DR MRIGANKA DE SARKAR ASSOCIATE PROFESSOR OF ECONOMICS CONTACT etmityahoocoin Monopoly Why Natural monopoly increasing returns to scale eg parts of utility companies Artificial monopoly ID: 1028066
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1. Monopoly M.COM. SEMESTER II _ MANAGERIAL ECONOMICS DR. MRIGANKA DE SARKARASSOCIATE PROFESSOR OF ECONOMICSCONTACT: et_mit@yahoo.co.in
2. Monopoly: Why?Natural monopoly (increasing returns to scale), e.g. (parts of) utility companies?Artificial monopolya patent; e.g. a new drugsole ownership of a resource; e.g. a toll bridgeformation of a cartel; e.g. OPECM.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKAR
3. Monopoly: AssumptionsMany buyersOnly one seller i.e. not a price-taker(Homogeneous product) Perfect informationRestricted entry (and possibly exit)M.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKAR
4. Monopoly: FeaturesThe monopolist’s demand curve is the (downward sloping) market demand curveThe monopolist can alter the market price by adjusting its output level.M.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKAR
5. Monopoly: Market BehaviourM.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKARy = Qp(y)Higher output y causes alower market price, p(y).D
6. Monopoly: Market BehaviourM.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKARWhat output level y* maximizes profit?Suppose that the monopolist seeks to maximize economic profit
7. Monopoly: Market Behaviour At the profit-maximizing output level, the slopes of the revenue and total cost curves are equal, i.e.MR(y*) = MC(y*)M.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKAR
8. Marginal Revenue: ExampleM.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKARp = a – by (inverse demand curve)TR = py (total revenue) TR = ay - by2Therefore, MR(y) = a - 2by < a - by = p for y > 0
9. Marginal Revenue: ExampleM.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKARP = a - byaya/bMR = a - 2bya/2bPMR= a - 2by < a - by = p for y > 0
10. Monopoly: Market BehaviourM.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKARThe aim is to maximise profits MC = MR< 0MR lies inside/below the demand curveNote: Contrast with perfect competition (MR = P)
11. Monopoly: EquilibriumM.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKARy = QPMRDemand
12. Monopoly: EquilibriumM.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKARyPMCMRDemand
13. Monopoly: EquilibriumM.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKARyPACMCMRDemand
14. Monopoly: EquilibriumM.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKARyPACMCMROutput DecisionMC = MRymDemand
15. Monopoly: EquilibriumM.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKARyPACMCMRDemandPm = the priceymPm
16. Monopoly: EquilibriumFirm = MarketShort run equilibrium diagram = long run equilibrium diagram (apart from shape of cost curves)At qm: pm > AC therefore you have excess (abnormal, supernormal) profitsShort run losses are also possibleM.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKAR
17. Monopoly: EquilibriumM.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKARyPACMCMRDemandThe shaded area is the excess profitymPm
18. Monopoly: ElasticityM.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKARWHY? Increasing output by y will have two effects on profitsWhen the monopoly sells more output, its revenue increase by pyThe monopolist receives a lower price for all of its output
19. Monopoly: ElasticityM.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKARRearranging we get the change in revenue when output changes i.e. MR
20. Monopoly: ElasticityM.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKAR = elasticity of demand
21. Monopoly: ElasticityM.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKARRecall MR = MC, therefore,Therefore, in the case of monopoly, < -1, i.e. || 1. The monopolist produces on the elastic part of the demand curve.
22. Application: Tax Incidence in MonopolyM.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKARyPMCMRDemandMC curve is assumed to be constant (for ease of analysis)
23. Application: Tax Incidence in Monopoly Claim When you have a linear demand curve, a constant marginal cost curve and a tax is introduced, price to consumers increases by “only” 50% of the tax, i.e. “only” 50% of the tax is passed on to consumers M.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKAR
24. Application: Tax Incidence in MonopolyM.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKARyPMCbtMRDemandybtOutput decision is as before, i.e. MC=MRSo Ybt is the output before the tax is imposed
25. Application: Tax Incidence in MonopolyM.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKARyPMCbtMRDemandybtPrice is also the same as beforePbt = price before tax is introduced.Pbt
26. Application: Tax Incidence in MonopolyM.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKARyPMCbtMRDemandybtThe tax causes the MC curve to shift upwardsMCatPbt
27. Application: Tax Incidence in MonopolyM.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKARyPMCbtMRDemandybtThe tax will cause the MC curve to shift upwards.MCatPbt
28. Application: Tax Incidence in MonopolyM.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKARyPMCbtMRDemandybtPrice post tax is at Ppt and it higher than before.MCatPbtyatPpt
29. Application: Tax Incidence in MonopolyFormal Proof M.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKARStep 1: Define the linear (inverse) demand curve Step 2: Assume marginal costs are constantMC = CStep 3: Profit is equal to total revenue minus total cost
30. Application: Tax Incidence in MonopolyFormal Proof M.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKARStep 4: Rewrite the profit equation asStep 5 : Replace price with P=a-bY Profit is now a function of output only
31. Application: Tax Incidence in MonopolyFormal Proof M.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKARStep 6: SimplifyStep 7: Maximise profits by differentiating profit with respect to output and setting equal to zero
32. Application: Tax Incidence in MonopolyFormal Proof M.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKARStep 8: Solve for the profit maximising level of output (Ybt)
33. Application: Tax Incidence in MonopolyFormal Proof M.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKARStep 9: Solve for the price (Pbt) by substituting Ybt into the (inverse) demand functionRecall that P = a - bY therefore
34. Application: Tax Incidence in MonopolyFormal Proof M.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKARStep 10: SimplifyMultiply by - bb cancels out
35. Application: Tax Incidence in MonopolyFormal Proof M.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKAR
36. Application: Tax Incidence in MonopolyFormal Proof M.COM. SEMESTER II _ MANAGERIAL ECONOMICS _ MONOPOLY DR. MRIGANKA DE SARKARStep 11: Replace C = MC with C = MC + t (one could repeat all of the above algebra if unconvinced)So price after the tax Pat increases by t/2Price before tax