CHAPTER 10 • Market Power: Monopoly and Monopsony 367 $/Q P1 F IGURE 10.5 EFFECT OF EXCISE TAX ON MONOPOLIST ΔP P0 MC ϩ t t D ϭ AR MC With a tax t per unit, the firm’s effective marginal cost is increased by the amount t to MC ϩ t In this example, the increase in price ⌬P is larger than the tax t MR Q1 Q0 Quantity Shifting the marginal cost curve upward results in a smaller quantity and higher price Sometimes price increases by less than the tax, but not always—in Figure 10.5, price increases by more than the tax This would be impossible in a competitive market, but it can happen with a monopolist because the relationship between price and marginal cost depends on the elasticity of demand Suppose, for example, that a monopolist faces a constant elasticity demand curve, with elasticity −2, and has constant marginal cost MC Equation (10.2) then tells us that price will equal twice marginal cost With a tax t, marginal cost increases to MC ϩ t, so price increases to 2(MC ϩ t) ϭ 2MC ϩ 2t; that is, it rises by twice the amount of the tax (However, the monopolist’s profit nonetheless falls with the tax.) *The Multiplant Firm We have seen that a firm maximizes profit by setting output at a level where marginal revenue equals marginal cost For many firms, production takes place in two or more different plants whose operating costs can differ However, the logic used in choosing output levels is very similar to that for the single-plant firm Suppose a firm has two plants What should its total output be, and how much of that output should each plant produce? We can find the answer intuitively in two steps • Step Whatever the total output, it should be divided between the two plants so that marginal cost is the same in each plant Otherwise, the firm could reduce its costs and increase its profit by reallocating production For example, if marginal cost at Plant were higher than at Plant 2, the firm could produce the same output at a lower total cost by producing less at Plant and more at Plant • Step We know that total output must be such that marginal revenue equals marginal cost Otherwise, the firm could increase its profit by raising or lowering total output For example, suppose marginal costs were the same at each plant, but marginal revenue exceeded marginal cost In that case, the firm would better by producing more at both plants because the revenue earned from the