Welcome to week eight of the Power of Markets course. Last week we focused on one extreme setting that a firm can find itself in, perfect competition. Atomistic sellers, buyers, perfect information, product homogeneity, no barriers to entry or exit. In that setting as you will recall the firm had no control over price. It was stuck, it was had to take the price that was set by the market, and then determine how much to supply. And as we saw each firm looked at where price hit it's individual marginal cost curve. So long as variable costs were covered. This week we'll turn to the opposite case, where a firm does have control over the price it can charge. And we'll look first at pure monopoly, where there's only one supplier in the market, admittedly rare. And then to cases where there may be more suppliers than one. But still each individual firm may have some ability to set price. Pure monopoly, again, is a rare case. Single seller. The firm in such a setting is a price maker. It faces the entire demand curve, and has to decide at what point to operate. What price and quantity combination will maximize profits. And then, in other cases, where the firm isn't the sole seller, but it may compete with several other sellers, the individual firm may still be able to exercise some monopoly power, some ability to set price above marginal cost. We'll turn to both of those cases. First, let's look at Table 11.1. And this is a case of pure monopoly, where an individual firm faces the entire market demand curve. Now let's look at what's interesting about this. only at the first unit of output is marginal revenue equal to average revenue. So I'm going to circle that. But at every unit of output below the first unit, Marginal revenue is below average revenue. Now, average revenue, as you can see, is the same as price. So, the price the firm chooses along the demand curve it faces, is the same as the average revenue point if you can only charge one price in a market. Toward the end of this week, we'll turn to cases where we can charge individual buyers different prices, and why you can make more money doing that. But for now, you're a price setter with the ability to pick only one price and charge that average price across every consumer of the product that you sell. Marginal revenue in these cases is below the price that you charge. Why? Let's turn to the next graph figure 11.1 to show why. And we're looking at a particular setting that, some of you may have watched the TV hit series Desperate Housewives. The co-stars have to figure out how many shows do we produce in a season and what price do we charge as producers of these shows. At one extreme, we could produce one show per season, charge a million dollars for that show. Or we could produce more shows, three shows, and charge $800. $800,000 on average per show, or even more shows for a season and charge $700,000 per show. Now let's say we've moved from three to four, and we increase output. We select a lower price, a lower average revenue. Why will marginal revenue be below the price we choose at four units? When we make the step from three the four shows per season, we definitely pick up another show. And for that additional show we can earn 700,000 dollars, so for that additional show the gain is area B, of $700,000. And yet to take that step, because we can only charge one price across all the shows we produce, we also have to lower the price we charge on the proceeding units we are selling at a higher price. So we lose 100,000, on the first three shows. Marginal revenue is the difference between the gain and the loss. So the 700,000 gain on the incremental show and the lower price we have to charge on the shows that were already sold or could have been sold beforehand. 100,000 per show times 3, 300,000. And that's why the marginal revenue, the difference between those two, is 400,000. And if we flip back to the table proceeding at an output of four, the marginal revenue is $400,000 is less than the $700,000 that on average we would be charging for shelf. Anytime we face a market demand curve and we have to pick one price, one point along that demand curve. Marginal revenue will be below the price point we pick. Except for the very first unit sold. Now this is another example of the average marginal revenue relation-, average marginal relationship. The average revenue is the same as price. It's declining as we increase output and any time average is declining. ... The marginal must be below it to be pulling it down, except for the very first unit. Okay, so to again, it illustrates the same relationship we saw with cost curves. Any time we saw in that case where average cost was falling, the marginal cost had to be below it to be dragging it down. That's the basics of the monopoly situation. In the next session we'll cover, how do you pick the best price quantity combination if you want to maximize profit.
