© 2009 Pearson Education Canada 10/1 Chapter 10 Monopoly

© 2009 Pearson Education Canada10/1

Chapter 10Chapter 10

MonopolyMonopoly


MonopolyMonopoly

A firm is a A firm is a monopolymonopoly if no other firm if no other firm produces the same good or a close produces the same good or a close substitute for it.substitute for it.

The degree to which goods are The degree to which goods are substitutes is measured by the substitutes is measured by the cross cross price elasticity price elasticity of demand.of demand.


The Monopolist’s Revenue FunctionThe Monopolist’s Revenue Function

A monopolist faces a downward sloping A monopolist faces a downward sloping market demand curve. market demand curve.

To sell additional units the monopolist To sell additional units the monopolist must lower its price. must lower its price. p=D(y).p=D(y).

Since all units must sell for the same Since all units must sell for the same price, p=price, p=averageaverage revenuerevenue (AR).(AR).

Total revenueTotal revenue is output times price: is output times price: TR(y)=y(D)(y)TR(y)=y(D)(y)


The Monopolist’s Revenue FunctionThe Monopolist’s Revenue Function

Marginal revenueMarginal revenue MR(y)MR(y) is the rate at is the rate at which total revenue changes with which total revenue changes with changes in output.changes in output.

Since the monopolist must reduce price Since the monopolist must reduce price to sell additional units of output, for any to sell additional units of output, for any positive output, positive output, MRMR is less than price. is less than price.

As As ΔΔpp approaches zero, approaches zero, MRMR is equal to is equal to (p)(p) plus quantity plus quantity (y)(y) multiplied by the slope multiplied by the slope of the demand curve. of the demand curve.


Figure 10.1 The monopolist’s marginal revenueFigure 10.1 The monopolist’s marginal revenue


Marginal Revenue and Price Marginal Revenue and Price Elasticity of DemandElasticity of Demand

Price elasticity of demand Price elasticity of demand (E)(E) at a at a point point (y, p)(y, p) on the demand curve is: on the demand curve is:

E=p/(yE=p/(y x slope of demand curve) x slope of demand curve) Rearranging: Rearranging: MR(y)=p(1-1/MR(y)=p(1-1/llEEll)) Marginal revenue is positive if Marginal revenue is positive if

demand is price elastic and is demand is price elastic and is negative if demand is price inelastic.negative if demand is price inelastic.


Figure 10.2 A linear demand function and the Figure 10.2 A linear demand function and the associated total and marginal revenue functionsassociated total and marginal revenue functions


From Figure 10.2From Figure 10.2

Linear demand curve: Linear demand curve: P=a-byP=a-by TR=P*yTR=P*y, Therefore: , Therefore: TR(y)=ay-byTR(y)=ay-by22

MR(y)=a-2byMR(y)=a-2by The demand curve intersects the The demand curve intersects the

quantity axis at quantity axis at a/ba/b.. The The MR MR curve intersects the quantity curve intersects the quantity

axis at axis at a/2ba/2b..


From Figure 10.2From Figure 10.2

1.1. When When TRTR function has a positive function has a positive slope, slope, MR MR is positive.is positive.

2.2. When the When the TRTR function is at its function is at its maximum, maximum, MRMR is zero. is zero.

3.3. When When TRTR function has a negative function has a negative slope slope, slope slope, MRMR is negative. is negative.


Maximizing Profit Maximizing Profit

Maximize profit by choosing output (y*) Maximize profit by choosing output (y*) where MC intersects MR (from below).where MC intersects MR (from below).

From the demand curve, find the price From the demand curve, find the price (p*)(p*) that corresponds with the profit that corresponds with the profit maximizing y. maximizing y.


Figure 10.3 Maximizing monopoly profitFigure 10.3 Maximizing monopoly profit


Figure 10.4 The inefficiency of monopolyFigure 10.4 The inefficiency of monopoly


The Inefficiency of MonopolyThe Inefficiency of Monopoly

Because Because p*p* exceeds exceeds MCMC in equilibrium, some in equilibrium, some potential gains from trade are not realized, potential gains from trade are not realized, representing representing market failuremarket failure..

EfficiencyEfficiency criterioncriterion requires producing output requires producing output to the point where to the point where p=MCp=MC. The monopoly . The monopoly equilibrium is therefore not Pareto-optimal.equilibrium is therefore not Pareto-optimal.

A A deadweight lossdeadweight loss occurs because at occurs because at equilibrium, there exists unrealized gains from equilibrium, there exists unrealized gains from trade, signalling unrealized monopoly profit. trade, signalling unrealized monopoly profit.


Sources of MonopolySources of Monopoly

Government FranchiseGovernment Franchise Patent MonopolyPatent Monopoly Resource Based MonopolyResource Based Monopoly Technological (Natural) MonopolyTechnological (Natural) Monopoly Monopoly by Good Management Monopoly by Good Management


Figure 10.5 Natural monopolyFigure 10.5 Natural monopoly


Regulatory Responses to aRegulatory Responses to a Natural Monopoly Natural Monopoly

Average Cost PricingAverage Cost Pricing: Forcing the : Forcing the monopoly to produce a level of monopoly to produce a level of output where output where p=ACp=AC..

This regulation will fail to minimize This regulation will fail to minimize production costs.production costs.


Figure 10.6 Average cost pricingFigure 10.6 Average cost pricing


Regulatory Responses to aRegulatory Responses to a Natural Monopoly Natural Monopoly

Rate of Return RegulationRate of Return Regulation: Aimed : Aimed at limiting the rate of return on at limiting the rate of return on invested capital.invested capital.

Under this regulation, the firm will Under this regulation, the firm will choose an input bundle that is not choose an input bundle that is not cost minimizing, choosing too much cost minimizing, choosing too much capital and too little labour. capital and too little labour.


Figure 10.7 Rate-of-return regulationFigure 10.7 Rate-of-return regulation


Patent PolicyPatent Policy

Appropriability ProblemAppropriability Problem: Many : Many inventions with social value are not inventions with social value are not pursued because inventors do not pursued because inventors do not have the private incentives to pursue have the private incentives to pursue them (they are not able to capture them (they are not able to capture the social benefits). the social benefits).


Figure 10.8 The inducement to developFigure 10.8 The inducement to develop


Optimal Patent PolicyOptimal Patent Policy

At the optimal patent period, the At the optimal patent period, the marginal social benefit of increasing marginal social benefit of increasing the patent period is equal to the the patent period is equal to the marginal social cost.marginal social cost.

The optimal patent policy maximizes The optimal patent policy maximizes aggregate social valueaggregate social value less less aggregate social costsaggregate social costs..

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© 2009 Pearson Education Canada 10/1 Chapter 10 Monopoly