eaton micro 6e ch10

7/27/2019 Eaton Micro 6e Ch10

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2005 Pearson Education Canada Inc.10.1

Chapter 10

Monopoly


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Monopoly

A firm is a monopoly if no other firmproduces the same good or a closesubstitute for it.

The degree to which goods aresubstitutes is measured by the crossprice elasticityof demand


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The Monopolists Revenue Function

A monopolist faces a downward slopingmarket demand curve.

To sell additional units the monopolistmust lower its price. p=D(y).

Since all units must sell for the sameprice, p=average revenue (AR).

Total revenue is output times price:TR(y)=y(D)


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The Monopolists Revenue Function

Marginal revenue MR(y) is the rate atwhich total revenue changes withchanges in output.

Since the monopolist must reduce priceto sell additional units of output, for anypositive output, MR is less than price.

As p approaches zero, MR is equal to(p) plus quantity (y) multiplied by theslope of the demand curve.


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Figure 10.1 The monopolists marginal revenue


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Marginal Revenue and Price

Elasticity of Demand

Price elasticity of demand (E) at apoint (y, p) on the demand curve is:

E=p/(y x slope of demand curve)

Rearranging: MR(y)=p(1-1/lEl)

Marginal revenue is positive if

demand is price elastic and isnegative of demand is price inelastic.


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Figure 10.2 A linear demand function and the

associated total and marginal revenue functions


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From Figure 10.2

Linear demand curve: P=a-by

TR=P*y, Therefore: TR(y)=ay-by2

MR(y)=a-2byThe demand curve intersects the

quantity axis at a/b.

The MR curve intersects the quantityaxis at a/2b.


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From Figure 10.2

1. When TR function has a positiveslope, MR is positive.

2. When the TR function is at itsmaximum, MR is zero.

3. When TR function has a negativeslope slope, MR is negative.


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Maximizing Profit

Maximize profit by choosing output (y*)where MC intersects MR (from below).

From the demand curve, find the price(p*) that corresponds with the profitmaximizing y.


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Figure 10.3 Maximizing monopoly profit


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Figure 10.4 The inefficiency of monopoly


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The Inefficiency of Monopoly

Because p* exceeds MC in equilibrium, somepotential gains from trade are not realized.

Efficiency requires producing output to the

point where p=MC. The monopoly equilibrium isnot Pareto-optimal.

A deadweight loss occurs because atequilibrium there exists unrealized gains fromtrade, signalling unrealized monopoly profit.


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Sources of Monopoly

Government Franchise

Patent Monopoly

Resource Based MonopolyTechnological (Natural) Monopoly

Monopoly by Good Management


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Figure 10.5 Natural monopoly


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Regulatory Responses to a

Natural Monopoly

Average Cost Pricing: Forcing themonopoly to produce a level ofoutput where p=AC.

This regulation will fail to minimizeproduction costs.


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Figure 10.6 Average cost pricing


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Regulatory Responses to a

Natural Monopoly

Rate of Return Regulation: Aimed atlimiting the rate of return oninvested capital.

Under this regulation, the firm willchoose an input bundle that is notcost minimizing, choosing too much

capital and too little labour.


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Figure 10.7 Rate-of-return regulation


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Patent Policy

Appropriability Problem: Manyinventions with social value are notpursued because inventors do not

have the private incentives to pursuethem (they are not able to capturethe social benefits).


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Figure 10.8 The inducement to develop


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Optimal Patent Policy

At the optimal patent period, themarginal social benefit of increasingthe patent period is equal to the

marginal social cost.

eaton micro 6e ch10

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