Chapter 14 (3) Flashcards
We have to begin our analysis of a monopoly’s behaviour by understanding its wants & constraints
► Like any other firm: wants to maximize its profits
It is known that a firm in a perfectly competitive market = constrained by the fact that its production decisions cannot affect the prevailing market price
A monopoly = does not face this constraint–but it is constrained by the market demand curve
MONOPOLISTS AND THE DEMAND CURVE
► As the ONLY PRODUCER in the market –> a monopolist faces the downward-sloping market demand curve
► The monopolist can choose to sell AT ANY PRICE it wants w/out fear of being undercut –> b/c there are no other firms to do the undercutting
○ However, it is still constrained by market demand
Naturally, it would love to sell a huge quantity of goods at a high price
But how would consumers respond to a high-price?
► The monopoly can choose any price-quantity combination on the demand curve –> but is unable to choose points THAT ARE NOT ON THE CURVE
○ It can’t force customers to buy or less than the quantity they demand a any given price
Example: The monopolist can choose to sell at a high price of $5,000 per diamond, but only by selling a small quantity–three diamonds
► Or: it can choose to sell 5 more diamonds –> reaching a total of eight, but only lowering its price to $2, 500 per diamond.
De Beers recognized the fact that its sales were limited by demand
► That’s why it went beyond controlling the supply side of the market & invested heavily in shifting the demand curve outward through the marketing methods
MONOPOLY REVENUE
► The first step in understanding a monopolist’s quest for profits = to map out the revenues it can bring in
Example: can choose the price of the diamonds it offers for sale in Canada
► Let’s assume that De Beers sells diamonds of uniform size (one-carat violet diamonds) and quality
What revenue can it expect to bring in at each possible price?
► Because it is constrained by demand –> DeBeers has to accept the quantity that American consumers are willing to buy at a given price
TOTAL REVENUE - price x quantity
► As price increases & quantity sold decreases – total revenue = first rises & the falls
○ Note, that total revenue increases on sections of the demand curve --> where demand = price-elastic ○ It decreases on sections of the curve where demand = price-inelastic
AVERAGE REVENUE - total revenue / quantity
AR = price
► UNLIKE a firm in a competitive market –> a monopolist’s MARGINAL REVENUE ***is not EQUAL to price
► Marginal revenue = is the revenue generated by selling each additional unit
○ Calculation: by taking total revenue at a certain quantity & subtracting the total revenue when quantity is one unit lower
In a market dominated by a monopoly –> the monopoly’s choice to produce an additional unit drives down the market price
► Because of this effect, producing an additional unit of output has two separate effects on total revenue:
1. QUANITY EFFECT: Total revenue increases due to the money brought in by the sale of an additional unit 2. PRICE EFFECT: Total revenue decreases, because all units sold now bring in a lower price than they did before
Depending on which of these effects = larger, total revenue might increase/decrease when De Beers increases the quantity of diamonds it sells
► Marginal revenue = always less than the price –> except for the very first unit sold
► For that first unit: average revenue & marginal revenue = both equal to the price
Average revenue curve = the same as the market demand curve
► The marginal revenue curve lies below the average revenue curve –> bc marginal revenue = always less than price after the very first unit sold
► Marginal revenue = can sometimes be (-)
► Thus, the point at which the MR curve crosses the x-axis represents the revenue-maximizing quantity
MAXIMIZING PROFITS BY PICKING PRICE & QUANTITY SOLD
► De Beers exerted control over the diamond market through the quantity of diamonds it released for sale at any given time
○ The company = held back stockpiles of diamonds worth billions of dollars for years at a time to maintain this control
Purpose of this stockpiling: was to ensure that the quantity of diamonds for sale = always the quantity that maximized De Beer’s profits
► Sometimes, the profit-maximizing quantity = lower than the total quantity of diamonds available
–> and so it was in De Beer’s interest to hold back from the market
How can a monopolist choose the price-quantity combination that maximizes profit?
► It can approach this problem in exactly the same way that a firm in a competitive market would
► The general appearance of these curves should be familiar from the “Perfect Competition”
► The only relevant difference between the curves for a monopoly & the equivalent ones for a firm in a competitive market:
Is that marginal & average revenue slope downward for the monopolist
