For this post, let's focus on the main differences between the basics of Perfect Competition and Monopoly. (We'll look at graphs on Tuesday.)
If we are just looking at numbers and calculating costs and profits, there isn't really much of a difference. If we had one of our usual charts to fill out, we would have all of the same columns and we would be using the same formulas as before with one addition. There is really only two differences.
The first difference is that demand, average revenue and price now decrease as the quantity increases.
In perfect competition each individual firm represented such a small portion of the total production, that each firm could produce and sell any amount of product. (Graphically, that was shown by the horizontal MRDARP line.)
In a monopoly there is only one firm. They represent all of the supply in the market and thus they must meet all of the demand in the market. For each firm there is only a limited number of people who are willing to buy at any given price. Thus if a firm wants to increase the number of products they are selling, they will have to convince more people to buy. The only way to do that is to lower the price.
For a chart this means that we will probably need to add a column for price. But as price and average revenue are still equal to each other, the new price column will be a copy of the average revenue column.
The second difference is that Marginal Revenue is now also different. It also now decreases as quantity increases. However, it is no longer the same as Demand, Average Revenue and Price. In fact, MR will always be lower than DARP.
Why?
This is a question that they like to ask. So being able to give a good explanation is key. Here's one way to say it:
In a monopoly the "additional revenue generated from the sale of another product" (aka - Marginal Revenue) is always less than the price and the "average amount generated from all products" (aka - Average Revenue) because those two lines are downward sloping. To increase the quantity sold we have to reduce the price. But we do not just reduce the price on the new unit sold. We also reduce the price on all previous units we were going to sell Thus the new money brought in by the new unit is reduced by the money we are no longer getting from the previous units.
Wow, that's a mouthful. Here's some basic math to help us understand.
I'm currently thinking about setting my price. I know that if I set my price at $100, I will sell 5 units. I'd like to sell more than 5, but to do that I would have to offer all of my customers a lower price.
If I were to offer a price of $95 then I would sell 6 units.
Looking at those facts, it might seem like the additional revenue I gain from selling a sixth unit is $95. But it isn't. Yes, the sixth unit would bring in $95, but I have to remember the first 5 units are no longer bringing in $100. They are now also only bringing in $95. Each of those 5 is now making $5 less.
Thus my revenue is going to change by: $95 - (5 x $5) or $95-$25 or $70
My marginal revenue is $75 and not the $95 dollars that represents the new price.
[Remember, I haven't actually sold any units yet. I'm still figuring things out. So, I haven't received the $100 for the first five units. I know if I set my price at $100 I will sell 5 units, but if I set my price at $95 I will sell 6. Nothing has actually been sold.]
Here's another way to look at it.
The total revenue from selling 5 units at $100 is $500
The total revenue from selling 6 units at $95 is $570
My TR only increased by $70. Saying that another way, my MR is $70
My AR at 6 units is still $95. Because I sold all 6 units at $95. Thus the average amount I took in was $95. But my MR is less.
Let's trying giving a shorter explanation for why MR is always less than DARP in a monopoly.
The MR is less than DARP because in order to sell a greater number of units, I have to lower the price on each additional unit sold, as well as lowering the price on all of the units I would have sold at the higher price.
Here's a bit more practice. For this chart, figure out the TR, AR and MR for each price level.
Price
|
Quantity
|
Total Revenue (TR)
|
Average Revenue (AR)
|
Marginal Revenue (MR)
|
$100
|
1
|
|||
$90
|
2
|
|||
$80
|
3
|
|||
$70
|
4
|
|||
$60
|
5
|
|||
$50
|
6
|
|||
$40
|
7
|
We don't have enough information here to determine where we should produce. (We'd need some data about costs to do that.) But we can say for sure that we wouldn't want to produce 7 units. Why?
I'll post the answers on Tuesdays blog post.
Power Point:
Worksheets:
Hopefully you got a copy of these before we left. If not ask a friend to get you a copy of theirs.
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