The Production Decision of a Monopoly Firm Alternative market structures: perfect competition monopolistic competition oligopoly monopoly.
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The Production Decision of a Monopoly Firm Alternative market structures: perfect competition monopolistic competition oligopoly monopoly
The following market attributes characterize the case of monopoly: –There is a single seller of a product having no close substitutes; there is only one source of supply. –There is complete information regarding price and product availability. –There are barriers to new firms entering the market.
Reasons for barriers to entry include the following: Government franchises and licenses Patents and copyrights Ownership of the entire supply of a resource Economies of scale (natural monopoly)
Generally, a firm has monopoly power if by producing more or less of the good, the market price is affected. A firm with monopoly power is a price-maker. Such a firm is not able to choose price and quantity.
The firm’s marginal revenue from selling an additional unit will be less than the price received for that unit; MR < P. Marginal revenue for a firm with monopoly power Suppose a firm’s demand curve is downward sloping and all units of the good are sold at the same price.
Marginal revenue is the additional revenue that results from the sale of an additional unit. MR = P - (reduction in price)(previous quantity) $8.30 = $9.10 - (.10 $/unit)(8 units) = $9.10 - $0.80
Explanation for why MR < P: To sell additional units, the firm must lower price. There is an associated revenue loss resulting from the infra-marginal units being sold at a lower price than would otherwise have been the case.
FACT: Marginal revenue can be negative even when price is positive. MR = P - (reduction in price)(previous quantity) -$0.10 = $4.90 - (.10 $/unit)(50 units) = $4.90 - $5.00
Q Q Q3Q3 Q Q1Q1 Q1Q1 Q1Q1 Q2Q2 Q2Q2 Q2Q2 Q3Q3 Q3Q3 Q4Q4 Q4Q4 Q4Q4 Q5Q5 Q5Q5 Q5Q5 $ $/Q P1P1 P2P2 P3P3 P4P4 P5P5 P TR D MR elastic demand inelastic demand TR 1 TR 2 TR 4 TR 3 TR 5 Marginal Revenue and the price elasticity of demand. Q Q3Q3 $/Q MR D
Marginal Revenue and the price elasticity of demand. D P Q Unit elastic demand Inelastic demand Elastic demand MR
FACT: A firm having monopoly power will never choose to produce a level of output corresponding to an inelastic point on its demand curve. Π = TR - TC If demand is price inelastic, reducing the level of output will result in an increase in TR and a reduction in TC, implying an increase in profits, Π.
Q $ per unit MC AVC P1P1 Q1Q1 D MR What level of output will the firm produce? Q2Q2
Profit maximizing output rule: A profit-maximizing firm will produce the level of output where MC = MR, provided that the corresponding total revenue is at least as large as than associated total variable cost (i.e., P > AVC). If the price corresponding to the output where MR = MC is less than the corresponding AVC, the firm will shut down.
In the long-run, a monopolist may exit or adjust its scale of production (i.e., adjust its mix of inputs). Profits will be nonnegative in the long-run. If a firm continues to produce, it will do so at the lowest average cost possible.
Q P $/Q MC Q1Q1 P1P1 Q2Q2 D MR Marginal value to buyer (and society) Marginal private (and social) cost Marginal value to monopolist The Welfare Cost of Monopoly
Q P $/Q MC Q1Q1 P1P1 Q2Q2 D MR deadweight loss Q P $/Q MC Q1Q1 P1P1 Q2Q2 D MR monopoly output efficient quantity The Welfare Cost of Monopoly monopoly output efficient quantity
Perfect Price Discrimination A monopolist who knows each buyer’s demand (willingness to pay) and is able to charge each buyer a different price for each unit purchased is said to be able to perfectly price discriminate.