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Perfect Competition:Effect of Excise Tax on Monopolist

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Microeconomics ­ECO402
VU
Lesson 31
A Rule of Thumb for Pricing
­ We want to translate the condition that marginal revenue should equal marginal cost into
a rule of thumb that can be more easily applied in practice.
­ This can be demonstrated using the following steps:
ΔR
Δ ( PQ )
1 . MR =
=
ΔQ
ΔQ
⎛ Q ⎞⎛ Δ P ⎞
ΔP
= P + P ⎜  ⎟⎜
⎟
2 . MR = P + Q
P ⎠⎜ Δ Q ⎟
ΔQ
⎝
⎝
⎠
= ⎛ P  ⎞⎛ Δ Q
⎞
⎜  Q ⎟⎜
ΔP ⎟
3. E  d
⎝
⎠⎝
⎠
)(
)
(
1
Q
Δ P
=
4.
Δ Q
P
E
d
⎛
⎞
1
=
P +P ⎜
5. M R
⎟
⎝ E
⎠
d
6 . š is maximized
@ MR = MC
⎡ 1 ⎤
1
P + P⎢
=-
⎥
⎣ED ⎦
ED
MC
P =
1 + (1 E D )
1
7. -
= the markup over MC as a percentage of price (P-MC)/P
E d
8. The markup should equal the inverse of the elasticity of demand.
MC
9. P =
()
1
1+
Ed
Assume
Ed = -4
MC = 9
9
9
P=
=
= $12
(
)
.75
1+ 1
-4
Monopoly pricing compared to perfect competition pricing:
­  Monopoly
P > MC
­  Perfect Competition
P = MC
Monopoly pricing compared to perfect competition pricing:
146
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Microeconomics ­ECO402
VU
­ The more elastic the demand the closer price is to marginal cost.
­ If Ed is a large negative number, price is close to marginal cost and vice versa.
A Monopolist's Pricing
The Monopolist's Output Decision
­ Price of Medicine A = $3.50/daily dose
­ Price of Medicine B and Medicine C = $1.50 - $2.25/daily dose
­ MC of Medicine A = 30 - 40 cents/daily dose
♦The Monopolist's Output Decision
MC
. 35
P =
=
=
1+ [ E
]
1 + [ - 1 .1]
1
1
D
MC
. 35
=
= $ 3 . 89
1 + (- . 91
)
. 09
♦Price of $3.50 is consistent with "the rule of thumb pricing"
Shifts in Demand
­ In perfect competition, the market supply curve is determined by marginal cost.
­ For a monopoly, output is determined by marginal cost and the shape of the demand
curve.
Shift in Demand Leads to Change in Price but Same Output
MC
$/Q
P1
P2
D2
D1
MR2
MR1
Quantity
Q1= Q2
MC
$/Q
P1 = P2
D2
MR2
D
MR1
Q1
Q
Quantity
147
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Microeconomics ­ECO402
VU
Monopoly
Observations
­ Shifts in demand usually cause a change in both price and quantity.
­ A monopolistic market has no supply curve.
­ Monopolist may supply many different quantities at the same price.
­ Monopolist may supply the same quantity at different prices.
The Effect of a Tax
­ Under monopoly price can sometimes rise by more than the amount of the tax.
To determine the impact of a tax:
­ t = specific tax
­ MC = MC + t
­ MR = MC + t : optimal production decision
Effect of Excise Tax on Monopolist
$/Q
Increase in P: P0 to P1 > increase in tax
P1
ΔP
P0
MC + tax
D = AR
t
MC
MR
Q0
Q1
Quantity
Question
­ Suppose: Ed = -2
­ How much would the price change?
Answer
MC
P=
1+ ⎛ 1
⎞
⎜  E
⎟
⎝
⎠
d
If E  d = - 2 →
P = 2 MC
If MC increases  to MC + t
Δ P = 2 ( MC + t ) = 2 MC + 2 t
Price increases
by twice
the tax.
What would happen to profits?
148
Table of Contents:
  1. ECONOMICS:Themes of Microeconomics, Theories and Models
  2. Economics: Another Perspective, Factors of Production
  3. REAL VERSUS NOMINAL PRICES:SUPPLY AND DEMAND, The Demand Curve
  4. Changes in Market Equilibrium:Market for College Education
  5. Elasticities of supply and demand:The Demand for Gasoline
  6. Consumer Behavior:Consumer Preferences, Indifference curves
  7. CONSUMER PREFERENCES:Budget Constraints, Consumer Choice
  8. Note it is repeated:Consumer Preferences, Revealed Preferences
  9. MARGINAL UTILITY AND CONSUMER CHOICE:COST-OF-LIVING INDEXES
  10. Review of Consumer Equilibrium:INDIVIDUAL DEMAND, An Inferior Good
  11. Income & Substitution Effects:Determining the Market Demand Curve
  12. The Aggregate Demand For Wheat:NETWORK EXTERNALITIES
  13. Describing Risk:Unequal Probability Outcomes
  14. PREFERENCES TOWARD RISK:Risk Premium, Indifference Curve
  15. PREFERENCES TOWARD RISK:Reducing Risk, The Demand for Risky Assets
  16. The Technology of Production:Production Function for Food
  17. Production with Two Variable Inputs:Returns to Scale
  18. Measuring Cost: Which Costs Matter?:Cost in the Short Run
  19. A Firm’s Short-Run Costs ($):The Effect of Effluent Fees on Firms’ Input Choices
  20. Cost in the Long Run:Long-Run Cost with Economies & Diseconomies of Scale
  21. Production with Two Outputs--Economies of Scope:Cubic Cost Function
  22. Perfectly Competitive Markets:Choosing Output in Short Run
  23. A Competitive Firm Incurring Losses:Industry Supply in Short Run
  24. Elasticity of Market Supply:Producer Surplus for a Market
  25. Elasticity of Market Supply:Long-Run Competitive Equilibrium
  26. Elasticity of Market Supply:The Industry’s Long-Run Supply Curve
  27. Elasticity of Market Supply:Welfare loss if price is held below market-clearing level
  28. Price Supports:Supply Restrictions, Import Quotas and Tariffs
  29. The Sugar Quota:The Impact of a Tax or Subsidy, Subsidy
  30. Perfect Competition:Total, Marginal, and Average Revenue
  31. Perfect Competition:Effect of Excise Tax on Monopolist
  32. Monopoly:Elasticity of Demand and Price Markup, Sources of Monopoly Power
  33. The Social Costs of Monopoly Power:Price Regulation, Monopsony
  34. Monopsony Power:Pricing With Market Power, Capturing Consumer Surplus
  35. Monopsony Power:THE ECONOMICS OF COUPONS AND REBATES
  36. Airline Fares:Elasticities of Demand for Air Travel, The Two-Part Tariff
  37. Bundling:Consumption Decisions When Products are Bundled
  38. Bundling:Mixed Versus Pure Bundling, Effects of Advertising
  39. MONOPOLISTIC COMPETITION:Monopolistic Competition in the Market for Colas and Coffee
  40. OLIGOPOLY:Duopoly Example, Price Competition
  41. Competition Versus Collusion:The Prisoners’ Dilemma, Implications of the Prisoners
  42. COMPETITIVE FACTOR MARKETS:Marginal Revenue Product
  43. Competitive Factor Markets:The Demand for Jet Fuel
  44. Equilibrium in a Competitive Factor Market:Labor Market Equilibrium
  45. Factor Markets with Monopoly Power:Monopoly Power of Sellers of Labor