3. Government intervention on product markets Flashcards
what is consumer surplus? + graph
When people buy something for less than it is worth to them, they receive a
consumer surplus: the consumption of intramarginal units which have a larger utility than the price paid (excess of the benefit received from a good over the amount paid for it)
MB (or value) - price
–The area between the demand curve and the price
level
what is producer surplus?
When price exceeds marginal cost, the firm receives a producer surplus: the extra benefit due to the sale of intramarginal units that a firm also would have sold for a lower price (because of lower marginal costs (the excess of the amount received from the sale of a good or service over the cost of producing it)
profit + fixed costs
– The area between the price level and the supply curve
in perfect competition how are consumer and producer surplus + graph
at the maximum
what are the 5 important features of perfect competition in the LR?
(in the LR: Profit maximization occurs where marginal cost equals marginal revenue (MR = LRMC)).
* Amount of capital used is no longer fixed
* Free entry and exit of firms
* Profits tend to become zero in the long run (at least excess profits disappear) because of free entry of firms resulting in an increase in supply: firms keep on entering in the market until too much supply so no more profit
* In the long run only firms survive which have chosen the technology with the least average total costs (the cheapest mean of production, otherwise no efficient).
* In the long run market secures that all firms move to production point where: P = MC = ATC with the lowest average total production costs technically possible
what is the least long term cost point?
the minimum point of the Long-Run Average Total Cost (LRATC) curve. This point represents the output level where economies of scale are fully exploited before diseconomies of scale set in.
-> LRATC is at its minimum → This means the firm is producing at the lowest possible cost per unit in the long run.
-> LRMC = LRATC at the minimum point → This indicates that marginal cost is not pushing average costs up or down, meaning costs are optimized.
SO In a perfectly competitive market, firms produce at this minimum LRATC in the long run, ensuring zero economic profit.
If a firm produces less or more than this optimal output, costs rise due to diseconomies of scale or inefficiencies
what are the different market type?
*1. Perfect competition
* 2. Monopoly
* 3. Monopolistic competition
* 4. Oligopoly
explain monopoly as a market type+ what is the demand curve,
-only one firm
-no close substitute
-high barriers to entry
→ able to manipulate the price (=/ price taker) but can only sell more at lower prices (bcs downward-sloping demand curve: as price decrease, demand will increase)
-bcs the firm sets the price, Demand Curve = Average Revenue (AR) Curve: The price consumers are willing to pay for each unit is also the firm’s average revenue
in a monopoly, where are demand elastic and inelastic?
see graph
let’s take the point A on the AR (demand curve), it is positionned exactly at the place where A= demand= AR
-> all the demands up are elastic and all the demands down are inelastic
Why is MR Lower than Price in a Monopoly?
If a monopolist wants to sell more units, it must lower the price for all units sold, not just the additional ones. This causes MR to fall faster than price.
graphique rep of a monopoly
*The Demand Curve (AR curve) is downward sloping.
*The MR curve is also downward sloping but lies below the demand curve (because lowering the price to sell more units reduces the revenue earned from previous units).
*TR initially increases but starts declining when MR becomes negative.
graph of monopoly profit
see graph
graph of profit of perfect competition
see graph
what is a welfare loss in monopoly?
monopolies produce less output at a higher price than would be the case in a perfectly competitive market. This leads to an inefficient allocation of resources and a deadweight loss (DWL) to society.
what is economies of scale and what does it implies in monopolies
cost advantages that businesses experience as they increase production (when scale of output grows, the average cost per unit of production decreases bcs fixed costs are spread over more units, and efficiency improves with larger-scale operations)
-> in monopolies: firms have to sell at lower costs, so that the demand grows
what are the 3 types of barrier (bcs 3 types of monopolies) that firms face when they try to enter in monopolies?
- ownership: when one firm owns a significant portion of a resource (ex: De Beers controlled up to 90% of the world’s supply in diamond)
- natural -> where a single firm can produce the entire industry’s output at a lower cost than multiple competing firms. This typically occurs due to significant economies of scale, where average total cost (ATC) continues to decline as production increases, making it inefficient for multiple firms to operate.
EX: Electricity companies—because the cost of building power grids is so high, it is more efficient for one company to serve the entire market rather than multiple firms duplicating infrastructure. - legal -> creates legal monopoly: the granting of:
-a monopoly franchise
-a government licence
-a patent
-or a copyright
in a monopoly, when is the revenu maximized?
*When MR = MC= 0 ( If MR > MC, increasing output raises profit AND If MC > MR, reducing output raises profit), total revenue is maximized, and demand is unit elastic
*If demand is elastic, reducing price increases total revenue, making MR positive (ex: if reduction of 1% of the price, then more that 1% increase in demand so total revenue increase, and MR is positive, meaning selling an additional unit generates extra revenue).
* If demand is inelastic, reducing price decreases total revenue, making MR negative (ex: if demand is inelastic, a 1% decrease in price leads to a less than 1% increase in quantity demanded)
what is the efficient outcome of perfect competition?
*Firms produce where P = Marginal Cost, which ensures that the quantity produced is socially optimal.
*Efficiency condition: At equilibrium (Pᴄ, Qᴄ), Marginal Social Benefit (MSB) = Marginal Social Cost (MSC) → No misallocation of resources.
*Total surplus (consumer + producer surplus) is maximized because all mutually beneficial trades occur
*Long-run efficiency:
-Firms enter and exit freely.
-Production occurs at the lowest long-run average cost (LRAC).
-No deadweight loss—resources are allocated efficiently.
explain that outcomes inefficient in monopoly
-Firms produce where Marginal Revenue (MR) = Marginal Cost (MC), not where P = MC.
*Producing less than the socially optimal quantity (Qᴹ < Qᴄ): The lower quantity produced by the monopoly is lower than the higher quantity produced in perfect competition, which is the socially optimal level
*Charging a higher price than in perfect competition (Pᴹ > Pᴄ): the higher monopoly price is higher than the lowest competitive pirce (bcs no competition
*Creating deadweight loss,
Higher price (Pᴹ > Pᴄ) → Consumer surplus shrinks.
Lower output (Qᴹ < Qᴄ) → Some consumers who would have bought at Pᴄ can no longer afford Pᴹ.
what is efficiency in economics
the optimal use of resources to maximize total welfare (total surplus) in society.
2 types:
-Allocative Efficiency: when P = MC
This means resources are allocated where they create the greatest benefit for society (goods and services are produced in the exact quantities that consumers desire, given their willingness to pay).
In perfect competition, firms produce at P = MC, ensuring no wasted resources.
-Productive Efficiency: when goods are produced at the lowest possible cost (at the minimum point of the Long-Run Average Cost (LRAC) curve).
Perfectly competitive firms achieve this in the long run, whereas monopolies might not due to lack of competition.
what does deadweight loss means
Transactions that would have occurred under perfect competition no longer happen, causing inefficiency.
-> Deadweight loss (DWL) occurs when market output is restricted below the efficient level where marginal social benefit (MSB) = marginal social cost (MSC).
how are costs inefficient in monopolies
In perfect competition, firms minimize costs due to competition.
In monopoly, firms lack pressure to minimize costs, leading to potential inefficiencies and higher long-run costs.
what are the assumptions of monopolistic competition as a type of market + graph
Most real-world markets are competitive, but not perfectly competitive because firms in these markets have some power to set their prices
1. Many suppliers, many buyers and a heterogeneous /differentiated product
* 2. The market behaviour of 1 firm does not have any influence on the total market
* 3. The goal of firms is maximizing profit
* 4. Firms have more or less identical cost structures (identical cost curves)
* 5. Firms are able to manipulate their price.
* 6. In the long run there are no barriers to the entry or exit of firms (so a firm cannot make an economic profit in the long run)
see graph
in monopolistic competition, what are the three implications for the firms in the industry(as there is many suppliers and buyers)
a. small market share (Each firm produces only a small portion of the total industry output so no single firm has significant market power)
b. firms ignore each other (Each firm focuses on its own pricing and product decisions, rather than reacting to specific competitors)
c. collusion is impossible (collusion is not possible because too many firms exist, making coordination difficult + firm acts independently, focusing on its own product and pricing + Market entry is easy, meaning new competitors can undercut collusive prices).
explain oligopoly as a type of market
Oligopoly
* Only a limited number of firms are active in this market
* If there are only two firms: duopoly
* Usually some barriers to entry, or some economies of scale
* Profits not only depend on the decisions (price) of the firm, but also on the decisions (prices) of the competitors
* Two examples of oligopolistic models:
– Game theory (2 firms: not discussed, if the one do smtg, the other react…)
– Cartel
