Chapter 5 & Main Monopoly Chapter 5 & Main Monopoly

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

Q (units) P =AR (£) TR (£) MR (£) AR MR AR, MR (£) Quantity AR and MR curves for a firm facing a downward-sloping D curve

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 three units sold.But now have reduced price from 6 to 5 on the first 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 all units sold previously (3) = 5 – 3 = 2MR = 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 To differentiate P.Q we use the product rule. Let u=P and v=Q

Why is the MR curve below the Demand Curve? MR = price of extra unit (5) less price reduction on all units sold previously (3)MR = price of extra unit (5) less price reduction on all units sold previously (3) = 5 – 3 = 2= 5 – 3 = 2

TR curve for a firm facing a downward-sloping D curve TR Quantity TR (£) MR

revenue curves and price elasticity of demand Consider once again the derivative of the Total Revenue Function

revenue curves and price elasticity of demand

For Perfect Competition the demand curve the firm faces is elastic so,

revenue curves and price elasticity of demand For a downward sloping demand function, when Total Revenue is a maximum

TR curve for a firm facing a downward-sloping D curve TR Elasticity = -1 Elastic Inelastic Quantity TR (£)

AR MR Elasticity = -1 Elastic Inelastic AR, MR (£) Quantity AR and MR curves for a firm facing a downward-sloping D curve

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!!!!

£ Q O AC MC MR AR Profit maximising under monopoly

£ Q O AC MC AR QmQm MR AR What is the supply curve for the monopolist? There isn’t any Why not?

£ Q O P0P0 QmQm a b What is the supply curve for the monopolist? P1P1 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

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 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 £ 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 Q1Q1 MR AR = D P1P1 Equilibrium of industry under perfect competition and monopoly: with the same MC curve

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 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 £ O Q LRAC MC

Natural Monopoly £ O Q LRAC MC With one firm, however, QmQm D DmDm

Natural Monopoly Here with competition no production at allHere with competition no production at all But with monopoly production takes place that would not otherwise happen.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.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

£ Q O MC ( = supply) perfect competition MR Q2Q2 MC monopoly AR = D Equilibrium of industry under perfect competition and monopoly: with different MC curves P 2 =MR. =MC

Economies of Scale Here with competition high priced production and low scaleHere with competition high priced production and low scale Monopoly allows economies of scale to be exploited and hence a lower cost of production.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:There may be supernormal profits, but consumers still better off than before: Lower Price and Greater QuantityLower Price and Greater Quantity

£ Q O MC ( = supply) perfect competition Q1Q1 MR P1P1 Q2Q2 MC monopoly x AR = D Note Monopoly is better as long as the new MC curve lies below point x P 2 =MR. =MC

£ Q O MC ( = supply) perfect competition Q1Q1 MR P1P1 P2P2 Q2Q2 MC monopoly AR = D Any suggestions as to Price regulator might choose? AC

£ Q O MC ( = supply) perfect competition Q1Q1 MR P1P1 P2P2 Q2Q2 MC monopoly AR = D Any suggestions as to Price regulator might choose? AC

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?) 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 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 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