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ECMA04H – Week Nine Test this Friday (November 11th) 3-5 p.m. in various rooms. Check www.utsc.utoronto.ca/~cleveland for location Material on test includes: - tax incidence - excess burden of taxation - production, marginal product, average product - costs: fixed and variable; marginal, total and average; short run and long run - perfect competition: firm and industry; short run and long run - today’s lecture on monopoly 25 MC questions, mathematical and theoretical 1 Objectives this week: a. The monopoly model. How does monopolist behave? What are the results? b. Inefficiency and monopoly. Dynamic efficiency vs. allocative efficiency. c. Where does monopoly come from; what conditions are necessary; what are the public policy responses? d. Excise tax on a monopoly 2 The Monopoly Model Only one supplier. Entry to market is blocked. Single seller faces entire market demand curve (price maker, not price taker) Graphically: Price per unit quantity MC AC Demand MR 0 3 Quantity produced per unit of time What about Marginal Revenue (MR)? MR = dTR/dq or dTR/dQ TR = P x Q. To PC firm, P was a constant (price taker) To monopolist, P is a choice variable, so we must treat P as a function of Q So, MR = [(dP/dQ) x Q] + [(dQ/dQ) x P] Or MR = P + Q(dP/dQ) For a linear demand curve P = a – bQ, MR = (a – bQ) + (Q[-b]) = a – 2bQ So MR has the same intercept and twice the slope of the linear demand curve 4 Algebraic example of monopoly industry Market Demand: P = 100 - .02Q So, total revenue = TR = PxQ = 100Q - .02Q2 Marginal Revenue = dTR/dQ = 100 - .04Q (the rate at which total revenue is changing as output increases) Assume total cost function of monopoly firm is: TC = .01q2 + 10q + 432 or .01Q2 + 10Q + 432 So, MC = .02Q + 10 (the rate at which total cost is changing as output increases) AC = .01Q + 10 + 432Q-1 5 We can solve by forming the profit function and maximizing with respect to Q Π = TR – TC = (100Q - .02Q2) – (.01Q2 + 10Q + 432) = 90Q - .03Q2 – 432 Therefore, dΠ/dQ = 90 - .06Q Setting = 0, we have .06Q = 90 or Q* = 1500 Substituting into the demand function, we have P* = 100 - .02(1500)= $70 6 Alternative solution method We can set MC = MR and solve for Q MC = .02Q + 10 MR = 100 - .04Q .02Q + 10 = 100 - .04Q .06Q = 90 Q* = 1500 Substituting into the demand function, we have P* = 100 - .02(1500)= $70 7 How much is the profit of the monopolist? Where is the monopolist’s supply curve? What about the long run? 8 Is the monopolist efficient? Several perspectives: Does the monopolist minimize costs? 9 Is marginal benefit equal to marginal cost at the monopolist’s equilibrium output? 10 Does the monopolist’s output maximize the Gain to Society? 11 A distributional concern (not allocative efficiency): Does the monopolist transfer potential CS into profit for the producer? 12 What about dynamic efficiency? 13 Classic view is that monopoly distorts resource allocation and causes deadweight efficiency loss. Monopolist produces too little output (uses too few resources). In practice, there are other considerations, to judge on a case by case basis. 14 Where does monopoly come from? (a) cost advantage – economies of scale which are large relative to the size of the market (known as “natural monopoly”) (b) government licence or restriction (patent) (c) ownership of scarce but essential resource (d) some other barrier to entry (e.g., huge advertising costs, manipulation of access to market) (e) Cartel – Joint monopoly 15 An excise tax on a monopoly Price per unit quantity MC AC Demand MR 0 Quantity produced per unit of time 16