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Chapter 5.4 &6
Monopoly
REVENUE
• Revenue curves when price varies with
output (downward-sloping demand curve)
Revenues for a firm facing a downward sloping
demand curve
Q (units)
P (£)
TR (£)
AR (£)
1
8
8
8
2
7
14
7
3
6
18
6
4
5
20
5
5
4
20
4
6
3
18
3
7
2
14
2
REVENUE
• Revenue curves when price varies with
output (downward-sloping demand curve)
– average revenue (AR)
TR P.Q
AR 

P
Q
Q
REVENUE
• Revenue curves when price varies with
output (downward-sloping demand curve)
– average revenue (AR)
– marginal revenue (MR)
AR and MR curves for a firm facing a downward-sloping D curve
Q P =AR
(units) (£)
8
1
7
2
6
3
5
4
4
5
3
6
2
7
8
6
AR, MR (£)
5
4
2
D= AR
0
1
-2
-4
2
3
4
5
6
7
Quantity
• TR at P=6, Q = 3 is 18
• TR at P=5, Q = 4 is 20
• So MR = 2
• Alternative Story:
• Gain from selling one more unit = 5
• But now have reduced price from 6 to 5 on the first
three units sold.
• So losing 3*£1=£3 as a result
• MR = price of extra unit (5) less price reduction on
all units sold previously (3) = 5 – 3 = 2
Revenues for a firm facing a downward sloping
demand curve
Q
(units)
P=AR
(£)
TR
(£)
MR
(£)
1
8
8
2
7
14
6
3
6
18
4
4
5
20
22
5
4
20
0
6
3
18
-2
7
2
14
-4
AR and MR curves for a firm facing a downward-sloping D curve
Q P =AR
(units) (£)
8
1
7
2
6
3
5
4
4
5
3
6
2
7
8
AR, MR (£)
6
4
2
TR MR
(£) (£)
8
6
14
4
18
2
20
0
20
-2
18
-4
14
AR
0
1
2
3
4
5
6
7
-2
-4
MR
Quantity
Why is the MR curve below the Demand
Curve
dTR
MR 
dQ
d [ P.Q]
MR 
dQ
but TR  P.Q
Do differentiate P.Q we use
the product rule. Let u=P and
v=Q
d [ P.Q]
dQ
dP
P
Q
dQ
dQ
dQ
d [ P.Q]
dP
 PQ
dQ
dQ
d [u.v]
dv
du
u
v
dQ
dQ
dQ
Why is the MR curve below the Demand
Curve?
dTR
d [ P.Q]
dP
MR 

 PQ
dQ
dQ
dQ
Why is the MR curve below the Demand
Curve?
dP
MR  P  Q
dQ
•MR = price of extra unit (5) less price
reduction on all units sold previously (3)
•= 5 – 3 = 2
AR and MR curves for a firm facing a downward-sloping D curve
Q P =AR
(units) (£)
8
1
7
2
6
3
5
4
4
5
3
6
2
7
8
AR, MR (£)
6
4
2
TR MR
(£) (£)
8
6
14
4
18
2
20
0
20
-2
18
-4
14
AR
0
1
2
3
4
5
6
7
-2
-4
MR
Quantity
REVENUE
• Revenue curves when price varies with
output (downward-sloping demand curve)
– average revenue (AR)
– marginal revenue (MR)
– total revenue (TR)
TR curve for a firm facing a downward-sloping D curve
20
16
Quantity P = AR
(units)
(£)
TR (£)
12
1
2
3
4
5
6
7
8
4
TR
(£)
8
7
6
5
4
3
2
8
14
18
20
20
18
14
5
6
0
0
1
2
3
4
Quantity
7
TR curve for a firm facing a downward-sloping D curve
20
16
Quantity P = AR
(units)
(£)
TR (£)
12
1
2
3
4
5
6
7
8
4
TR
TR
(£)
8
7
6
5
4
3
2
8
14
18
20
20
18
14
5
6
0
0
1
2
3
4
Quantity
7
TR curve for a firm facing a downward-sloping D curve
20
16
TR
TR (£)
12
8
4
0
0
1
2
3
4
Quantity
5
6
MR
7
REVENUE
• Revenue curves when price varies with
output (downward-sloping demand curve)
– average revenue (AR)
– marginal revenue (MR)
– total revenue (TR)
– revenue curves and price elasticity of demand
AR and MR curves for a firm facing a downward-sloping D curve
8
Elastic
Elasticity = -1
AR, MR (£)
6
4
Inelastic
2
AR
0
1
2
3
4
5
6
7
-2
-4
MR
Quantity
MONOPOLY
• Essential Characteristics of the
monopolist's demand curve
– downward sloping
– MR below AR
Profit maximising under monopoly
£
AR
MR
O
Q
MONOPOLY
• The monopolist's demand curve
– downward sloping
– MR below AR
• Equilibrium price and output
Profit maximising under monopoly
£
MC
AC
AR
MR
O
Q
Profit maximising under monopoly
£
MC
MR=MC rule
still applies
Determines
Qm
MR
O
Qm
Q
Profit maximising under monopoly
£
AR
MC
Given
MR=MC, we
then find Price
at Qm
a
AR
MR
O
Qm
Q
Profit maximising under monopoly
£
AR
AC
..and
profits?
MC
AC
a
b
AR
MR
O
Qm
Q
What is the supply curve for the monopolist?
£
There isn’t
any
MC
AC
Why not?
AR
AR
MR
O
Qm
Q
What is the supply curve for the monopolist?
£
O
The Supply Curve is
a unique relationship
between Price and
Quantity
Qm
Q
What is the supply curve for the monopolist?
£
P0
P1
But here
not unique
MC
AC
a
b
AR1
MR0
O
Qm
AR0
MR1
Q
What is the supply curve for the monopolist?
£
P0
P1
The Supply Curve is
a unique relationship
between Price and
Quantity
a
b
Here we found that
monopolist will
supply the same
amount at two
different prices
So no Supply Curve
O
Qm
Q
What is the supply curve for the monopolist?
£
The Supply Curve is
a unique relationship
between Price and
Quantity
Here we found that
monopolist will
supply the same
amount at two
different prices
O
Qm
Q
MONOPOLY
• Defining monopoly
• Barriers to entry
• Natural monopoly
MONOPOLY
• Defining monopoly
• Barriers to entry
– economies of scale
– product differentiation and brand loyalty
– lower costs for an established firm
– ownership or control over key factors
– ownership or control over outlets
– legal restrictions
– mergers and takeovers
– aggressive tactics
– intimidation
• Natural monopoly
Natural Monopoly
£
Long –Run average cost
curve is downward sloping
When will this occur?
If there are large Fixed
Costs and small MC
LRAC
MC
O
Q
MONOPOLY
• Disadvantages of monopoly
– high prices / low output: short run
Equilibrium of industry under perfect competition and monopoly:
with the same MC curve
£
MC
P1
AR = D
MR
O
Q1
Q
Equilibrium of industry under perfect competition and monopoly:
with the same MC curve
£
MC
P1
P2
AR = D
MR
O
Q1
Q2
Q
Equilibrium of industry under perfect competition and monopoly:
with the same MC curve
£
MC ( = supply under
perfect competition)
P1
P2
AR = D
MR
O
Q1
Q2
Q
MONOPOLY
• Disadvantages of monopoly
– high prices / low output: short run
– high prices / low output: long run (Profits not
eliminated)
MONOPOLY
• Disadvantages of monopoly
– high prices / low output: short run
– high prices / low output: long run
– lack of incentive to innovate
MONOPOLY
• Disadvantages of monopoly
– high prices / low output: short run
– high prices / low output: long run
– lack of incentive to innovate
– X-inefficiency
MONOPOLY
• Disadvantages of monopoly
– high prices / low output: short run
– high prices / low output: long run
– lack of incentive to innovate
– X-inefficiency
• Advantages of monopoly
MONOPOLY
• Disadvantages of monopoly
– high prices / low output: short run
– high prices / low output: long run
– lack of incentive to innovate
– X-inefficiency
• Advantages of monopoly
– economies of scale
Natural Monopoly
£
LRAC
MC
O
Q
Industry Demand Curve
£
Pmax
DD
If two firms in the
industry (A Duopoly)
the demand curve for
each is D1
At prices above Pmax
competitor gets all the
business
D
O
Q
Natural Monopoly
£
This industry is
uncompetitive with two
firms
And no production occurs
DD
LRAC
MC
O
Q
Natural Monopoly
£
Dm
With one firm, however,
equilibrium occurs at Qm
Pm
DD
LRAC
MC
MR
O
Qm
Q
An alternative version of the story is to examine an
industry where the cost curve an individual firm
faces falls as the scale of production rises.
SO now we are going to examine the Equilibrium of
industry under perfect competition and monopoly:
with different MC curves
Equilibrium of industry under perfect competition and monopoly:
with different MC curves
£
MC ( = supply)perfect competition
P2=MR
. =MC
AR = D
MR
O
Q2
Q
Equilibrium of industry under perfect competition and monopoly:
with different MC curves
£
MC ( = supply)perfect competition
MCmonopoly
P2=MR
. =MC
AR = D
MR
O
Q2
Q
Equilibrium of industry under perfect competition and monopoly:
with different MC curves
£
MC ( = supply)perfect competition
MCmonopoly
P2=MR
. =MC
P1
AR = D
MR
O
Q2
Q1
Q
Equilibrium of industry under perfect competition and monopoly:
with different MC curves
£
MC ( = supply)perfect competition
MCmonopoly
AC
P2=MR
. =MC
P1
AR = D
MR
O
Q2
Q1
Q
Note Monopoly is better as long as the new MC curve lies below
point x
£
MC ( = supply)perfect competition
MCmonopoly
P2=MR
. =MC
P1
x
AR = D
MR
O
Q2
Q1
Q
Suppose a regulator set the price at P3 (Average Cost Pricing). How
would this effect the behaviour of the monopolists?
£
MC ( = supply)perfect competition
MCmonopoly
AC
P2
P1
P3
AR = D
MR
O
Q2
Q1
Q
Suppose a regulator set the price at P3 (Average Cost Pricing). How
would this effect the behaviour of the monopolists?
£
MC ( = supply)perfect competition
MCmonopoly
P2
P1
P3
AR = D
MR
O
Q2
Q1
Q3
Q
MONOPOLY
• Disadvantages of monopoly
– high prices / low output: short run
– high prices / low output: long run
– lack of incentive to innovate
– X-inefficiency
• Advantages of monopoly
– economies of scale
– profits can be used for investment (Dodgy)
MONOPOLY
• Disadvantages of monopoly
– high prices / low output: short run
– high prices / low output: long run
– lack of incentive to innovate
– X-inefficiency
• Advantages of monopoly
– economies of scale
– profits can be used for investment (dodgy!!)
– promise of high profits encourages risk taking (Still a bit
dodgy – what is appropriate risk taking?)
MONOPOLY
• The monopolist's demand curve
– downward sloping
– MR below AR
• Equilibrium price and output
• Limit pricing
Limit pricing
£
AC monopolist
O
Q
Limit pricing
£
AC new entrant
AC monopolist
O
Q
Limit pricing
£
AC new entrant
P
L
AC monopolist
O
Q
TR curve for a firm facing a downward-sloping D curve
Elasticity = -1
20
16
TR
TR (£)
12
8
4
0
0
1
2
3
4
Quantity
5
6
7
REVENUE
• Revenue curves when price varies with
output (downward-sloping demand curve)
– average revenue (AR)
– marginal revenue (MR)
– total revenue (TR)
– revenue curves and price elasticity of demand
• Shifts in revenue curves
PROFIT MAXIMISATION
• Using total curves
– maximising the difference between TR and TC
Finding maximum profit using total curves
TC
24
TR, TC, TP (£)
20
16
TR
12
8
4
0
1
-4
-8
2
3
4
5
6
7
Quantity
PROFIT MAXIMISATION
• Using total curves
– maximising the difference between TR and TC
– the total profit curve
Finding maximum profit using total curves
TC
24
TR, TC, TP (£)
20
16
TR
12
8
4
0
1
2
3
4
5
6
-4
-8
TP
7
Quantity
Finding maximum profit using total curves
TC
24
b
TR, TC, TP (£)
20
16
TR
a
12
8
4
c
0
1
d
2
3
4
5
6
-4
-8
TP
7
Quantity
TR, TC, TP (£)
Finding maximum profit using total curves
24
22
20
18
16
14
12
10
8
6
4
2
0
-2
-4
-6
-8
TC
d
TR
e
f
1
2
3
4
5
6
TP
7
Quantity
PROFIT MAXIMISATION
• Using total curves
– maximising the difference between TR and TC
– the total profit curve
• Using marginal and average curves
PROFIT MAXIMISATION
• Using total curves
– maximising the difference between TR and TC
– the total profit curve
• Using marginal and average curves
– stage 1:
profit maximised where MR = MC
Finding the profit-maximising output using marginal curves
MC
20
Costs and revenue (£)
16
12
8
4
0
1
-4
2
3
4
5
6
7 Quantity
MR
Finding the profit-maximising output using marginal curves
MC
20
Costs and revenue (£)
16
12
8
4
Profit-maximising output
e
0
1
-4
2
3
4
5
6
7 Quantity
MR
PROFIT MAXIMISATION
• Using total curves
– maximising the difference between TR and TC
– the total profit curve
• Using marginal and average curves
– stage 1:
profit maximised where MR = MC
– stage 2:
using AR and AC curves to measure maximum
profit
Finding the profit-maximising output using marginal curves
16
MC
Costs and revenue (£)
12
8
4
e
Profit-maximising output
0
1
-4
2
3
4
5
6
7
Quantity
MR
Measuring the maximum profit using average curves
16
MC
Costs and revenue (£)
12
AC
8
4
AR
0
1
-4
2
3
4
5
6
7
Quantity
MR
Measuring the maximum profit using average curves
16
MC
Costs and revenue (£)
12
AC
8
a
6.00
4.50
b
4
AR
0
1
-4
2
3
4
5
6
7
Quantity
MR
Measuring the maximum profit using average curves
16
MC
Costs and revenue (£)
12
AC
8
6.00
4.50
TOTAL PROFIT
4
AR
0
1
-4
2
3
4
5
6
7
Quantity
MR
PROFIT MAXIMISATION
• Some qualifications
– long-run profit maximisation
– the meaning of profit
• What if a loss is made?
– loss minimising:
still produce where MR = MC
Loss-minimising output
MC
Costs and revenue (£)
AC
AR
O
MC
Quantity
Loss-minimising output
MC
Costs and revenue (£)
AC
AR
O
Q
MC
Quantity
Loss-minimising output
MC
Costs and revenue (£)
AC
AC
AR
AR
O
Q
MC
Quantity
Loss-minimising output
MC
Costs and revenue (£)
AC
AC
LOSS
AR
AR
O
Q
MC
Quantity
PROFIT MAXIMISATION
• Some qualifications
– long-run profit maximisation
– the meaning of profit
• What if a loss is made?
– loss minimising:
still produce where MR = MC
– short-run shut-down point:
P = AVC
Costs and revenue (£)
The short-run shut-down point
AC
AVC
O
Quantity
Costs and revenue (£)
The short-run shut-down point
AC
AVC
AR
O
Quantity
Costs and revenue (£)
The short-run shut-down point
P=
AVC
AC
AVC
AR
O
Q
Quantity
PROFIT MAXIMISATION
• Some qualifications
– long-run profit maximisation
– the meaning of profit
• What if a loss is made?
– loss minimising:
still produce where MR = MC
– short-run shut-down point:
P = AVC
– long-run shut-down point:
P = LRAC