191T7 - ECON191 (Spring 2009) 23-24.3.2009 (Tutorial 7)...

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1 ECON191 (Spring 2009) 23-24.3.2009 (Tutorial 7) Chapter 7 Monopoly power (Chapter 10 & 11 of textbook) MR and the price elasticity of demand ± Price elasticity of demand (facing the firm): Q P dP dQ P P Q Q E d . / = Δ Δ = ± ) ( 1 1 Q P PQ P MR Q Q + + = [When Q is very small, 1 + Q P approaches P ] Q dQ Q dP Q P dQ Q Q dP dQ dTR MR ) ( ) ( ) ( + = = = ) ( ) ( ) ( ) ( Q P Q P Q dQ Q dP Q P MR + = d E Q P Q P MR ) ( ) ( + = + = d E Q P MR 1 1 ) ( ± A monopoly’s profit is maximized when MR = MC , MC E Q P MR d = + = 1 1 ) ( Ö + = d E MC Q P 1 1 ) ( when ) ( ) ( Q MC Q P E d = = Ö The price charged by the monopolist inversely related to d E . Ö The above expression shows that when = d E , MR = P . That means the more inelastic the demand (the smaller the absolute value of d E ), the larger the divergence between MC and P . (The higher the ability the monopolist to charge a price above MC ) Ö The steeper the demand curve, the higher the monopoly power ± A firm’s market power depends on the elasticity of market demand, the level of competition, number of firms in the market, etc. ± Elasticity of market demand positively affects the elasticity of demand facing the firm ± The more competitive the market is, the larger the absolute value of d E Lerner’s index ± Measure of monopoly power calculated as excess of price over MC Ö d d E P E Q P P P P MC P L 1 ) ( = = = (0 < L < 1) ± High monopoly power does not necessarily imply high profit, it depends on AC relative to price
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2 Example : Supermarkets and convenience stores (P.358) ± Supermarkets: several firms selling similar products ± No single supermarket can raise its price very much without losing customers to other stores ± The elasticity of demand for individual supermarket: –10 Ö P = MC /(1 – 0.1) = 1.11 MC ± Lerner index: ( P MC )/ P = –1/ E d = 0.1 ± Convenience stores: charge a higher price than supermarkets (less elastic demand) ± The elasticity of demand for individual supermarket: –5 ± P = MC /(1 – 0.2) = 1.25 MC ± Learner index: ( P MC )/ P = –1/ E d = 0.2 ± Convenience stores have more monopoly power.
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This note was uploaded on 10/11/2009 for the course ECON 191 taught by Professor Chen during the Spring '08 term at HKUST.

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191T7 - ECON191 (Spring 2009) 23-24.3.2009 (Tutorial 7)...

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