Exam 4 Econ 102 SDSU
Terms in this set (57)
Characteristics of a Perfect Competition Market
1. No barriers to entry or exit (results in competitive firms producing at the efficient scale; min ATC)
2. Many buyers and sellers
3. Identical products
4. Firms are price takers. i.e. no market power
5. Perfectly elastic (horizontal) demand curve
6. Perfectly elastic demand =
impossible to have excess capacity in LR
- Competitive firms can only have excess capacity if they are producing less than is efficient in the
. Competitive firms typically do not produce less than the efficient output so there has to be a negative externality present.
P is given and subsequently so is MR
MR = ΔTR/Δq = P
Profit Maximization Rule
MR ≥ MC
When MR > MC, increase Q
When MR < MC, decrease Q
When MR = MC, profit is maximized.
Price point for Perfect Competition Market
P = MC
Price where Demand (P) meets Marginal Cost
P = Marginal Revenue = Average Revenue
AR = TR/q = P*q/q = P = MR = ΔTR/Δq(=1)
Shut Down Rule
A firm will shut down if TR < VC
or if P < AVC
A firm will exit the market if in the long run, P < ATC
or if TR < TC
Firms do not normally exit the market in the short run.
In the short run, TR must be larger or equal to VC.
If this requirement is not met, the firm will shut down (not exit).
π = TR - TC
= (P x q) - (ATC x q)
= (P - ATC) x q
For Loss, move price point below ATC and visualize where q hits ATC.
The area between ATC and P is the Loss.
Price Point for Monopoly
MC = MR
Price where Marginal Cost meets Marginal Revenue
Monopolies are able to pick their own price but must stick to the profit maximizing rule because the price point is bounded by the market demand. (MR = MC)
≠ In PC markets P is given.
P > MC - "markup"
Monopolies Create a DWL
Monopolies cut down economic activity and create a deadweight loss.
Because a monopoly sets its price above marginal cost, it places a wedge between the consumer's willingness to pay and the producer's cost (markup). This is the main reason for a DWL.
This wedge causes the quantity sold to fall short of the social optimum (excess capacity).
Price is higher than in a PC and therefore less is produced.
See Price Points for both markets.
Notice that monopolies produces less than the socially efficient quantity of output (excess capacity).
The deadweight loss caused by a monopoly is similar to the deadweight loss caused by a tax.
The difference between the two cases is that the government gets the revenue from a tax, whereas a private firm gets the monopoly profit.
Characteristics of a Monopolistic
1. No barriers to entry or exit
2. Many buyers and sellers
3. Product Differentiation - products are similar but
(products cannot have close substitutes)
- The firm must be the sole seller of its product.
4. Firms are price makers. i.e. market power
5. Downward-sloping demand curve (MR < P)
6. Markup over marginal cost (cause of DWL)
7. Excess Capacity (mainly apparent in LR but can also appear in SR if firm is producing less than it could in normal conditions; similar to DWL but in reference to output)
Note: The number of firms can be too large or too small.
1 & 2 are the same as a PC market but they differ on all other characteristics.
Monopoly versus Competitive Markets (MC & PC)
- Is the sole producer
- Faces a downward-sloping demand curve (same as market demand because a monopoly is its own market)
- Is a price maker
- Reduces price to increase sales
- MR < P (always)
- P > MC (always)
NO ENTRY IN LR
- Able to earn economic profits in LR
- Possibility of Price Discrimination
A monopolist's profit-maximizing level of output is below the level that maximizes the sum of consumer and producer surplus.
Competitive Firms: PC & MC
- Is one of many producers
- Faces a horizontal demand curve (MC has a downward sloping demand curve)
- Is a price taker (MC is a price maker)
- Sells as much or as little at same price (MC makes price)
- (MC: MR = MC)
- MR = P
- P = MC
- Free entry always
- Cannot earn economic profits in LR (P = ATC for both)
- Unable to Price Discriminate; each consumer is charged the same price
- The number of firms in the market will adjust until economic profits are zero
- Monopolies are different than Monopolistically Competitive Firms.
Competitive Markets Visualization
Lowest point on ATC is productively efficient.
PC: P = MC; Demand = MR
MC: MR = MC up to Demand and find Price
Four Types of Market Structures: Examples & Chart
- Tap Water
- Cable TV
- Tennis Balls
- Crude Oil
Imperfectly Competitive Markets
Imperfect competition refers to those market structures that fall between perfect competition and pure monopoly.
Many firms selling products that are similar but not identical.
These markets have some features of competition and some features of monopoly.
Attributes of monopolistic competition:
- Many sellers
- Product differentiation (at least slightly different)
- Free entry and exit
Only a few sellers, each offering a similar or identical product to the others.
Demand Curves for Competitive and Monopoly Firms
Since a monopoly is the sole producer in its market, it faces the market demand curve.
Causes of Monopolies
The fundamental cause of monopoly is barriers to entry.
Common barriers include:
- Ownership of a key resource (patents).
- The government gives a single firm the exclusive right to produce some good.
- Costs of production make a single producer more efficient than a large number of producers.
A Monopoly's Revenue
A monopoly's marginal revenue is always less than the price of its good.
The demand curve is downward sloping.
When a monopoly drops the price to sell one more unit, the revenue received from previously sold units also decreases.
Price falls for ALL units sold.
This is why MR is < P.
When a monopoly increases the amount it sells, it has two effects on total revenue (P * q):
- The output effect—more output is sold, so q is higher.
- The price effect—price falls, so P is lower.
Profit Maximization in a Monopoly
A monopoly maximizes profit by producing the quantity at which MR = MC.
It then uses the demand curve to find the price that will induce consumers to buy that quantity.
Profit Maximization in a Monopoly versus Competitive Firms & Visualization
For a competitive firm, price equals marginal cost.
P = MR = MC
For a monopolistic firm, price exceeds marginal cost.
P > MR = MC
Remember, all profit-maximizing firms set
MR = MC.
Profit Formula stays the same.
The Monopolist's Profit
Graph from Demand (where MR = MC) down to ATC and over to Price.
The monopolist will receive economic profits as long as P > ATC.
Monopolies have the ability to generate positive profit in the LR.
The Market for Drugs
After the patent expires, the firm is no longer a monopoly because they do not hold sole ownership/production rights to the product.
The Price then falls to where it would be in a Competitive Market. (P = MC)
Government Created Monopolies
Governments may restrict entry by giving a single firm the exclusive right to sell a particular good in certain markets.
Patent and copyright laws are two important examples of how government creates a monopoly to serve the public interest.
Public Policy Towards Monopolies
Government responds to the problem of monopoly in one of four ways:
- Making monopolized industries more competitive.
- Regulating the behavior of monopolies.
- Turning some private monopolies into public enterprises.
- Doing nothing at all.
(If the market failure is deemed small, policymakers may decide to do nothing at all.)
They take action through what are called Antitrust Laws.
Antitrust laws are a collection of statutes aimed at curbing monopoly power.
Antitrust laws give government various ways to promote competition.
- They allow government to prevent mergers.
- They allow government to break up companies.
- They prevent companies from performing activities that make markets less competitive.
Government may regulate the prices that the monopoly charges.
The allocation of resources will be efficient if price is set to equal marginal cost.
Two Important Antitrust Laws
Sherman Antitrust Act (1890)
- Reduced the market power of the large and powerful "trusts" of that time period.
Clayton Antitrust Act (1914)
- Strengthened the government's powers and authorized private lawsuits.
An industry is a natural monopoly when a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms.
A natural monopoly arises when there are economies of scale over the relevant range of output.
Marginal Cost Pricing for a Natural Monopoly
If regulators set P = MC, the natural monopoly will lose money.
In practice, regulators will allow monopolists to keep some of the benefits from lower costs in the form of higher profit, a practice that requires some departure from marginal-cost pricing.
Rather than regulating a natural monopoly that is run by a private firm, the government can run the monopoly itself (e.g. in the United States, the government runs the Postal Service).
Price discrimination is the business practice of selling the same good at different prices to different customers, even though the costs for producing for the two customers are the same.
Price discrimination is not possible when a good is sold in a competitive market since there are many firms all selling at the market price. In order to price discriminate, the firm must have some market power.
Perfect Price Discrimination:
- Perfect price discrimination refers to the situation when the monopolist knows exactly the willingness to pay of each customer and can charge each customer a different price.
Two important effects of price discrimination:
- It can increase the monopolist's profits.
- It can reduce deadweight loss.
- It can raise economic welfare.
Price Discrimination Examples & Visualization
Examples of Price Discrimination:
- Movie tickets
- Airline prices
- Discount coupons
- Financial aid
- Quantity discounts
Perfect Price Discrimination Visualization
Consumer surplus and deadweight loss have both been converted into profit.
Every consumer gets charged a different price -- the highest price they are willing to pay -- so in this special case, the demand curve is also MR!
MC Profit/Loss in the Short Run
π ≤≥ 0
Anything can happen in the SR.
Whether they make a profit depends on if the ATC curve is below or above Demand (P).
Below = Profit
Above = Losses
Intersecting = Breaking Even
encourage new firms to enter the market. This:
- Increases the number of products offered.
- Reduces demand faced by firms already in the market.
- Incumbent firms' demand curves shift to the left.
- Demand for the incumbent firms' products fall, and their profits decline.
encourage firms to exit the market. This:
- Decreases the number of products offered.
- Increases demand faced by the remaining firms.
- Shifts the remaining firms' demand curves to the right.
- Increases the remaining firms' profits.
The Competitive Firm's Short Run Supply Curve
The SR supply curve is the portion of the MC curve that lies above AVC.
If P > AVC, firm will continue to produce in the short run.
The firm will also be earning a positive profit. (They earn profit in the
short run only
; competitive markets can not earn profit in the long run)
Market Supply with a Fixed Number of Firms in the Short Run
The SR market supply is the horizontal sum of each firm's SR supply.
If the industry has 1000 identical firms, then at each market price, industry output will be 1000 times larger than the representative firm's output.
Market Supply with Entry & Exit in the Long Run
Firms will enter or exit the market until profit is driven to zero
, where profits = (P - ATC) * q.
Hence, in the LR, only those firms for which P = minimum ATC stay.
LR market supply is horizontal at that P.
LR equilibrium has firms operating at their efficient scale and earning zero profit.
The Competitive Firm's Long Run Supply Curve
The LR supply curve is the portion of the MC curve that lies above ATC.
A firm will enter this market if P > ATC.
A firm will exit this market if P < ATC. (exit rule)
Firms will either enter or exit until Profits (π) for all firms are driven towards zero. (at zero, firms will neither enter nor exit)
MC Profit/Loss in the Long Run
π = 0
P = ATC & P > MC
(The demand curve is tangent to the ATC curve & this tangency lies vertically above the intersection of MR and MC.)
Output is less than the efficient scale of perfect competition.
- The difference in quantity between producing at MR = MC and ideal output (ATC minimum)
- Similar to DWL but instead of loss in profit Excess Capacity refers to the loss in quantity
- Emerges mainly because of the downward sloping demand curve
There is free entry under these conditions (in the Long Run).
Firms will enter or exit until firms in the market are making exactly zero economic profits.
MC versus PC output Visualization
MC produces where MC = MR to maximize profits not output.
PC produces where ATC is lowest to maximize output (efficient scale).
MC & PC: Markup over Marginal Cost
For a competitive firm, P = MC.
For a monopolistically competitive firm, P > MC (markup).
Because P > MC, an extra unit sold at the posted price means more profit for the monopolistically competitive firm.
Monopolistic Markup Visualization
Note that an
is formed by the differences in output between MC quantity produced and the efficient scale.
There is the normal deadweight loss of monopoly pricing in monopolistic competition caused by the markup of price over marginal cost.
The Effects of Monopolistic Competition on the Welfare of Society
Another way in which monopolistic competition may be socially inefficient is that the number of firms in the market may not be the "ideal" one. There may be too much or too little entry.
Externalities of entry include:
- Because consumers get some consumer surplus from the introduction of a new product, entry of a new firm conveys a
externality on consumers.
- Because other firms lose customers and profits from the entry of a new competitor, entry of a new firm imposes a
externality on existing firms.
Firms that sell highly differentiated consumer goods typically spend between 10 and 20 percent of revenue on advertising.
Overall, about 2 percent of total revenue, or over $200 billion a year, is spent on advertising.
of advertising argue that firms advertise in order to manipulate people's tastes.
- They also argue that it impedes competition by implying that products are more different than they truly are.
argue that advertising provides information to consumers.
- They also argue that advertising increases competition by offering a greater variety of products and prices.
The willingness of a firm to spend advertising dollars can be a signal to consumers about the quality of the product being offered.
argue that brand names cause consumers to perceive differences that do not really exist.
have argued that brand names may be a useful way for consumers to ensure that the goods they are buying are of high quality.
- providing information about quality.
- giving firms incentive to maintain high quality
Differences in Market Structure Chart (PC, MC, & Monopoly)
Only a monopoly can earn economic profits in the long run.
Why Do Competitive Firms Stay in Business If They Make Zero Profit?
Profit (π) = TR - TC, but TC includes all the opportunity costs of the firm, including the compensation to owners for the time and money they expend to keep the business going.
Owners are paid even though the firm itself is not earning profit.
Problems with Free Entry
Free entry leads to a decrease in demand.
Effects of Increases in Demand in both SR and
In the SR:
- An increase in D raises P and q. Firms earn profits because P now exceeds ATC.
The higher P encourages firms to produce more and generates Short Run Profit.
Profits induce entry and market supply increases.
In the LR:
- New firms enter and drive P down. Profits then drop and firms stop entering when they reach zero.
- P and q* go back to what they were before D increased, but the market quantity is now bigger because there are more firms in the market.
In the long run market price is restored, but market supply is greater.
(See graph for "market")
A market begins in long run equilibrium.
And firms earn zero profit.
PC Profit in the Long Run
π = 0
P = ATC
Identical to MC Profit in the Long Run.
MC compared to PC in the Long Run
- Price (P) decreases
- Quantity (q) increases
- ATC decreases
- MC increases
The equilibrium in a monopolistically competitive market differs from perfect competition in that each firm has excess capacity and each firm charges a price above marginal cost.
Accounting versus Economic Profit
Accounting Profit will always be higher or equal to Economic Profit because of what is contained in their respective formulas.
Accounting Profit: TR - Explicit Costs only
Economic Profit: TR - TC (explicit and implicit costs)
Implicit Costs are are input costs that do not require an outlay of money by the firm, i.e. opportunity costs.
Total Cost (TC) Formula
Total Costs (TC) = Fixed Costs (FC) + Variable Costs (VC)
Variable Costs vary with the quantity of output produced.
Fixed Costs do not vary with the quantity of output produced.
Average Total Cost (ATC) Formula
Average Total Cost (ATC) = TC/q
ATC is the cost of each typical unit of product. It is the sum of:
- Average Fixed Costs (AFC = FC/Q)
- Average Variable Costs (AVC = VC/Q)
ATC = (AFC + AVC)
Marginal Cost (MC) Formula
Marginal Cost (MC) = (Change in TC/Change in Q)
Therefore, MC measures the increase in total cost that arises from an extra unit of production.
It answers the question:
- How much does it cost to produce one more unit of output?
ATC and why it is U-shaped
At very low levels of output, ATC is high because FC are spread over only a few units, i.e. AFC is high.
Average total cost declines as output increases as Q divides both FC and VC and diminishing marginal returns have not "kicked in" yet.
ATC starts rising because as Q increases, AVC (which by then dominates AFC) rises due to diminishing marginal returns.
The bottom of the U-shaped ATC curve occurs at the quantity that minimizes average total cost. This quantity is sometimes called the efficient scale of the firm.
MC in relation to ATC
MC eventually rises with the quantity of output.
ATC is U-shaped.
MC crosses ATC at its minimum.
Whenever MC is less than ATC, ATC is falling.
Whenever MC is greater than ATC, ATC is rising.
(Think of it graphically)
- GPA and Econ 102's grade.
Cost Curves Examples & Visualization
Note how MC hits both ATC and AVC at their minimum points.
Marginal Cost declines at first and then increases due to diminishing marginal product.
AFC, a short-run concept, declines throughout.
Costs in the Short Run compared to Long Run
In the short run, some costs are fixed.
In the long run, all fixed costs become variable costs.
Because many costs are fixed in the SR but variable in the LR,
a firm's LR cost curves differ from its SR cost curves.
Economies and Diseconomies of Scale
Economies of scale refer to the property whereby LR ATC falls as Q increases. (Beginning to minimum most point)
Remember: ATC does rise exponentially as Q rises past efficient levels because of Diminishing Marginal Returns.
Diseconomies of scale refer to the property whereby LR ATC rises as Q increases. (Minimum and beyond)
ATC is U-Shaped and both properties are applicable each time.
Constant returns to scale refers to the property whereby LR ATC stays the same as Q increases. (Must have long minimum point or an absence of DMR)
Rare because of Diminishing Marginal Returns (DMR). Product must not have Diminishing Marginal Returns for this property to be explicitly apparent.
Economies and Diseconomies of Scale Example
Small Firms typically have a steep Economies of Scale section of their ATC.
Large Firms typically have a steep Diseconomies of Scale section of their ATC.
Medium Firms are more balanced.
YOU MIGHT ALSO LIKE...
Principles of Microeconomics
microecon test 4
Chapter 12 economics
ECN 201 EXAM 3
OTHER SETS BY THIS CREATOR
GEO final Unit 4A
GEO final Unit 3
GEO final Unit 2
GEO final Unit 1
THIS SET IS OFTEN IN FOLDERS WITH...
Exam 3 Econ102 SDSU
Econ-102 Final SDSU