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ECON 100 Tutorial 7

ECON 100 Tutorial 7. Rob Pryce www.robpryce.co.uk/teaching. Question 1. Mankiw and Taylor, p.315. AR. AR. MR. Why does the marginal revenue curve lie below the average revenue curve?. Remember, competitive firms are price takers . They cannot affect market prices. MR = Price

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ECON 100 Tutorial 7

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  1. ECON 100Tutorial 7 Rob Pryce www.robpryce.co.uk/teaching

  2. Question 1 Mankiw and Taylor, p.315

  3. AR

  4. AR MR

  5. Why does the marginal revenue curve lie below the average revenue curve? Remember, competitive firms are price takers. They cannot affect market prices. MR = Price But because monopolies face a downward sloping demand curve… When it increases output it must reduce the price. What does this mean? MR < PRICE

  6. Question 1: MR and AR P A competitive firm A monopoly P D = AR=MR AR = D 0 q Q MR

  7. Question 2 This seems funny - how can selling an additional unit lead to less revenue? Recall the diagram (which is taken from Mankiw and Taylor, p. 315) AR MR

  8. Question 2 Remember that monopolies are not price takers If a monopoly decides to increase quantity, it must decrease price Not just at the extra unit of output, but across all units

  9. AR MR At 4 units, the monopoly set the price at 0.7. TR = 2.8. At 8 units, the monopoly set the price at 0.3. TR = 2.4 Q: 4 → 5, P: 0.7 → 0.6, TR: 2.8 → 3 MR = 0.2 Q: 5 → 6, P: 0.6 → 0.5, TR: 3 → 3 MR = 0 Q: 6 → 7, P: 0.5 → 0.4, TR: 3 → 2.8 MR = -0.2

  10. Question 3 Caroline’s 8 barriers (there are others): • Absolute Cost Advantage • Product Differentiation Advantages • Economies of Scale • Switching Costs • Network Externalities • Legal Barriers to Entry • Geographic Barriers to Entry • Control of Key Inputs

  11. Question 4 The (Bain-) Sylos Postulate: “The entrant believes that the incumbent would maintain the same output after entry that it did before entry” It’s a very useful assumption for limit pricing But it’s also naïve It may be that once another firm enters the market, the monopolists best strategy is to “accommodate” the entrant rather than fight It needs to be a credible threat that the monopoly would maintain previous output How can it do this? Sunk Cost

  12. Question 5-1 (a)What is the maximum-profit output?

  13. Question 5-1 (a)What is the maximum-profit output? 200 units (where MC = MR)

  14. Question 5-1 (a)What is the maximum-profit output? 200 units (where MC = MR) (b)What is the maximum-profit price?

  15. Question 5-1 (a)What is the maximum-profit output? 200 units (where MC = MR) (b)What is the maximum-profit price? £60 (given by AR curve at 200 units)

  16. Question 5-1 (a)What is the maximum-profit output? 200 units (where MC = MR) (b)What is the maximum-profit price? £60 (given by AR curve at 200 units) (c)What is the total revenue at this price and output?

  17. Question 5-1 (a)What is the maximum-profit output? 200 units (where MC = MR) (b)What is the maximum-profit price? £60 (given by AR curve at 200 units) (c)What is the total revenue at this price and output? £12 000 (i.e. £60  200)

  18. Question 5-1 (a)What is the maximum-profit output? 200 units (where MC = MR) (b)What is the maximum-profit price? £60 (given by AR curve at 200 units) (c)What is the total revenue at this price and output? £12 000 (i.e. £60  200) (d)What is the total cost at this price and output?

  19. Question 5-1 (a)What is the maximum-profit output? 200 units (where MC = MR) (b)What is the maximum-profit price? £60 (given by AR curve at 200 units) (c)What is the total revenue at this price and output? £12 000 (i.e. £60  200) (d)What is the total cost at this price and output? £6000 (i.e. £30 (AC)  200)

  20. Question 5-1 (a)What is the maximum-profit output? 200 units (where MC = MR) (b)What is the maximum-profit price? £60 (given by AR curve at 200 units) (c)What is the total revenue at this price and output? £12 000 (i.e. £60  200) (d)What is the total cost at this price and output? £6000 (i.e. £30 (AC)  200) (e)What is the level of profit at this price and output?

  21. Question 5-1 (a)What is the maximum-profit output? 200 units (where MC = MR) (b)What is the maximum-profit price? £60 (given by AR curve at 200 units) (c)What is the total revenue at this price and output? £12 000 (i.e. £60  200) (d)What is the total cost at this price and output? £6000 (i.e. £30 (AC)  200) (e)What is the level of profit at this price and output? £6000 (i.e. TR – TC)

  22. Question 5-2 (f)If the monopolist were ordered to produce 300 units, what would be the market price?

  23. Question 5-2 (f)If the monopolist were ordered to produce 300 units, what would be the market price? £50 (given by AR curve)

  24. Question 5-2 (f)If the monopolist were ordered to produce 300 units, what would be the market price? £50 (given by AR curve) (g)How much profit would now be made?

  25. Question 5-2 (f)If the monopolist were ordered to produce 300 units, what would be the market price? £50 (given by AR curve) (g)How much profit would now be made? £4500 (i.e. £15  300)

  26. Question 5-2 (f)If the monopolist were ordered to produce 300 units, what would be the market price? £50 (given by AR curve) (g)How much profit would now be made? £4500 (i.e. £15  300) (h)If the monopolist were faced with the same demand, but average costs were constant at £60 per unit, what output would maximise profit?

  27. Question 5-2 (f)If the monopolist were ordered to produce 300 units, what would be the market price? £50 (given by AR curve) (g)How much profit would now be made? £4500 (i.e. £15  300) (h)If the monopolist were faced with the same demand, but average costs were constant at £60 per unit, what output would maximise profit? 100 units (where AC = MC = MR = £60)

  28. Question 5-2 (f)If the monopolist were ordered to produce 300 units, what would be the market price? £50 (given by AR curve) (g)How much profit would now be made? £4500 (i.e. £15  300) (h)If the monopolist were faced with the same demand, but average costs were constant at £60 per unit, what output would maximise profit? 100 units (where AC = MC = MR = £60) (i)What would be the price now?

  29. Question 5-2 (f)If the monopolist were ordered to produce 300 units, what would be the market price? £50 (given by AR curve) (g)How much profit would now be made? £4500 (i.e. £15  300) (h)If the monopolist were faced with the same demand, but average costs were constant at £60 per unit, what output would maximise profit? 100 units (where AC = MC = MR = £60) (i)What would be the price now? £70 (given by AR curve at 100 units)

  30. Question 5-2 (f)If the monopolist were ordered to produce 300 units, what would be the market price? £50 (given by AR curve) (g)How much profit would now be made? £4500 (i.e. £15  300) (h)If the monopolist were faced with the same demand, but average costs were constant at £60 per unit, what output would maximise profit? 100 units (where AC = MC = MR = £60) (i)What would be the price now? £70 (given by AR curve at 100 units) (j)How much profit would now be made?

  31. Question 5-2 (f)If the monopolist were ordered to produce 300 units, what would be the market price? £50 (given by AR curve) (g)How much profit would now be made? £4500 (i.e. £15  300) (h)If the monopolist were faced with the same demand, but average costs were constant at £60 per unit, what output would maximise profit? 100 units (where AC = MC = MR = £60) (i)What would be the price now? £70 (given by AR curve at 100 units) (j)How much profit would now be made? £10  100 = £1000

  32. Question 5-3 (k)Assume now that the monopolist decides not to maximise profits, but instead sets a price of £40. How much will now be sold?

  33. Question 5-3 (k)Assume now that the monopolist decides not to maximise profits, but instead sets a price of £40. How much will now be sold? 400 units (given by AR curve)

  34. Question 5-3 (k)Assume now that the monopolist decides not to maximise profits, but instead sets a price of £40. How much will now be sold? 400 units (given by AR curve) (l)What is the marginal revenue at this output?

  35. Question 5-3 (k)Assume now that the monopolist decides not to maximise profits, but instead sets a price of £40. How much will now be sold? 400 units (given by AR curve) (l)What is the marginal revenue at this output? 0

  36. Question 5-3 (k)Assume now that the monopolist decides not to maximise profits, but instead sets a price of £40. How much will now be sold? 400 units (given by AR curve) (l)What is the marginal revenue at this output? 0 (m)What does the answer to (l) indicate about total revenue at a price of £40?

  37. Question 5-3 (k)Assume now that the monopolist decides not to maximise profits, but instead sets a price of £40. How much will now be sold? 400 units (given by AR curve) (l)What is the marginal revenue at this output? 0 (m)What does the answer to (l) indicate about total revenue at a price of £40? Maximised

  38. Question 5-3 (k)Assume now that the monopolist decides not to maximise profits, but instead sets a price of £40. How much will now be sold? 400 units (given by AR curve) (l)What is the marginal revenue at this output? 0 (m)What does the answer to (l) indicate about total revenue at a price of £40? Maximised (n)What is the price elasticity of demand at a price of £40? (You do not need to do a calculation to work this out: think about the relationship between MR and TR.)

  39. Question 5-3 (k)Assume now that the monopolist decides not to maximise profits, but instead sets a price of £40. How much will now be sold? 400 units (given by AR curve) (l)What is the marginal revenue at this output? 0 (m)What does the answer to (l) indicate about total revenue at a price of £40? Maximised (n)What is the price elasticity of demand at a price of £40? (You do not need to do a calculation to work this out: think about the relationship between MR and TR.) –1 (this is the case where TR is maximised).

  40. Any Questions? Office hour: Wednesday 12:30 – 1:30 Email: r.pryce@lancaster.ac.uk

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