Chap 2 Lecture Notes

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Monopoly and Profit Maximization
• The monopolist maximizes profit by equating marginal revenue with marginal cost • This is a two-stage process $/unit

Stage 1: Choose output where MR = MC

PM Profit ACM MR QM QC

This gives output QM Output by the monopolist isStage 2: Identify the market clearing price less MC than the perfectly gives price PM This competitive output QC AC MR is less than price Price is greater than MC: loss of efficiency Price is greater than average cost Demand Positive economic profit Long-run equilibrium: no entry 1

Quantity

Chapter 2: Basic Microeconomic Tools

Efficiency and surplus: illustration
$/unit The demand curve measures the willingness to pay for each unit Consumer surplus is the area between the demand curve and the equilibrium price Competitive Supply

The supply curve measures the marginal cost of each unit Producer surplus is the area between the supply curve and the equilibrium price

PC

Consumer surplus Producer surplus

Equilibrium occurs where supply equals demand: price PC quantity QC

Demand
Aggregate surplus is the sum of consumer surplus and producer surplus The competitive equilibrium is efficient Chapter 2: Basic Microeconomic Tools

QC

Quantity

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Problem 2 Monopoly
• Now suppose that the manufacturing of cellular phone, as described in problem 1, in now monopolized. The monopolist has 50 identical plants to run. Each plant has the same cost function as described in problem 1. The overall marginal cost function for the multiplant monopolist is described by MC(Q) = 10 +Q/25. The market demand function is assumed to be the same as in problem 1. Recall QD = (6000-50P)/9. Industrial Organization: Chapter 1 3

Problem 2 Monopoly (continued)
• Show that the monopolist’s marginal revenue function is MR(Q)=120-18Q/50. • Show that the monopolist’s profit-maximizing output level is QM=275. What price does the monopolist set to sell this output level of output? • What is the profit earned at each of the monopolist’s plants?

Industrial Organization: Chapter 1

4

Problem 2 Part A
• Inverse demand curve is P=(6000-9Q)/50. Hence, MR=120-(18Q/50) • MR is derived from TR • TR=PQ • So TR=[(6000-9Q)/50]Q TR=(6000Q-9Q2)/50 • MR=dTR/dQ=6000/50 -18Q/50 MR=120-18Q/50 Industrial Organization: Chapter 1 5

Problem 2 Part B
• MC=10+Q/25. Equate with MR to obtain Q=275. At this output, P=$70.50 • Set MR=MC=0 120-18Q/50=10+Q/25 120-.36Q=10+.04Q 110=.40Q 110/.40=Q Q=275 Substituting Q=275 back into our inverse demand function, P=(60009Q)/50, we get P=$70.50 Industrial Organization: Chapter 1 6

Problem 2 Part C
• The monopolist will have each of its 50 indentical plants operate where MR=MC. Each plant will produce q=5.5 units • Total revenue= $19,387.50 . Each plant will produce 5.5 units and incur a total cost of $185.25 [based up each plant having cost function TC=100 +q2 + 10 q]. MC for each plant is MC=2q +10 Each plant earns a revenue of $387.75 (TR=$70.50 x 5.5). Profit at each plant is $202.50 (TR-TC=profit). Total profit is $10,125.00 for all 50 plants. Industrial Organization: Chapter 1 7

Market Structure and Market Power

Chapter 3: Market Structure and Market Power

8

Introduction
• Industries have very different structures
– numbers and size distributions of firms
• ready-to-eat breakfast cereals: high concentration • newspapers: low concentration

• How best to measure market structure
– – – – summary measure concentration curve is possible preference is for a single number concentration ratio or Herfindahl-Hirschman index

Chapter 3: Market Structure and Market Power

9

Measure of concentration
• Compare two different measures of concentration:
Firm Rank
1 2 3

Market Share (%)
25 25

Squared Market Share
625
625 625 25 25 25

25
5

4 5
6 7 8 Concentration Index

5
5 5 5 CR4 = 80
Chapter 3: Market Structure and Market Power

25 25
H = 2,000
10

• Concentration index is...
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