16April, 2006
Tests: Returned Next Time
Reading: Chapter 8. Finish
Chapter 11 next
Homework.Hand outProblem 14
Lecture 33
REVIEW______:
VII. Chapter 8. Managing in Competitive, Monopolistic and Monopolistically Competitive Markets.
A. Competition.
1. Assumptions
2. Optimal short run decisions:
3. Long run decisions.
Preview______
B. Monopoly
1. Assumptions, Sources of monopoly power.
2. Characterization:
3. Optimizing decisions.
- Optimizing with Demand Curve
4. Observations: Social Costs of Monopoly
C. Monopolistic Competition
.1. Assumptions
2. Characterization:
3. Optimizing decisions.
4. Observations.
- Social cost of product differentiation
- Optimal Advertising decisions.
Lecture______
Now we turn our attention to the case exactly opposite to the competitor: The monopolist. The insight critical to understanding monopoly is that for one reason or another (reasons that we will discuss momentarily) the monopolist is the market. Cost conditions, on the other hand do not necessarily differ) Thus, to analyze optimizing decisions for the monopolist, we must combine the market demand curve with the firm’s supply curves.
.
PPc /
S
D /
MC ATC
P*
c =0
Market Q Firm Q* Q
1. Reasons for monopoly: A single firm may come to dominate a market for a variety of reasons.
a) Economies of scale. If it is the case that production is characterized by economies of scale over range under the market demand curve, then only a single firm can efficiently exist in an industry. These types of cases are typically regulated monopolies, such as electric utilities and water and sewer service.
b) Patents. Many monopolies are the consequence of government activity. If an inventor develops a cost saving technology, or a unique product, and secures a defensible patent for the invention, the inventor has a legal monopoly for 17 years following the patent. This monopoly power is provided as an incentive for creative activity. In the absence of patents, new developments would be copied by firms that did not incur the product development costs, undercutting the incentive for new product development.
c) Economies of Scope and Cost Complementarities. If firms enjoy economies of scope, and particularly cost complementarities, they can produce a product more cheaply than any rival, because costs are defrayed by the production of the complementary product.
2. Characterizing the problem for a monopolist.
a. Demand. Critically, when a firm faces a downsloping demand curve, P=AR no longer equals MR. This is true as long as the monopolist cannot price discriminate, or charge different prices to different consumers. In this case, the Marginal Revenue is different from P = AR. The reason is that in order to sell additional units, the firm must lower the price, causing the firm to lose sales on units that would have sold at the higher price.
Po
P1MR for the range Po - P1
D = AR= P
Qo Q1 MR
In terms of the above graph, the marginal revenue from lowering the price from Po to P1 is the change in total revenues over that range. Essentially, it is the “quantity box” less the “price box.”
b. Costs and Monopoly Supply: As we will demonstrate formally in a moment, for any linear demand curve, the MR curve has exactly twice the slope of the demand curve.
There is no well-defined supply curve for the monopolist. Unlike the competitor, the monopolist does not produce goods until P = MC. Thus, the MC curve is not a supply curve. Rather, willingness-to-produce is the combination of MC and the demand curve.
2. Optimization for the Monopolist.
a. A Homogeneous Product Monopolist, with a down-sloping demand curve. Placing the market demand curve over the cost curves for the firm generates, the optimizing decisions for the monopolist follow the same rules as for a competitor. (For simplicity, AVC is again suppressed.)
P
MC
...... ATC
. Profits . .
......
D = AR = P
Q
Q* MR
i) The optimal quantity Q* is determined by the intersection of MR and MC curves.
ii) The optimal price is the intersection of the demand curve and the vertical line extending up from AR.
iii) Profits are the difference between the price, and ATC, multiplied by Q*
An algebraic example. Suppose you are a monopolist of a firm. Your total cost and inverse demand curves are, respectively
TC = 50 + .5Q2
P = 200 - 2Q
a. What is the marginal revenue curve for the monopolist?
MR = 200 – 4Q
b. What is the optimal quantity for the monopolist?
MR = MC
200 – 4Q = Q
Q = 40
P = 200 – 2(40) = 120
c. Determine monopoly profits.
= TR - TC
=120(40)-[50 + .5(40)2]
=4800-850
=3950