Download ECON308: Monopoly = Price Searcher

ECON 308 Week 6 Fall 2009 Sept. 28 – Oct. 1, 2009 Market Structure Chapter 6
1. The Demand facing the individual Firm: The degree of competition facing the firm is
reflected by the elasticity of demand. The more close substitutes (D1 – D4) the more elastic the
demand facing the firm and the less the market power of the firm.
P
P
P
D1
Q
Monopoly
P
D2
Q
Oligopoly
D3
Q
Monopolistic Comp.
D4
Q
Perfect Competition
Firms in the MOST competitive market (D4) are called price-takers and have no market power.
1. All firms that are not in perfectly competitive markets face a downward sloping demand curve.
We can then use the (monopoly model = Price Searcher) to represent the pricing behavior and
production decision of all other firms.
2. If demand is downward sloping, marginal revenue is less then Price.
Demand
Price Qty
$10
1
$9
2
$8
3
$7
4
$6
5
Total Revenue Marginal Revenue
$ 10
$ 18
$ 24
$ 28
$ 30
$10
$8
$6
$4
$2
The marginal revenue (addition to revenue from selling one more unit) is less than price, because
to sell more, you must lower the price to all buyers.
3. The degree of competition facing the firm is reflected by the elasticity of demand. With fewer
competitors the demand is more inelastic (steeper), with more competitors it is more elastic
(flatter)
4. The Monopoly model: downward sloping demand curve ( Price-Searcher)
$Price
Marginal
Cost
Demand
Pm
MC
Marginal
Revenue
Qm
Qty / Time
5. The profit maximizing output is where MR = MC, just like for the price taker firm.
A. The Price is above MR, and therefore, the price is above marginal cost (MC).
B. The monopolist will always set price in range where MR > 0, and therefore demand is
elastic.
6. Measure of Monopoly Power:The ratio of price to marginal cost is a measure of the market
power of the firm. The Lerner index = (Price – Marginal Cost) / Price. The index varies between
zero (zero market power) and one. The higher the index value, the greater the ratio on P to MC,
and the greater the market power of the firm.
A. For a straight line demand curve, Total Revenue (TR) is always maximized at the
midpoint of the curve. At this point, Marginal Revenue (MR) = 0. It is at this point that
Price Elasticity of demand is unitary.
$ Price
Ed > 1
Ed < 1
Ed = 1
Ed > 1
Ed < 1
Marginal
Revenue
DEMAND
Quantity /Time Period
On the upper half of the demand curve, demand is elastic, therefore MR >0, and a decrease in
price increases Total Revenue.
On the lower half of the demand curve, demand is inelastic, MR < 0, and an increase in price will
increase Total Revenue.
2.As there are more similar products or substitutes, the demand becomes more elastic and the
marginal revenue becomes closer to price.
$Price
Marginal Cost
MC
Marginal
Revenue
Qty/ Time Period
$Price
DEMAND
MC
Marginal
Revenue
Qty/ Time Period
$Price
MC
DEMAND
Marginal
Revenue
Qty/ Time Period
DEMAND
$Price
MC
Marginal
Revenue
Qty/ Time Period
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3. In the infinitely elastic case, Marginal Revenue equals price as the firm can sell its entire
possible output at the market price and has no reason to lower price.
$Price
DEMAND = MR
$ P eq.
Qty/ Time Period
8. Monopoly Profits ?
MC
$ Price
Demand
ATC
Pm
$ Profit
AC
Marginal
Revenue
Qm
Qty / Time
9. Monopoly profits only occur if TR( Pm x Qm) is greater than TC (AC x Qm) There is nothing in
being a monopoly that guarantees profits.
A. The existence of profits will stimulate resource owners to produce similar products.
B. As more close substitutes enter the market, the demand facing the monopoly will decline
and become more elastic. This means competition will bring lower prices and lower profits. There
are no profits in the long run, UNLESS the firm can limit competition.
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C. Monopoly after competition from similar products.
MC
$ Price
ATC
Pm
Demand
MR
Qty / Time
Qm
10. Efficiency ( Dead-Weight) Loss from reduced output ?
Marginal
Cost
$Price
Pm
D
MC
MR
Qm
Qty / Time
Qc
The monopolist produces at Qm so the units from Qm to Qc are not produced. Since these
units have a marginal cost of production that is less than the marginal value to buyers, there is a
potential efficiency loss of the shaded area. (MV – MC)
5. Sources of Monopoly power: Barriers to entry:
A. Absolute Cost Advantage: Unique access to production technique or an essential imput.
B. Natural Monopoly: Economies of Scale
C. Product differentiation
D. Regulatory Barriers: Patents, copyrights, franchise, license.
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