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Econ 4010 Lecture 22

# Econ 4010 Lecture 22 - 10 Market Power...

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<Lecture 22> 10. Market Power: Monopoly Market Power Ability to affect the price of a good Monopoly Market that has only one seller but many buyers To maximize profit, the monopolist must first determine its costs and the characteristics of market demand. Given this knowledge, the monopolist must then decide how much to produce and sell. Consider a firm facing the following demand curve: P = 6 – Q TR = P * Q = (6 - Q) Q, AR = TR / Q = 6 – Q, MR = dTR / dQ = 6 – 2Q Average and Marginal Revenue (p.341) Profit Maximization (p.342) 1

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Example: Suppose the cost of production is C = 50 + Q 2 , and demand is given by P = 40 – Q. AC = 50/Q + Q, MC = 2Q, R = P * Q = 40Q – Q 2 , MR = 40 – 2Q. By setting marginal revenue equal to marginal cost, you can verify that profit is maximized when Q = 10. A Rule of Thumb for Pricing: (P – MC)/P = - 1 / E d , or P = MC / [1 + (1 / E d )] MR = dR / dQ = d(PQ) / dQ = (dP / dQ) Q + P = (dP / dQ) (Q / P) P + P = [(1 / E d ) + 1] P = MC The Elasticity of Demnad: E d = (P / Q) (dQ / dP) (P - MC)/P is the markup over MC as a percentage of price. In a perfectly competitive market in which demand is extremely elastic, P = MC. Q1. A monopolist firm faces a demand with constant elasticity of -2.0. It has a constant marginal cost of \$20 per unit and sets a price to maximize profit. If marginal cost should increase by 25 percent, would the price
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Econ 4010 Lecture 22 - 10 Market Power...

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