| uM CHAPTER 2 The Welfare Economies of Market Power Figure 2,5, Pioil-Msiialzing Monepotist, Exeveise 241 Monopoly Pricing wish Constartt Marginal Costs md! Linceer Demand: Suppose that (i) demand is linear P(Q) = A ~6Q, where A and b are both positive parameters, ‘and (tt that marginal costis constant and equal to ¢. Find the monapoly price and output Solution The slope of this inverse demand function is —b. IP TW wants to vell another pitcher of beer. i will have to lower its price by b. Substituting into the marginal revenue function MR(Q) = P(O) + 1d P(Q)/40\024 Market Power a thotd P(Q)/dO = —band the inverse demand function for P(Q). we find thatthe marginal revenue fretion is! MR(Q) = A 260. (2.13) Marginal cost isc, $o using 2.13) and (2.12), A o” (2a) ob ‘We can then substitute Q" back into the demand curve to determine TW’s monopoly price: pate ats) Which is cleanly greater than marginal eost provided 4 > e. ‘Substituting both P"-and Q" into the firm’s profit function, we find that monopoly profits in this case are (Are 2:16) = 2.16) cs “The ease of linear demand and constant marginal cos WL equals the area ofthe dark triangle: illustrated in Figure 2.5. The size of the on =o! DWL= Qin ‘The socially optimal quantity Q* isthe amount demanded when price equals marginal cost: (218) D “This is twice as large as the monopoly output, given by 2.14), Substituting (2.14). (2.18),and (2.48) ino 2.17). ia TT aia revene i format the fst derisive of the revenue fancton. Wea mene demand is Hiner, AQ) = (4-80}0 = AD HQ? and thus dtd = A 20.0 CHAPTER 2 The Welfare 6 oncnniies OF Market Power Comparing consumer surplus, monopoly profits, and deadweight loss in this case, we see that C5 = DWL and cach is half of monopoly profi. soo 24.2 Measurement and Determinants of Mat PCa ™ 224) Fe2e eg ae Which is detined as the ratio of the firm is arises because the greater ¢, the greater the reduction in guamtity demanded when pri ei iit «1 monopolist, we did not ii dis eerie between the et ea and the mane curve of the firm—they were the same. However, in general a firm may have market power ‘and not be ai monopolist, The extent to which a firm in imperfectly competitive markels can etree Travis’ rower depends on the elasticity of ts demand curve. The preter the number of competion, (for homogeneous goods) or the larger the eross-lasticily of demand with the produete oF other Predlucets (for differentiated products), the greater the elasticity ofthe firm's demand curve aid the less its market A nee ean: we have dis he uct of demi be sive Hower, Sunt ees dominant relaoni petveen quay demanied aad pce neg. Ape stateay et 2 ears that «1% tneease in price kas to 2% derease in quanty demande