the production decision of a monopoly firm alternative market structures: perfect competition...
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The Production Decision of a Monopoly Firm
Alternative market structures:
• perfect competition
• monopolistic competition
• oligopoly
• monopoly
The following market attributes characterize the case of monopoly:
– There is a single seller of a product having no close substitutes; there is only one source of supply.
– There is complete information regarding price and product availability.
– There are barriers to new firms entering the market.
Reasons for barriers to entry include the following:
• Government franchises and licenses
• Patents and copyrights
• Ownership of the entire supply of a resource
• Economies of scale (natural monopoly)
Generally, a firm has monopoly power if by producing more or less of the good,
the market price is affected.
A firm with monopoly power is a price-maker.
Such a firm is not able to choose price and quantity.
The firm’s marginal revenue from selling an additional unit will be less than the price
received for that unit; MR < P.
Marginal revenue for a firm with monopoly power
Suppose a firm’s demand curve is downward sloping and all units of the good are sold at
the same price.
Marginal revenue is the additional revenue that results from the sale of an additional unit.
MR = P - (reduction in price)(previous quantity)
$8.30 = $9.10 - (.10 $/unit)(8 units)
= $9.10 - $0.80
Explanation for why MR < P:
To sell additional units, the firm must lower price. There is an associated revenue loss resulting from the infra-marginal units being sold at a lower price than would otherwise have been the case.
FACT: Marginal revenue can be negative even when price is positive.
MR = P - (reduction in price)(previous quantity)
-$0.10 = $4.90 - (.10 $/unit)(50 units)
= $4.90 - $5.00
Q
QQ3
Q
Q1
Q1
Q1
Q2
Q2
Q2
Q3
Q3
Q4
Q4
Q4Q5
Q5
Q5
$
$/Q
$/Q
P1P2
P3P4P5
P
TR
TR
D
MR
elastic demand
inelastic demand
TR1
TR2
TR4
TR3
TR5
Marginal Revenue and the price elasticity of
demand.
QQ3
$/Q
MR
D
Marginal Revenue and the price elasticity of demand.
D
P
Q
Unit elastic demand
Inelastic demand
Elastic demand
MR
FACT: A firm having monopoly power will never choose to produce a level of output corresponding to an inelastic point on its demand curve.
Π = TR - TC
If demand is price inelastic, reducing the level of output will result in an increase in TR and a reduction in TC, implying an increase in profits, Π.
Q
$ perunit MC
AVCP1
Q1
D
MR
What level of output will the firm produce?
Q2
Profit maximizing output rule:
A profit-maximizing firm will produce the level of output where MC = MR, provided that the corresponding total revenue is at least as large as than associated total variable cost (i.e., P >AVC).
If the price corresponding to the output where MR = MC is less than the corresponding AVC, the firm will shut down.
Q
P$ perunit
MC
AVC
10,000
$2.00
$2.50
$5.00
FC
FC
FCAVCPQ
FCAVCQPQ
FCVCTR
000,25$
)50.2$00.5($000,10
)(
In the long-run, a monopolist may exit or adjust its scale of production (i.e., adjust its mix of inputs).
Profits will be nonnegative in the long-run.
If a firm continues to produce, it will do so at the lowest average cost possible.
Q
P$/Q
MC
Q1
P1
Q2
DMR
Marginal value to buyer (and society)
Marginal private (and social) cost
Marginal value to monopolist
The Welfare Cost of Monopoly
Q
P$/Q
MC
Q1
P1
Q2
D
MR
deadweight loss
Q
P$/Q
MC
Q1
P1
Q2
D
MR
monopolyoutput
efficient quantity
The Welfare Cost of Monopoly
monopolyoutput
efficient quantity
Perfect Price Discrimination
A monopolist who knows each buyer’s demand (willingness to pay) and is able to charge each buyer a different price for each unit purchased is said to be able to perfectly price discriminate.
Q
P$/Q
Q1
P1
DMR
MR with noprice discrimination
MR with perfect price discrimination
Marginal Revenue with and without Perfect Price Discrimination
Q
P$/Q
MC = AC
Q1
P1
Q2
D = MR
Profit Maximization in the Case of Perfect Price Discrimination
Q
P$/Q
MC = AC
Q1
P1
Q2
DMR
Profit Maximization in the Case of No Price Discrimination
Consumers surplus
Producer surplus (monopoly profits)
Q
P$/Q
MC = AVC
Q1
P1
Q2
D = MR
Distributional Consequences of Perfect Price Discrimination