Pricing and Output Decisions:: Monopolistic Competition and Oligopoly

Chapter 10
Pricing and Output

MONOPOLY
Decisions: Monopolistic
Competition and Oligopoly
Managerial Economics: Economic
MICROECONOMICS (ECO101)
Tools forMNU
Today’s Decision
Business Makers, 4/e
School
By
ThePaul Keat and
Maldives PhilipUnivers
National Young
Ahmed Munawar
MONOPOLY MARKETS
• A monopoly market consists of one

firm.
• The firm is the market.
• Power to establish any price it wants.
• The firm’s ability to set price is limited
by the demand curve for its product,
and in particular, the price elasticity of
demand.
Lecturer:The
KemMaldives National PhD
Reat Viseth, University
(Economics) Microeconomics Ahmed
Managerial Economics, 4/e, Munawar
Keat/Young
Pricing and Output Decisions in
Monopoly Markets
• In the graph,
assume
• Demand is linear
which implies that
MR is linear and
twice as steep.
• MC is constant.
• How much should
the firm produce to
maximize profit?
Lecturer:The
Keat/Young
Monopoly Markets
• In the graph, assume
• Demand is linear
which implies that MR
is linear and twice as
steep.
• Diminishing returns.
• How much should the
firm produce to
maximize profit?
Lecturer:The
Keat/Young
Monopoly Markets
• Using the information in the following
table, determine how much the firm
should produce in order to maximize
profits.
Lecturer:The
Keat/Young
Monopoly Markets
Lecturer:The
Keat/Young
Monopoly Markets
Lecturer:The
Keat/Young
Monopoly Markets
• Graphically:
• Set output where
MR=MC
• At this output,
read the price to
set off of the
demand curve.
• Profits = rectangle
ABCD
Lecturer:The
Keat/Young
Five Sources of Market Power
1. Exclusive control over inputs

2. Patents and copyrights
3. Government licenses or franchises
4. Economies of scale (natural
monopolies)
5. Network economies
Lecturer:The
Keat/Young
Monopoly and How It Arises
 Monopoly Price-Setting Strategies

• For a monopoly firm to determine the quantity it sells,
it must choose the appropriate price.
• There are two types of monopoly price-setting
strategies:
1. A single-price monopoly is a firm that must sell each unit
of its output for the same price to all its customers.
2. Price discrimination is the practice of selling different
units of a good or service for different prices. Many firms
price discriminate, but not all of them are monopoly firms.
Lecturer:The
Keat/Young
A Single-Price Monopoly’s Output and
Price Decision
• Price and Marginal Revenue

• A monopoly is a price setter, not a price
taker like a firm in perfect competition.
• The reason is that the demand for the
monopoly’s output is the market demand.
• To sell a larger output, a monopoly must set
a lower price.
Lecturer:The
Keat/Young
Price Decision
• Figure illustrates
the relationship
between price and
marginal revenue
and derives the
marginal revenue
curve.
• Suppose the
monopoly sets a
price of $16 and
sells 2 units.
Lecturer:The
Keat/Young
Price Decision
• Now suppose the
firm cuts the price to
$14 to sell 3 units.
o It loses $4 of total revenue on
the 2 units it was selling at $16
each.
o And it gains $14 of total
revenue on the 3rd unit.
o So total revenue increases by
$10, which is marginal
revenue.
Lecturer:The
Keat/Young
Price Decision
• The marginal revenue
curve, MR, passes
through the red dot
midway between 2 and
3 units and at $10.
o You can see that MR < P at
each quantity.
o Compare this with perfect

competition
Lecturer:The
Keat/Young
Price Decision
• Marginal Revenue and

Elasticity
o A single-price
monopoly’s marginal
revenue is related to the
elasticity of demand for
its good:
o If demand is elastic, a fall
in price brings an
increase in total revenue.
Lecturer:The
Keat/Young
Price Decision
• The increase in revenue

from the increase in
quantity sold outweighs
the decrease in revenue
from the lower price
per unit, and MR is
positive.
• As the price falls, total
revenue increases.
Lecturer:The
Keat/Young
Price Decision
• If demand is inelastic, a
fall in price brings a
decrease in total
revenue.
• The rise in revenue
from the increase in
quantity sold is
outweighed by the fall
in revenue from the
lower price per unit,
and MR is negative.
Lecturer:The
Keat/Young
Price Decision
 As the price falls, total
revenue decreases.
o If demand is unit elastic, a fall
in price does not change total
revenue.
o The rise in revenue from the
increase in quantity sold
equals the fall in revenue
from the lower price per unit,
and MR = 0.
o Total revenue is maximized
when MR = 0.
Lecturer:The
Keat/Young
Price Decision
In Monopoly, Demand Is Always Elastic
 A single-price monopoly never produces an output at which
demand is inelastic.
 If it did produce such an output, the firm could increase total
revenue, decrease total cost, and increase economic profit by
decreasing output.
 The monopoly faces the same types of technology constraints as
the competitive firm, but the monopoly faces a different market
constraint.
 The monopoly selects the profit-maximizing quantity in the same
manner as a competitive firm, where MR = MC.
 The monopoly sets its price at the highest level at which it can sell
the profit-maximizing quantity.
Lecturer:The
Keat/Young
Price Decision
• The firm produces
the output at which
MR = MC and sets
the price at which it
can sell that quantity.
o The ATC curve tells us the

average total cost.
o Economic profit is the profit
per unit multiplied by the
quantity produced—the blue
rectangle.
Lecturer:The
Keat/Young
Price Decision
• The monopoly might make an economic
profit, even in the long run, because the
barriers to entry protect the firm from
market entry by competitor firms.
• But a monopoly that incurs an economic
loss might shut down temporarily in the
short run or exit the market in the long
run.
Lecturer:The
Keat/Young
Single-Price Monopoly and
Competition Compared
• Comparing Price and

Output
• Figure compares the price
and quantity in perfect
competition and
monopoly.
• The market demand
curve, D, in perfect
competition is the
demand curve that the
firm in monopoly faces.
Lecturer:The
Keat/Young
• The market supply

curve in perfect
competition is the
horizontal sum of the
individual firm’s
marginal cost curves,
S = MC.
• This curve is the
monopoly’s marginal
cost curve.
Lecturer:The
Keat/Young
Perfect Competition
• Equilibrium occurs
where the quantity
demanded equals the
quantity supplied at
quantity QC and
price PC.
Lecturer:The
Keat/Young
 Equilibrium output, QM,

occurs where marginal
revenue equals marginal cost,
MR = MC.
 Equilibrium price, PM, occurs
on the demand curve at the
profit-maximizing quantity.
 Compared to perfect
competition, monopoly
produces a smaller output and
charges a higher price.
Lecturer:The
Keat/Young
• Efficiency Comparison
• Figure shows the efficiency of
perfect competition.
• The market demand curve is
the marginal social benefit
curve, MSB, and the market
supply curve is the marginal
social cost curve, MSC.
• So competitive equilibrium is
efficient: MSB = MSC.
Lecturer:The
Keat/Young
 Total surplus, the

sum of the consumer
surplus and producer
surplus, is
maximized and the
quantity produced is
efficient.
Lecturer:The
Keat/Young
• Figure shows the

inefficiency of
monopoly.
• Because price exceeds
marginal social cost,
marginal social benefit
exceeds marginal social
cost, and a deadweight
loss arises.
Lecturer:The
Keat/Young
Redistribution of
Surpluses
• Some of the lost
consumer surplus
goes to the
monopoly as
producer surplus.
Lecturer:The
Keat/Young
Rent Seeking
• Any surplus—consumer surplus, producer surplus,
or economic profit—is called economic rent.
• Rent seeking is the pursuit of wealth by capturing
economic rent.
• Rent seekers pursue their goals in two main
ways:
o Buy a monopoly—transfers rent to creator of
monopoly.
o Create a monopoly—uses resources in political
activity.
Lecturer:The
Keat/Young
Rent-Seeking Equilibrium
• The resources used in

rent seeking can
exhaust the
monopoly’s economic
profit and the
monopoly breaks
even.
• Figure shows the rent
seeking equilibrium.
Lecturer:The
Keat/Young
Rent-Seeking Equilibrium
• A potential profit
shown by the blue
area gets used up in
rent seeking.
• Average total cost
increases and the
profits disappear to
become part of the
enlarged deadweight
loss from rent
seeking.
Lecturer:The
Keat/Young
Price Discrimination
• Price discrimination is the practice of selling

different units of a good or service for different
prices.
• To be able to price discriminate, a monopoly must:
1. Identify and separate different buyer types.
2. Sell a product that cannot be resold.
• Price differences that arise from cost differences
are not price discrimination.
Lecturer:The
Keat/Young
• Capturing Consumer Surplus
 Price discrimination captures consumer surplus and
converts it into economic profit.
 A monopoly can discriminate
 Among units of a good. Quantity discounts are an
example. (But quantity discounts that reflect lower
costs at higher volumes are not price
discrimination.)
 Among groups of buyers. (Advance purchase and
other restrictions on airline tickets are an example.)
Lecturer:The
Keat/Young
• Profiting by Price
Discriminating
o Figures show the same

market with a single price
and price discrimination.
o As a single-price monopoly,
this firm maximizes profit
by producing 8 trips a year
and selling them for $1,200
each.
Lecturer:The
Keat/Young
 By price
discriminating, the
firm can increase its
profit.
 In doing so, it converts

consumer surplus into
economic profit.
Lecturer:The
Keat/Young
Perfect price discrimination
 Perfect price discrimination

occurs if a firm is able to
sell each unit of output for
the highest price anyone is
willing to pay.
 Marginal revenue now

equals price and the
demand curve is also the
marginal revenue curve.
Lecturer:The
Keat/Young
Perfect price discrimination
• The profit-maximizing
output increases to the
quantity at which price
equals marginal cost.
• Economic profit increases

above that made by a
single-price monopoly.
• Deadweight loss is
eliminated.
Lecturer:The
Keat/Young
Efficiency and Rent Seeking with
• The more perfectly a monopoly can price

discriminate, the closer its output is to the
competitive output (P = MC) and the more efficient
is the outcome.
• But this outcome differs from the outcome of
perfect competition in two ways:
1. The monopoly captures the entire consumer surplus.
2. The increase in economic profit attracts even more
rent-seeking activity that leads to inefficiency.
Lecturer:The
Keat/Young
Monopoly Policy Issues
 A single-price monopoly creates

inefficiency and a price-discriminating
monopoly captures consumer surplus and
converts it into producer surplus and
economic profit.
 And monopoly encourages rent-seeking,
which wastes resources.
 But monopoly brings benefits.
Lecturer:The
Keat/Young
Gains from Monopoly
1. Incentives to Innovation
Patents and copyrights provide protection from
competition and let the monopoly enjoy the
profits stemming from innovation for a longer
period of time.
2. Economies of Scale and Scope
Where economies of scale or scope exist, a
monopoly can produce at a lower average total
cost than what a large number of competitive
firms could achieve.
Lecturer:The
Keat/Young
Natural monopoly
 A natural monopoly is an
industry in which economies
of scale enable one firm to
supply the entire market at
the lowest possible cost.
 Natural barriers to entry

create natural monopoly.
 When demand and cost

conditions create natural
monopoly, government
agencies regulate the
monopoly.
Lecturer:The
Keat/Young
Natural monopoly
 One firm can produce

4 millions units of output
at 5 cents per unit.
 Two firms can produce

4 million units—2 units
each—at 10 cents per
unit.
Lecturer:The
Keat/Young
Natural monopoly
 In a natural monopoly,
economies of scale are
so powerful that they are
still being achieved even
when the entire market
demand is met.
 The LRAC curve is still

sloping downward when
it meets the demand
curve.
Lecturer: Kem Reat Viseth, PhD (Economics) Managerial Economics, 4/e, Keat/Young
Natural monopoly
Profit Maximization
• The monopoly
maximizes economic
profit by producing the
quantity at which
marginal revenue equals
marginal cost and
charging the highest
price at which that
quantity will be bought.
Lecturer:The
Keat/Young
Natural monopoly
The Efficient Regulation
• Regulating a natural
monopoly in the social
interest sets the quantity
where MSB = MSC.
• With no external benefits, the
demand curve is the MSB
curve.
• With no external costs, the
marginal cost curve is the
MSC curve.
• Efficient regulation sets the
price equal to marginal cost.
Lecturer:The
Keat/Young
Natural monopoly
• Regulation that sets the
price equal to marginal
cost is called the marginal
cost pricing rule.
• The marginal cost pricing
rule is efficient but with
average cost exceeding
price, the firm incurs an
economic loss.
Lecturer:The
Keat/Young
Natural monopoly
• If the monopoly receives a
subsidy to cover its loss,
taxes must be imposed on
other economic activity,
which create deadweight
loss.
• Where possible, a regulated
natural monopoly might be
permitted to price
discriminate to cover the loss
from marginal cost pricing.
Lecturer:The
Keat/Young
Natural monopoly
Average Cost Pricing
 Another alternative is
to permit the firm to
produce the quantity at
which price equals
average cost and to set
the price equal to
average cost—the
average cost pricing
rule.
Lecturer:The
Keat/Young

Pricing and Output Decisions:: Monopolistic Competition and Oligopoly

Cargado por

Información del documento

Título original

Derechos de autor

Formatos disponibles

Compartir este documento

Compartir o incrustar documentos

Opciones para compartir

¿Le pareció útil este documento?

¿Este contenido es inapropiado?

Copyright:

Formatos disponibles

Pricing and Output Decisions:: Monopolistic Competition and Oligopoly

Cargado por

Copyright:

Formatos disponibles

Chapter 10

Pricing and Output

• A monopoly market consists of one

1. Exclusive control over inputs

 Monopoly Price-Setting Strategies

• Price and Marginal Revenue

o Compare this with perfect

• Marginal Revenue and

• The increase in revenue

o The ATC curve tells us the

• Comparing Price and

• The market supply

 Equilibrium output, QM,

 Total surplus, the

• Figure shows the

• The resources used in

• Price discrimination is the practice of selling

o Figures show the same

 In doing so, it converts

 Perfect price discrimination

 Marginal revenue now

• Economic profit increases

• The more perfectly a monopoly can price

 A single-price monopoly creates

 Natural barriers to entry

 When demand and cost

 One firm can produce

 Two firms can produce

 The LRAC curve is still

También podría gustarte