Slide 1Econ 410: Micro TheoryMonopolistic MarketsMonday, November 26th, 2007Slide 2Recall from last time… When discussing production so far, we have focused on competitive markets Price = MC = LRAC Zero economic profits in the long run Large numbers of buyers and sellers However, most markets aren’t perfectly competitive “Brand Consciousness” A firm has market power if… It can raise its price relative to other firms without losing all of its sales.Slide 3Monopolies Characteristics of a monopoly… One seller - many buyers Single product with no true substitutes Barriers to entry Price Maker The monopolist controls the entire supply side of the market Controls price but must consider consumer demand Profits will be maximized at the quantity where MR=MCSlide 4Average & Marginal Revenue What is the monopolist’s average revenue? Price received per unit sold Measured by the market demand curve Why? To maximize profit, what does the monopolist need to know? The firm needs to find marginal revenue Change in revenue resulting from a single unit change in outputSlide 5Average & Marginal Revenue Book Example - Assume a monopolist faces the demand curve P = 6 – Q.  How do we find average and marginal revenue at each price?Slide 6Average & Marginal Revenue What do we notice about the table? When demand is downward sloping, the price (average revenue) is greater than marginal revenue For sales to increase, price must fallSlide 7Average & Marginal RevenueOutput1 2 3 4 5 6 70123$4567Average Revenue (Demand)MarginalRevenue How would we view this graphically?Slide 8Profit Maximization How is this situation different from perfect competition? To increase sales the price must fall P > MR for a monopoly instead of P=MR How is it the same? Profits maximized where MR = MC Cost functions are the same Mathematically:MCMRorQCQRQQCQRQ0///)()()(Slide 9Profit Maximization GraphicallyMCACQuantity$D = ARMRP*Q*Slide 10Sample Exam Question Elmo is a monopoly producer. His demand curve and total cost functions are given as follows: What quantity should Elmo produce? Solution: To find the optimal quantity, we need to find MR & MC and set them equal to each other. Revenue = P(Q)·Q =  Marginal Revenue = QQP4140)(QQTC 4)(  QQ 4140QQR2140Slide 11 Marginal Cost =  Setting MR = MC and solving:Sample Exam Question What quantity should Elmo produce? Solution: Marginal Revenue =QQP4140)(QQTC 4)( QQR21404QC42140  Q 3621Q72* QSlide 12Sample Exam Question What will be the price of Elmo’s product? Solution: To find the product’s price, we simply substitute the optimal quantity into the original demand function:QQP4140)( 221840724140)( QP How much profit will Elmo make? Profit = TR – TC = P(Q)·Q-TC(Q)= 22·72 – 4Q = 22·72 - 4·72= $1,296Slide 13Sample Exam Question What does this look like graphically?Profit D=ARMRMC=AC=4P=22Quantity0 50 72 100$/Q40AC=4Profit = (P - AC) x Q = ($22 - $4)(72) = $1,296Slide 14Monopoly Pricing How does monopoly pricing compare to perfect competition? Monopoly P > MC Price is larger than MC by an amount that depends inversely on the elasticity of demand Perfect Competition Demand is perfectly elastic, so P=MC If demand is very elastic, there is little benefit to being a monopolist The larger the elasticity, the closer the price will be to a perfectly competitive marketSlide 15Monopoly Market Supply The firm is the market in a monopolistic industry – there is no additional market supply curve For a monopoly, output is determined by marginal cost and the shape of the demand curve Shifts in demand for a monopoly  Demand shifts do not trace out price & quantity changes corresponding to a supply curve A competitive market supplies a specificquantity at every price This relationship does not exist for a monopoly Price, quantity, or both could changeSlide 16Taxes We have seen that in a competitive market, a per-unit tax causes price to rise by less than the tax The burden is shared by producers and consumers Under monopoly, price can sometimes rise by more than the amount of the tax To determine the impact of a tax: Let t = specific tax MC = MC + t GraphicallySlide 17TaxesQuantity$/QMCD = ARMRQ0P0MC + taxtPQ1P1The tax increases marginal cost by tBefore the tax, the monopoly sets a price of P0to sell Q0Price increases by ΔP, more than the amount of the tax.As a result, the monopolist sells Q1at a price of P1Slide 18Taxes Price may or may not increase by more than the tax The amount the price increases depends on the elasticity of demand in the market In a competitive market, the price cannot increase by more than tax Profits for monopolist will always fall with a taxSlide 19Monopoly Power and Profits In the real world, do monopolies exist? A market with several firms, each facing a downward sloping demand curve, could still produce such that price exceeds marginal cost Even if a firm has some monopoly power, it is not guaranteed to earn positive economic profits Profits depend on average cost relative to price The more elastic the demand, the less markup the monopoly will charge over priceSlide 20Monopoly Power and ProfitsP*MRD$/QQuantityMCQ*P*-MCElastic DemandDMR$/QQuantityMCQ*P*P*-MC Inelastic DemandSlide 21Monopoly Power Why do some firms have more monopoly power than others? Monopoly power is determined by ability to set price higher than marginal cost A firm’s monopoly power, therefore, is determined by the firm’s elasticity of demand A firm’s elasticity of demand is determined by: Elasticity of market demand Number of firms in market The interaction among firmsSlide 22Monopoly Power For a true monopoly, the firm’s demand curve is the market demand curve Degree of monopoly power the firm holds is determined completely by demand elasticity With more firms, individual demand may differ from market demand The demand for a firm’s product is more elastic than the market elasticity Monopoly power falls as firms increase Firms would like to create barriers to entry to keep new firms out of market Patent,