# Thumb Rule of Pricing

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10.1

MONOPOLY

A Rule of Thumb for Pricing
Chapter 10: Market Power: Monopoly and Monopsony

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. To do this, we first write the expression for marginal revenue:

Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall • Microeconomics • Pindyck/Rubinfeld, 7e.

9 of 50

10.1

MONOPOLY

A Rule of Thumb for Pricing
Chapter 10: Market Power: Monopoly and Monopsony

Note that the extra revenue from an incremental unit of quantity, ∆(PQ)/∆Q, has two components: 1. Producing one extra unit and selling it at price P brings in revenue (1)(P) = P. 2. But because the firm faces a downward-sloping demand curve, producing and selling this extra unit also results in a small drop in price ∆P/∆Q, which reduces the revenue from all units sold (i.e., a change in revenue Q[∆P/∆Q]). Thus,

Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall • Microeconomics • Pindyck/Rubinfeld, 7e.

10 of 50

10.1

MONOPOLY

A Rule of Thumb for Pricing
Chapter 10: Market Power: Monopoly and Monopsony

(Q/P)(∆P/∆Q) is the reciprocal of the elasticity of demand, 1/Ed, measured at the profit-maximizing output, and Now, because the firm’s objective is to maximize profit, we can set marginal revenue equal to marginal cost: which can be rearranged to give us (10.1) Equivalently, we can rearrange this equation to express price directly as a markup over marginal cost: (10.2)
11 of 50

Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall • Microeconomics • Pindyck/Rubinfeld, 7e.

Applying MR-MC Output and Pricing
Chapter 10: Market Power: Monopoly and Monopsony

MC P  1  1  Ed    Ed  4 MC  9 9 9   \$12 P .75 1 1 4

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...10.1 MONOPOLY A Rule of Thumb for Pricing Chapter 10: Market Power: Monopoly and Monopsony 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. To do this, we first write the expression for marginal revenue: Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall • Microeconomics • Pindyck/Rubinfeld, 7e. 9 of 50 10.1 MONOPOLY A Rule of Thumb for Pricing Chapter 10: Market Power: Monopoly and Monopsony Note that the extra revenue from an incremental unit of quantity, ∆(PQ)/∆Q, has two components: 1. Producing one extra unit and selling it at price P brings in revenue (1)(P) = P. 2. But because the firm faces a downward-sloping demand curve, producing and selling this extra unit also results in a small drop in price ∆P/∆Q, which reduces the revenue from all units sold (i.e., a change in revenue Q[∆P/∆Q]). Thus, Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall • Microeconomics • Pindyck/Rubinfeld, 7e. 10 of 50 10.1 MONOPOLY A Rule of Thumb for Pricing Chapter 10: Market Power: Monopoly and Monopsony (Q/P)(∆P/∆Q) is the reciprocal of the elasticity of demand, 1/Ed, measured at the profit-maximizing output, and Now, because the firm’s objective is to maximize profit, we can set marginal revenue equal to marginal cost: which can be rearranged to give us (10.1) Equivalently, we can rearrange this equation...

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