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Monopoly Algebra
Monopoly Algebra
Letssupposethatwearefacingthefollowingtwoequationsforourmonopolist.
Demand:P=100Q
Supply:P=4+3Q
Weknowfromourpastdiscussionsthatthemarketwilllooklikethis:
Iveidentifiedthecompetitivemarketequilibrium,howeveritreallywontdoanythingforusexcept
calculateresourcemisallocation.Whatweneedinthisexample(sincethisisamonopoly)isthe
marginalrevenuecurve.Withourstraightlinedemandcurve,wearesimplyfindingthelinethathas
thesameinterceptandaslopethatistwiceassteep.Basically,ourP=100QtransformsintoP=
1002Q.Theproofforthisislistedattheend.Ifyouarenotversedincalculus,thenIsuggest
ignoringtheproofandtakingmywordforit.
NowthatweknowMRisP=1002Q,wecanaddittoourgraph.
Wenowhavethedistastefultaskoffiguringoutwhataandbarenumerically.Thisshouldseem
familiar;infact,wedidthistofindtheequilibriumquantityandprice.
Weareagainsettingtwoequationsequaltooneanother.Thistimewellusesupplyandournewly
discoveredmarginalrevenueequation.Mathematically,thisisidentical(inproceduralterms)towhat
wedidtofindtheequilibrium.Economically,whatweredoingissettingMR=MC(sincesupplyis
marginalcost,didyouforgetthat?).TheQwefindwillbetheprofitmaximizingpointofproductionfor
amonopolist.
P=1002QandP=4+3Q
1002Q=4+3Q
Setthemequaltoeachother
96=5Q
Usealgebra:subtract4fromandadd2Qtobothsides
19.2=Q
Dividebothsidesby5.
Sorryforthedecimal;ithappens.NowthatweknowQ,wecantakethatandputitintoeitherthe
supplyequationorthemarginalrevenueequation.Eitherway,youshouldgetthesameresult.
IntoMarginalRevenue
IntoSupply
P=1002(19.2)
P=4+3(19.2)
P=10038.4
P=4+57.6
P=61.6
P=61.6
Voila!Letsputthatintothegraph.
Onelaststepwiththeequations.Togetthepriceamonopolistcharges,weneedapointonthe
demandcurve.Specifically,weneedthepointondemandthatcorrespondstotheprofitmaximizing
quantity(orinourexample19.2).Amonopolistisnotgoingtosimplycharge$61.60or$76.Whynot?
Becauseamonopolistisnotstupid!Themonopolistisgoingtochargeashighofapriceashe/shecan
get,whichcorrespondstoapointonthedemandcurve(rememberthatdemandismeasuring
reservationprice,orthehighestamountoneiswillingtopay).
Hmmmwhattodowhattodo.Iknow!IknowthatthequantityIaminterestedinis19.2,yes?So,if
IhaveaQandImlookingforaPthatisbasedondemand,ImerelyneedtoputthatQintothedemand
equation.Likeso
P=100Q
MakesureyouareusingDandnotMR!
P=100(19.2)
P=80.8
Sopointcis80.8.Letsgetthatonthegraph.
Nowwehaveallthenumbersweneedtoanalyzethemonopoly.Wecannowfind:
MonopolyQuantity
MonopolyPrice
Markup
ResourceMisallocation
DeadweightLoss
Intheend,youshouldgetsomethingthatlookslikethis(ifyouretryingtofigureoutthesefivethings).
Letmegiveyousomehints.
MonopolyQuantity:whereMR=MC,thisisthequantitythatmaximizesthemonopolistsprofit
MonopolyPrice:Theamountamonopolistcharges,shouldbereadoffthedemandcurve
Markup:PriceMarginalCost,givesasenseofhowmuchmarketpoweramonopolisthas
ResourceMisallocation:Deviationfromequilibrium
DeadweightLoss:Costtosocietyofthepresenceofamonopoly
(Answeronnextpage,dontscrollaheaduntilyouvetrieditonyourown.)
Heresthekey:
MonopolyPrice:$80.80
MonopolyQuantity:19.2
Markup:$80.80$61.60=$19.20
ResourceMisallocation:4.8toofew
DeadweightLoss:($19.20)*(4.8)*(0.5)=$46.08
Getit?Here,tryanotherone.Illgiveyoutheequations.Youfindthefivethingswejustidentified
basedontheseequations.Thenextpageistheanswerkey.DONTLOOKUNTILYOUVETRIED!!You
onlylearnbymakingmistakes.
Demand:
P=403Q
Supply:
P=3Q
(P.S.Icantguaranteeanyoftheseareniceevennumbers.Ijustmadethemuponthespot.)
Well?
ProofofMR
Forthoseofyouwhohavesomecalculusbehindyouandwishtoseewhyweareabletosimplydouble
theslope,herewego.
Sincewearedealingwithamonopoly,thedemandcurveisacollectionofprice/quantitycombinations
thatweareabletosell.BecauseitislistedasP=mQ+b,itsdefinedasaprice.
So,ifwewereinterestedinatotalrevenuefunction,wewouldsimplybemultiplyingpricetimes
quantity.
TR=P*Q
ButweknowwhatPis.Wecansubstituteourequation.Justtodoanexample,Illusetheequation
fromthefirstexampleonthisstudysheet.
Puttingthatin,wesee:
100
Thisbecomes:
100
WhileItrytoshyawayfromusingthisterminologyinaprinciplesclass,thefactthatyouhavecomethis
farmeansyoureinterested.Themarginalisthefirstderivativeofthetotal.So,ifIwanttofindthe
marginalrevenuecurve,Icansimplytakethefirstderivativeofthetotalwithrespecttoquantity.Here
goes.
100
Andthatsit!TheresmyMRfunction.
Wanttoseeitagain?Great,Illshowyou.Takethesecondequation.
40 3
40
3
40
Workseverytime!Infact,thenicethingaboutthismethodisitworksforanyfunctionnomatterhow
crazyyouwanttomakedemand.
ItevenworksforthePerfectCompetitioncasewedid.TheTRfunctionforperfectcompetitionissimply
P*Q.SincewearerestrictedtosellingatPe,itsnomorecomplicatedthanPe*Q.Workingourmagic
RememberhowtheMRcurveincompetitionwassimplyahorizontallineatmarketequilibriumprice?
Thatswhatthisis!!Beautiful!