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Chapter 5 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 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 • 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 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 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 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 Profit maximising under monopoly £ MC AC AR MR O Q Profit maximising under monopoly £ AR AC ..and profits? MC AC a b AR MR O Qm Q Profit maximising under monopoly £ MC AC AR MR O 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 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 Equilibrium of industry under perfect competition and monopoly: with the same MC curve £ MC P1 AR = D MR O Q1 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 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 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 MCmonopoly P2=MR . =MC AR = D MR O Q2 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 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?)