Midterm 2 Flashcards
law of supply
firms are willing to produce and sell a greater quantity of a good when the price of the good is HIGHER
Industrial organization
the study of how firms decisions about prices and quantities depend on the market conditions they face
-a firms COSTS are a key determinant of its production and pricing decisions
total revenue, cost and profit
Total revenue - the amt. the firm receives for the sale of its output (Q*P)
Total cost - the amt. the firm pays to buy inputs
profit - firm’s total revenue minus its total cost
Explicit costs
input costs that require an outlay of money by the firm (ingredients, materials, workers wages)
—accountants measure explicit - money that flows into and out of firms…but ignore implicit costs
Implicit costs
Input costs that do not require an outlay of money by the firm
—cookie store owner is also comp. programmer and could earn $100 per hour…for every hour she works in cookie factory she gives up $100 in income (opp. cost)
—economists study how firms make production and pricing decisions (study both explicit and implicit - even though can’t see implicit costs…it affects the decisions they make
Implicit costs pt. 2
Total cost = sum of explicit and implicit costs
imp. implicit cost is opportunity cost of financial capital that has been invested in the business
- –used $300,000 of savings to buy factory…if had left in the bank would have made 5% interest a year in interest income = IMPLICIT COST (accountants would ignore, but economists count the 15,000 as an implicit cost she gives up0
if instead had used $100,000 savings and borrowed $200,000 from bank at interest rate of 5%…accountants will measure the $10,000 of interest paid on bank loan each year as a cost bc money flows out of the firm
—but economists look at opp. cost of owning business as the 15,000 = (interest on bank loan - explicit cost of 10,000 plus the forgone interest on savings (implicit of $5000)
Economic profit vs. accounting profit
economic profit - total revenue minus total cost (including both explicit and implicit costs)
accounting revenue - total revenue minus EXPLICIT costs (usually larger than economic profit)
- –from economic standpoint - in order to be profitable total revenue must EXCEED all opp.costs, both explicit and implicit
- -when firms economic losses (negative economic profit) - business owners are failing to earn enough revenue to cover all costs of production
production function
the relationship btw quantity of inputs (workers) used to make a good and quantity of output (cookies) of that good - input on horizontal and output on vertical (look at costs in the short run - assume factory size fixed)
- -production function is positive slope that gets flatter as hire more workers (bc diminishing marginal product)
- -first picture
total cost curve
shows relationship btwn quantity of output produced (horizontal) and total cost of production) - gets steeper as quantity of output increases bc of diminishing marginal product)
–2nd picture
marginal product
the increase in output that arises from an additional unit of input (when # of workers foes from 1 to 2, cookie production increases from 50 to 90 - marginal product of 2nd worker is 40 cookies)
diminishing marginal product
property whereby the marginal product of an input declines as the quantity of the input increases (marginal product from 1-2 workers (40 cookies) is less than that from 2-3 workers (30 cookies))
—kitchen gets more crowded and have to share the equipment and materials (as hire more, each contributes fewer cookies)
SLOPE OF PRODUCTION FUNCTION
MEASURES MARGINAL PRODUCT
—most important relationship is btw quantity produced and total cost
OPPOSITE: Total cost curve gets steeper as amt. produced rises, where production function gets flatter as production rises
- –many workers = crowded - each additional worker adds less to production - reflects diminishing marginal product (so production function is flat)
- -when kitchen is crowded, producing an additional cookie requires a lot of additional labor and costly - the quantity produced is large, total-cost curve is steep
fixed and variable costs
fixed - do not vary with quantity of output produced
variable - change as firm alters quantity of output produced (ingredients, workers’ salaries)
–total cost is sum of fixed and variable costs
average total cost
total cost divided by quantity of output (cost of typical unit produced)
—tells as cost of typical unit, but not how much total cost will change as alters production levels
ATC = TC/Q
average fixed and variable cost
AFC - fixed cost divided by quantity of output
AVC - variable cost divided by quantity of output
Marginal cost
marginal cost - the increase in total cost that arises from an extra unit of production
—MC = CHANGE TC/ CHANGE Q
–IMP!!! ATC tells us cost of a typical unit of output if total cost is divided evenly over all units. Marginal cost tells us the increase in total cost that arises from producing an additional unit (use both when making decisions of how much to supply)
Average total cost and marginal cost curves
quantity on x and costs on y (costs MC, ATC, AVC, AFC
- MARGINAL COST RISES AS QUANTITY OF OUTPUT INCREASES
- —bc of diminishing marginal product (with small quantity = marginal product of extra worker is large and marginal cost of extra cup of coffee is small - but with large Q = many workers and marginal product is low but marginal cost of extra cup is large) - ATC CURVE IS U SHAPED
- –ATC = AVC + AFC
- –AFC always DECLINES as output RISES bc FC is spread over large number of units
- –VC usually RISES as output INCREASES bc diminishing marginal product
- -ATC reflects changed in AFC and AVC
- –efficient scale - Q of output that minimizes ATC - if produce less than amt. ATC is higher and bc FC is spread over so few units - if produce more, ATC is higher bc marginal product of inputs has diminished - MARGINAL-COST CURVE CROSSES ATC CURVE AT THE MINIMUM OF ATC
- –whenever marginal cost is less than ATC, ATC is falling (and when MC is > ATC, ATC is rising)
- –ex. like grades - ATC = grade point average, MC = grade in next course - if grade in next course is lower than grade pt. ave., ave. will fall
- -MC crosses ATC at minimum ATC - bc low levels of output, MC is below ATC, so ATC is falling - but after curves cross, MC rises above ATC
ATC MC AVF AFC curves
4th picture!!
–at low levels of output, firm experiences increasing MC and MC curve falls - eventually exp. diminishing marginal product and MC curve starts to rise
–doesn’t always simply fall with first new worker - usually see increasing marginal product for a while before diminishing marginal product
short run and long run ATC
Many decisions (factory size) are fixed in short run but variable in long run
–picture 5
long run have much flatter U shape (firms are more flexible in the long run)
-shape of long run ATC shows info. about production processes that a firm has available for manufacturing a good (by size of firm)
Economies of scale, diseconomies and constant returns to scale
economist of scale - property whereby long-run ATC falls as Q of output increases - usually bc high production levels allow specialization among workers (assembly line)
diseconomies of scale - property whereby long-run average total cost rises as Q of output increases
–arise bc coordination problems (less effective)
constant returns to scale - long run ATC does not vary with levels of output
Competitive market basic info.
how do you maximize profit in perfectly comp. society? - by producing Q where marginal revenue = marginal cost
- –benefit of shutting down is saving VC - will not save FC (bc still pay rent)
- -if P > AVC, then firm produces Q where P = MC
- -As long as you can cover VC want to keep producing - anything over VC is helping overcome the loss coming from FC
Competitive market
each buyer and seller is small compared to the size of the market, therefore has little ability to influence market prices (Each buyer and seller is a price taker - meaning they must accept the price the market determines)
Perfectly competitive if
- Many buyers and sellers in the market
- Goods offered by various sellers are largely the same
- Firms can freely enter or exit the market (not a necessary condition but usually happens)
- –But when there is free entry and exit in a comp. market, it is a powerful force shaping the long-run equilibrium
Market power - if a firm can influence the market price of the good it sells (water company)
revenue of a competitive firm
Tries to maximize revenue (total revenue minus total cost) - (TR = P x Q)
—Price does not depend on the quantity produced - Total revenue is proportional to the amount of output
Total Revenue = P x Q
average and marginal revenue in comp. market
Average Revenue = TR / Q sold (total revenue divided by total output)
—Tells us how much revenue firm receives for typical unit sold - (IMP!!) for all types of firms (not only competitive) average revenue equals the price of the good
Marginal revenue = (Change in TR) / (Change in Q)
- –The change in total revenue from the sale of each additional unit of output
- –Total revenue is P x Q and P is FIXED for competitive firms - when Q rises by 1 unit, total revenue rises by P dollars
IMP!! for competitive firms marginal revenue equals the price of the good
Example of profit maximization for comp. market (picture 6 - gallons of milk)
Can look and see it is maximized when produces either 4 or 5 gallons (profit)
- –Can find profit-maximizing quantity by comparing marginal revenue and marginal cost from each unit produces
- –(IMP!!) As long as marginal revenue exceeds marginal cost, increasing the quantity produced raises profits
Marginal cost = (Change in Total Cost / (change in quantity)
Change in profit = (marginal revenue) - (marginal cost)
Revenue and Marginal revenue are CONSTANT in COMPETITIVE firms - bc price is same
One of ten principles of economics - “rational people think at the margin
MC curve in comp. market (picture 7)
firm MAXIMIZES profit by producing Q where MC = MR (or PRICE bc P = MR in comp. market)
- —Marginal cost curve is upward sloping (bc variable costs same per unit)
- —Average-total-cost curve is U shaped
- —Marginal cost curve crosses average-total-cost curve at the MINIMUM of average total cost
- —MARKET PRICE IS HORIZONTAL LINE IN COMPETITIVE MARKET BC CONSTANT PRICE
Already know the price - trying to find the profit-maximizing quantity
—For a competitive firm, price equals both the firm’s average revenue and its marginal revenue
Learn 3 things from this analysis (key to rational decision making by profit-maximizing firm)
1. If marginal revenue is greater than marginal cost, the firm should increase its output 2. If marginal cost is greater than marginal revenue, the firm should decrease its output 3. At the profit-maximizing level of output, marginal revenue and marginal cost are exactly equal
IMP!!! In competitive markets, the marginal revenue is equal to price - so to find the profit-maximizing quantity - look at intersection of price and Marginal cost curve
IMP!!! Because the firm’s marginal cost curve determines the quantity of the good the firm is willing to supply at any price, the marginal-cost curve is also the competitive firm’s supply curve
Temporary shut down in comp. market
Shutdown - short-run decision not to produce during a specific period of time bc of current market conditions (Still will pay fixed costs)
—If shuts down, loses all revenue from sales, but also saves the variable costs - still will lose money but loses more staying open
Firm shuts down if REVENUE THAT IT WOULD EARN FROM PRODUCING is less than its variable cost of production
Shut down if TR < VC or (TR/Q < VC/Q)
Left side can just be P bc TR=Q x P - and right side is AVC (Average variable cost)
Shut down if P < AVC
Exit (long run decision in comp. market)
Exit - long-run decision to leave the market (can’t avoid fixed costs in short run but can in long run)
—For comp. markets - produce the Q where MC = P, but if P is < AVC, firm is better off shutting down temporarily
◦ A comp. firm’s short-run supply curve is the portion of its marginal-cost curve that lies above the AVC
(graph = picture 8)
sunk cost
cost that has already been committed and cannot be recovered - ignore them when making decisions bc nothing can be done
—Fixed costs are SUNK in the short run, firm should ignore them when deciding how much to produce
—Short-run supply curve is part of marginal-cost curve above the AVC, and size of fixed costs don’t matter for supply decision
—Look at the value and see If it exceeds the opportunity cost (sunk cost) - lost $10 ticket for $15 movie don’t want to pay $20, but the $15 is worth more than the $10 you lost
Golf courses, restaurants at lunch time - when decided when to open and temporarily close down - look if the revenue made will exceed variable costs (bc fixed costs are irrelevant, will pay regardless)
long run decisions to exit or enter a market (graph #9) in comp. market
—Exits if the revenue it would get from producing is less that its TOTAL COST (Bc loses revenue but also saves VC and FC in long run)
Exit if TR < TC
◦ TR/Q < TC/Q —> Exit if P < ATC
• Enter if P > ATC (Exact opposite for entering)
A firm’s long run supply curve is the portion of its marginal-cost curve that lies above average TOTAL COST
profit in comp. market
Profit = TR - TC
• Rewrite —> Profit = (TR/Q - TC/Q) x Q
◦ TR/Q is average revenue, which is = to price, and TC/Q is average total cost
PROFIT = (P-ATC) x Q
profit max. Q is where MC and MR (or P) cross - the area above that point too ATC is a loss - the area below that point to ATC is profit (picture 9)
short run supply curve in comp. market
The short run: market supply with a fixed number of firms (bc short run = diff. to enter and exit)
- –Choose Q where MX = P —> as long as P > AVC, each firm’s marginal cost curve is its supply curve
- –Market supply curve found by adding quantity of output from each firm - sum
- –Same curve but quantity is much larger - but same bc firms are all equal
long run: market supply with entry and exit (comp. market)
Decision to enter/exit depend on incentives facing owners of existing firms and entrepreneurs who could start new firms
- –Firms already in market are profitable = new firms have incentive to enter - expand # of firms, increase Q supplied and decrease price and profits
- –If firms are making losses - then some existing firms will exit market - exit will reduce number of firms, decrease Q supplied, increase prices and profits
- –At the end of entry and exit process, firms that remain in the market must be making zero economic profit
Zero economic profit when Price = ATC - process of entry and exit ends only when price and average total cost are driven to equality
- –Free entry and exit force price to equal average total cost
- –Marginal cost and ATC are equal, ONLY when the firm is operating at the minimum of average total cost (also equal to Price)
efficient scale in long run equilibrium of comp. market
Called the efficient scale - in the long run equilibrium of a competitive market with free entry and exit, firms must be operating at their efficient scale ◦ Shows long run - price P = MC so firm is maximizing profit - P also = ATC, so profit is 0
- –New firms have no incentive to enter and existing firms have no incentive to exit
- –Enter and exit until profit is driven to 0 - then process stops - long-run market supply curve is horizontal at this price
- –At this point, only ONE price consistent with zero profit - minimum of ATC
- –Any price above would generate profit, leading to entry and increase in Total quantity supplied
- –Any price below would generate losses, leading to exit and decrease in quantity supplied
- –Eventually number of firms in market adjusts so price = minimum ATC, and there are enough firms to satisfy demand at this price
why comp. stay open at zero profit?
Profit = TR - TC —> total cost includes all opportunity costs to firm and business owners (including time and money)
- –In zero profit equilibrium, firm’s revenue must compensate owners for these opportunity costs
- –Remember at zero-profit equilibrium…economic profit is zero, but accounting profit is positive
shift in demand in short run and long run of comp. market (picture 11 I think!! the one with 6 pictures)
At zero profit, Price = the MINIMUM of Average total cost
A. Equilibrium - each firm makes zero profit and price equals minimum average total cost
B. Short run demand rises. Equilibrium moves from A to B and price rises and Quantity sold rises = profit - encourages new firms to enter the market - price now exceeds ATC, so each firm makes profit - shifts supply curve to the right\
—Bc each firm’s supply curve reflects its marginal cost curve - how much each firm increases production is determined by its marginal-cost curve
C. New long-run equilibrium - Price returned to P1, but quantity sold increased to Q3. Profits again zero and price is back to minimum of ATC, but market has more firms to satisfy the greater demand - each firm is once again producing at its efficient scale, but bc more firms, Q is higher
long run supply curve in comp. market
—Entry and exit can cause the long-run market supply curve to be perfectly elastic
—Large number of potential entrants - each faces the same costs
◦ As a result, long-run market supply curve is horizontal at the minimum of average total cost
◦ When D increases, long-run result is an increase in number of firms and in total quantity supply - NO change in price
2 reasons long-run market supply curve might slope upward
1. Some resources used in production may be available only in limited quantities (Farm - anyone can choose to buy land and start farm, but quantity of land is limited - as more ppl become farmers, price of farmland increases and raises the costs of all farmers in the market) - increase D, Cost, Q Supplied, and Price - result is a long-run market supply curve that is upward sloping, even with free entry 2. Firms may have different costs - (painters - anyone can enter market, but not everyone has same costs - some work faster than others, some use their time diff.) - to increase quantity of painting services supplied, entrants must be encouraged o enter market - new entrants have higher costs, so price must rise to make entry profitable for them - result is long-run market supply curve that slopes upward
- -If firms have diff. costs, some firms earn profit even in the long run - in this case, market price reflects average total cost of the marginal firm (firm that would exit the market if price were any lower) - this firm earns zero profit, but firms with lower costs earn positive profit
- –Thus a higher price may be necessary to induce a larger quantity supplied - in this case the long-run supply curve is upward-sloping, not horizontal
- –However, basic truth - because firms can enter and exit more easily in the long run than in the short run, the long-run supply curve is typically more elastic than short-run - more horizontal
conclusion of comp. market
—When you buy a good from a firm in a competitive market, you can be assured that the price you pay is close to the cost of production
—Competitive and profit-maximizing firms - price = marginal cost of making that good
—If firms can freely enter and exit the market, the price also equals the lowest possible average total cost of production
—Price of a good equals both the firm’s average revenue and its marginal revenue
—Maximize profit - firm chooses a quantity of output so marginal revenue = marginal cost, therefore chooses one that price = marginal cost (bc in comp. market price = marginal rev.)
◦ Thus firm’s marginal-cost curve is its supply curve
—Profit diff. over time - short run - increase in demand raises prices and leads to profits, and decrease in D lowers prices and leads to losses - in long run, number of firms adjusts to drive market back to the zero-profit equilibrium
In the competitive market - demand curve is perfectly elastic, so is horizontal - meaning it is the same as the price, marginal revenue and average revenue graphs
Graphing question with marginal cost, price and quantity - in order to produce a positive output, need to choose quantity where price = marginal cost (where the price and MC curve would intersect is your quantity)
◦ Then have to decide if it will produce at all - firm’s decision in the short run depends on whether it can earn enough revenue to cover its variable cost (price line must but above the AVC line
monopoly - intro.
—Are price makers - have market power
—Comp. firms take market price of its output and chooses the quantity it will supply so that price equals marginal cost - monopoly charges a price to exceed marginal cost
—The outcome in a market with monopoly is often not in the best interest of society
Monopoly - firm that is the sole seller of a product without any close substitutes
—Main cause of monopoly is barriers to entry - remains only seller in market bc other firms cannot enter and compete with it
Barriers to entry - 2 sources
- Monopoly resources - Key resource required for production is owned by a single firm
◦ Not as common - bc huge world and many resources - can find substitutes - Gov. regulation - gov. gives a single firm the exclusive right to produce a good or service
a. Patent (medical drugs) and copyright laws (makes author a monopolist in selling her novel) - encourage research and author’s to write more books (bc high price) - The production process - a single firm can produce output at a lower cost than a larger number of firms
◦ Natural monopoly - a single firm can supply a good or service to an entire market at a lower cost than could 2 or more firms
◦ Arises when there are economies of scale over the relevant range of output
◦ Ex. Water - too many fixed costs to have more than one firm build buildings and pipes to provide water - lowest ATC if a single firm serves the market
◦ Club good - excludable but not RIC (uncongested toll bridge)
• Depends on market size - when pop. Is small, one bridge can satisfy and is natural monopoly - but when market expands, natural monopoly can evolve into a more competitive market (Require 2 or more bridges)
monopoly vs. competition (picture!! of two graphs)
Main difference is that monopoly can control its price - consider the demand curve of each type of market
- –Competitive firm faces a horizontal demand curve bc a comp. firm can sell as much or as little as it wants at a horizontal, constant price - bc comp. firm sells product with many perfect substitutes (all other firms in market), demand curve that any one firm faces is perfectly elastic (horizontal)
- –Bc monopoly is sole producer, its demand curve is the market demand curve - slope downward - if raises price, consumers buy less - or if it reduces the quantity of output it produces and sells, the price of its output increases (provides a constraint on a monopoly’s ability to profit from its market power)
- –Can’t sell at whatever price it wants bc of the market demand curve
monopoly’s revenue
TR = Q x P
Average Revenue = TR/Q of output (AR always equals the PRICE of a good - in comp. and monopoly)
Marginal revenue = (change in TR) / (change in Q) - amt. of revenue a firm receives for each additional unit of output
A monopoly’s marginal revenue is LESS THAN the price of its good - (bc monopoly faces a downward-sloping demand curve) - to inc. amt. sold, monopoly firm must decrease the price it charges to all customers
when monopoly increases amt. it sells, has 2 effects on total revenue (P x Q)
- The output effect - more output sold, so Q is higher, which increases TR
- The price effect - price falls, so P is lower, which tends to decrease TR
- —As a result, marginal revenue is less than its price (for monopoly only)
demand curve in monopoly
Because price = average revenue, demand curve is also the average-revenue curve (PICTURE)
—These 2 curves always start at the same point on the vertical axis bc the marginal revenue of the first unit sold equals the price of the good - but marginal revenue of all units after the first is less than the price of the good -thus marginal revenue is below the demand curve
Marginal revenue can become negative when price effect on revenue is greater than the output effect - means when firm produces an extra unit of output, price falls by enough to cause the firm’s total revenue to decline, even though selling more units
- –Maximum of total revenue occurs at the peak of the graph - the peak corresponds to the point on the marginal revenue curve at which marginal revenue is = 0
- ——–Bc marginal revenue is defines as the change in total revenue from producing one more unit, the marginal revenue curve corresponds to the slop of the total revenue curve at a given point
- ———When marginal revenue is positive, total revenue has not yet maximized and must be increasing (bc producing an additional unit increases TR)
- ——When it is negative, producing that last unit actually lowers total revenue
- —–At its peak, total revenue is neither rising nor falling, therefore its slope is = to 0
Question I missed about MR
“comparing your total revenue graph to your marginal revenue graph, you can see that total revenue is MAXIMIZED at the output at which MARGINAL REVENUE is = to 0
profit maximization in monopolies
Monopoly maximizes profit by choosing Q at which Marginal Revenue = Marginal cost,
—-Then uses the Demand curve AT that quantity to determine the PRICE
—-If was producing at Q1, cost is less than revenue so firm increases profit by inc. Q
—-But if Q2, cost is greater than revenue - save money by reducing Q
—-A monopolies profit-maximizing quantity of output is determined by the intersection of the marginal -revenue curve and the marginal-cost curve
• Same in comp. firms - choose Profit MAX when MC = MR, but diff. is in comp. firms MR = PRICE, but in Monopoly MR < P
• FOR COMP. FIRM: P = MR = MC
• FOR MONOPOLY: P > MR = MC (looks at demand curve to find price, bc shows how much customers are willing to pay at that profit maximizing Q)
Key diff. btwn comp. and monopoly is: in comp. market, price = Marginal cost…in monopoly, price > marginal cost
monopoly’s profit (PICTURE)
Profit = TR-TC
- –(rewrite) Profit = (TR/Q - TC/Q) x Q
- –TR/Q is average revenue which = PRICE (AVERAGE REVENUE = PRICE)
- –And TC/Q = Average total cost
PROFIT = (P - ATC) x Q
Area of the box is the profit - HEIGHT (BC) is PRICE - AVERAGE TOTAL COST = Profit per unit sold
- –Measure price in monopoly market using market demand curve and firm’s cost curves
- —Monopoly does not have a supply curve - when monopolist chooses the Q to supply, that decision (along with the demand curve) determines the price
- –Whereas comp. firms are price takers, determine what amount to produce at a given price - monopolists are price makers - comp. market, firm’s decisions can be analyzed without knowing the demand curve…not true in monopoly
Graph with patented goods
With patented goods, such as drugs - the product will originally have a high monopoly price - when patent runs out and new firms enter market, becomes competitive and price is driven down from the monopoly price to marginal cost
the welfare cost of monopolies
Monopolies are expensive to consumers, but high price makes them profitable to seller’s - do the benefits to firm owners exceed the costs imposed on consumer…making it desirable to society as a whole?
Total surplus - the sum of consumer surplus and producer surplus (measure economic well-being of society - welfare economics (Ch. 7)
—-Consumer surplus - price consumer is willing to pay minus the amt. actually pay
—Producer surplus - amt. producers receive for a good minus production costs
• In comp. market - invisible hand naturally leads total surplus to be as large as possible
deadweight loss (picture!)
Monopoly run by someone who cares about both profits and benefits received by customers - wants to Maximize TOTAL SURPLUS (CS + PS) OR (value of the good to consumers minus the costs incurred by producer)
—-Demand curve represents value of good to consumers (willingness to pay)
◦ Marginal cost curve = costs of the monopolist
◦ Socially efficient quantity is where demand curve and marginal-cost curve intersect
• Below this quantity, value of extra unit to consumers exceeds cost to provide (increase output to raise total surplus)
• Above this, cost of producing exceeds value to consumers (decrease output to raise total surplus)
Efficient by charging price at intersection of demand and marginal-cost
—-In comp. firm, charge price = to marginal cost - price give consumers accurate signal about cost of producing the good
how to evaluate efficiency of monopoly (picture!!)
Evaluate efficiency of monopoly by comparing level of output firm chooses to level of output social planner would choose
- –Monopolists choose where Marginal revenue and marginal cost intersects
- —Social planner chooses were demand and marginal cost curves intersect
Bc. Monopoly charges above marginal cost, not all consumers who value the good at more than its cost buy it - thus Q output is below socially efficient level
• Deadweight loss - area btwn demand curve (reflects value to consumers) and marginal cost curve (reflects costs of monopoly producer)
▪ Deadweight loss caused by a monopoly is similar to the deadweight loss caused by a tax - monopolist is like a private tax collector
▪ Tax places a wedge btwn consumers willingness to pay (represented by demand curve) and producers cost (Represented by supply curve)
▪ Monopoly places wedge bc exerts its market power by charging price above marginal cost
• However not bad for total surplus (and society) - transfer of more money from consumers to producers - same size pie of total surplus…but producers slice gets bigger and consumers is smaller (in monopoly)
• Monopoly profit is NOT a social problem
▪ The problem stems from deadweight loss - an inefficiently in low quantity
price discrimination in monopoly
Price discrimination - the business practice of selling the same good at diff. prices to diff. customers (don’t charge same price to all customers)
—Price discrimination is not possible when a good is sold in competitive market
◦ To discriminate, must have some market power
Story about selling books to consumers ($30 each to 100,000 people or $5 to 500,000 people - profit is higher with $30, even though deadweight loss arises to 400,000 ppl - then realizes the $30 ppl in Australia and $5 in US - charges diff. to max. profit
- –In price discrimination - monopolist charges each customer a price closer to her willingness to pay than is possible with a single price - need to be able to separate
- –Forces can prevent firms from price discriminating
arbitrage
process of buying a good in one market at a low price and selling it in another market at a higher price to profit from the price difference (ex. If Australian’s bought the book from US and sold within Australia)
price discrimination and economic welfare (PICTURE)
Price discrimination can RAISE economic welfare - eliminates the deadweight loss (bc will sell it to all people at their willing to pay price
◦ This increase in welfare shoes as a higher producer surplus than consumer surplus
Perfect price discrimination - monopolist knows exactly each customer’s willingness to pay and can charge each a diff. price - charge exactly their willingness to pay, and monopolist gets the entire surplus in every transaction
Monopolistic competition (Class notes)
Main key is differentiation (Water)
LOOK UP THE DIFFERENCES BTWN THE MARKETS CHART IN HIS SLIDES!!! - EXPLAINS IT ALL
—–Why is ATC curve U-shaped? — bc average fixed costs are spread out at first so it is spread amongst more Q of products - but as Q increases AVC increases and can’t be spread out and the ATC curves upward again
—Make most revenue at the MINIMUM of the AVERAGE TOTAL COST CURVE
If demand curve is below ATC curve = A LOSS
Book business - seem monopolistic - bc each book is unique and are price makers - price exceeds marginal cost
◦ But also seems competitive - bc SO many authors and books - thousands of competing products to choose from
◦ Bc are monopolistic competition companies
Btwn monopoly and perfect competition
◦ Price in perfectly competitive market always equals the marginal cost of production - in long run, entry and exit drive economic profit to 0, so price equals average TC
◦ Monopoly firms use market power to keep prices above marginal cost, leading to positive economic profit for firm and deadweight loss for society
advertising (Class notes)
most useful with differentiated products (monopolistic competition) - 10-20% of methods
- –Experts argue that firms advertise to manipulate people’s tastes - psychological rather than informative - advertising impedes competition
- –Those who defend it say informed buyers can more easily find and exploit price differences - provides necessary information
- —Eyeglasses were MORE expensive in states that PROHIBITED advertising than in states that did not restrict it
Look up the summary’s at the end of each chapter!!! - explain the main points and differences in the markets
