Download Marginal Revenue

Measuring the Effect of Monopoly: Consumer and Producer Surplus
Consumer
Net benefit
buyers
enjoy
A profitSurplus:
maximizing
monopoly
will
always
from purchasing and consuming the good.
P
WHAT IF the monopoly
produce a quantity
Height
firm acts as though it
and of Market Demand Curve: Reflects the benefit a
buyer enjoys
consuming a specific unit of the good.
were a firm in a perfectly
chargefrom
a price
Consumer
Surplus:
The benefit
each
buyer enjoys from
competitive industry?
that lies on
the market
demand
curve.
consuming the good less what each buyer must pay for
A
Dead
Marginal Revenue (MR):
the good.
“S”
weight loss
PM = 1.50
TheBeneath
marginal
Area
therevenue
Demandcurve
Curvelies
Lying
MC
Above
thethe
Price:
Reflects
all thecurve.
net benefits
B
below
market
demand
C
buyers enjoy, the
consumer
surplus,
from
P
=
1.25
MR < Price
C
E
purchasing and consuming the good.
D
D
Producer Surplus: The net benefit sellers
MC = 1.00
enjoy from producing and selling the good
F
Height of Market Supply Curve: The seller’s
MR
opportunity cost of providing a specific unit of the good.
Producer Surplus: What each seller receives
from the sale of the good less the opportunity
cost each seller incurs by providing it.
Q
50
75
Area above the Supply Curve Lying beneath the
Who does monopoly
Price: Reflects all the net benefit sellers enjoy, the
hurt? Consumers
producer surplus, from producing and selling the good.
help? The monopoly firm
Competition
Monopoly
Change
What
as Ba &
whole.
Consumer Surplus
A+B+C
A about society
Lose
Lose C
Producer Surplus
Total Surplus
D+E+F
A+B+C+D+E+F
B+D+F
A+B+D+F
Gain B & Lose E
Lose C & Lose E
Connecting the Pareto approach to efficiency with consumer and producer surplus
Question: How did we argue that
P
monopoly was inefficient?
We chose an individual, Joe, who
Did not by a hamburger when the
price was $1.50, the monopoly price.
But would be a hamburger at a
PM = 1.50
price of $1.40, a value above
Mary’s marginal cost.
We then devised a special (secret) deal
that made both Joe and Mary better
MC = 1.00
off which did not affect anyone else.
Question: What were the critical aspects in
choosing Joe:
Price
Marginal Cost
The dead weight loss represent all the Joes
who are around. All those who can make
special deals with Mary help the two of them
and do no hurt anyone else.
Dead
weight loss
MC
D
50 Joe
75
Q
Question: Where on the market
demand curve would you “place” Joe?
Answer: Joe is in the dead weight loss
(excess burden) region.
A Multi-Plant Monopoly
Claim: To maximize profits, two conditions must be satisfied when a firm has two plants:
Marginal costs of each plant must be equal: MCA = MCB
Marginal revenue must equal each plant’s marginal cost: MR = MCA = MCB
MCA
MCB
MCA
100
100
80
80
60
60
40
40
20
20
MCB
Total Production
Q = 75
Question: Is it possible for the firm to
produce 75 units more cheaply by
transferring productions from on plant
to the other?
qA
50
100
qA = 50 MCA = $60
Plant A produces
1 fewer unit

Plant A’s total
costs decrease
by $60
qB
50
100 150 200
qB = 25 MCB = $30
Plant A produces
1 more unit

Plant B’s total
costs increase by
$30
Profits will
Firm’s total costs decrease by $30
rise by $30.
MC = Change in total cost resulting
from a one unit change in production
Intuition: We can reduce the firm’s
total costs without reducing the total
quantity of output produced by shifting
production from the high marginal cost
plant to the low marginal cost plant.
Question: Can this go on
indefinitely?
A Multi-Plant Monopoly
Claim: To maximize profits, two conditions must be satisfied when a firm has two plants:
Marginal costs of each plant must be equal: MCA = MCB
Marginal revenue must equal each plant’s marginal cost: MR = MCA = MCB
MCA
MCB
MCA
100
100
80
80
60
60
40
40
20
20
MCB
Total Production
Q = 75
Question: Is it possible for the firm to
produce 75 units more cheaply by
transferring productions from on plant
to the other?
qA
50
100
qA = 25
50 MCA = $40
$60
qB
50
qB = 50
25
100 150 200
MCB = $40
$30
As production is transferred
from Plant A to Plant B
MCA decreases
MCB increases
Until they are equal
MC = Change in total cost resulting
from a one unit change in production
Intuition: We can reduce the firm’s
total costs without reducing the total
quantity of output produced by shifting
production from the high marginal cost
plant to the low marginal cost plant.
Question: Can this go on indefinitely?
A Multi-Plant Monopoly
Claim: To maximize profits, two conditions must be satisfied when a firm has two plants:
Marginal costs of each plant must be equal: MCA = MCB
Marginal revenue must equal each plant’s marginal cost: MR = MCA = MCB
MCA
MCB
MCA
MCB
100
100
100
80
80
80
60
60
60
40
40
40
20
20
20
qA
50
100
qA = 25 MCA = $40
D
MR
Q
qB
50
qB = 50
100 150 200
MCB = $40
50
100 150 200 200
qA + qB = Q = 75
MR = $90
MC = Change in total cost resulting
MR = Change in total revenue resulting
from a one unit change in production
from a one unit change in production
Profit
=
TR

TC



Produce 1
Up by $50
Up by $90
Up by $40 more unit
To maximize profit: MR = MC
A Multi-Plant Monopoly
To maximize profits, two conditions must be satisfied when a firm has two plants:
Marginal costs of each plant must be equal: MCA = MCB
Marginal revenue must equal each plant’s marginal cost: MR = MCA = MCB
MCA
MCB
MCA
MCB
100
100
100
80
80
80
60
60
60
40
40
40
20
20
20
qA
50
100
qA = 50 MCA = 60
D
MR
Q
qB
50
100 150 200
qB = 100 MCB = 60
Claim: To maximize profit:
qA = 50 and qB = 100
50
100 150 200 200
qA + qB = = 150 MR = 60
P = 90
Question: What price will the monopoly charge?
Answer: A monopoly produces a quantity and
charges a price that lies on the market demand curve.
Review: Efficiency and the Two Polar Cases of Market Structure
Perfectly Competitive Industry
Monopoly


A large number of small firms
One large firm


A single firm’s production decision
Monopoly produces a quantity and charges a price
does not significantly affect the price.
that lies on the market demand curve.


MR curve horizontal:
MR curve lies beneath the market demand curve:
MR = Price
MR < Price
or
Profit Maximization
or

Price = MR
Price > MR
MR = MC
Price = MR = MC
Price > MR = MC


Price = MC
Price > MC


Consumers base decisions
Consumers base decisions
on accurate information
on misleading information


Efficient
Inefficient
Perfectly Competitive Industry
Oligopoly
Monopoly



A large number of small firms
A few moderately sized firms
One large firm



Efficient
Question: Efficient or Inefficient?
Inefficient
Oligopoly
Challenge of Oligopoly: While it is straightforward to predict the price and quantity in a
perfectly competitive market or a monopoly it is more difficult to do so in an oligopoly.
Project: Explaining OPEC’s Vacillating Behavior in 1993
In late September, the members of OPEC negotiated quotas to restrict the quantity of oil
produced. The agreement was applauded by OPEC oil ministers.
Shortly thereafter, oil prices promptly rose.
The increase in oil prices proved to be short lived, however.
OPEC members violated their agreement within two weeks of consummating it.
Within a few weeks, the price of oil fell.
Conflicting Interests of an Oligopolies and Cartels: Collective versus Individual
It is in the collective interests of the firms in an industry to establish a cartel to maximize
their joint profits.
It is in their collective interests to collude by reducing production below the
competitive level; by do so they can act like a monopoly to maximize the joint profits
of the entire industry by restricting production below the competitive level.
On the other hand, if a cartel is established it may be in the individual interests of each firm
to cheat on the cartel agreement to maximize its individual profit.
If the cartel agreement is in place, it may be in the individual interests of a firm to
produce more than the agreement allows thereby pushing production toward the
competitive level.
Strategy: Begin with a multi-plant monopoly and then “convert” it to an oligopoly.
A Multi-Plant Monopoly
To maximize profits, two conditions must be satisfied when a firm has two plants:
Marginal costs of each plant must be equal: MCA = MCB
Marginal revenue must equal each plant’s marginal cost: MR = MCA = MCB
MCA
MCB
MCA
MCB
100
100
100
80
80
80
60
60
60
40
40
40
20
20
20
qA
50
100
qA = 50 MCA = $60
D
MR
Q
qB
50
100 150 200
qB = 100 MCB = $60
50
100 150 200 200
qA + qB = = 150 MR = $60
Marginal Revenue for the Monopoly
Slope of Demand Curve =
Rise
Run
=
20
100
=  .20
P = $90
Marginal Revenue for the Monopoly
Tomorrow
Today
Tomorrow:
Today:
Slope of Demand Curve = .20
To clear the market the quantity
demanded must increase by 1 unit.
The price must fall by .20, from
$90.00 to $89.80.
Quantity Price
151
$89.80
150
$90.00
Quantity
Price
151
89.80
150
Total Revenue = Price  Quantity
89.80151
89.80(1 + 150)
= 89.80 +
90.00
89.80150
90.00150
Marginal Revenue = 89.80 + 89.80150  90.00150
= 89.80 + (89.80  90.00)150
= 89.80 +
(.20)150


TR tends to rise by 89.80,
TR tends to fall by 30.00,
the price, as a consequence
as a consequence of the
of the additional unit sold.
lower price.


Output Effect
Price Effect


MR
=
89.80

30.00
= $59.80
 $60
Convert the Multi-Plant Monopoly into an Oligopoly
To maximize profits, two conditions must be satisfied when a firm has two plants:
Marginal costs of each plant must be equal: MCA = MCB
Marginal revenue must equal each plant’s marginal cost: MR = MCA = MCB
MCA
MCB
MCA
MCB
100
100
100
80
80
80
60
60
60
40
40
40
20
20
20
qA
50
100
qA = 50 MCA = $60
D
MR
Q
qB
50
100 150 200
qB = 100 MCB = $60
50
100 150 200 200
qA + qB = = 150 MR = $60
Owner retires and gives Plant A to his son Adam and Plant B to his daughter Beth
Adam’s Firm
Beth’s Firm
Total Production
qA = 50
qB = 100
Q = 150


P = $90
MCA = $60
MCB = $60
P = $90
Scenario 1: No Retaliation – Does Adam have an incentive to cheat if Beth does not retaliate?
Quantity
Slope of Demand Curve = .20
Adam Beth Joint
Price
To clear the market the quantity
demanded must increase by 1 unit.
Tomorrow
51
100 151
89.80
Today
50
100 150
90.00
The price must fall by .20, from
$90.00 to $89.80.
MCA = $60.00
Adam’s
Adam’s
Quantity
Price
Total Revenue = Price  Quantity
Tomorrow:
Today:
51
50
Question: What does
Adam’s marginal
revenue (MRA) equal?
Does Adam have an
incentive to cheat if
Beth does not
retaliate?
Yes
89.80
89.8051
89.80(1 + 50)
= 89.80 +
90.00
89.8050
90.0050
Adam’s Marginal Revenue = 89.80 + 89.8050  90.0050
= 89.80 +
(89.80  90.00)50
= 89.80 +
(.20)50


TR tends to rise by 89.80,
TR tends to fall by 10.00,
the price, as a consequence
as a consequence of the
of the additional unit sold.
lower price.


Output Effect
Price Effect


MRA = Adam’s Marginal Revenue
=
89.80

10.00
= $79.80
Adam produces one more unit of output and Beth does not retaliate: qA: 50  51
qB = 100
P: $90.00  $89.80
qA: 50  51 Increased by 1
Adam’s Profit
MRA = $79.80
MR = Change in total revenue resulting
from a one unit change in production
Adam’s Profit

Up by $19.80
=
Beth’s Profit
MCA = $60.00
MC = Change in total cost resulting
from a one unit change in production
TR

TC
Produce 1


more unit
Up by $79.80 Up by $60.00
qB = 100: Unchanged
P: $90.00  $89.80 Down by $.20
Beth’s Profit

Down by $20.00
TR

TC


Down by $20.00 Unchanged
=
Production
unchanged:
100 units
$.20  100
Question: What happens to their joint profit? Question: Down by $.20
Beth produces one more unit of output and Adam does not retaliate: qB: 100  101
qB = 50
P: $90.00  $89.80
qB: 50  51 Increased by 1
Beth’s Profit
MRA = $69.80
MR = Change in total revenue resulting
from a one unit change in production
Beth’s Profit

Up by $9.80
=
MCA = $60.00
MC = Change in total cost resulting
from a one unit change in production
TR

TC
Produce 1


more unit
Up by $69.80 Up by $60.00
Adam’s Profit
qA = 50: Unchanged
P: $90.00  $89.80 Down by $.20
Adam’s Profit

Down by $10.00
TR

TC


Down by $10.00 Unchanged
=
Production
unchanged:
50 units
$.20  50
Question: What happens to their joint profit? Question: Down by $.20
Summary
Adam’s Marginal Revenue = 89.80 +
Adam: MRA = $79.80 MCA = $60
= 89.80 +
= 89.80 +
When Adam producers
1 more unit his profit rises

by approximately $19.80
TR tends to rise by 89.80,
the price, as a consequence
Question: Who has the
of the additional unit sold.
greater incentive to cheat?

Adam has a greater incentive
Output Effect
to cheat. Why?

Adam’s MR is greater. Why?
MRA =
89.80

Adam’s price effect is smaller.
Why?
Beth’s Marginal Revenue = 89.80 +
Adam is the smaller producer.
= 89.80 +
Conclusion: The smaller
= 89.80 +
producer has a greater

incentive to cheat.
TR tends to rise by 89.80,
the price, as a consequence
Beth: MRB = $69.80 MCB = $60
of the additional unit sold.
When Beth producers

1 more unit her profit rises
Output Effect
by approximately $9.80.

MRB
=
89.80

89.8050  90.0050
(89.80  90.00)50
(.20)50

TR tends to fall by 10.00,
as a consequence of the
lower price.

Price Effect

10.00
= 79.80
89.80100  90.00100
(89.80  90.00)100
(.20)100

TR tends to fall by 20.00,
as a consequence of the
lower price.

Price Effect

20.00
= 69.80