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Ch.11&12 Notes - Intermediate Microeconomics Professor...

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Intermediate Microeconomics Professor Yongmin Chen Topic 8. Price and Output under Monopoly Monopoly A monopoly is a situation where there is only one seller in the market. Contrary to a firm under perfect competition, which has no effect on the market demand and thus is a price taker, a monopolist's demand coincides with the market demand, and the monopolist is a price setter.. There are several possible reasons for the existence of monopolies, and they may differ in their implications for economic welfare. First, a firm may control the entire supply of a basic input that is needed to produce a certain product. Second, the industry may be a natural monopoly. An industry is called a natural monopoly if production exhibits decreasing average cost (economies of scale) in the output range that would meet the entire market demand at a profitable price. In such an industry, it is desirable to have only one firm to minimize the production cost. Public utilities are often examples of natural monopolies. Third, monopolies may be created through laws and government regulations. One case is the legal protection for patents. The purpose of this is to provide incentives for innovation. It typically involves the trade-offs between dynamic efficiency and static efficiency. Another situation is that the government may issue a license only to a particular firm in a market. Monopoly Pricing How does a monopolist set price to maximize profit? It will set price such that MR = MC. To a monopolist, its MR curve is below its demand curve. Since MR = p(1+1/ η ), the profit-maximization condition for the monopolist can be written as: p(1+1/ η ) = MC The profit-maximizing price for the monopolist is (if 1+1/ η is not zero):
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p = MC / (1+1/ η ) Example 8-1. Suppose MC = 1, and η = -2, what is the monopoly price?
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