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1
Market Power andMonopoly
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For a Perfectly Competitive firmThe Demand = Marginal Revenue
40
30
20
15
10
MarketPrice
1 2 3 4 5 6 7 8
Market QuantityMillions of Bushels ofWheat
MarketSupply ofWheat
MarketDemandfor Wheat
Marketfor Wheat
ChicagoMercantile
Exchange
40
30
20
15
10
Price
20 40 60 80 100
MarketPrice = D =MR
Farmer inNebraska
Farmers
Quantity ofWheat
Market sets the price.
Firm can sell all they want at the market price Demand Curve for the firm is perfectly elastic at the marketprice. Marginal Revenue = Change Revenue/Change in Output =Market Price. Market Price = D = MR
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3
Demand Curve for Firmswith Market Power
0
$200
175
150
125
25
100
75
50
Price
1 2 3 4 5 6 7 8 9 10
Quantity
D
MarketPowermeans thefirm has
some controlover pricewhich meansthe demandcurve isdownward
sloping
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4
Relation between theDemand Curve and
Revenues
Price Discrimination: The firm
charges each customer exactlywhat the customer is willing topay for the product.
No price Discrimination: Allcustomers pay exactly thesame price.
D d C d M i l R
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Demand Curve and Marginal RevenuePerfect Price Discrimination
MR = (Change in Rev)/(Change in Q)
D = MR only if firms can perfectly pricediscriminate6
5
4
3
2
1
01 2 3 4 5 6 7 8
P Qd$5
$4
$3
$2
$1
1
2
3
4
5
DemandSchedule
P
Q
D = MR
$5
$4
$3
$2
$1
MarginalRevenue
$5
$9
$12
$14
$15
CumulativeRevenues
Revenues =$5 for the 1st
+ $4 for the second+
+ $1 for the 5th
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Demand Curve and RevenuesNo Price Discrimination: All customers
pay the same price
6
5
4
3
2
1
01 2 3 4 5 6 7 8
P Qd$5
$4
$3
$2
$1
1
2
3
4
5
DemandSchedule
P
Q
D
$5
$8
$9
$8
$5
Revenues
Revenues= Price XQuantity =$3 X 3 = $9
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No Price DiscriminationCharging all customers the
same price6
5
4
3
2
1
01 2 3 4 5 6 7 8
P
Q
D
Two Effects of a Price
Change1. Reprice effect. Change
the price for existingcustomers. (lower pricemeans existingcustomers pay less.raise price existingcustomers pay more).
2. Stimulation effect. Gain
or lose new customers(Lower prices gaincustomers. Raiseprices you losecustomers)
Example.
Lower price from $3 to$2.
Reprice effect: 3 existingpay $1 less = -$3
reprice effect.
Stimulation effect: Soldto 1 new customer atprice of $2 =$2 stimeffect.
Total effect = Reprice +Stim = -3 + 2 = -$1.
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No Price DiscriminationCharging all customers the
same price6
5
4
3
2
1
01 2 3 4 5 6 7 8
P
Q
D
Two Effects of a Price
Change1. Reprice effect. Change
the price for existingcustomers. (lower pricemeans existingcustomers pay less.raise price existingcustomers pay more).
2. Stimulation effect. Gain
or lose new customers(Lower prices gaincustomers. Raiseprices you losecustomers)
MR from the 4thunit = $2 - $1 * 3
customers = -$1
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eman anMarginal Revenue Curves
MR = (Change in Rev)/(Change in Q)
MR < Price for non price discriminating firm6
5
4
3
2
1
01 2 3 4 5 6 7 8
P Qd$5
$4
$3
$2
$1
1
2
3
4
5
DemandSchedule
P
Q
D
$5
$8
$9
$8
$5
RevenuesMR$5
$3
$1
-$1
-$3
MR
R d C t f Fi
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Revenue and Costs for Firmswith Market Power
To facilitate comparison to Perfect Competition
assume the same Short Run Cost Structure(1)
QuantityOf Output
(2)Price
(AverageRevenue)
(3)Total
Revenue(1) X (2)
(4)MarginalRevenue
(5)Average
Total Cost
(6)Total Cost
(1) X (5)
(7)Marginal
Cost
(8)Profit (+)
or Loss (-)
0
123456789
10
$172
162152142132122112102928272
$0
162304426528610672714736738720
$162142122102
8262
42222
-18
$190.00135.00113.33100.0094.0091.6791.4393.7597.78
103.00
$100
190270340400470550640750880
1030
$908070607080
90110130150
$-100
-28+34+86
+128+140+122
+74-14
-142-310
Revenue Data Cost Data
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Can you See Profit Maximization?
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Profit Maximization
0
$200
175
150
125
25
100
75
50
Price,
Costs,andRevenue
1 2 3 4 5 6 7 8 9 10
Quantity
Firms with market power
D
MR
ATC
MC
MR=MC
Pm=$122
A=$94
EconomicProfit
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Firms with Market Power
Monopoly
Oligopoly
Monopolistically CompetitiveFirms
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Monopoly
A single seller in a market
Must have barriers to entry elsethere would be entry and theeconomic profits would go to
zero. Special Recipe at a restaurant.
Patented product
Utility company
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A monopoly can earn economic
profits in the long run
0
$200
175
150
125
25
100
75
50
Price,
Costs,andRevenue
1 2 3 4 5 6 7 8 9 10
Quantity
D
MR
ATC
MC
MR=MC
Pm=$122
A=$94
EconomicProfit
M li ti ll C titi
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Monopolistically CompetitiveFirm
Product is differentiated from
other producers
But there are no barriers to entry.
Very similar to perfectcompetition (zero profits)
M li t d M li ti ll
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Monopolist and MonopolisticallyCompetitive Firms look the same in
the short run.Short-Run Economic Profits = (P-ATC)*Q = ($10-$9)*1000 =$1,000
Quantity
P
riceand
Costs
MR = MC
MC
MR
D1
ATC
EconomicProfit
1000
9
10
0
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Monopolistically Competitive Firms cannot earn economic profits in the long run
Short-Run Economic Profits = (P-ATC)*Q = ($10-$9)*1000 =$1,000
Quantity
P
riceand
Costs
MR = MC
MC
MR
D1
ATC
EconomicProfit
1000
9
10
0 950
LONG RUNEconomic Profits = (P-ATC)*Q = ($9-$9)*950 =$0