EC111LectNG6

EC111LectNG6 - University of Essex Department of Economics...

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1 University of Essex Session 2011/12 Department of Economics Autumn Term EC111: INTRODUCTION TO ECONOMICS MONOPOLY AND REGULATION Monopoly is the opposite extreme to perfect competition. In this case there is only one (actual and potential) supplier of a good. Monopoly relies on barriers to entry to the industry; these could be legal barriers, they could be the result of special resources (factors or materials) owned by the firm, or they could be the result of technology. The key feature is that the monopolist faces the entire market demand curve. The marginal revenue, MR, curve is downward sloping and below the demand curve (which represents average revenue, AR). In order to sell more the monopolist drives down the price of all units sold, not just the marginal unit. Hence MR is the addition to total revenue of selling one more unit minus the fall in revenue from dropping the price of all the intra-marginal units. Thus MR < P at any level of output. MR P, MR Elasticity = 1 Q D
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2 Note that: MR is zero at the point of unit elasticity on the demand curve. This is where total revenue for the firm (total expenditure of the buyers) is maximised. Beyond that, total revenue falls, so marginal revenue is negative. The slope of MR is two times the slope of AR (the demand curve). In the linear case the MR bisects the horizontal axis between zero and the intecept of the demand curve. The relationship between marginal revenue and price depends on the elasticity of demand: E 1 1 P MR . When demand is perfectly elastic, E = ∞, and MR = P. 1 Profit maximising equilibrium for the monopolist is where MR = MC. For a monopolist with ‗U‘ shaped costs we have: 1 To show this we require some calculus. Note that the change in Total Revenue along the demand curve can be expressed as PdQ QdP dTR and therefore Marginal Revenue is P dQ dP Q dQ dTR MR . The elasticity of demand is Q P dP dQ E and thus P dQ dP P Q P MR . Remembering that elasticity is always expressed as a positive number we have E 1 1 P MR P P * Q * Q MR Profit D MC AC
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3 Note that: The monopolist has market power. Unlike the competitive firm, it can influence the price. The monopolist chooses the price (and therefore the quantity) that maximises its profits. The monopolist picks a point on the demand curve where demand is elastic. Q: How can we be sure of this? Here we are not distinguishing between the short run and the long run (the diagrams would look somewhat similar). But it is useful to think of the long run. Q: Why? The monopolist makes profit (P – AC)×Q. Because P > AC the monopolist makes super-normal profits, i.e. profits in excess of opportunity costs. Because there is no threat of entry the monopolist can sustain super-normal profits in the long run. A numerical example with constant costs.
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This note was uploaded on 03/15/2012 for the course EC 111 taught by Professor Timhatton during the Spring '12 term at Uni. Essex.

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EC111LectNG6 - University of Essex Department of Economics...

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