LECTURE 31
MONOPOLY
General Rule for setting output: MR = MC.
- using this “new” rule for a competitive firm
Monopoly: drawing MR curve for monopoly
Monopoly: output and price decision
Monopoly: profit
Mankiw: Chapter 15
REVIEW: FIRM DECISION RULE
Firm seeks to maximize profit. Profit = TR - TC
Marginal analysis: to maximize profit,
firm moves margin and produces extra unit if extra money exceeds extra cost
or until
MR = MC
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- general rule
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We have been saying that managers of perfectly competitive firm increase
output until
MC = price .
Now saying that managers always increase output until
MC = MR.
What is going on?
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REVIEW: PERFECT COMPETITION
UNDERSTANDING THE NEW BY COMPARING WITH THE KNOWN:
Applying the General Rule to the perfectly competitive firm.
Competitive firm: No connection between what firm produces and market
price.
FIRM
MARKET
100 firms, each producing 20.
If firm doubles output 20 6 40, shift in S is small, almost no effect on price.
Price is determined outside the firm. Firm takes price as given - price-taking.
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Firm feels that it can sell any quantity it wants at prevailing price
- demand curve as perceived by firm for its product is horizontal.
Competitive Firm: D curve / MR curve
If output 20, pre-existing revenue = 10 x 20
= 200
If produce extra unit, revenue
= 10 x 20 + 10 x 1 = 210
Marginal revenue= 10
MR = price
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Competitive Firm: Decision-making
DEMAND SIDE
COST SIDE
Managers compare revenue gained by producing extra unit (from MR curve)
with cost to produce extra unit (from MC curve).
Put two side together:
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Manager’s decision-rule: increase output until MC = MR
For competitive firm: MR / price.
decision-rule becomes: increase output until MC = price
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MONOPOLY
Monopoly: Big connection between what firm produces and the price.
Only one firm: firm’s demand curve is the market demand curve
- downward sloping.
Only one firm: if firm doubles output, large increase in total output and price must fall.
Firm sets price by choosing its output - price-making.
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Monopoly: D curve lies above MR curve
Pre-existing quantity 1000 (chips/day)
Pre-existing price:
350 ($/chip)
Pre-existing revenue: 350 x 1000
area.
= 350 000 ($/day), or solid
To sell extra chip, must lower price to 349.75($/chip)
New revenue:
349.75 x 1000 + 349.75 = 349 750 + 349.75
= 350 099.75 ($/day).
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Revenue gain = 99.75
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If sell extra unit:
- on extra unit sold, gain price = 349.75 (=350) $ (area A)
- BUT price falls so lower revenue on all pre-existing sales
used to get: 350
x 1000
$
now get:
349.75 x 1000 $
loose:
250 $
(area B)
Overall: MR = A - B = price - B.
Important point: MR < price
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8
99.75 350
Note: with competitive firm, this does not happen as pre-existing sales are so small
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Drawing the monopolist’s MR curve
Intel calculates its demand curve as:
Output
(m
chiops/yr)
Price
($/chip)
0
100
20
90
40
80
60
70
80
60
100
50
Draw its Marginal Revenue Curve.
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Output
(m chips/yr)
Price
($/chip)
TR
(m $/yr)
0
100
0
MR
($/chip)
90
20
90
1800
70
40
80
3200
50
60
70
4200
30
80
60
4800
10
100
50
5000
Calculated MR is the average of MR s - associate with midpoint of interval
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Unit
MR
20
80
21
79
22
78
30
70
31
69
40
60
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Monopoly: Decision-making
Monopolist demand curve is industry demand curve.
By choosing price, chooses output.
Or by choosing output, chooses price 7 we analyze.
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Monopoly’s managers consider whether to move margin by comparing MR with MC.
D and MR curves are no longer horizontal.
DEMAND SIDE
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COST SIDE
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Put two side together:
If Q = 40 (m chips/day) MR > MC,
profits increase if move margin and produce more.
Continue till MR = MC.
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If Q = 80 (m chips/day),
MC > MR: if produce less, costs saved exceed revenue foregone - produce less.
Continue till MC = MR
To maximize profit, monopoly produces chips till MR = MC.
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MONOPOLY PRICE-MAKING
From demand curve: when Q = 60, price = 70 ($/chip)
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PROFIT OF MONOPOLY
Output: MR = MC, Q = 60 (m chips/day)
Price: 70 ($ /chip)
Profit = TR-TC = (p - ATC)Q
= shaded area
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= (70-50)60 = 1200 (m$/day).
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CLICKER QUESTION
Intel is a monopolist producing computer-memory chips. If it manufactures one
more memory chip, the price at which it sells the marginal memory chip
exceeds its marginal revenue because:
A: to sell the additional memory chip, Intel must charge a lower price.
This causes it to get less revenue from its pre-existing sales.
B: Intel’s marginal cost is increasing.
C: the market forces Intel to lower the price to reflect the lower cost of the
new technology.
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