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Lecture

ECO101H1 Lecture Notes - Marginal Revenue, Natural Monopoly, Price Discrimination


Department
Economics
Course Code
ECO101H1
Professor
James Pesando

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Topic 9 Monopoly
(Week night Nov 10th - Nov 15th)
Outline:
1. Definition;
2. MR < P (DD)
3. Profit-Maximizing output & price
4. Contrived Scarcity: when Competitive Industry is monopolized;
5. Price Discrimination;
6. Why is Monopoly Bad?
7. Natural Monopoly & Regulation of a natural monopoly.
Monopoly
-- Single seller of product with no close substitutes;
-- Barrier to entry:
1) legal barriers (legal monopoly);
-- e.g. post office (legal monopoly on first class mail); patents
2) natural barriers (natural monopoly);
MR < P
-- In monopoly, Marginal Revenue is always smaller than Price.
Why? Because monopolists face a downward-sloping demand unlike perfectly competitive firms face
horizontal demand.
The Output Effect: More output is sold, so Q is higher;
The Price Effect: The Price falls, so P is lower.
Monopoly Perfect Competition
Assume Q1-Q0=1 (an additional unit)
Q0 Q1 Quantity
Price
PPrice
ee
Q0 Q1 Quantity
Price
PPrice
ee
P0
P1
P0 = P1
MR = change in TR/change in Q
= (P1xQ1 P0XQ0)
= output effect price effect
= P1(Q1-Q0) Q0(P0-P1)
= P1 a real number
which is always smaller than simply P1
Monopolists face a downward-sloping
demand, so higher quantity must have a
trade-off of a lower price. Thus MR of
monopolists is affected by both output
effect and price effect;
Output effect
MR = change in TR/change in Q
= P1/( Q1-Q0)
= P1
Firms in perfect competition face a
horizontal demand curve, and the firm is
able to sell any quantity it likes in a constant
price. Thus there is no price effect on
individual firms in perfect competition.

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Therefore, the downward-sloping demand curve that monopolists face lead to the fact that at certain level
of output, its MR is always smaller than the price it charges at that quantity.
Numerical Example
P
Q
TR
(PXQ)
MR
(TR/Q)
10
0
0
-
9
1
9
9
8
2
16
7
7
3
21
5
6
4
24
3
5
5
25
1
4
6
24
-1
3
7
21
-3
2
8
16
-5
Profit Maximizing Output and Price
1. Monopolist chooses QM where MR=MC;
At Q1, MR > MC: the revenue of producing an additional unit of output exceeds the cost of it; the firm
should expand output;
At Q2, MR < MC: the cost of producing an additional unit of output exceeds the revenue of it; the firm
should contract output;
At Q0, MR = MC: the revenue of producing an additional unit of output equals the cost of it; this is the
profit maximizing level of output for the firm.
2. To sell the maximized output QM, monopolists must charge PM (according to the demand curve);
1 2 3 4 5 6 7 8 Quantity
Price
PPrice
ee
10
9
8
7
6
5
4
3
2
DD
MR
For monopolists, MR lies everywhere to the left of market DD.
Q1 QM Q2 Quantity
Price
PPrice
ee
DD
MR
MC
Observation:
1. Downward-Sloping demand;
2. The revenue you received for additional
output is everywhere less than the price you
sell for that output;
PM
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