Chapter 6-9 Flashcards
4 major market structures
- perfect competition
- monopolistic competition
- oligopoly
- monopoly
characteristics of perfect competition
- many buyers and sellers (neither have control over price)
- homogeneous product
- no significant barriers to entry and exit
why study the perfectly competitive market
- information about how markets operate (entry, exit, costs)
- can be applied to imperfect market structures
- point of comparison to evaluate real-world markets
individual price taker’s demand curve
- individual sellers won’t sell at higher price because buyers can buy from someone else
- won’t sell for less because they can sell all they want at current price
- horizontal (at market price) over entire range of output quantity
effect of change in market price on individual price taker’s demand curve
varies directly with market price
total revenue
price times quantity sold (TR = P x q)
average revenue
total revenue divided by quantity sold (AR = TR/q)
marginal revenue
change in total revenue from the sale of an additional output (MR= ΔTR/Δq)
profit-maximizing output rule
- a firm should always produce where MR=MC
- when MR>MC expand production to increase profits
- when MR
profit-maximizing output level (q*)
- where MR=MC
- if at q* price is greater than ATC –> economic profit
- if at q* price is less than ATC –> economic loss
- if at q* price is equal to ATC –> zero economic profits (normal)
individual firm’s short run supply curve
the portion of the MC curve that lies above the minimum of the AVC curve
- shows the marginal cost of producing any given output
- shows the equilibrium output that the firm will supply at various prices in the short run
short-run production decisions of an individual competitive firm
as market price rises, the output decisions of a competitive firm evolve from not producing at all (shutting down), to operating at an economic loss, to economically breaking even, to generating an economic profit
economic profits in the long run
encourage entry of new firms –> shift market supply curve to the right –> drive down prices and revenue
economic losses in the long run
signal resources to leave industry –> supply reduction –> higher prices and increased revenue
long run equilibrium for the individual firm
when there is no entry/exit into the industry, at zero economic profits
constant-cost industries
input prices (and cost curves) do not change as industry output changes (industry must be very small demander of resources in the market)
increasing-cost industry
cost curves of the individual firms rise as total output increases (typical)
decreasing-cost industry
cost curves decline as total output increases
perfect competition long-run equilibrium
achieves productive efficiency, allocative efficiency, and production allocated to reflect consumers’ wants, making perfect competition economically efficient
productive efficiency
production at least possible cost
allocative efficiency
where P = MC and production is allocated to reflect consumer preferences
total profit
total profit = TR - TC
price taker
takes the price that it is given by the intersection of the market demand and market supply curves (perfectly competitive firm)
short run market supply curve
the horizontal summation of the individual firms’ supply curves in the market
utility
a measure of the relative levels of satisfaction consumers get from the consumption of goods and services
util
one unit of satisfaction
total utility (TU)
total amount of satisfaction derived from the consumption of a certain number of units of a good or service
marginal utility (MU)
extra satisfaction generated by an additional unit of a good that is consumed in a particular time period
diminishing marginal utility
the concept that as an individual consumes more and more of a good, each successive unit generates less and less utility (or satisfaction)
consumer equilibrium
allocation of consumer income that balances the ratio of marginal utility to the price of the goods purchased
consumer surplus
the monetary difference between the price a consumer is willing and able to pay for an additional unit of a good and the price the consumer actually pays; for the entire market, it is the sum of all of the individual consumer surpluses for those consumers who have purchased the good
producer surplus
the difference between what a producer is paid for a good and the cost of producing that unit of the good; for the market, it is the sum of all the individual sellers’ producer surpluses—the area above the market supply curve and below the market price
total welfare gains
the sum of consumer and producer surplus
deadweight loss
net loss of total surplus that results from the misallocation of resources
connection between law of demand and law of diminishing marginal utility
A fall in a good’s price will raise its marginal utility–price ratio above that of other goods purchased. This relatively greater ratio will lead a rational consumer to purchase more of this good at the expense of other goods.
marginal utility formula
MU = ΔTU/ΔQ
explicit costs
the opportunity costs of production that require a monetary payment
implicit costs
the opportunity costs of production that do not require a monetary payment
profits
the difference between total revenue and total cost
accounting profits
total revenues minus total explicit costs
economic profits
total revenues minus explicit and implicit costs
sunk costs
costs that have been incurred and cannot be recovered
short run
a period too brief for some production inputs to be varied
long run
a period over which all production inputs are variable
production function
the relationship between the quantity of inputs and the quantity of outputs produced
total product (TP)
the total output of a good produced by the firm
marginal product (MP)
the change in total product resulting from a unit change in input
diminishing marginal product
as a variable input increases, with other inputs fixed, a point will be reached where the additions to output will eventually decline
fixed costs
costs that do not vary with the level of output in the short run
total fixed cost (TFC)
the sum of the firm’s fixed costs
variable costs
costs that vary with the level of output
total variable cost (TVC)
the sum of the firm’s variable costs
total cost (TC)
the sum of the firm’s total fixed costs and total variable costs
average total cost (ATC)
a per-unit cost of operation; total cost divided by output
average fixed cost (AFC)
a per-unit measure of fixed costs; fixed costs divided by output
average variable cost (AVC)
a per-unit measure of variable costs; variable costs divided by output
marginal cost (MC)
the change in total costs resulting from a one-unit change in output
economies of scale
occur in an output range where LRATC falls as output increases
constant returns to scale
occur in an output range where LRATC does not change as output varies
diseconomies of scale
occur in an output range where LRATC rises as output expands
minimum efficient scale
the output level where economies of scale are exhausted and constant returns to scale begin
total production in the short run
Total output increases as variable inputs are increased. Marginal product initially rises but eventually declines as variable inputs are added. Finally, negative marginal product can occur, indicating a fall in total output
relationship between marginal and average amounts
Adding a marginal amount affects the value of the average amount—the average will rise (fall) when the marginal amount is larger (smaller) than the initial average
relationship between marginal product and marginal costs
An inverse relationship exists between marginal product and marginal cost—when marginal product increases, marginal cost must fall, and when marginal product falls, marginal cost must rise
U-shaped average total cost curve
Average total cost declines with expanding output as average fixed costs decline, but then increases as output expands due to increasing marginal cost
relationship between marginal cost and average (total/variable) cost
When marginal cost is less than (greater than) an average cost, the average cost must be falling (rising); when marginal cost is greater than (less than) an average cost, the average cost must be rising (falling)
long-run average total cost curve
In the long run, firms can vary inputs that are fixed in the short run, such as plant size and equipment, in some cases, lowering average costs per unit. The long-run average total cost curve shows the lowest average total cost for producing each output in the long run
causes of cost curve shift
Input prices, taxes, technology, and regulation can shift the cost curves.
marginal product formula
MP = ΔTP/L
total cost formula
TC = TVC + TFC
average fixed cost formula
AFC = TFC/Q
average variable cost formula
AVC = TVC/Q
average total cost formula
ATC = TC/Q = AVC + AFC
marginal cost formula
MC = ΔTC/ΔQ
monopoly
a market with only one seller of a product that has no close substitute and there are natural and legal barriers to entry that prevent competition
price maker
a monopolistic firm that sets the price of its product so as to maximize its profits
natural monopoly
a firm that can produce at a lower cost than a number of smaller firms could
marginal cost pricing
the decision to set production where the price of a good equals marginal cost
average cost pricing
production where the price of a good equals average total cost
price discrimination
the practice of charging different consumers different prices for the same good or service when the cost of providing that good or service is not different for different consumers
sources of monopoly power
Sources of monopoly power include legal barriers, economies of scale, and control over important inputs.
monopolist demand curve
The monopolist’s demand curve is downward sloping because it is the market demand curve. To produce and sell another unit of output, the firm must lower its price on all units. As a result, the marginal revenue curve lies below the demand curve.
why is marginal revenue less than price in a monopoly
The monopolist’s marginal revenue will always be less than price because there is a downward-sloping demand curve. In order to sell more output, the monopolist must accept a lower price on all units sold. This means that the monopolist receives additional revenue from the new unit sold but receives less revenue on all of the units it was previously selling.
relationship between elasticity of demand and total and marginal revenue
Along the elastic portion of the demand curve, a fall in price leads to an increase in total revenue, making marginal revenue positive. Along the inelastic portion of the demand curve, a fall in price leads to a fall in total revenue, making marginal revenue negative. Therefore, the monopolist will operate in the elastic portion of its demand curve.
monopolist profit-maximizing output
where MR = MC (like perfect competition)
- price is set by going up at that quantity to the demand curve
- P > MR
- P > MC
monopoly profit or loss
Monopoly profits can be found by comparing price per unit and average total cost at Q*. If P>ATC, there are economic profits. If P=ATC, there are zero economic profits. If P
does monopoly promote inefficiency
- Monopoly results in smaller output and a higher price than would be the case under perfect competition.
- monopolist produces at an output where P>MC, this means the value to society of the last unit produced is greater than its cost - not allocatively efficient
does monopoly hinder innovation
Monopoly may lead to greater concentration of economic power and could hinder innovation.
anti-combine laws
Anti-combine laws are designed to reduce the abuses of monopoly power and push production closer to the social optimum.
government regulation
Privately owned monopolies may be allowed to operate, but under the regulation of a government agency.
reason for price discrimination
Price discrimination occurs where differences in prices are not explained by differences in marginal cost - a result of the profit-maximization motive. If different groups have different demand curves for a good or service, a seller can make more money by charging these different buyers different prices
price discrimination and higher profits
A monopolist that can perfectly price-discriminate will produce a greater amount of output and earn a greater amount of economic profit when compared to a monopolist that charges a single monopoly price.
monopoly long term equilibrium
same as short term equilibrium, because barriers to entry allow them to keep profits, and negative profits would result in shut down
allocative efficiency
when P=MC, marginal benefits of consumption, reflected by price, equal the marginal costs of production
3 economic wastes of monopoly
- deadweight loss
- X-inefficiency
- rent seeking
deadweight loss (harberger)
loss in allocative efficiency because monopolist produces less than the socially efficient level and charges higher than competitive price –> loss to society from foregone resources
X-inefficiency (from the work of Harvey Leibenstein)
monopolists are wasteful because they have no competition to keep them cost efficient –> ATC may be higher than lowest possible costs
rent seeking (from the work of Gordon Tullock)
monopolist’s profit box draws other firms to the industry –> monopolist spends part of profits trying to prevent other firms from entering + entrants spend resources trying to get part of profits
monopoly and “creative destruction”
entry barriers can be circumvented by technological change - engine of progress
price regulation on the monopolist
- first best solution
2. second best solution
first best solution
deadweight loss equals zero because government forces monopoly to charge where MC = D (like perfectly competitive market)
problems with first best solution
- regulator does not know marginal costs of monopolist
2. competitive price would be too low and monopolist would make negative profits
second best solution
sometimes government may use “fair rate of return” price where P=ATC –> smaller deadweight loss
problem with second best solution
discourages technological innovations which would lower the ATC
3 types of price discrimination
- first degree
- second degree
- third degree
(not mutually exclusive)
first degree price discrimination
monopolist charges a different price for each unit of quantity - if done for each consumer, would capture all consumer surplus (not common, requires too much information)
second degree price discrimination
decreasing block price (buy more costs less) or increasing block price (buy more costs more)
third degree price discrimination
different prices for different groups of consumers with different demand elasticities
necessary conditions for price discrimination
- firm must have control over price (not perfectly competitive)
- firm must be able to identify different groups of consumers cheaply and legally
- firms must be able to prevent arbitrage
arbitrage
low price buyer sells the product to a high price buyer at a price below the discriminating firm’s price (more likely to occur with goods than services)
