In order to maximize profits, firms must ensure that any given output level is produced at least cost and then select the price-output combination that results in total revenue exceeding total cost by the greatest amount possible. With this in mind, this second module of the Power of Markets course addresses how firms can most effectively convert inputs into final output and then covers determining the best price-output combination for a firm and how this varies depending on whether the firm is operating in a perfectly competitive or imperfectly competitive market setting.
Further Implications of Monopoly Analysis
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Из курса от партнера University of Rochester
The Power of Markets II: Market Structure and Firm Behavior
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Week 8 - Monopoly Power: Its Sources and How to Use It
The Sources and Uses of Monopoly Power.
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Mark ZupanProfessor of Economics and Public Policy
Simon School of Business
Welcome back.
For implications about monopoly analysis, four things to keep in mind.
First, unlike perfectly competitive settings,
a monopolist has no supply curve.
There's no unique combination of output with price.
Now a way to demonstrate that is what we did in the last session.
In a sense, when people are close to the airport, demand just shifted out.
And demand has also become more interlastic.
And yet what we saw in that setting, in a
competitive setting increased demand would lead to increased output, increased price.
In this particular monopoly setting, it leads to
an increased price but no change in output.
Output is still determined by the intersection between marginal revenue and
marginal cost.
And because the monopolist gets to choose a particular point.
And has to determine, what's the best point in terms of maximizing profit?
There isn't that same unique association of price with quantity supplied.
The monopolist is still using marginal revenue and marginal cost
to determine the right output, whether in monopoly or perfect competition.
But a higher demand
in monopoly cases can lead to no change in output and higher price.
It can lead to higher price and higher output.
Or it can also lead to settings.
And you should check this out graphically and test yourself.
It can lead to cases where there's no change in price, but higher output.
Second thing, we often think monopolies should be profitable.
But they needn't be.
Their cases where monopolies also have to
shut down, where average revenue doesn't meet
average variable cost, it may be better for a monopolist to shut down as well.
Let's look at a particular case as depicted in figure 11.5.
This firm has monopoly power, has, has the ability to
choose any point along its demand or average revenue curve.
Can then figure out where marginal revenue equals marginal
cost, and yet at Q1, the best output level.
By following marginal revenue marginal cost, average revenue in a
long run setting still falls below long run average cost.
Revenues don't meet variable costs.
It's better to choose an output level zero and to shut down.
And to understand this point, there are lots of patents issued every year
in the United States and other countries that prove not to be profitable.
Now people, inventors, for example, have come up with ideas to arm chickens with
goggles so to keep them from establishing a pecking order and hurting each other.
The goggles idea never got off the ground.
There's people that have invented escape coffins, where if somebody's accidentally
buried and they were still alive, they can ring a bell.
That idea has never taken off. I like to invent
as well, and one of my ideas that I hoped to make a lot of money on a few years ago.
Was you've probably seen how in many locations' golf courses
they have sprinkler heads that pop out of the ground.
And that then rotate around and water a circular area.
I thought it would be easy maybe to invent something similar
like a fish line that would come out of the ground.
And would mow that entire circular area.
The problem is, you still have to
invent an accompanying warning device to keep small
kids or to keep kids or pets from
being harmed from this fishing line spinning around.
So that idea, even though I probably could've gotten a
patent on it has proven not to be profitable for me.
Third thing, monopolies' demand is elastic when marginal revenue is positive.
Let's see why.
And let's look at figure 11.6, what
the top panel depicts is the demand curve.
Or average revenue curve, the associated marginal revenue curve.
And something we wont stress here but if you look more closely at the associated
text book, where ever you have a linear demand, marginal revenue will, will start
off with the same vertical intercept. But have twice the slope will fall at,
twice the rate that average revenue does. So if the demand curve intercepts
the horizontal axis, is in this case at 26, for a linear demand curve.
And this is just to refer linear demand curve.
Marginal revenue will intercept the, horizontal, will intercept the horizontal
axis at half the distance at 13. Now if we plot in the panel
below it the total revenue curve it has this upside down bowl shape to it.
So long as the marginal revenue is positive up
to an output of 13, total revenue keeps rising.
So, up to 13 total revenue keeps rising
because the marginal revenue curve above it is positive.
Total revenue is flat, right where marginal revenue is equal to zero.
Where there's no incremental revenue being added, we've topped off total revenue.
And total revenue is declining where marginal revenue starts to get negative.
Now, look at what happens.
We can map out different regions of the demand curve.
Over the first 13 units of output, price is going down.
Quantity's going up.
And total revenue is going up.
Ilusticited demand measures the ratio of percentage change in quantity demanded.
Produced by a percentage change in price.
So, over this 13, this first 13 units of output Quantities having
a bigger pull on total revenue and in an opposite direction from price.
So in this particular setting, elasticity of demand, and elasticity
again is the percentage change in climb demanded over
the percentage change in price in absolute value terms.
Quantity's gotta have the bigger driving force to it.
And because it's pulling total revenue with it,
that is where elasticity demands greater than one.
Beyond 13, it's sort of the range beyond 13 out to 26.
Quantity's going up. Price is going down.
But this is a case where total revenue's going down.
So price over this range is having the dominant effect on total revenue.
And where the denominator has the dominant effect
in the elasticity ratio, and it pulls in the opposite
direction from quantity, that's where elasticity of demand's less than one.
And if the two effects exactly counter balance
each other, quantity's going up right at 13.
Price is going down, but total revenue doesn't change.
That's where right at the top of the
total revenue curve, elasticity of demand's equal to one.
So, we see for a linear demand
curve, elasticity of demand varies along the curve.
Starts off elastic, hits a point where it's equal to one, where total
revenue is at its peak or marginal revenue has hit the horizontal axis.
Beyond that is less than one.
Now, notice the final implication.
Monopolies always charge a price where demand is elastic.
We often hear statements that monopolies confront inelastic demand curves
or try to control the market so demand is inelastic.
Yet, so long as marginal costs are positive, monopolies
will always choose a point where elasticity of demand is greater than one.
Would never want to push output beyond the
level where marginal revenue is actually started
diminishing total revenue. So long as marginal costs are positive.
Now, last thing to keep in mind, sometimes people on the
supply side get incented based based on their percentage of total revenue.
Book publish book authors do this. Or sometimes actors do.
And there's always a tension between the way
a actor for example gets rewarded relative to
what a movie production studio, how it gets rewarded.
The outfit producing the movie.
gets incented or gets motivated by profits that they earn.
So they'll always want to be looking for where does profits end up being maximized.
Take the case of the film Forrest Gump.
Tom Hanks, the lead actor in the movie earned a percentage of total revenue.
If you want to maximize total revenue.
What price quantity combination will you want the
[INAUDIBLE]
to choose.
For somebody that want to, wants to maximize total revenue, want to be
at the price quantity combination where total revenue is at its peak.
So you want to choose a lower price.
A price total revenue max that is lower than the profit maximizing price.
So you'd want to choose PTR max relative
to where marginal revenue meets marginal cost.
Of course, not everybody always structures contracts, and the reason why
actors typically do this is because revenues are easy to measure.
Or at least easier to measure than profits.
The person who wrote the script for Forrest Gump, a person
by the name of Winston Groom has yet to earn any money.
Even though he wrote an incredibly productive script.
Why?
Because he was promised to be paid 4% of
the profits. That the production studio earned.
The production studio claimed we made no profits.
The total revenue was exceeded by total costs, and therefore we owe you nothing.
You had to take the studio to court.
And even though total revenues were over a billion dollars on Forrest Gump over time,
this poor person that wrote the script never profited
from that benefit.
By contrast Tom Hanks made 40 million on the movie.
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