOPOLY
• Disadvantages of monopoly– high prices / low output: short run– high prices / low output: long run– lack of incentive to innovate
MONOPOLYMONOPOLY
• Disadvantages of monopoly– high prices / low output: short run– high prices / low output: long run– lack of incentive to innovate– X-inefficiency
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
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
Natural MonopolyNatural Monopoly£
O Q
LRAC
MC
This industry is uncompetitive with two
firms
And no production occurs
DD
Natural MonopolyNatural Monopoly£
O Q
LRAC
MC
With one firm, however, equilibrium occurs at Qm
MR
Qm
Pm
DD
Dm
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
MR
P2=MR. =MC
Q2
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
£
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
Q2
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
Q2
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
AC
£
Q O
MC ( = supply)perfect competition
Q1
MR
P1
Q2
MCmonopoly
x
AR = D
Note Monopoly is better as long as the new MC curve lies below Note Monopoly is better as long as the new MC curve lies below point xpoint x
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
£
Q O
MC ( = supply)perfect competition
Q1
MR
P1
P2
Q2
MCmonopoly
Q3
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?
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)
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?)
MONOPOLYMONOPOLY
• The monopolist's demand curve– downward sloping– MR below AR
• Equilibrium price and output• Limit pricing
Limit pricingLimit pricing
AC monopolist
£
O Q
Limit pricingLimit pricing
AC new entrant
AC monopolist
£
O Q
Limit pricingLimit pricing
AC new entrant
AC monopolist
£
O Q
PL
TRTR curve for a firm facing a downward-sloping curve for a firm facing a downward-sloping DD curve curve
0
4
8
12
16
20
0 1 2 3 4 5 6 7
TR
Elasticity = -1
Elastic
Inelastic
Quantity
TR (£
)
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
• Shifts in revenue curves
PROFIT MAXIMISATIONPROFIT MAXIMISATION
• Using total curves– maximising the difference between TR and TC
Finding maximum profit using total curvesFinding maximum profit using total curvesTR
, TC
, T
(£)
TR
TC
Quantity
-8
-4
0
4
8
12
16
20
24
1 2 3 4 5 6 7
PROFIT MAXIMISATIONPROFIT MAXIMISATION
• Using total curves– maximising the difference between TR and TC– the total profit curve
-8
-4
0
4
8
12
16
20
24
1 2 3 4 5 6 7
TR, T
C, T
(£
)
T
TR
TC
Quantity
Finding maximum profit using total curvesFinding maximum profit using total curves
-8
-4
0
4
8
12
16
20
24
1 2 3 4 5 6 7
TR, T
C, T
(£
)
T
TR
TC
a
b
c d
Quantity
Finding maximum profit using total curvesFinding maximum profit using total curves
-8-6-4-202468
1012141618202224
1 2 3 4 5 6 7
TR, T
C, T
(£
)
T
TR
TC
d
e
f
Quantity
Finding maximum profit using total curvesFinding maximum profit using total curves
PROFIT MAXIMISATIONPROFIT MAXIMISATION
• Using total curves– maximising the difference between TR and TC– the total profit curve
• Using marginal and average curves
PROFIT MAXIMISATIONPROFIT MAXIMISATION
• Using total curves– maximising the difference between TR and TC– the total profit curve
• Using marginal and average curves– stage 1:
profit maximised where MR = MC
-4
0
4
8
12
16
20
1 2 3 4 5 6 7
MC
MR
Quantity
Cos
ts a
nd re
venu
e (£
)Finding the profit-maximising output using marginal curvesFinding the profit-maximising output using marginal curves
-4
0
4
8
12
16
20
1 2 3 4 5 6 7
Finding the profit-maximising output using marginal curvesFinding the profit-maximising output using marginal curvesMC
MR
Quantity
Cos
ts a
nd re
venu
e (£
)
Profit-maximising outpute
PROFIT MAXIMISATIONPROFIT MAXIMISATION
• Using total curves– maximising the difference between TR and TC– the total profit curve
• Using marginal and average curves– stage 1:
profit maximised where MR = MC– stage 2:
using AR and AC curves to measure maximum profit
-4
0
4
8
12
16
1 2 3 4 5 6 7
MR
Quantity
Cos
ts a
nd re
venu
e (£
)
Profit-maximising outpute
MCFinding the profit-maximising output using marginal curvesFinding the profit-maximising output using marginal curves
-4
0
4
8
12
16
1 2 3 4 5 6 7
Measuring the maximum profit using average curvesMeasuring the maximum profit using average curves
MR
Quantity
Cos
ts a
nd re
venu
e (£
)
MC
AC
AR
-4
0
4
8
12
16
1 2 3 4 5 6 7
MR
Quantity
Cos
ts a
nd re
venu
e (£
)
MC
AC
AR
6.004.50
a
b
Measuring the maximum profit using average curvesMeasuring the maximum profit using average curves
-4
0
4
8
12
16
1 2 3 4 5 6 7
MR
Quantity
Cos
ts a
nd re
venu
e (£
)
MC
AC
AR
6.004.50 TOTAL PROFITTOTAL PROFIT
Measuring the maximum profit using average curvesMeasuring the maximum profit using average curves
PROFIT MAXIMISATIONPROFIT MAXIMISATION
• Some qualifications– long-run profit maximisation– the meaning of profit
• What if a loss is made?– loss minimising:
still produce where MR = MC
Loss-minimising outputLoss-minimising output
O
Cos
ts a
nd re
venu
e (£
)
Quantity
MC
AC
AR
MC
O
Cos
ts a
nd re
venu
e (£
)
Quantity
MC
AC
AR
MC
Q
Loss-minimising outputLoss-minimising output
O
Cos
ts a
nd re
venu
e (£
)
Quantity
MC
AC
AR
MC
Q
AC
AR
Loss-minimising outputLoss-minimising output
O
Cos
ts a
nd re
venu
e (£
)
Quantity
MC
AC
AR
MC
Q
LOSSLOSS
AC
AR
Loss-minimising outputLoss-minimising output
PROFIT MAXIMISATIONPROFIT 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
The short-run shut-down pointThe short-run shut-down point
O
Quantity
AVCAC
Cos
ts a
nd re
venu
e (£
)
O
Quantity
AVCAC
AR
Cos
ts a
nd re
venu
e (£
)The short-run shut-down pointThe short-run shut-down point
O
Cos
ts a
nd re
venu
e (£
)
Quantity
AR
AVCACP =
AVC
Q
The short-run shut-down pointThe short-run shut-down point
PROFIT MAXIMISATIONPROFIT 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
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