Chapter 11 PPT Perloff Microecon 1e

Chapter 11
Monopoly
Topics
Monopoly
profit maximisation
Effects
of a shift of the demand curve
Market
power
Welfare
Cost
effects of monopoly
advantages that create monopolies
Government
11-1
actions that create monopolies
Copyright 2014 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781442532830/Perloff/Microeconomics/1e
Marginal Revenue and Price
A firms revenue is:

R = pq
A firms marginal revenue, MR, is the change in its

revenue from selling one more unit:
MR = R/q
11-2
If the firm sells exactly one more unit q = 1, its

marginal revenue is MR = R.
Marginal Revenue and Price
11-3
The marginal revenue of a monopoly differs from

that of a competitive firm because the monopoly
faces a downward-sloping demand curve unlike the
competitive firm.
The monopolist can increase sales by reducing price.
Thus, the monopolys marginal revenue curve lies

below the demand curve at every positive quantity.
Figure 11.1 Average and Marginal Revenue

Price, P, $ per unit
Demand curve
P1
Price, P, $ per unit
(b) Monopoly
(a) Competitive firm
P1
P2
11-4
q + 1 Quantity, q, Units per year
C
Demand curve
A
Q Q+1
Quantity, Q, Units per year
Deriving the Marginal Revenue Curve

For a monopoly to increase its output by Q, the
monopoly lowers its price per unit by p / Q, which
is the slope of the demand curve.
By lowering its price, the monopoly loses
(p / Q) x Q on the units it originally sold at the
higher price.
But it earns an additional p on the extra output it
now sells thus, the monopolys marginal revenue
is 1.
11-5
Deriving the Marginal Revenue Curve (cont)

Thus, the monopolys marginal revenue is:
p
MR p
Q
Q
For a linear demand curve:
p 24 Q
p
MR p
Q (24 Q ) (1)Q 24 2Q
Q
The slope of this marginal revenue curve is
MR / Q = 2, so the marginal revenue curve is
twice as steep as the demand curve.
11-6
Marginal Revenue and Price Elasticity of Demand.

At a given quantity:
1
MR p 1
marginal revenue is closer to price as demand becomes

more elastic.
Where the demand curve hits the price axis (Q = 0), the
demand curve is perfectly elastic, so the marginal
revenue equals price: MR = p
Where the demand elasticity is unitary, = 1, marginal
revenue is zero: MR = p[1 + 1/(1)] = 0
Marginal revenue is negative where the demand curve is
inelastic, 1 < 0
11-7
P, $ per unit
Figure 11.2 Elasticity of Demand and Total,

Average, and Marginal Revenue
24
Perfectly elastic
Elastic , < 1
MR = 2
P = 1
Q = 1
12
Q = 1
= 1
Inelastic, 1 < < 0
Demand ( P= 24 Q)
0
11-8
12
MR = 24 2 Q
Perfectly
inelastic
24
Q, Units per day
Figure 11.3
Maximising Profit
11-9
Copyright 2014 Pearson Australia (a division of Pearson Australia

Group Pty Ltd) 9781442532830/Perloff/Microeconomics/1e
Profit-Maximising Output
Because a linear demand curve is more elastic at
smaller quantities:
11-10
monopoly profit is maximised in the elastic portion

of the demand curve
equivalently, a (single price) monopoly never

operates in the inelastic portion of its demand
curve.
Effects of a Shift of the Demand Curve
11-11
Unlike a competitive firm, a monopoly does not

have a supply curve.
A given quantity can correspond to more than

one monopoly-optimal price.
A shift in the demand curve may cause the

monopoly-optimal price to stay constant and
the quantity to change or both price and
quantity to change.
Figure 11.4 Effects of a Shift of the Demand Curve
11-12
Market Power
Market power the ability of a firm to charge a
price above marginal cost and earn a positive profit:
1
MR p 1 MC
and rearranging the terms

p
1
MC 1 (1 / )
so the ratio of the price to marginal cost depends
only on the elasticity of demand at the profitmaximising quantity.
11-13
Solved Problem 11.1

Apples constant marginal cost of producing its top-of-the-line
iPod is $200, its fixed cost is $736 million, and its inverse
demand function is p = 600 25Q, where Q is units measured
in millions.
What
is Apples average cost function?
Assuming
that Apple is maximising short-run monopoly profit,

what is its marginal revenue function?
What
are its profit-maximising price and quantity, profit, and

Lerner Index?
What
is the elasticity of demand at the profit-maximising level?
Show
Apples profit-maximising solution in a figure.
11-14
Solved Problem 11.1
11-15
Sources of Market Power

All else the same, the demand curve a firm faces becomes
more elastic as:
11-16
better substitutes for the firms product are

introduced
more firms enter the market selling the same

product, or
firms that provide the same service locate closer to

this firm.
Figure 11.5 Deadweight Loss of Monopoly
11-17
Solved Problem 11.2

In the linear example in Figure 11.3, how does charging
the monopoly a specific tax of = $8 per unit affect the
monopoly optimum and the welfare of consumers, the
monopoly, and society (where societys welfare includes
the tax revenue)?
What is the incidence of the tax on consumers?
11-18
Solved Problem 11.2
11-19
Welfare Effects of Ad Valorem Versus Specific Taxes

A government raises more tax revenue with an
ad valorem tax applied to a monopoly than with
a specific tax when and are set so that the
after-tax output is the same with either tax.
11-20
Figure 11.6 Ad Valorem Versus Specific Tax
11-21
Cost Advantages That Create Monopolies

Why some markets are monopolised:
11-22
a firm has a cost advantage over other firms or
a government created the monopoly.
Sources of Cost Advantages

Reasons for cost advantages:
11-23
the firm controls an essential facility a scarce

resource that a rival needs to use to survive
the firm uses a superior technology, or has a

better way of organising production.
Natural Monopoly
Natural monopoly situation in which one firm
can produce the total output of the market at lower
cost than several firms could.
Believing that they are natural monopolies,
Australian governments in the past owned the
public utilities to provide essential goods or services
such as water, gas, electric power, or mail delivery.
11-24
Figure 11.7 Natural Monopoly
11-25
Barriers to Entry
Governments create monopolies in one of three
ways:
11-26
1.
by making it difficult for new firms to

obtain a license to operate,
2.
by granting a firm the rights to be a

monopoly, or
3.
by auctioning the rights to be

monopoly.
Patents
Patent an exclusive right granted to the inventor to sell
a new and useful product, process, substance, or design
for a fixed period of time.
The length of a patent varies across countries
Patents are just one example of how intellectual property

can act as barrier to entry. Others include copyright and
registered designs.
Question: if a firm with a patent monopoly sets a high
price that results in deadweight loss then why do
governments grant patent monopolies?
11-27
Optimal Price Regulation

In some markets, the government can
eliminate the deadweight loss of monopoly by
requiring that a monopoly charge no more than
the competitive price.
11-28
Figure 11.8 Optimal Price Regulation
11-29
Solved Problem 11.4

Suppose that the government sets a price, p2, that is
below the socially optimal level, p1, but above the
monopolys minimum average cost. How do the price,
the quantity sold, the quantity demanded, and welfare
under this regulation compare to those under optimal
regulation?
11-30
Solved Problem 11.4
11-31
Problems in Regulating
There are problems that governments face in
regulating monopolies, such as:
11-32
because they do not know the actual demand and

marginal cost curves, governments may set the
price at the wrong level
many governments use regulations that are less

efficient than price regulation
regulated firms may bribe or otherwise influence

government regulators to help the firms rather than
society as a whole.
Figure 11.9 Regulating a Telephone Utility
11-33

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Chapter 11

of a shift of the demand curve

advantages that create monopolies

actions that create monopolies

Marginal Revenue and Price

A firms revenue is:

A firms marginal revenue, MR, is the change in its

If the firm sells exactly one more unit q = 1, its

Marginal Revenue and Price

The marginal revenue of a monopoly differs from

The monopolist can increase sales by reducing price.

Thus, the monopolys marginal revenue curve lies

Figure 11.1 Average and Marginal Revenue

Price, P, $ per unit

(a) Competitive firm

q + 1 Quantity, q, Units per year

Deriving the Marginal Revenue Curve

Deriving the Marginal Revenue Curve (cont)

Marginal Revenue and Price Elasticity of Demand.

marginal revenue is closer to price as demand becomes

Figure 11.2 Elasticity of Demand and Total,

Inelastic, 1 < < 0

Copyright 2014 Pearson Australia (a division of Pearson Australia

monopoly profit is maximised in the elastic portion

equivalently, a (single price) monopoly never

Effects of a Shift of the Demand Curve

Unlike a competitive firm, a monopoly does not

A given quantity can correspond to more than

A shift in the demand curve may cause the

Figure 11.4 Effects of a Shift of the Demand Curve

and rearranging the terms

Solved Problem 11.1

is Apples average cost function?

that Apple is maximising short-run monopoly profit,

are its profit-maximising price and quantity, profit, and

is the elasticity of demand at the profit-maximising level?

Apples profit-maximising solution in a figure.

Solved Problem 11.1

Sources of Market Power

better substitutes for the firms product are

more firms enter the market selling the same

firms that provide the same service locate closer to

Figure 11.5 Deadweight Loss of Monopoly

Solved Problem 11.2

Solved Problem 11.2

Welfare Effects of Ad Valorem Versus Specific Taxes

Figure 11.6 Ad Valorem Versus Specific Tax

Cost Advantages That Create Monopolies

a firm has a cost advantage over other firms or

a government created the monopoly.

Sources of Cost Advantages

the firm controls an essential facility a scarce

the firm uses a superior technology, or has a

Figure 11.7 Natural Monopoly

by making it difficult for new firms to

by granting a firm the rights to be a

by auctioning the rights to be

The length of a patent varies across countries

Patents are just one example of how intellectual property