1. © 2009 Pearson Education Canada 10/1 Chapter 10 Monopoly

2. © 2009 Pearson Education Canada 10/2 Monopoly  A firm is a monopoly if no other firm produces the same good or a close substitute for it.  The degree to which goods are substitutes is measured by the cross price elasticity of demand.

3. © 2009 Pearson Education Canada 10/3 The Monopolist’s Revenue Function  A monopolist faces a downward sloping market demand curve.  To sell additional units the monopolist must lower its price. p=D(y).  Since all units must sell for the same price, p=average revenue (AR).  Total revenue is output times price: TR(y)=y(D)(y)

4. © 2009 Pearson Education Canada 10/4 The Monopolist’s Revenue Function  Marginal revenue MR(y) is the rate at which total revenue changes with changes in output.  Since the monopolist must reduce price to sell additional units of output, for any positive output, MR is less than price.  As Δp approaches zero, MR is equal to (p) plus quantity (y) multiplied by the slope of the demand curve.

5. © 2009 Pearson Education Canada 10/5 Figure 10.1 The monopolist’s marginal revenue

6. © 2009 Pearson Education Canada 10/6 Marginal Revenue and Price Elasticity of Demand  Price elasticity of demand (E) at a point (y, p) on the demand curve is: E=p/(y x slope of demand curve)  Rearranging: MR(y)=p(1-1/lEl)  Marginal revenue is positive if demand is price elastic and is negative if demand is price inelastic.

7. © 2009 Pearson Education Canada 10/7 Figure 10.2 A linear demand function and the associated total and marginal revenue functions

8. © 2009 Pearson Education Canada 10/8 From Figure 10.2  Linear demand curve: P=a-by  TR=P*y, Therefore: TR(y)=ay-by 2  MR(y)=a-2by  The demand curve intersects the quantity axis at a/b.  The MR curve intersects the quantity axis at a/2b.

9. © 2009 Pearson Education Canada 10/9 From Figure 10.2 1. When TR function has a positive slope, MR is positive. 2. When the TR function is at its maximum, MR is zero. 3. When TR function has a negative slope slope, MR is negative.

10. © 2009 Pearson Education Canada 10/10 Maximizing Profit  Maximize profit by choosing output (y*) where MC intersects MR (from below).  From the demand curve, find the price (p*) that corresponds with the profit maximizing y.

11. © 2009 Pearson Education Canada 10/11 Figure 10.3 Maximizing monopoly profit

12. © 2009 Pearson Education Canada 10/12 Figure 10.4 The inefficiency of monopoly

13. © 2009 Pearson Education Canada 10/13 The Inefficiency of Monopoly  Because p* exceeds MC in equilibrium, some potential gains from trade are not realized, representing market failure.  Efficiency criterion requires producing output to the point where p=MC. The monopoly equilibrium is therefore not Pareto-optimal.  A deadweight loss occurs because at equilibrium, there exists unrealized gains from trade, signalling unrealized monopoly profit.

14. © 2009 Pearson Education Canada 10/14 Sources of Monopoly  Government Franchise  Patent Monopoly  Resource Based Monopoly  Technological (Natural) Monopoly  Monopoly by Good Management

15. © 2009 Pearson Education Canada 10/15 Figure 10.5 Natural monopoly

16. © 2009 Pearson Education Canada 10/16 Regulatory Responses to a Natural Monopoly  Average Cost Pricing: Forcing the monopoly to produce a level of output where p=AC.  This regulation will fail to minimize production costs.

17. © 2009 Pearson Education Canada 10/17 Figure 10.6 Average cost pricing

18. © 2009 Pearson Education Canada 10/18 Regulatory Responses to a Natural Monopoly  Rate of Return Regulation: Aimed at limiting the rate of return on invested capital.  Under this regulation, the firm will choose an input bundle that is not cost minimizing, choosing too much capital and too little labour.

19. © 2009 Pearson Education Canada 10/19 Figure 10.7 Rate-of-return regulation

20. © 2009 Pearson Education Canada 10/20 Patent Policy  Appropriability Problem: Many inventions with social value are not pursued because inventors do not have the private incentives to pursue them (they are not able to capture the social benefits).

21. © 2009 Pearson Education Canada 10/21 Figure 10.8 The inducement to develop

22. © 2009 Pearson Education Canada 10/22 Optimal Patent Policy  At the optimal patent period, the marginal social benefit of increasing the patent period is equal to the marginal social cost.  The optimal patent policy maximizes aggregate social value less aggregate social costs.