CHAPTER 10 - PHALL-82241 PINDYCK CHAPTER 10 page 5 of 21...

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Unformatted text preview: PHALL-82241 PINDYCK CHAPTER 10 page 5 of 21 FIGURE 10.1 Average and Marginal Revenue Dollars per unit of output 7 6 5 4 Average Revenue (demand) 3 2 1 0 Marginal Revenue 1 2 3 4 5 Average and marginal revenue are shown for the demand curve P = 6 ? Q. Fig 10-01.EPS 6 7 Output PHALL-82241 PINDYCK CHAPTER 10 page 6 of 21 FIGURE 10.2 Profit Is Maximized When Marginal Revenue Equals Marginal Cost Price MC P1 P* AC P2 Lost Profit from Producing Too Little (Q 1) and Selling at Too High a Price (P1) D = AR Lost Profit from Producing Too Much (Q 2) and Selling at Too Low a Price (P2) MR Q1 Q* Q2 Q* is the output level at which MR = MC. If the firm produces a smaller output-say, Q1-it sacrifices some profit because the extra revenue that could be earned from producing and selling the units between Q1 and Q* exceeds the cost of producing them. Similarly, expanding output from Q* to Q2 would reduce profit because the additional cost would exceed the additional revenue. Fig 10-02.EPS Quantity PHALL-82241 PINDYCK CHAPTER 10 page 7 of 21 FIGURE 10.3 Example of Profit Maximization $ C 400 R r� 300 c� r 200 150 Profit 100 c 50 5 10 15 (a) 20 Quantity $/Q 40 MC 30 20 AC Profit AR 15 MR 10 5 10 (b) 15 20 Quantity Part (a) shows total revenue R, total cost C, and profit, the difference between the two. Part (b) shows average and marginal revenue and average and marginal cost. Marginal revenue is the slope of the total revenue curve, and marginal cost is the slope of the total cost curve. The profit-maximizing output is Q* = 10, the point where marginal revenue equals marginal cost. At this output level, the slope of the profit curve is zero, and the slopes of the total revenue and total cost curves are equal. The profit per unit is $15, the difference between average revenue and average cost. Because 10 units are produced, total profit is $150. Fig 10-03.EPS PHALL-82241 PINDYCK CHAPTER 10 page 8 of 21 FIGURE 10.4 Shifts in Demand $/Q MC $/Q MC P1 P1 = P2 D2 P2 MR2 D2 D1 D1 MR2 MR1 MR1 Q1 = Q 2 (a) Quantity Q1 Q2 Quantity (b) Shifting the demand curve shows that a monopolistic market has no supply curve-i.e., there is no onetoone relationship between price and quantity produced. In (a), the demand curve D1 shifts to new demand curve D2. But the new marginal revenue curve MR2 intersects marginal cost at the same point as the old marginal revenue curve MR1. The profit-maximizing output therefore remains the same, although price falls from P1 to P2. In (b), the new marginal revenue curve MR2 intersects marginal cost at a higher output level Q2. But because demand is now more elastic, price remains the same. Fig 10-04.EPS PHALL-82241 PINDYCK CHAPTER 10 page 9 of 21 FIGURE 10.5 Effect of Excise Tax on Monopolist $/Q P1 ∆P P0 MC � t t D � AR MC MR Q1 Q0 Quantity With a tax t per unit, the firm’s effective marginal cost is increased by the amount t to MC + t. In this example, the increase in price ⊗P is larger than the tax t. Fig 10-05.EPS PHALL-82241 PINDYCK CHAPTER 10 page 10 of 21 FIGURE 10.6 Production with Two Plants $/Q MC 1 MC 2 MCT P* MR* D � AR MR Q1 Q2 QT Quantity A firm with two plants maximizes profits by choosing output levels Q1 and Q2 so that marginal revenue MR (which depends on total output) equals marginal costs for each plant, MC1 and MC2. Fig 10-06.EPS PHALL-82241 PINDYCK CHAPTER 10 page 11 of 21 FIGURE 10.7 The Demand for Toothbrushes 2.00 2.00 $/Q $/Q Market Demand Demand Faced by Firm A MCA 1.60 1.50 1.50 1.40 DA 1.00 MRA 1.00 10,000 20,000 (a) 30,000 Quantity 3000 5000 7000 QA (b) Part (a) shows the market demand for toothbrushes. Part (b) shows the demand for toothbrushes as seen by Firm A. At a market price of $1.50, elasticity of market demand is ?1.5. Firm A, however, sees a much more elastic demand curve DA because of competition from other firms. At a price of $1.50, Firm A’s demand elasticity is ?6. Still, Firm A has some monopoly power: Its profit-maximizing price is $1.50, which exceeds marginal cost. Fig 10-07.EPS PHALL-82241 PINDYCK CHAPTER 10 page 12 of 21 FIGURE 10.8 Elasticity of Demand and Price Markup $/Q $/Q P * – MC MC P* MC P* AR P * – MC MR AR MR Q* (a) Quantity Q* Quantity (b) The markup (P ? MC)/P is equal to minus the inverse of the elasticity of demand facing the firm. If the firm’s demand is elastic, as in (a), the markup is small and the firm has little monopoly power. The opposite is true if demand is relatively inelastic, as in (b). Fig 10-08.EPS PHALL-82241 PINDYCK CHAPTER 10 page 13 of 21 Billions of dollars FIGURE 10.9 Video Sales 18 16 14 12 10 8 6 4 2 0 1990 1992 1994 1996 VHS 1998 DVD 2000 2002 2004 2006 HD-DVD Between 1990 and 1998, lower prices induced consumers to buy many more videos. By 2001, sales of DVDs overtook sales of VHS videocassettes. High-definition DVDs were introduced in 2006, and are expected to displace sales of conventional DVDs. Fig 10-09.EPS 2008 PHALL-82241 PINDYCK CHAPTER 10 page 14 of 21 FIGURE 10.10 Deadweight Loss from Monopoly Power $/Q Lost Consumer Surplus Deadweight Loss MC Pm A B Pc C AR MR Qm Qc Quantity The shaded rectangle and triangles show changes in consumer and producer surplus when moving from competitive price and quantity, Pc and Qc, to a monopolist’s price and quantity, Pm and Qm. Because of the higher price, consumers lose A + B and producer gains A ? C. The deadweight loss is B + C. Fig 10-10.EPS PHALL-82241 PINDYCK CHAPTER 10 page 15 of 21 FIGURE 10.11 Price Regulation $/Q MR MC Pm Marginal revenue curve when price is regulated to be no higher than P1 P1 P2 � Pc AC P3 P4 AR Qm Q1 Q 3 Qc Q′ 3 Quantity If left alone, a monopolist produces Qm and charges Pm. When the government imposes a price ceiling of P1 the firm’s average and marginal revenue are constant and equal to P1 for output levels up to Q1. For larger output levels, the original average and marginal revenue curves apply. The new marginal revenue curve is, therefore, the dark purple line, which intersects the marginal cost curve at Q1. When price is lowered to Pc, at the point where marginal cost intersects average revenue, output increases to its maximum Qc. This is the output that would be produced by a competitive industry. Lowering price further, to P3 reduces output to Q3 and causes a shortage, Q’3 ? Q3. Fig 10-11.EPS PHALL-82241 PINDYCK CHAPTER 10 page 16 of 21 FIGURE 10.12 Regulating the Price of a Natural Monopoly $/Q Pm Pr AC MC Pc AR MR Qm Qr Qc A firm is a natural monopoly because it has economies of scale (declining average and marginal costs) over its entire output range. If price were regulated to be Pc the firm would lose money and go out of business. Setting the price at Pr yields the largest possible output consistent with the firm’s remaining in business; excess profit is zero. Fig 10-12.EPS Quantity PHALL-82241 PINDYCK CHAPTER 10 page 17 of 21 FIGURE 10.13 Competitive Buyer Compared to Competitive Seller $/Q $/Q P* ME � AE MC P* AR � MR D � MV Q* (a) Quantity Q* Quantity (b) In (a), the competitive buyer takes market price P* as given. Therefore, marginal expenditure and average expenditure are constant and equal; quantity purchased is found by equating price to marginal value (demand). In (b), the competitive seller also takes price as given. Marginal revenue and average revenue are constant and equal; quantity sold is found by equating price to marginal cost. Fig 10-13.EPS PHALL-82241 PINDYCK CHAPTER 10 page 18 of 21 FIGURE 10.14 Monopsonist Buyer $/Q ME S � AE Pc P* m MV Q* m Qc Quantity The market supply curve is monopsonist’s average expenditure curve AE. Because average expenditure is rising, marginal expenditure lies above it. The monopsonist purchases quantity Q*m, where marginal expenditure and marginal value (demand) intersect. The price paid per unit P*m is then found from the average expenditure (supply) curve. In a competitive market, price and quantity, Pc and Qc, are both higher. They are found at the point where average expenditure (supply) and marginal value (demand) intersect. Fig 10-14.EPS PHALL-82241 PINDYCK CHAPTER 10 page 19 of 21 FIGURE 10.15 Monopoly and Monopsony $/Q $/Q ME P* S � AE MC Pc Pc P* MV AR MR Qc Q* (a) Quantity Q* (b) Qc Quantity These diagrams show the close analogy between monopoly and monopsony. (a) The monopolist produces where marginal revenue intersects marginal cost. Average revenue exceeds marginal revenue, so that price exceeds marginal cost. (b) The monopsonist purchases up to the point where marginal expenditure intersects marginal value. Marginal expenditure exceeds average expenditure, so that marginal value exceeds price. Fig 10-15.EPS PHALL-82241 PINDYCK CHAPTER 10 page 20 of 21 FIGURE 10.16 Monopsony Power: Elastic versus Inelastic Supply $/Q $/Q MV – P* ME ME S � AE S � AE P* MV – P* P* MV Q* (a) Quantity MV Q* Quantity (b) Monopsony power depends on the elasticity of supply. When supply is elastic, as in (a), marginal expenditure and average expenditure do not differ by much, so price is close to what it would be in a competitive market. The opposite is true when supply is inelastic, as in (b). Fig 10-16.EPS PHALL-82241 PINDYCK CHAPTER 10 page 21 of 21 FIGURE 10.17 Deadweight Loss from Monopsony Power $/Q ME S � AE De adweight Loss B Pc A C Pm MV Qm Qc Quantity The shaded rectangle and triangles show changes in buyer and seller surplus when moving from competitive price and quantity, Pc and Qc, to the monopsonist’s price and quantity, Pm and Qm. Because both price and quantity are lower, there is an increase in buyer (consumer) surplus given by A ? B. Producer surplus falls by A + C, so there is a deadweight loss given by triangles B and C. Fig 10-17.EPS ...
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This note was uploaded on 09/28/2011 for the course ECON 105 taught by Professor Prof.eco during the Spring '11 term at Indian School of Business.

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