Lecture 23: Theory of the firm and Monopoly Flashcards
For perfectly competitive firms, we will see that AR =
AR = MR = P
The goal of a competitive firm is to what?
maximise profit
At what point is profit maximised in a perfectly competitive firm?
MR = MC
If firms in a perfectly competitive market are price takers, how do they determine how much they sell?
They sell at the market price and pick the quantity that will maximise their profit
The quantity to maximise profit for a firm in a perfectly competitive market will be where?
where MR = MC
How can we calculate economic profit on a perfectly competitive market curve?
π = Q (AR - ATC)
On the curve for a perfectly competitive market, where is there zero economic profit?
Where P = MR = AR
On the curve for a perfectly competitive market, where are firms making negative economic profit?
When AR < ATC
because the cost of making the product is below the price it is being sold for
In the short run supply curve, the MC curve shows how much the supplier will produce and sell at each price. Therefore, the MC curve appears to be the what?
supply curve
What is the short run shut-down rule?
a firm will operate only if the average revenue is greater than or equal to the average variable cost
ie P>AVC otherwise the firm will shut down
When P < ATC, we have ___________ economic profits
negative
When will a firm shut down in a perfectly competitive market?
If P < AVC
In the long run, firms will enter or exit the market until profit is driven to ___________ and price equals the minimum ___________ _________ ___________ (___________ scale)
zero
average total cost
efficient
The study of the long run depends on how entry of new firms affects the price of inputs. They may
- be unaffected by entry
- increase due to entry
- decrease due to entry
What happens in the long run if there is economic profit in the market?
Firms will enter in the long run, enticed by the profit. However this changes the industry and the profit eventually disappears
Why is the long-run supply curve up-ward sloping?
because previously some resources used in production may be available only in limited quantities and firms have different costs
Define marginal firm
the firm that would exit the market if the price were any lower
What happens if the price decreases instead of increased (eg a decrease in demand)?
firms would leave the industry until there was zero economic profit
A monopoly firm is a price __________-
maker
When is a firm considered a monopoly?
- if it is the sole seller of its product
- its product does not have close substitutes
What are the three cases that cause a monopoly?
- when a firm owns a key resource
- when a firm has exclusive production rights from the government
- when a firm has production costs much lower than many smaller producers
What is a natural monopoly?
An industry where a single firm can supply a good or service to an entire market at a smaller cost than two or more firms could
What can governments do to create monopolies?
- by giving a single firm the exclusive rights to sell a particular good in certain markets
- by giving a single firm patent and copyright laws (to serve the public interest)
When does a natural monopoly arise?
When there are economies of scale over the relevant range of output
What sort of demand curve does a natural monopoly face?
a downward sloping demand curve
What subcategories does a monopoly fit under in the market structure?
When there is only one curve
Compare a monopoly and a perfectly competitive market:
- number of producers
- demand curve
- price maker or taker
- how much does it sell
- in a monopoly, there is only one producer, a competitive firm there are lots of producers
- a monopoly faces a downward-sloping demand curve whereas a competitive firm faces a horizontal demand curve
- a monopoly is a price maker and a competitive firm is a price taker
- a monopoly reduces the price to increase sales whereas a competitive firm sells as much or as little at the same price
Where does the MR curve fall in a monpoly?
The MR is twice as steep as the AR and so it falls underneath it.
In a monopoly, if a price fall sells one more unit, the revenue received from previously sold units also
decreases
A monopoly increasing its sales has two effects of TR. What are these?
- the output effect: more output is sold, so TR is higher
- the price effect: price falls so total revenue is lower
A monopoly maximises profit by producing the quantity at which
marginal revenue equals marginal cost
How is price determined in a monopoly?
the quantity to produce the profit is given where MC = MR and the corresponding price on the demand curve is the price charged to maximise profit
How is profit calculated on a monopoly curve?
(P - ATC) x q
The monopolist will receive economic profits as long as price is greater than what?
average total cost
When would a monopolist be making a loss?
when their average total costs rise so that they are higher than the price
In a monopoly, where is the efficient quantity?
where the demand crosses the marginal cost curve
What does demand represent on a monopoly curve?
the value to buyers
In a monopoly, what happens at the quantities that are to the left of the efficient quantity equilibrium?
The cost to the monopolist is less than the value to buyers which is a good thing for the monopolist
In a monopoly, what happens at the quantities that are to the right of the efficient quantity equilibrium?
the cost to the monopolist is greater than the value to the buyers
The market allocates goods to people who ________ it the ________ and to producers who __________ it the ____________
value
most
produce
cheapest
In contrast to a competitive firm, a monopoly charges a price above the
marginal cost
From the standpoint of consumers, this high price makes monopoly
undesirable
From the standpoint of the owners of the firm, the high price makes the monopoly very
desirable
Is there a deadweight loss in a competitive market? Why?
no because in a competitive market, total surplus is maximised
Is there a DWL in a monopoly? Why?
yes
at q, P>MC so there is economic inefficiency
How can this deadweight loss be eliminated in a monopoly?
by charging more than one price (price discrimination)
Define price descrtimination
charging different prices on differences in consumer willingness to pay, not on differences in costs
How would producers price discriminate?
- charge those who value higher the higher prices
- charge those who have a smaller MV a lower price
What are three conditions for price discrimination?
- the supplier must have some market power (it must be a price maker not a price taker)
- the firm must be able to distinguish consumers according to their willingness to pay
- there must be no arbitrage possibilities (a customer can’t buy at a low price and sell at a higher price)
Why does price discrimination eliminate DWL?
because if every consumer is paying their willingness to pay, total CS = 0 so everything is PS
What are the three types of price discrimination?
- first degree
- second degree
- third degree
Where does price discrimination not go past?
MC
What is first degree price discrimination?
- the monopolist must charge the most anyone is willing to pay for each unit of output (ie. charge everyone their willingness to pay)
- this is perfect price discrimination
What is second degree price discrimination?
- within consumer price discrimination some people buy multiple units of a god per time period and their MV falls as Q increases
- price discriminating strategy: charge a high price for the first unit, reduce price on additional purchases (eg. buy one get half price)
What is third degree price discriminaton?
Where consumers are broken into groups based on their responsiveness to price eg. a price unresponsive group and a price responsive group
eg. student discounts in a movie theatre
There are several groups with different demand curves (and different revenue curves)
