How does a monopolist set its price and output What is wrong with monopoly What are some other pricing strategies a monopolist can use Causes of a Monopoly B arriers to entry Technical barriers to entry ID: 759206
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Slide1
Chapter 11
Monopoly
Slide2Objective
How
does a monopolist set its price and output?
What is wrong with monopoly?
What are some other pricing strategies a monopolist can use?
Slide3Causes of a Monopoly
B
arriers to entry
–
Technical barriers to entry
Diminishing average cost over a broad range of output like a
natural monopoly
.
Special knowledge of a low-cost method of production.
Ownership of a key resource
Possession of unique managerial talent.
Legal barriers to entry.
Patents and copyrights.
Exclusive franchise or license.
Slide4Definitions
Revenue = price * quantity
TR=
pq
Profit = Revenue – Costs
π
= TR – C
Marginal
revenue=
Δ
TR/
Δ
q
Change in total
revenue from selling an extra
unit of
output
Slide5Revenue Analysis for a Monopoly
Slide6A Monopoly’s Revenue
Marginal Revenue
∆
TR
/∆
Q
=
MR
How does MR compare to P in a monopoly market?
To sell an extra unit the monopolist has to lower price.
He sells the extra unit at the new price (thus total revenue rises), but lowers price on all previous units sold (which reduces total revenue)
MR<P
Slide7A Monopoly’s Revenue
An increase in sales has two effects on total revenueThe output effect—revenue earned on the extra unitThe price effect—revenue lost on previous units.
$5
$5
$5
$4
$4
$4
$4
PQTRMR$5315$1$4416
Note that MR<P
MR=P + (
Δ
p/
Δ
q)(q
)
Slide8Total Revenue
Quantity
Price
$11
10
9
8
7
6
5
4
3
2
1
0
–1
–2
–3
–4
1
2
3
4
5
6
7
8
Total Revenue increases and then decreases.
9
Total
Revenue
Slide9Q
Total
Revenue
Q
Marginal
Revenue
Marginal Revenue is the slope of the total revenue curve
Marginal revenue is positive (negative) when total revenue is increasing (decreasing)
Marginal revenue is zero when total revenue reaches a maximum
Slide10Marginal Revenue
Marginal revenue curveBelow demand curveSlope = 2* Slope of demand curveMR=P + (Δp/Δq) (q)MR=p-|Δp/Δq|(q)=p(1-1/|ξ|)ξ = elasticity of demand
10
Slide11Marginal revenue and demand
11
The marginal revenue curve is steeper than the demand curve. With a straight-line demand curve, the slope of the marginal revenue curve is twice the slope of the demand curve
Quantity
0
Price
D
p = A -
bq
MR =
A
- 2bq
a
Inverse
demand function
p= f(q)=A-
bq
Price – from any given
quantity
Demand function: q = f(p)=
(A-p)/b
quantity
demanded at each price
Slide12Demand and Elasticity
12
Quantity
0
Price
p
MAX
A
p
1
μ
|
ξ
|>1
|
ξ
|=1
|
ξ
|<1
Quantity
demanded: q
=
A
-
bp
Slide13Pricing and Quantity Decisions
The Elasticity RuleThe firm will never choose a point on inelastic portion of demand curveWhen |ξ|<1, then marginal revenue is negativeSelling an extra unit of output will reduce profit It increases costs and decreases revenue
13
Slide14Optimal Price and Quantity Results
Profit-maximizing quantity, q*Increase production if MR>MCUntil MR=MCProfit-maximizing price, p*On demand curve, at q*
14
Slide15Optimal price and quantity
15
The profit-maximizing price and quantity equate marginal cost with marginal revenue
Quantity
0
Price
D
MR
MC
α
q*
ρ
p*
Slide16Optimal Price and Quantity Results
# 2: Profit-maximizing priceOn the demand curveAt optimal quantityMR=p(1-1/|ξ|)p=MR(1-1/|ξ|); MR=MCp=MC(1-1/|ξ|)
16
Slide17Optimal Price and Quantity Results
Deadweight lossDollar measure - Loss to societyProfit maximization results in units not produced where marginal social benefit > marginal social costSome of the consumer surplus under perfect competition is transferred to the monopolist.
17
Slide18The socially optimal price
18
Compared to perfect competition, a monopoly produces less output and charges a higher price
Quantity
0
Price
MR
MC
b
f
D
d
p
q
Slide19Two-Part Tariffs
Monopolist chargesA lump sum feeA unit priceThe two part tariff allows the monopoly to Capture consumer surplusEarn extra-normal profitSell the optimal output level
19
Slide20Two-Part Tariffs
Assume there are identical consumers in the market
Consumers buy more of the good as its price declines
Each gets the same consumer surplus
Slide21Two-Part Tariffs
21
Quantity
0
Price
MR
e
d
MC
b
a
c
Fee
Unit Price
The producer charges each consumer, in addition to the per-unit price, a fixed fee equal to her share of the consumer
surplus:
Fee=CS/N
Slide22Two-Part Tariffs and Profit
22
Quantity
0
Price
MR
e
d
MC
b
a
c
Unit Price
The producer
earns a higher profit
Profit
Slide23Two-Part Tariffs and A Higher Profit
23
Quantity
0
Price
MR
e
MC
Unit Price
The producer
earns a higher profit if he lowers the price to MC and charges a higher fee
Profit
Slide24Two-Part Tariffs and Efficiency
24
Quantity
0
Price
MR
e
MC
Unit Price
The producer
is efficient:
He sells the socially optimal amount
Sets a price equals MC
Profit
Slide25E
A two-part tariff enables the monopolist to earn positive
profits
Quantity
0
Price
MC
AC
q
c
p
Two-Part
Tariffs when the monopoly realizes a loss
Slide26Problems with uniform Pricing
When consumers are not identical
S
ome buyers with a willingness to pay above marginal cost do not buy because the price is high
Lowering price to capture this market segment may reduce monopoly profit.
Slide27When the monopoly charges a single price……
27
Transactions represented by the blue line are not undertaken
Quantity
0
Price
MR
MC
b
f
D
d
p
q
Slide28B
T
wo part Tariff may not be optimal when consumers are not identical
Half the consumers are type A and half are B
The monopoly sets a fee=A+B/2The Elizabeths are willing to pay the fixed fee, but the Geoffreys are not
Quantity
0
Price
D
Geoffreys
D
Elizabeths
p*
q
1
q
2
A
Slide29Non uniform pricing / Price Discrimination
Separate consumers
Groups/ markets
Slightly different products
Tastes
No reselling
Different prices
Slide30Price Discrimination
Price discriminationCharge different prices to different consumersSegmented marketsPhysical separation/other characteristicsArbitrage - impossible
30
Slide31Price Discrimination: the Market for Movie Tickets
Demand
Marginal cost
MR
Demand
Q 2
MR
Q 1
(b) Senior citizen demand
(b) Demand by people below age 60
P
P1
P2
The relative prices charged will depend on the price elasticity of demand in each market:
Slide32Price Discrimination
Price
Discrimination in Segmented Markets
Produce q* (profit maximizing quantity)
Marginal revenue (any market) = marginal cost
Marginal revenue (one market) = Marginal revenue (other) market
MR
g
=MR
e
=MC
t
Slide33Practice Questions: #1
Given:
Inverse demand: P=100 - Q
MC constant at $50 and no fixed costs
Find
Socially optimal output level
Monopoly output and price
If the monopoly can charge a fee in addition to the above price, what is the fee? The profit?
What is the optimal price and fee? The profit?
Slide34Practice Questions: #2
Given:
Two groups of buyers: P1=130-2Q1 and P2=60-Q2
MC constant at $50 and no fixed costs
Find
Price and quantity to each group
Is the monopoly output socially efficient?