1. Profit Maximization: Marginal Revenue and Marginal Cost Marginal Revenue (MR): Change in the firm’s total revenue resulting from a one unit change in production. Marginal Cost (MC): Change in the firm’s total cost resulting from a one unit change in production. MR > MC  More production increases profit MR < MC  Less production increases profit MR = MC  Profit is maximized Monopoly and Efficiency Preview: Monopoly and Perfect Competition Similarity: Motivation Both the monopoly firm and the perfectly competitive firm seek to maximize profit. Difference: Marginal Revenue (MR) Competitive firm: MR = Price Monopoly firm: MR < Price

2. Perfectly Competitive Industry  A large number of small independent firms  A single firm’s production decision does not significantly affect the price.  A firm can only decide on the quantity of output to produce  A firm takes the price as given, as a constant  MR curve horizontal: MR = Price Monopoly  One large firm  The monopoly firm decides not only on quantity to produce, but also on the price to charge. Preview of Monopoly Monopoly produces a quantity and charges a price that lies on the market demand curve. Monopoly’s marginal revenue curve lies beneath the market demand curve: MR < Price Perfect Competition, Monopoly, and Marginal Revenue MR = Price Price MR q P, MR Q D Price Quantity

3. Monopoly and the Market Demand Curve Claim: A profit maximizing monopoly 2505007501,000 2,000 2,500 3,000 3,500 P ($ per computer) Q (Computers per day) D and charges a price that lies on the market demand curve. produces a quantity Suppose that Apple produced 500 computers per day. Demand Curve for Personal Computers in 1980 Claim: Apple would charge a price of $3,000. Suppose that Apple continued to charge a price of $3,000, but produced 750 computers per day. Suppose that Apple continued to produce 500 computers per day, but charged a price of $2,000. Profit = Total Revenue  Total Cost Suppose that the firm reduced production without changing the price. UnaffectedDecreased A monopoly would never produce a quantity and charge a price above the demand curve. Profit = Total Revenue  Total Cost Suppose that the firm raised the price without changing production. IncreasedUnaffected A monopoly would never produce a quantity and charge a price below the demand curve. Increased

4. Monopoly and the Market Demand Curve A profit maximizing monopoly 2505007501,000 2,000 2,500 3,000 3,500 P ($ per computer) Q (Computers per day) D and charges a price that lies on the market demand curve. produces a quantity Slope =  2 Marginal Revenue (MR): Change in the firm’s total revenue resulting from a one unit change in production. Slope = Rise Run =  1,000 500 =  2 Suppose that Apple produced 500 computers per day. QuantityPrice Total Revenue = Price  Quantity Oct 6 Oct 5 501 5003,000 2,998 2,998  501 3,000  500 = 1,500,000 = 1,501,998 = 1,998Marginal Revenue What is the slope of the demand curve? What price would Apple charge? $3,000 What is Apple’s marginal revenue (MR)? What price would Apple now charge? $2,998 Puzzle: Why is marginal revenue less than the price?

5. Monopoly and the Market Demand Curve A profit maximizing monopoly will always 2505007501,000 2,000 2,500 3,000 3,500 P ($ per computer) Q (Computers per day) D and charge a price that lies on the market demand curve. produce a quantity Slope of demand curve =  2 Marginal Revenue (MR): Change in the firm’s total revenue resulting from a one unit change in production. QuantityPrice Total Revenue = Price  Quantity Oct 6 Oct 5 501 5003,000 2,998 2,998  501 3,000  500 2,998  (1 +500) = 2,998 + 2,998  500 + 2,998  500  3,000  500 = 2,998 + (2,998  3,000)  500 = 2,998 + (  2)  500 = 2,998 = 2,998  1,000 = 1,998 Output Effect: TR tends to increase by $2,998, the price. Price Effect: TR tends to decrease by $1,000 because the price must be reduce to sell the additional unit Marginal Revenue 3,000  500 = NB: As a consequence of the price effect marginal revenue for a monopoly is less than the price. Monopoly: MR < Price 1,000

6. Monopoly and the Market Demand Curve A profit maximizing monopoly 2505007501,000 2,000 2,500 3,000 3,500 P ($ per computer) Q (Computers per day) D and charges a price that lies on the market demand curve. produces a quantity The marginal revenue curve for a monopoly lies below the market demand curve. MR MC Q* = 500 P* = 3,000 When Q = 500 P = 3,000 Monopoly: MR < Price MR < 3,000 Question: How many computers will Apple produce? Answer: The profit maximizing quantity.  MR = MC Question: What price will Apple charge? Q* = 500 P* = 3,000

7. Perfect Competition  A single firm’s production decisions cannot affect the price significantly  MR = Price or Price = MR Monopoly  The monopoly firm decides not only on quantity to produce, but also on the price to charge.  MR Profit Maximization  MR = MC Price = MR = MC  Price = MC Price > MR = MC  Price > MC Summary : Perfect Competition, Monopoly, and Profit Maximization

8. Wall Street Journal May 26, 2010, 9:03 AM ET Getting to Know You: Apple and the Government’s Trustbusters By Ashby Jones Once upon a time, like 10 years ago, Apple was the scrappy underdog of the computer world. That’s all. It made computers fringed in colors like tangerine and blueberry which crashed from time to time, just like all the others. Question: Why is big “bad” and small “good? ”. But then came a new operating system, a stream of better computers, and all the “i’s” — the iPod, the iPhone, iTunes, etc., etc., etc. Ten years later, Apple’s a top dog, and top dogs get hard looks from antitrust regulators.. And that brings us to this story in Wednesday’s New York Times. According to the piece, antitrust lawyers in the Justice Department are examining Apple’s tactics … More specifically, why is monopoly bad. Monopolies earn obscenely high profits. Monopolies create inefficiency.

9. Pareto’s Efficiency Question: Are we getting the most from our economy’s finite resources? Could the monopoly be earning negative profit? Why is monopoly bad?P Q D MR MC Q* P* Monopoly: MR curve lies below the demand curve Profit maximization: MR = MC Monopoly: P and Q lie on the demand curve. ATC Monopolies exploit the public by earning obscenely high profits? Question: Can we determine the monopoly’s profit from the information appearing on the diagram? Answer: No, we need to compare the price and the ATC curve. Could the monopoly be earning positive profit? P > ATC P < ATC Profit > 0Profit < 0 Pareto’s Query: Given the state of affairs in question, is it possible to make at least one individual better off without hurting anyone else? Yes  Is the state of affairs getting the most from the economy’s resources? No  State of affairs is inefficient. No  Is the state of affairs getting the most from the economy’s resources? Yes  State of affairs is efficient. Profit = TR – TC = (P – ATC)  Q