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November 5 Lecture Notes EC 110

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EC 110
Kent Zirlott

Key: Examples Formula Emphasis Definition Notes Reference 1) Introduction a) Monopoly: A firm that is the sole seller of a product without close substitutes i) A normal firm has no market power. A monopoly does 2) Why Monopolies Arise a) The main cause is barriers to entry- other firms cannot enter the market i) Three Sources: (1) A single firm owns a key resource (2) The government gives a single firm the exclusive right to produce the good (a) Patents, copyright laws (3) Natural Monopoly (a) Natural Monopoly: A single firm can produce the entire market quantity at lower cost than could several firms (b) Average Total Cost curve is always downward sloping (c) Marginal Revenue =/= Price (in a monopoly) (i) Marginal Revenue will always be below Price Q P TR AR MR 0 $4.50 $0 n.a. 1 $4.00 4 $4.00 4 2 $3.50 7 3.50 3 3 $3.00 9 3.00 2 4 $2.50 10 2.50 1 5 $2.00 10 2.00 0 6 $1.50 9 1.50 -1 3) Understanding the Monopolies Marginal Revenue a) Increasing quantity has two effects on revenue i) Output effect: higher output raises revenue ii) Price effect: lower price reduces revenue iii) To sell a larger Q, the monopolist must reduce the price on all units it sells iv) That’s why: Marginal Revenue < Price v) Marginal Revenue (MR) could even been negative if the price effect exceeds the output effect 4) Profit Maximization a) Marginal Cost still equals Marginal Revenue b) Still bonded to the demand curve c) (Price – Average Total Cost) * Quantity 5) A Monopoly Does Not Have a Supply Curve a) A competitive firm i) Takes price as given ii) Has a supply curve (MC) that shows how its quantity depends on price b) A monopoly firm i) Is a Price Maker ii) Q does not depend on Price, rather, Q and P are jointly determined by Marginal Cost, Marginal Revenue and the demand curve iii) There is no supply curve 6) The Welfare Cost of Monopoly a) Recall: In a competitive market equilibrium, Price = Marginal Cost and total surplus is maximized b) In the monopoly eq’m, Price > Marginal Revenue = Marginal Cost i) The value to buyers of an additional unit (Price) exceeds the cost of the reso
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