lecture 6

# lecture 6 - LECTURE 6 MONOPOLY AND REGULATION 1 What's...

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1 LECTURE 6 MONOPOLY AND REGULATION

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2 What’s Monopoly? A monopoly is an industry that produces a good or service for which no close substitute exists and in which there is ONE supplier that is protected from competition by a barrier preventing the entry of new firms. A monopoly is a price setter, not a price taker. Why? Key decisions to be made: What is the optimal amount of output to produce?
3 Pricing and Quantity Decisions Objective: maximize total profit Total Profit = Total Revenue – Total Cost or, TPr = TR – TC TR = p(q)q , where p(q) is called as the inverse demand function , implying the optimal price is given once the optimal quantity is known, and vice versa. TC is also a function of q , that is, TC(q). max ( ) ( ) ( ) ( ) q TR q TC q MR q MC q - =

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4 Pricing and Quantity Decisions ( ) ( ) MC q dTC q dq =
5 Pricing and Quantity Decisions MR(q) < p(q) given demand function is downward sloping. By definition, the inverse demand curve p(q) is equivalent to the average revenue curve AR(q). Therefore, MR(q) < AR(q). Also, [ ] ( ) ( ) ( ) ( ) MR q dTR q dq p q q dp q dq = = + 1 ( ) ( ) 1 ( ) 1 q dp MR q p q AR q p dq ξ = + = -

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6 Pricing and Quantity Decisions For linear demand p=A-bq , MR(q)=A-2bq .
7 Pricing and Quantity Decisions Pricing Rule 1: The Elasticity Rule for Monopoly Pricing Never price a commodity on the inelastic portion of the demand curve.

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8 Pricing and Quantity Decisions Pricing Rule 2: The Profit-Maximizing Determination of Price The optimal price for a monopolist is the price that is on the demand curve at the optimal quantity point. Extra-normal Profit = TR(q) – TC(q) = (p – AC)q AC Economic Profit
9 Pricing and Quantity Decisions Solved Problem 9.4 (pp 339~340) Assume that you have market where the demand for the product is linear and equal to . Also assume that all firms produce the good using a constant marginal cost function where . a) What price will maximize the sum of producer and consumer surplus in this market? b) What price will be set in the market if a monopolist sets the price to maximize its 100 4 p q = - 4 MC =

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10 Pricing and Quantity Decisions Answer: a) The socially optimal price is where the marginal cost curve intersects the demand curve, or b) If the market was organized as a monopoly, the monopolist would equate marginal cost to marginal revenue, where the marginal revenue curve associated with this demand curve is . Thus, a 4 100 4 24, 4 MC p q q p = = - = = 100 8 MR q = - 100 8 4 * 12, * 52 MR MC q q p = - = = =
11 Pricing and Quantity Decisions Answer: c) In the right figure, at the socially optimal price- quantity, the consumer surplus is the area of triangle abc , or The consumer surplus existing after the monopoly prices is the area of triangle dec , or And the loss of consumer surplus is the difference in these two areas, or 1 2 (\$96)(24) \$1,152 area = = 1 2 (\$48)(12) \$288 area = = 12 52 24 \$1,152 \$288 \$864 - =

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12 Pricing and Quantity Decisions Monopoly pricing does not guarantee a positive profit!
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## This note was uploaded on 01/17/2009 for the course ECON ECON 191 taught by Professor Chan during the Spring '09 term at HKUST.

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lecture 6 - LECTURE 6 MONOPOLY AND REGULATION 1 What's...

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