eaton micro 6e ch10
TRANSCRIPT
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Chapter 10
Monopoly
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Monopoly
A firm is a monopoly if no other firmproduces the same good or a closesubstitute for it.
The degree to which goods aresubstitutes is measured by the crossprice elasticityof demand
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The Monopolists Revenue Function
A monopolist faces a downward slopingmarket demand curve.
To sell additional units the monopolistmust lower its price. p=D(y).
Since all units must sell for the sameprice, p=average revenue (AR).
Total revenue is output times price:TR(y)=y(D)
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The Monopolists Revenue Function
Marginal revenue MR(y) is the rate atwhich total revenue changes withchanges in output.
Since the monopolist must reduce priceto sell additional units of output, for anypositive output, MR is less than price.
As p approaches zero, MR is equal to(p) plus quantity (y) multiplied by theslope of the demand curve.
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Figure 10.1 The monopolists marginal revenue
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Marginal Revenue and Price
Elasticity of Demand
Price elasticity of demand (E) at apoint (y, p) on the demand curve is:
E=p/(y x slope of demand curve)
Rearranging: MR(y)=p(1-1/lEl)
Marginal revenue is positive if
demand is price elastic and isnegative of demand is price inelastic.
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Figure 10.2 A linear demand function and the
associated total and marginal revenue functions
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From Figure 10.2
Linear demand curve: P=a-by
TR=P*y, Therefore: TR(y)=ay-by2
MR(y)=a-2byThe demand curve intersects the
quantity axis at a/b.
The MR curve intersects the quantityaxis at a/2b.
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From Figure 10.2
1. When TR function has a positiveslope, MR is positive.
2. When the TR function is at itsmaximum, MR is zero.
3. When TR function has a negativeslope slope, MR is negative.
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Maximizing Profit
Maximize profit by choosing output (y*)where MC intersects MR (from below).
From the demand curve, find the price(p*) that corresponds with the profitmaximizing y.
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Figure 10.3 Maximizing monopoly profit
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Figure 10.4 The inefficiency of monopoly
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The Inefficiency of Monopoly
Because p* exceeds MC in equilibrium, somepotential gains from trade are not realized.
Efficiency requires producing output to the
point where p=MC. The monopoly equilibrium isnot Pareto-optimal.
A deadweight loss occurs because atequilibrium there exists unrealized gains fromtrade, signalling unrealized monopoly profit.
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Sources of Monopoly
Government Franchise
Patent Monopoly
Resource Based MonopolyTechnological (Natural) Monopoly
Monopoly by Good Management
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Figure 10.5 Natural monopoly
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Regulatory Responses to a
Natural Monopoly
Average Cost Pricing: Forcing themonopoly to produce a level ofoutput where p=AC.
This regulation will fail to minimizeproduction costs.
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Figure 10.6 Average cost pricing
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Regulatory Responses to a
Natural Monopoly
Rate of Return Regulation: Aimed atlimiting the rate of return oninvested capital.
Under this regulation, the firm willchoose an input bundle that is notcost minimizing, choosing too much
capital and too little labour.
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Figure 10.7 Rate-of-return regulation
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Patent Policy
Appropriability Problem: Manyinventions with social value are notpursued because inventors do not
have the private incentives to pursuethem (they are not able to capturethe social benefits).
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Figure 10.8 The inducement to develop
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Optimal Patent Policy
At the optimal patent period, themarginal social benefit of increasingthe patent period is equal to the
marginal social cost.