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

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9 Aug 2016
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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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