EC 100 Week 10
Overview
- This week: Market Power.
- Firms Profit: Revenue – Cost
- Where Revenue = Price * Quantity
- Cost = Fixed Cost + Marginal Costs * Quantity
- Under perfect Competition: Price is fixed, so a
firms supply decision is optimal when P=MC
- For a monopolist: equilibrium price is a function
of the Quantity that is sold on market – so a
monopolist can control prices by choosing
quantity.
Question 1
(Preliminary)
Name the 3 sources of monopoly
Question 1
(Preliminary)
1. “Natural monopoly”.
Increasing returns to scale everywhere, meaning falling AC. Gives initial
firm a competitive advantage over all others. Happens in industries with
high fixed costs, low marginal costs (hence falling AC). E.g. water pipes,
electricity distribution, roads.
2. Firm actions.
Firm can try to “corner a market” (buy all the stock – e.g. ram man). Firm
may own all natural resources, e.g. a diamond monopoly.
3. Government actions.
Government can create a monopoly for political or “economic” reasons
(e.g. Royal Mail, BT – note that this is now less common in UK). Governments
give patents to new inventions (to provide incentives to entrepreneurs, but
controversial – e.g. drug patents).
Question 1
• Which of the Following Answers Are Reasons
Why An Industry May Tend towards a
Monopoly?
Question 2
Output
Total Revenue
10
18
24
28
30
1
2
3
4
5
A Monopolists Problem
35
30
25
20
Revenue
15
10
5
0
1
2
3
4
5
Question 2
(Preliminary)
What is important about average revenue (AR)?
AR = TR/Q
Where TR = P*Q
This implies that AR = P
i.e. Average revenue is the price consumers are
willing to pay: it is the demand curve for a
monopolist
Question 2
Output
Average
Revenue
10
9
8
7
6
Total Revenue
1
10
2
18
3
24
4
28
5
30
Question 2: If firm
produces 3 units of
output, what is
average revenue?
A Monopolists Problem
35
30
25
20
Revenue
15
Average Revenue
10
5
0
1
2
3
4
5
Question 3
Output
Average
Revenue
Total Revenue
Marginal
Revenue
1
10
10
10
2
18
9
8
3
24
8
6
4
28
7
4
5
30
6
2
Question 3: If firm
increases output
from 3 to 4 units,
what is its marginal
revenue?
A Monopolists Problem
35
30
25
20
Revenue
Average Revenue
15
Marginal Revenue
10
5
0
1
2
3
4
5
Why is MR curve
below AR curve?
Question 4
If the marginal cost of every unit of output is 5, what is the
profit maximizing level of output?
Total
Revenue
Output
Average
Revenue
Marginal
Revenue
Marginal
Cost
Change in
Profits
1
2
10
18
10
9
10
5
5
8
5
3
3
24
8
6
5
1
4
5
28
30
7
6
4
5
-1
2
5
-3
• Firm will carry on producing until change in profits from one
more unit is zero
• i.e. MR = MC
“Textbook” Monopolist diagram
Price, P
1. Choose quantity by setting
MR = MC (understand why).
2. At that quantity, find price
by using demand curve
P*
Marginal
Revenue
Marginal Cost
Demand Curve
(Average Revenue)
Q*
Quantity, Q
“Textbook” Monopolist diagram
Price, P
Consumer
Surplus
1. Note that monopolist makes profits
2. If constant MC, then MC = AC (if fixed
cost=0. Footballer example)
3. Profits = (P-AC)*Q and so the box
denotes profits
P*
Producer
Surplus (profit)
Marginal Cost
Marginal
Revenue
Q*
Demand Curve
(Average Revenue)
Quantity, Q
Question 5
- Suppose there are two markets. In both there are
constant returns to scale and marginal costs of output
are the same. But demand is less sensitive to price in
market A than market B. if both markets are perfectly
competitive will the price be higher or lower or the
same in A or B? What if the markets are monopolies?
- Select one:
Question 5
- Suppose there are two markets. In both there
are constant returns to scale and marginal
costs of output are the same. But demand is
less sensitive to price in market A than market
B.
- Remember: under perfect competition, p=MC
– since MC the same, prices the same
- Shape of the demand curve matters for the
extent to which a monopolist can push up
prices.
Consider the following
two market demand curves
1. Which one has more elastic demand?
2. In which one will price be higher?
Price, P
Price, P
B
A
Marginal Cost
Marginal Cost
Marginal
Revenue
Demand Curve (Average
Revenue)
Demand Curve (Average
Revenue)
Marginal
Revenue
Quantity, Q
Quantity, Q
The Gap Between Price
and Marginal Cost
• The ability of a monopoly to raise prices above
marginal cost depends on the price elasticity
of the demand curve
• If demand is inelastic then prices will be
higher
• If demand is very elastic then prices will be
lower
• See diagrams above
Question 6
• If an industry goes from being perfectly
competitive to being a monopoly, what
happens to consumer and producer surplus?
Consumer and Producer
Surplus with Perfect Competition
Price, P
Consumer
Surplus
Producer
Surplus (profit)
1. Note that this is perfect
competition industry diagram
(not firm)
2. Marginal cost curve is supply
curve under perfect competition
(because firms set P = MC so MC
determines how much is
supplied at each price)
Marginal Cost
P
Demand Curve
(Average Revenue)
Q*
Quantity, Q
Consumer and Producer
Surplus with Monopoly
Price, P
Consumer
Surplus
P*
Important results:
1. Prices are higher (make
profits)
2. Quantity is lower
DWL
Producer
Surplus (profit)
Marginal Cost
Marginal
Revenue
Q*
Demand Curve
(Average Revenue)
Quantity, Q
Question 7
The following Table gives total labour supply to a monopsonist for different
wages a firm might pay:
• What numbers should go in the final column?
• Total cost of labour = wage * labour supply
Labour
Supply
Wage
4
6
8
10
Total Cost of Marginal
Labour
Costs
1
4
2
12
3
24
4
40
4
8
12
16
Question 8
The following Table gives total labour supply to a monopsonist
for different wages a firm might pay:
What is the marginal cost of labour in going
from 2 to 3 workers? 12
Marginal cost of labour = ∆ cost of labour
Wage
4
6
8
10
Labour Total Cost of
Supply
Labour
1
4
2
12
3
24
4
40
Marginal
Costs
4
8
12
16
Question 9
Wage
4
6
8
10
Labour Total Cost of
Supply
Labour
1
4
2
12
3
24
4
40
Marginal
Costs
4
8
12
16
If the marginal revenue product of a worker is 10, what will be
the profit maximising level of employment for the monopsonist?
Question 9
• Marginal Revenue Product of Labour
– Additional revenue from hiring one more worker
– Equals marginal product * price (because marginal
product is the additional output of the worker)
• Firm keeps hiring as long as MRP>MC
– Because this means hiring one extra worker adds
to profits
– So if MRP = 10, a firm should hire two workers.
– Hiring a third worker reduces profits as MRP < MC
= 12.
Question 10
• If the marginal revenue product of a worker is
10 what will be the profit maximizing level of
the wage for the monopsonist?
• Firm optimally hires two workers, which
supply their labour at a wage of 6 (from table)
Wage
Labour Supply
Total Cost of
Labour
4
1
4
4
6
2
12
8
8
3
24
12
10
4
40
16
Marginal Costs
Question 11
• If the marginal revenue product of a worker is
10 and the government imposes a minimum
wage of 9 what level of employment will the
firm choose?
• Now have a minimum wage, i.e. government
intervenes.
Question 11
• Previous table:
Wage
Total Cost of
Labour
Labour Supply
Marginal Costs
4
1
4
4
6
2
12
8
8
3
24
12
10
4
40
16
• New table:
with minimum wage
Labour Total Cost of
Supply
Labour
Marginal
Costs
Market Wage
New Wage
4
9
1
9
9
6
9
2
18
9
8
9
3
27
9
10
10
4
40
13
Note: total cost of
labour is different
and marginal cost of
labour is different
Question 11
• Again, firm hires an additional worker as long
as MRP>marginal cost
• Hence, firm hires 3 workers
• Hiring a fourth worker would have a marginal
cost of 13, and bring in revenue of just 10
Question 12
• With minimum wage = 11, no employment.
with minimum wage
Labour Supply
Total Cost of
Labour
Marginal Costs
11
1
11
11
6
11
2
22
11
8
11
3
33
11
10
11
4
44
11
Market Wage
New Wage
4