Topic 4 Flashcards
(37 cards)
How do all firms maximise their profit?
By setting MR = MC.
What does a firm’s demand curve show?
the price, P, it receives for selling a given quantity, q. The price is the average revenue the firm receives, so a firm’s revenue is R = Pq.
Marginal Revenue:
this is the change in its revenue from selling one more unit. MR = change in R/ change in q. Since a monopoly’s has a downward sloping D/P curve, its MR curves lies below the D curve at every possible quantity.
Monopoly MR equation:
MR = P + (change in P/ change in Q)Q
- Because the slope of the monopoly’s demand curve is negative, the last term in the equation is negative.
When is marginal profit zero?
Where MR = MC (this is because MP = MR – MC).
When does a monopoly shut down?
If the monopoly-optimal price is below its average cost (in the long run). In the short run, the monopoly shuts down if the monopoly-optimal prices is less than its AVC.
Does a monopoly have a supply curve?
No, unlike a competitive firm, it does not have a supply curve.
What is market power?
The ability of a firm to charge a price above MC and earn a positive profit.
What happens if the monopoly faces a highly elastic (nearly flat) D curve at the profit maximising quantity?
It would lose substantial sales if it raised its price even by a small amount.
What happens if the monopoly faces a inelastic (nearly vertical) D curve at the profit maximising quantity?
It would lose fewer sales if it raised its price.
What is the Lerner Index (or price mark up)?
The ratio of the difference between price and MC to the price:
(P – MC)/P
This is another way to show how the elasticity of demand affects a monopoly’ price relative to its MC.
Lerner Index:
LI is 0 for a competitive firm (because its demand curve is perfectly elastic)
LI is 0 to 1 for a profit maximising firm
LI increases as the demand becomes less elastic for a monopoly
- E.g. if E = -5
o The monopoly’s mark-up (Lerner Index) is 1/5 = 0.2
- E.g. if E = -2
When is a firms’ demand curve more elastic?
- Better substitutes for the firm’s product are introduced
- More firms enter the market selling the same product
- Firms that provide the same service locate closer to this firm.
This means it has to lower its price.
What is welfare?
The sum of CS and PS. This smaller under monopoly than under competition.
Why do monopolies create lower welfare?
Because they set prices above its MC which causes consumers to buy less than the competitive level of the good. In turn a DWL to society occurs.
What are the 2 key reasons that some markets are monopolised?
- A firm has a cost advantage over other firms OR
o If a low-cost firm profitably sells at a price so low that other potential competitors with higher costs would make losses, no other firm enters the market. - A government created the monopoly.
What are some sources of cost advantage?
- The firm controls and essential facility
o A scarce resource that a rival needs to use to survive
o E.g. a firm that owns the only quarry in a region is the only firm that can profitably sell gravel to local construction firms - The firm uses superior technology or has a better way of organising production
o When a firm develops a better production method that provides an advantage, the firm must either keep the info secret or obtain a patent.
What is a natural monopoly?
The situation in which one firm can produce the total output of the market at lower cost than several firms could. With a natural monopoly, it is more efficient to have only one firm produce than more firms.
- If all potential firms have the same strictly declining average cost curve, this market is a natural monopoly.
How do governments create barriers to entry?
- By making it difficult for new firms to obtain a licence to operate
- By granting a firm the rights to be the only supplier OR
- By auctioning the rights to be the only supplier.
How to governments regulate monopolies?
- Through laws (such as the CCA 2010) which forbid firms from driving other firms out of the market in an attempt to monopolise it
- By breaking up monopolies into smaller independent firms
- By encouraging other firms to enter the market
o Forces monopoly to reduce prices in order to compete (means welfare rises)
o Can do this by ending bans on imports (so that domestic monopolies face competition from foreign firms) - Subjecting monopolies to direct regulation
o E.g. Place a price ceiling on the price that a monopoly charges
What is optimal price regulation?
This is where the government is able to eliminate the DWL of monopoly by requiring that a monopoly charge no more than the competitive price.
What is non-optimal price regulation?
This is where welfare is reduced as the government does not set the price optimally. (Price will be lower = consumer willing to buy more, but monopoly won’t sell as much = DWL).
What is nonuniform pricing?
Charging consumers different prices for the same product or charging a single customer a price that depends on the number of units the customer buys.
What is price discrimination?
The practice in which a firm charges consumers different prices for the same good or charges different consumers the same prices when the costs of supplying them differ. This captures some or all consumer surplus. E.g. student and pensioner discounts.
