清华经管IMBA管理经济学课件8

清华经管IMBA管理经济学课件8CHAPTER10OUTLINE10.1Monopoly10.2MonopolyPower10.3SourcesofMonopolyPower10.4TheSocialCostsofMonopolyPowerCHAPTER10OUTLINE10.1Monopol● monopolyMarketwithonlyoneseller.● monopsonyMarketwithonlyonebuyer.●

marketpowerAbilityofasellerorbuyertoaffectthepriceofagood.MarketPower:MonopolyandMonopsony● monopolyMarketwithonlyMONOPOLY10.1AverageRevenueandMarginalRevenue●

marginalrevenueChangeinrevenueresultingfromaone-unitincreaseinoutput.TABLE10.1 Total,Marginal,andAverageRevenue

Total Marginal Average Price(P) Quantity(Q) Revenue(R) Revenue(MR) Revenue(AR) $6 0 $0 --- --- 5 1 5 $5 $5 4 2 8 3 4 3 3 9 1 3 2 4 8 -1 2 1 5 5 -3 1P=6-QMONOPOLY10.1AverageRevenueanMONOPOLY10.1AverageRevenueandMarginalRevenueAverageandmarginalrevenueareshownforthedemandcurve

P=6−Q.AverageandMarginalRevenueFigure10.1MONOPOLY10.1AverageRevenueanMONOPOLY10.1TheMonopolist’sOutputDecisionQ*istheoutputlevelatwhichMR=MC.Ifthefirmproducesasmalleroutput—say,Q1—itsacrificessomeprofitbecausetheextrarevenuethatcouldbeearnedfromproducingandsellingtheunitsbetweenQ1andQ*exceedsthecostofproducingthem.Similarly,expandingoutputfromQ*toQ2wouldreduceprofitbecausetheadditionalcostwouldexceedtheadditionalrevenue.ProfitIsMaximizedWhenMarginalRevenueEqualsMarginalCostFigure10.2MONOPOLY10.1TheMonopolist’sOMONOPOLY10.1TheMonopolist’sOutputDecisionWecanalsoseealgebraicallythatQ*maximizesprofit.Profitπisthedifferencebetweenrevenueandcost,bothofwhichdependonQ:AsQisincreasedfromzero,profitwillincreaseuntilitreachesamaximumandthenbegintodecrease.Thustheprofit-maximizingQissuchthattheincrementalprofitresultingfromasmallincreaseinQisjustzero(i.e.,Δπ/ΔQ=0).ThenButΔR/ΔQismarginalrevenueandΔC/ΔQismarginalcost.Thustheprofit-maximizingconditionisthat,orMONOPOLY10.1TheMonopolist’sOMONOPOLY10.1AnExamplePart(a)showstotalrevenueR,totalcostC,andprofit,thedifferencebetweenthetwo.Part(b)showsaverageandmarginalrevenueandaverageandmarginalcost.Marginalrevenueistheslopeofthetotalrevenuecurve,andmarginalcostistheslopeofthetotalcostcurve.Theprofit-maximizingoutputisQ*=10,thepointwheremarginalrevenueequalsmarginalcost.Atthisoutputlevel,theslopeoftheprofitcurveiszero,andtheslopesofthetotalrevenueandtotalcostcurvesareequal.Theprofitperunitis$15,thedifferencebetweenaveragerevenueandaveragecost.Because10unitsareproduced,totalprofitis$150.ExampleofProfitMaximizationFigure10.3C(Q)=50+Q2P(Q)=40-QMONOPOLY10.1AnExamplePart(a)MONOPOLY10.1ARuleofThumbforPricingWewanttotranslatetheconditionthatmarginalrevenueshouldequalmarginalcostintoaruleofthumbthatcanbemoreeasilyappliedinpractice.Todothis,wefirstwritetheexpressionformarginalrevenue:MONOPOLY10.1ARuleofThumbfoMONOPOLY10.1ARuleofThumbforPricingNotethattheextrarevenuefromanincrementalunitofquantity,Δ(PQ)/ΔQ,hastwocomponents:1.ProducingoneextraunitandsellingitatpricePbringsinrevenue(1)(P)=P.2.Butbecausethefirmfacesadownward-slopingdemandcurve,producingandsellingthisextraunitalsoresultsinasmalldropinpriceΔP/ΔQ,whichreducestherevenuefromallunitssold(i.e.,achangeinrevenueQ[ΔP/ΔQ]).Thus,MONOPOLY10.1ARuleofThumbfoMONOPOLY10.1ARuleofThumbforPricing(Q/P)(ΔP/ΔQ)isthereciprocaloftheelasticityofdemand,1/Ed,measuredattheprofit-maximizingoutput,andNow,becausethefirm’sobjectiveistomaximizeprofit,wecansetmarginalrevenueequaltomarginalcost:whichcanberearrangedtogiveus(10.1)Equivalently,wecanrearrangethisequationtoexpresspricedirectlyasamarkupovermarginalcost:(10.2)MONOPOLY10.1ARuleofThumbfoIn1995,Prilosec,representedanewgenerationofantiulcermedication.Prilosecwasbasedonaverydifferentbiochemicalmechanismandwasmuchmoreeffectivethanearlierdrugs.By1996,ithadbecomethebest-sellingdrugintheworldandfacednomajorcompetitor.Astra-MerckwaspricingPrilosecatabout$3.50perdailydose.ThemarginalcostofproducingandpackagingPrilosecisonlyabout30to40centsperdailydose.Thepriceelasticityofdemand,ED,shouldbeintherangeofroughly−1.0to−1.2.Settingthepriceatamarkupexceeding400percentovermarginalcostisconsistentwithourruleofthumbforpricing.MONOPOLY10.1In1995,Prilosec,representedMONOPOLY10.1ShiftsinDemandAmonopolisticmarkethasnosupplycurve.Thereasonisthatthemonopolist’soutputdecisiondependsnotonlyonmarginalcostbutalsoontheshapeofthedemandcurve.Shiftsindemandcanleadtochangesinpricewithnochangeinoutput,changesinoutputwithnochangeinprice,orchangesinbothpriceandoutput.MONOPOLY10.1ShiftsinDemandAMONOPOLY10.1ShiftsinDemandShiftingthedemandcurveshowsthatamonopolisticmarkethasnosupplycurve—i.e.,thereisnoone-to-onerelationshipbetweenpriceandquantityproduced.In(a),thedemandcurveD1shiftstonewdemandcurveD2.ButthenewmarginalrevenuecurveMR2intersectsmarginalcostatthesamepointastheoldmarginalrevenuecurveMR1.Theprofit-maximizingoutputthereforeremainsthesame,althoughpricefallsfromP1toP2.In(b),thenewmarginalrevenuecurveMR2intersectsmarginalcostatahigheroutputlevelQ2.Butbecausedemandisnowmoreelastic,priceremainsthesame.ShiftsinDemandFigure10.4MONOPOLY10.1ShiftsinDemandShMONOPOLY10.1TheEffectofaTaxWithataxtperunit,thefirm’seffectivemarginalcostisincreasedbytheamounttto

MC+t.Inthisexample,theincreaseinpriceΔPislargerthanthetaxt.EffectofExciseTaxonMonopolistFigure10.5Supposeaspecifictaxoftdollarsperunitislevied,sothatthemonopolistmustremittdollarstothegovernmentforeveryunititsells.IfMCwasthefirm’soriginalmarginalcost,itsoptimalproductiondecisionisnowgivenbyMONOPOLY10.1TheEffectofaTaMONOPOLY10.1*TheMultiplantFirmSupposeafirmhastwoplants.Whatshoulditstotaloutputbe,andhowmuchofthatoutputshouldeachplantproduce?Wecanfindtheanswerintuitivelyintwosteps.●

Step1.Whateverthetotaloutput,itshouldbedividedbetweenthetwoplantssothatmarginalcostisthesameineachplant.Otherwise,thefirmcouldreduceitscostsandincreaseitsprofitbyreallocatingproduction.●

Step2.Weknowthattotaloutputmustbesuchthatmarginalrevenueequalsmarginalcost.Otherwise,thefirmcouldincreaseitsprofitbyraisingorloweringtotaloutput.MONOPOLY10.1*TheMultiplantFiMONOPOLY10.1*TheMultiplantFirmWecanalsoderivethisresultalgebraically.LetQ1andC1betheoutputandcostofproductionforPlant1,Q2andC2betheoutputandcostofproductionforPlant2,andQT=Q1+Q2betotaloutput.ThenprofitisThefirmshouldincreaseoutputfromeachplantuntiltheincrementalprofitfromthelastunitproducediszero.StartbysettingincrementalprofitfromoutputatPlant1tozero:HereΔ(PQT)/ΔQ1istherevenuefromproducingandsellingonemoreunit—i.e.,marginalrevenue,MR,forallofthefirm’soutput.MONOPOLY10.1*TheMultiplantFiMONOPOLY10.1*TheMultiplantFirmThenextterm,ΔC1/ΔQ1,ismarginalcostatPlant1,MC1.WethushaveMR−MC1=0,orSimilarly,wecansetincrementalprofitfromoutputatPlant2tozero,Puttingtheserelationstogether,weseethatthefirmshouldproducesothat(10.3)MONOPOLY10.1*TheMultiplantFiMONOPOLY10.1*TheMultiplantFirmAfirmwithtwoplantsmaximizesprofitsbychoosingoutputlevelsQ1andQ2sothatmarginalrevenueMR(whichdependsontotaloutput)equalsmarginalcostsforeachplant,MC1andMC2.ProductionwithTwoPlantsFigure10.6MONOPOLY10.1*TheMultiplantFiMONOPOLYPOWER10.2Part(a)showsthemarketdemandfortoothbrushes.Part(b)showsthedemandfortoothbrushesasseenbyFirmA.Atamarketpriceof$1.50,elasticityofmarketdemandis−1.5.FirmA,however,seesamuchmoreelasticdemandcurveDAbecauseofcompetitionfromotherfirms.Atapriceof$1.50,FirmA’sdemandelasticityis−6.Still,FirmAhassomemonopolypower:Itsprofit-maximizingpriceis$1.50,whichexceedsmarginalcost.TheDemandforToothbrushesFigure10.7MONOPOLYPOWER10.2Part(a)shoMONOPOLYPOWER10.2Remembertheimportantdistinctionbetweenaperfectlycompetitivefirmandafirmwithmonopolypower:Forthecompetitivefirm,priceequalsmarginalcost;forthefirmwithmonopolypower,priceexceedsmarginalcost.MeasuringMonopolyPower●

LernerIndexofMonopolyPowerMeasureofmonopolypowercalculatedasexcessofpriceovermarginalcostasafractionofprice.Mathematically:Thisindexofmonopolypowercanalsobeexpressedintermsoftheelasticityofdemandfacingthefirm.(10.4)MONOPOLYPOWER10.2RemembertheMONOPOLYPOWER10.2TheRuleofThumbforPricingThemarkup(P−MC)/Pisequaltominustheinverseoftheelasticityofdemandfacingthefirm.Ifthefirm’sdemandiselastic,asin(a),themarkupissmallandthefirmhaslittlemonopolypower.Theoppositeistrueifdemandisrelativelyinelastic,asin(b).ElasticityofDemandandPriceMarkupFigure10.8MONOPOLYPOWER10.2TheRuleofMONOPOLYPOWER10.2Althoughtheelasticityofmarketdemandforfoodissmall(about−1),nosinglesupermarketcanraiseitspricesverymuchwithoutlosingcustomerstootherstores.Theelasticityofdemandforanyonesupermarketisoftenaslargeas−10.

WefindP=MC/(1−0.1)=MC/(0.9)=(1.11)MC.Themanagerofatypicalsupermarketshouldsetpricesabout11percentabovemarginalcost.Smallconveniencestorestypicallychargehigherpricesbecauseitscustomersaregenerallylesspricesensitive.Becausetheelasticityofdemandforaconveniencestoreisabout−5,themarkupequationimpliesthatitspricesshouldbeabout25percentabovemarginalcost.Withdesignerjeans,demandelasticitiesintherangeof−2to−3aretypical.Thismeansthatpriceshouldbe50to100percenthigherthanmarginalcost.MONOPOLYPOWER10.2AlthoughtheMONOPOLYPOWER10.2TABLE10.2RetailPricesofVHSandDVDs2007TitleRetailPriceDVDPurpleRain $29.88RaidersoftheLostArk $24.95JaneFondaWorkout $59.95TheEmpireStrikesBack $79.98AnOfficerandaGentleman $24.95StarTrek:TheMotionPicture $24.95StarWars $39.981985TitleRetailPriceVHSPiratesoftheCaribbean $19.99TheDaVinciCode $19.99Mission:ImpossibleIII $17.99KingKong $19.98HarryPotterandtheGobletofFire $17.49IceAge $19.99TheDevilWearsPrada $17.99Source(2007):Basedon.Suggestedretailprice.MONOPOLYPOWER10.2TABLE10.2MONOPOLYPOWER10.2Between1990and1998,lowerpricesinducedconsumerstobuymanymorevideos.By2001,salesofDVDsovertooksalesofVHSvideocassettes.High-definitionDVDswereintroducedin2006,andareexpectedtodisplacesalesofconventionalDVDs.VideoSalesFigure10.9MONOPOLYPOWER10.2Between1990SOURCESOFMONOPOLYPOWER10.3Ifthereisonlyonefirm—apuremonopolist—itsdemandcurveisthemarketdemandcurve.Becausethedemandforoilisfairlyinelastic(atleastintheshortrun),OPECcouldraiseoilpricesfarabovemarginalproductioncostduringthe1970sandearly1980s.Becausethedemandsforsuchcommoditiesascoffee,cocoa,tin,andcopperaremuchmoreelastic,attemptsbyproducerstocartelizethesemarketsandraisepriceshavelargelyfailed.Ineachcase,theelasticityofmarketdemandlimitsthepotentialmonopolypowerofindividualproducers.TheElasticityofMarketDemandSOURCESOFMONOPOLYPOWER10.3ISOURCESOFMONOPOLYPOWER10.3Whenonlyafewfirmsaccountformostofthesalesinamarket,wesaythatthemarketishighlyconcentrated.TheNumberofFirms● barriertoentryConditionthatimpedesentrybynewcompetitors.SOURCESOFMONOPOLYPOWER10.3WSOURCESOFMONOPOLYPOWER10.3Firmsmightcompeteaggressively,undercuttingoneanother’spricestocapturemoremarketshare.Thiscoulddrivepricesdowntonearlycompetitivelevels.Firmsmightevencollude(inviolationoftheantitrustlaws),agreeingtolimitoutputandraiseprices.Becauseraisingpricesinconcertratherthanindividuallyismorelikelytobeprofitable,collusioncangeneratesubstantialmonopolypower.TheInteractionAmongFirmsSOURCESOFMONOPOLYPOWER10.3FTHESOCIALCOSTSOFMONOPOLYPOWER10.4Theshadedrectangleandtrianglesshowchangesinconsumerandproducersurpluswhenmovingfromcompetitivepriceandquantity,PcandQc,toamonopolist’spriceandquantity,PmandQm.Becauseofthehigherprice,consumersloseA+B

andproducergainsA−C.ThedeadweightlossisB+C.DeadweightLossfromMonopolyPowerFigure10.10THESOCIALCOSTSOFMONOPOLYPTHESOCIALCOSTSOFMONOPOLYPOWER10.4RentSeeking●

rentseekingSpendingmoneyinsociallyunproductiveeffortstoacquire,maintain,orexercisemonopoly.In1996,theArcherDanielsMidlandCompany(ADM)successfullylobbiedtheClintonadministrationforregulationsrequiringthattheethanol(ethylalcohol)usedinmotorvehiclefuelbeproducedfromcorn.Why?BecauseADMhadanearmonopolyoncorn-basedethanolproduction,sotheregulationwouldincreaseitsgainsfrommonopolypower.THESOCIALCOSTSOFMONOPOLYPTHESOCIALCOSTSOFMONOPOLYPOWER10.4PriceRegulationIfleftalone,amonopolistproducesQmandchargesPm.WhenthegovernmentimposesapriceceilingofP1thefirm’saverageandmarginalrevenueareconstantandequaltoP1foroutputlevelsuptoQ1.Forlargeroutputlevels,theoriginalaverageandmarginalrevenuecurvesapply.Thenewmarginalrevenuecurveis,therefore,thedarkpurpleline,whichintersectsthemarginalcostcurveatQ1.PriceRegulationFigure10.11THESOCIALCOSTSOFMONOPOLYPTHESOCIALCOSTSOFMONOPOLYPOWER10.4PriceRegulationWhenpriceisloweredtoPc,atthepointwheremarginalcostintersectsaveragerevenue,outputincreasestoitsmaximumQc.Thisistheoutputthatwouldbeproducedbyacompetitiveindustry.Loweringpricefurther,toP3reducesoutputtoQ3andcausesashortage,

Q’3−Q3.PriceRegulationFigure10.11THESOCIALCOSTSOFMONOPOLYPTHESOCIALCOSTSOFMONOPOLYPOWER10.4NaturalMonopolyAfirmisanaturalmonopolybecauseithaseconomiesofscale(decliningaverageandmarginalcosts)overitsentireoutputrange.IfpricewereregulatedtobePcthefirmwouldlosemoneyandgooutofbusiness.SettingthepriceatPryieldsthelargestpossibleoutputconsistentwiththefirm’sremaininginbusiness;excessprofitiszero.● naturalmonopolyFirmthatcanproducetheentireoutputofthemarketatacostlowerthanwhatitwouldbeiftherewereseveralfirms.RegulatingthePriceofaNaturalMonopolyFigure10.12THESOCIALCOSTSOFMONOPOLYPTHESOCIALCOSTSOFMONOPOLYPOWERRegulationinPractice● rate-of-returnregulationMaximumpriceallowedbyaregulatoryagencyisbasedonthe(expected)rateofreturnthatafirmwillearn.Thedifficultyofagreeingonasetofnumberstobeusedinrate-of-returncalculationsoftenleadstodelaysintheregulatoryresponsetochangesincostandothermarketconditions.Thenetresultisregulatorylag—thedelaysofayearormoreusuallyentailedinchangingregulatedprices.THESOCIALCOSTSOFMONOPOLYPMiniCase-TakingaDimViewofSolarEnergy

AnalyzingtheNewsUtilitieshavelonghadmonopoliesinelectricpowergeneration.However,ascostscomedownforindividualsystemsthesebigutilitycompaniesarebeginningtogetconcerned.Fewercustomersmeanthatlongrunaveragecostswillincrease.Itwillbeinterestingtoseeifthebusinessmodelfollowedbythesemonopolieswillholdupwithmorecompetition.ThinkingCriticallyQuestionsWhyhaveutilitieshadmonopolypoweruptothispoint?Whatareeconomiesofscale?Whyareutilitycompaniesattemptingtothwartthegrowthofrooftopsolarpower?MiniCase-TakingaDimViewMiniCase-BehindOil'sSurprisingSurgeOilpricesmovedabove$70abarrelfromalowof$34onFebruary12,2009.Thehigherpricecomesinspiteofthefactthatworlddemandforoilisexpectedtofallbyabout3percentthisyearduetotheglobalrecession.Themarketisbeingdrivenhigherfortworeasons.OnereasonisthattheOrganizationofPetroleumExportingCountries(OPEC)hasslashedoutput.OPECmaintainstheworldpriceofoilshouldbebetween$75and$85abarrelinordertokeepexplorationandreinvestmentgoingandnotharmtheeconomicrecovery.AndthistimemostofOPEC'smembersappeartobefollowingthequotas.Thesecondreasonisspeculation.Investorsanticipatingaglobalrecoveryarelookingatcommoditiesastheplacetoparkcash.ThestockmarketisexpectedtolanguishorevenfallgiveninflationfearsfortheU.S.dollar.Theresultisthatinvestorsarepouringmoneyintoothercurrencies,oilandvariousothercommodities.MiniCase-BehindOil'sSurprMiniCase-TakingaDimViewofSolarEnergy

AnalyzingtheNewsOPEC'ssuccessfuloutputrestriction,coupledwithspeculation,haspushedoilpriceshigher.Asyoucanseeinthepreviousgraphaleftwardshiftinthesupplycurvepushespriceshigherandquantitylower.However,notshowninthegraphisanincreaseinspeculativedemandwhichwouldpushpricesevenhigherthanP1.FearofafallingU.S.dollarisdrivingmoneyoutofequitiesandtowardscommoditieslikeoil.

ThinkingCriticallyQuestionsWhyareoilpricesmovinghigher?WhyisOPECrestrictingoutput?WhatisOPEC'srationaleforhigheroilprices?MiniCase-TakingaDimViewPleaseReadtheMini-CaseStory,thenNextClassWewillinvitestudentstodiscussonCaseAnalysis!!!PleaseReadtheMini-CaseStor清华经管IMBA管理经济学课件8CHAPTER10OUTLINE10.1Monopoly10.2MonopolyPower10.3SourcesofMonopolyPower10.4TheSocialCostsofMonopolyPowerCHAPTER10OUTLINE10.1Monopol● monopolyMarketwithonlyoneseller.● monopsonyMarketwithonlyonebuyer.●

marketpowerAbilityofasellerorbuyertoaffectthepriceofagood.MarketPower:MonopolyandMonopsony● monopolyMarketwithonlyMONOPOLY10.1AverageRevenueandMarginalRevenue●

marginalrevenueChangeinrevenueresultingfromaone-unitincreaseinoutput.TABLE10.1 Total,Marginal,andAverageRevenue

Total Marginal Average Price(P) Quantity(Q) Revenue(R) Revenue(MR) Revenue(AR) $6 0 $0 --- --- 5 1 5 $5 $5 4 2 8 3 4 3 3 9 1 3 2 4 8 -1 2 1 5 5 -3 1P=6-QMONOPOLY10.1AverageRevenueanMONOPOLY10.1AverageRevenueandMarginalRevenueAverageandmarginalrevenueareshownforthedemandcurve

P=6−Q.AverageandMarginalRevenueFigure10.1MONOPOLY10.1AverageRevenueanMONOPOLY10.1TheMonopolist’sOutputDecisionQ*istheoutputlevelatwhichMR=MC.Ifthefirmproducesasmalleroutput—say,Q1—itsacrificessomeprofitbecausetheextrarevenuethatcouldbeearnedfromproducingandsellingtheunitsbetweenQ1andQ*exceedsthecostofproducingthem.Similarly,expandingoutputfromQ*toQ2wouldreduceprofitbecausetheadditionalcostwouldexceedtheadditionalrevenue.ProfitIsMaximizedWhenMarginalRevenueEqualsMarginalCostFigure10.2MONOPOLY10.1TheMonopolist’sOMONOPOLY10.1TheMonopolist’sOutputDecisionWecanalsoseealgebraicallythatQ*maximizesprofit.Profitπisthedifferencebetweenrevenueandcost,bothofwhichdependonQ:AsQisincreasedfromzero,profitwillincreaseuntilitreachesamaximumandthenbegintodecrease.Thustheprofit-maximizingQissuchthattheincrementalprofitresultingfromasmallincreaseinQisjustzero(i.e.,Δπ/ΔQ=0).ThenButΔR/ΔQismarginalrevenueandΔC/ΔQismarginalcost.Thustheprofit-maximizingconditionisthat,orMONOPOLY10.1TheMonopolist’sOMONOPOLY10.1AnExamplePart(a)showstotalrevenueR,totalcostC,andprofit,thedifferencebetweenthetwo.Part(b)showsaverageandmarginalrevenueandaverageandmarginalcost.Marginalrevenueistheslopeofthetotalrevenuecurve,andmarginalcostistheslopeofthetotalcostcurve.Theprofit-maximizingoutputisQ*=10,thepointwheremarginalrevenueequalsmarginalcost.Atthisoutputlevel,theslopeoftheprofitcurveiszero,andtheslopesofthetotalrevenueandtotalcostcurvesareequal.Theprofitperunitis$15,thedifferencebetweenaveragerevenueandaveragecost.Because10unitsareproduced,totalprofitis$150.ExampleofProfitMaximizationFigure10.3C(Q)=50+Q2P(Q)=40-QMONOPOLY10.1AnExamplePart(a)MONOPOLY10.1ARuleofThumbforPricingWewanttotranslatetheconditionthatmarginalrevenueshouldequalmarginalcostintoaruleofthumbthatcanbemoreeasilyappliedinpractice.Todothis,wefirstwritetheexpressionformarginalrevenue:MONOPOLY10.1ARuleofThumbfoMONOPOLY10.1ARuleofThumbforPricingNotethattheextrarevenuefromanincrementalunitofquantity,Δ(PQ)/ΔQ,hastwocomponents:1.ProducingoneextraunitandsellingitatpricePbringsinrevenue(1)(P)=P.2.Butbecausethefirmfacesadownward-slopingdemandcurve,producingandsellingthisextraunitalsoresultsinasmalldropinpriceΔP/ΔQ,whichreducestherevenuefromallunitssold(i.e.,achangeinrevenueQ[ΔP/ΔQ]).Thus,MONOPOLY10.1ARuleofThumbfoMONOPOLY10.1ARuleofThumbforPricing(Q/P)(ΔP/ΔQ)isthereciprocaloftheelasticityofdemand,1/Ed,measuredattheprofit-maximizingoutput,andNow,becausethefirm’sobjectiveistomaximizeprofit,wecansetmarginalrevenueequaltomarginalcost:whichcanberearrangedtogiveus(10.1)Equivalently,wecanrearrangethisequationtoexpresspricedirectlyasamarkupovermarginalcost:(10.2)MONOPOLY10.1ARuleofThumbfoIn1995,Prilosec,representedanewgenerationofantiulcermedication.Prilosecwasbasedonaverydifferentbiochemicalmechanismandwasmuchmoreeffectivethanearlierdrugs.By1996,ithadbecomethebest-sellingdrugintheworldandfacednomajorcompetitor.Astra-MerckwaspricingPrilosecatabout$3.50perdailydose.ThemarginalcostofproducingandpackagingPrilosecisonlyabout30to40centsperdailydose.Thepriceelasticityofdemand,ED,shouldbeintherangeofroughly−1.0to−1.2.Settingthepriceatamarkupexceeding400percentovermarginalcostisconsistentwithourruleofthumbforpricing.MONOPOLY10.1In1995,Prilosec,representedMONOPOLY10.1ShiftsinDemandAmonopolisticmarkethasnosupplycurve.Thereasonisthatthemonopolist’soutputdecisiondependsnotonlyonmarginalcostbutalsoontheshapeofthedemandcurve.Shiftsindemandcanleadtochangesinpricewithnochangeinoutput,changesinoutputwithnochangeinprice,orchangesinbothpriceandoutput.MONOPOLY10.1ShiftsinDemandAMONOPOLY10.1ShiftsinDemandShiftingthedemandcurveshowsthatamonopolisticmarkethasnosupplycurve—i.e.,thereisnoone-to-onerelationshipbetweenpriceandquantityproduced.In(a),thedemandcurveD1shiftstonewdemandcurveD2.ButthenewmarginalrevenuecurveMR2intersectsmarginalcostatthesamepointastheoldmarginalrevenuecurveMR1.Theprofit-maximizingoutputthereforeremainsthesame,althoughpricefallsfromP1toP2.In(b),thenewmarginalrevenuecurveMR2intersectsmarginalcostatahigheroutputlevelQ2.Butbecausedemandisnowmoreelastic,priceremainsthesame.ShiftsinDemandFigure10.4MONOPOLY10.1ShiftsinDemandShMONOPOLY10.1TheEffectofaTaxWithataxtperunit,thefirm’seffectivemarginalcostisincreasedbytheamounttto

MC+t.Inthisexample,theincreaseinpriceΔPislargerthanthetaxt.EffectofExciseTaxonMonopolistFigure10.5Supposeaspecifictaxoftdollarsperunitislevied,sothatthemonopolistmustremittdollarstothegovernmentforeveryunititsells.IfMCwasthefirm’soriginalmarginalcost,itsoptimalproductiondecisionisnowgivenbyMONOPOLY10.1TheEffectofaTaMONOPOLY10.1*TheMultiplantFirmSupposeafirmhastwoplants.Whatshoulditstotaloutputbe,andhowmuchofthatoutputshouldeachplantproduce?Wecanfindtheanswerintuitivelyintwosteps.●

Step1.Whateverthetotaloutput,itshouldbedividedbetweenthetwoplantssothatmarginalcostisthesameineachplant.Otherwise,thefirmcouldreduceitscostsandincreaseitsprofitbyreallocatingproduction.●

Step2.Weknowthattotaloutputmustbesuchthatmarginalrevenueequalsmarginalcost.Otherwise,thefirmcouldincreaseitsprofitbyraisingorloweringtotaloutput.MONOPOLY10.1*TheMultiplantFiMONOPOLY10.1*TheMultiplantFirmWecanalsoderivethisresultalgebraically.LetQ1andC1betheoutputandcostofproductionforPlant1,Q2andC2betheoutputandcostofproductionforPlant2,andQT=Q1+Q2betotaloutput.ThenprofitisThefirmshouldincreaseoutputfromeachplantuntiltheincrementalprofitfromthelastunitproducediszero.StartbysettingincrementalprofitfromoutputatPlant1tozero:HereΔ(PQT)/ΔQ1istherevenuefromproducingandsellingonemoreunit—i.e.,marginalrevenue,MR,forallofthefirm’soutput.MONOPOLY10.1*TheMultiplantFiMONOPOLY10.1*TheMultiplantFirmThenextterm,ΔC1/ΔQ1,ismarginalcostatPlant1,MC1.WethushaveMR−MC1=0,orSimilarly,wecansetincrementalprofitfromoutputatPlant2tozero,Puttingtheserelationstogether,weseethatthefirmshouldproducesothat(10.3)MONOPOLY10.1*TheMultiplantFiMONOPOLY10.1*TheMultiplantFirmAfirmwithtwoplantsmaximizesprof