Microeconomics: Monopoly Pricing Formula

Monopoly Pricing Formula

• The Monopoly pricing formula is also known as the inverse elasticity rule.
• The formula is derived from the Monopoly problem, which is defined as the Monopoly choosing the quantity that maximizes profit.
• The profit function is computed as the difference between total revenue and total costs.

Demand Curve

• The demand curve is a downward-sloping inverse demand curve.
• The demand curve is negatively sloped, indicating a negative relationship between the price and the quantity demanded.

Cost Function

• The cost function is represented as C(q), which tells the minimum total cost necessary to produce some quantity q.
• The marginal cost is the increase in cost that follows a tiny increase in quantity, represented as C'(q).

Price Elasticity of Demand

• The price elasticity of demand measures the change in quantity demanded of a product in relation to its price change.
• It is represented as η, and is calculated as the ratio of the percentage change in quantity to the percentage change in price.
• The elasticity is measured at a given point of the demand curve.

First Order Condition

• The first order condition is derived by taking the first order derivative of the profit function with respect to the quantity.
• The first order condition tells us what quantity the Monopoly chooses to maximize profit.

Monopoly Pricing Formula Derivation

• The Monopoly pricing formula is derived by solving the first order condition.
• The formula is expressed as (P - C'(q)) / P = 1 / η.

Lerner Index

• The Lerner Index is a measure of market power.
• It is defined as the ratio of the difference between the price and the marginal cost to the price.
• The Lerner Index is inversely related to the price elasticity of demand.

Market Power

• Market power is the capacity of a firm to raise the price above the marginal cost.
• In a perfectly competitive market, firms have no market power, and the price is equal to the marginal cost.
• In a Monopoly market, the firm has market power, and the price is above the marginal cost.

Monopoly Pricing Formula

• The monopoly pricing formula is derived from the profit function, which is the difference between total revenue and total costs.
• The formula is also known as the inverse elasticity rule, and is used to determine the optimal price and quantity for a monopolist.

Demand Curve

• The demand curve is downward-sloping, indicating a negative relationship between price and quantity demanded.
• The demand curve is used to determine the price elasticity of demand.

Cost Function

• The cost function, C(q), represents the minimum total cost necessary to produce a quantity q.
• The marginal cost, C'(q), is the increase in cost that follows a tiny increase in quantity.

Price Elasticity of Demand

• Price elasticity of demand, η, measures the change in quantity demanded in response to a change in price.
• It is calculated as the ratio of the percentage change in quantity to the percentage change in price.
• Elasticity is measured at a given point on the demand curve.

First Order Condition

• The first order condition is derived by taking the first order derivative of the profit function with respect to quantity.
• It determines the quantity that the monopolist chooses to maximize profit.

Monopoly Pricing Formula Derivation

• The monopoly pricing formula is derived by solving the first order condition.
• The formula is expressed as (P - C'(q)) / P = 1 / η.

Lerner Index

• The Lerner Index measures market power, which is the ability of a firm to raise price above marginal cost.
• It is defined as the ratio of the difference between price and marginal cost to price.
• The Lerner Index is inversely related to the price elasticity of demand.

Market Power

• Market power is the ability of a firm to raise price above marginal cost.
• In a perfectly competitive market, firms have no market power, and price is equal to marginal cost.
• In a monopoly market, the firm has market power, and price is above marginal cost.

Learn about the Monopoly pricing formula, also known as the inverse elasticity rule, and how it's derived from the Monopoly problem to maximize profit.