# ECON201 Lecture Notes - Lecture 10: Economic Equilibrium, Price Ceiling, Monopsony

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ECON 221 – Chapter #10 Notes

•A Monopoly is the only supplier of a good for which there is no close substitute.

•A monopoly’s output is the market output, and the demand curve a monopoly

faces is the market demand curve.

•Unlike a competitive firm, a monopolist can set its price.

The monopolist’s average revenue curve is also the market demand curve .

MR is twice the slope of the demand curve (it is steeper). MR and AR hit the vertical axis

at the same point

The MR curve hits the horizontal (quantity) axis at half the quantity as the demand curve.

As a matter of fact:

For all linear demand functions with the form:

P(q)= a-bq MUST BE DERIVED FOR P not Q

MR=a-2bq

•At Q*, MR = MC. Profit maximizing condition

•If the firm produces Q1—it sacrifices some profit because the extra revenue exceeds

the cost of producing them.

•Increase Q* to Q2 would reduce profit because the additional cost would exceed the

additional revenue.

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MR is the slope of the total revenue curve, and MC is the slope of the total cost curve.

The profit-maximizing output is Q* = 10, the point where MR=MC (i.e., slopes of the

total revenue and total cost curves are equal).

The profit per unit is $15, the difference between average revenue and average cost.

Because 10 units are produced, total profit is $150

A Rule of Thumb for Pricing

We want to translate MR=MC into a rule of thumb that can be easily applied in practice.

Because the firm’s objective is to maximize profit, we can set MR=MC

Recall

If demand is elastic, TR increases when price falls. Since demand is elastic when price

falls then Qd will increase by more than price falls thus TR increases

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If demand is inelastic, TR decreases when price falls. Since demand is inelastic when

price falls then Qd will increase by LESS than price falls thus TR decreases

When q increases, p falls, then

1. If demand is elastic, MR is positive

2. If demand is inelastic, MR is negative

3. If demand is unitary elastic, MR is zero

A monopolist has no supply curve —i.e., there is no one-to-one relationship between

price and quantity produced.

The Effect of a Tax

Suppose a specific tax of t dollars per unit is levied, so that the monopolist must pay t

dollars to the government for every unit it sells.

With a tax t per unit, the firm’s effective marginal cost is increased by the amount t to

MC + t. In this example, the increase in price ΔP is larger than the tax t.

Observations

•MC shifts up to MC+t

•Intersection corresponds to output level q1

•Difference between P1 and P0 is caused by the tax

•Increase in P is larger than the amount in tax

•In this case, the MC happens to be constant

•Vertical distance would be t, this is the effect of the tax

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