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Unformatted text preview: PHALL82241 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 1001.EPS 6 7
Output PHALL82241 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 outputsay, Q1it
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 1002.EPS Quantity PHALL82241 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 profitmaximizing 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 1003.EPS PHALL82241 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 curvei.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 profitmaximizing 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 1004.EPS PHALL82241 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 1005.EPS PHALL82241 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 1006.EPS PHALL82241 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 profitmaximizing price is $1.50, which exceeds marginal cost. Fig 1007.EPS PHALL82241 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 1008.EPS PHALL82241 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 HDDVD Between 1990 and 1998, lower prices induced consumers to buy many more videos.
By 2001, sales of DVDs overtook sales of VHS videocassettes. Highdefinition DVDs
were introduced in 2006, and are expected to displace sales of conventional DVDs. Fig 1009.EPS 2008 PHALL82241 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 1010.EPS PHALL82241 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 1011.EPS PHALL82241 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 1012.EPS Quantity PHALL82241 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 1013.EPS PHALL82241 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 1014.EPS PHALL82241 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 1015.EPS PHALL82241 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 1016.EPS PHALL82241 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 1017.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.
 Spring '11
 Prof.Eco

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