PERFECT COMPETITION AND MONOPOLY Flashcards
PROFIT MAXIMIZATION
R(Q) - C(Q)
R(Q) is total revenue and C(Q) total costs.
Do firms really maximize profits?
- Investors prefer to invest in firms that do maximize profits.
- A firm can hardly survive in a market if it does not earn any profits.
- Non-profit-organizations pursue higher-level goals.
Profit maximization problem
max π(Q) = R(Q) − C(Q)
–> in contrast to utility maximization and cost minimization problems, the profit maximization problem is not constrained.
Profit maximization solution
“marginal revenue = marginal cost”
R′(Q) = MR(Q) = C′(Q) = MC(Q).
Perfect competion : assumption
- Market participants are price takers
There are many (small) independent suppliers and consumers who cannot influence the market price P. - Homogeneous products
* From the perspective of the consumers the firms’ products are
identical.
* Hence, there is only one market price P. - Free market entry and exit
* There is no specific (cost) barriers to entry or exit.
* Consumers can easily switch among suppliers.
PROFIT MAXIMIZATION FOR A PERFECTLY COMPETITIVE FIRM
- The perfectly competitive firm is a price taker (P is fixed, see below).
- The firms see the demand curve as a horizontal straight line, i.e.
P = MR(Q) = AR(Q).
Profit maximization problem
max π(Q) = PQ − C(Q).
“price = marginal costs”
P = C′(Q) = MC(Q).
monopoly
is a market with many consumers served by only one supplier.
Market power
is the ability of a market participant to influence the market price of a good.
A monopolist can set the price above the marginal cost, so he has ?
market power
There are various sources of market power such as
– exclusive control over essential inputs.
– “natural monopoly”.
– state protection or regulation.
– patents
The cost function of a monopolist is given by C(Q), with…
C′(Q) > 0 and C′′(Q) > 0
The (inverse) demand function is P(Q), with…
P′(Q) < 0 and P′′(Q) ≤ 0
price to find input (contrary in normal demand is input to find price)
In Monopolist does it make a difference if we maximizes the profit with respect to quantity or price ?
No, It makes no difference whether a monopolist maximizes the profit with respect to quantity or price.
In Oligopolist does it make a difference if we maximizes the profit with respect to quantity or price ?
In oligopolistic competition it makes a difference whether the firms compete in quantities or prices
PROFIT MAXIMIZATION FOR A MONOPOLIST: solution
P(Qm) + P′(Qm)Qm = C′(Qm)
Lerner index : definition
The Lerner index measures the difference between the firm’s price and its marginal cost in percentages. This difference is also called markup.
–> The Lerner index is a measure of a firm’s market power and is between 0 and 1.
Lerner index : calculation
Pm −C′(Qm) / Pm
The lower the price elasticity of demand η (absolute value), the larger…
the markup
If demand is perfectly elastic (η → ∞), the Lerner index…
converges to zero (perfect competition).
The profit-maximizing monopolist always supplies in the price-elastic region (η > 1)
- profit maximiwing : mean the ealsticity need to be always more than 1
- If I can increase the price and my revenu go up
- I do that as long as the elastic below 1
- makes no longer efficient : to decrease the price
Price elasticity of demand
measures how sensitive the quantity demanded of a good or service is to a change in its price
Elastic Demand
(η>1)
This means that a change in price results in a larger percentage change in quantity demanded. For example, if the price of a product decreases by 10% and the quantity demanded increases by 20%, the demand is considered elastic.
Inelastic Demand (
η<1)
This indicates that a change in price results in a smaller percentage change in quantity demanded. For instance, if a price decrease of 10% leads to only a 5% increase in quantity demanded, the demand is inelastic.
Unitary Elastic Demand (η=1)
In this case, a change in price results in an equal percentage change in quantity demanded. A 10% price drop would lead to a 10% increase in quantity demanded.
Price elasticity of production
measures how much the quantity of output changes in response to a change in the price of inputs (such as labor, materials, and capital)
The monopolist solves the profit maximization problem
max π(κ, p; λ) = [p − c(κ)]D(κ, p; λ)
consumer surplus (competition)
is the area above the price and below the demand curve, representing the benefit to consumers.
Producer surplus (competition)
Under competition, the producer surplus is 0, as producers sell at marginal cost, not making a profit above this level.
consumer surplus (market power)
s the difference between what consumers are willing to pay for a good and what they actually pay. Under market power, firms charge a higher price than in a competitive market, reducing the consumer surplus.
Producer surplus (market power)
is the difference between the price producers receive for a good and the marginal cost of producing it. Under market power, producers can charge a price higher than marginal cost, increasing their surplus.
Deadweight loss from market power
In the context of market power, deadweight loss arises because firms restrict output to increase prices, resulting in fewer goods being sold than would occur in a perfectly competitive market.
Deadweight loss
loss is the loss of total economic welfare (the sum of consumer and producer surplus) that occurs when a market is not operating efficiently
The producer surplus
he area above the marginal cost curve and below the demand curve
short-run supply curve
equal to the marginal cost curve
long-run supply curve
firms produce where marginal cost equals average cost
