Economics Chapters 6-11

The three-step process explaining how a monopolist picks a quantity and how to compute the monopoly profit is as follows:

1. Find the quantity that satisfies the marginal principle, that is, the quantity at which marginal revenue equals marginal cost 2. Using the demand curve, find the price associated with the monopolist's chosen quantity 3. Compute the monopolist's profit. The profit per unit sold equals the price minus the average cost, and the total profit equals the profit per unit times the number of units sold

Although price discrimination is widespread, it is not always possible. A firm has an opportunity for price discrimination if three conditions are met:

1. Market power 2. Different consumer groups 3. Resale is not possible

A market equilibrium will generate the largest possible surplus when four conditions are met:

1. No external benefits: the benefits of a product (a good or service) are confined to the person who pays for it 2. No external costs: the cost of producing a product is confined to the person who sells it 3. Perfect information: buyers and sellers know enough about the product to make informed decisions about whether to buy or sell it 4. Perfect competition: each firm produces such a small quantity that the firm cannot affect the price

Perfect competition Here are the five features of a perfectly competitive market:

1. There are many sellers 2. There are many buyers 3. The product is homogenous 4. There are no barriers to market entry 5. Both buyers and sellers are price takers

Short-Run Total Cost Fixed Cost (FC)

Cost that does not vary with the quantity produced

Price taker

A buyer or seller that takes the market price as given

Sunk cost

A cost that a firm has already paid or committed to pay, so it cannot be recovered

Short-run market supply curve

A curve showing the relationship between market price and the quantity supplied in the short run

Long-run market supply curve

A curve showing the relationship between the market price and quantity supplied in the long run

Short-run supply curve

A curve showing the relationship between the market price of a product and the quantity of output supplied by a firm in the short run

Firm-specific demand curve

A curve showing the relationship between the price charged by a specific firm and the quantity the firm can sell

Production and Marginal Product Total-product curve

A curve showing the relationship between the quantity of labor and the quantity of output produced, ceteris paribus

Monopoly

A market in which a single firm sells a product that does not have any close substitutes

Natural monopoly

A market in which the economies of scale in production are so large that only a single large firms can earn a profit

Monopolistic competition

A market served by many firms that sell slightly different products

Perfectly competitive market

A market with many sellers and buyers of a homogenous product and no barriers to entry

Total Surplus is Lower with a Price Below the Equilibrium Price Price ceiling

A maximum price set by the government

Deadweight loss from monopoly

A measure of the inefficiency from monopoly; equal to the decrease in the market surplus

Total Surplus is Lower with a Price Above the Equilibrium Price Price Floor

A minimum price set by the government

Explicit cost

A monetary payment Ex. Monetary payments for labour, capital, materials

Using the marginal principle

A monopolist can use the marginal principle to decide how much output to produce Marginal principle - increase the level of an activity as long as its marginal benefit exceeds its marginal cost. Choose the level are which the marginal benefit equals the marginal cost

The marginal approach

A perfectly competitive firm takes the market price as given, so the marginal benefit, or marginal revenue, equals the price

Licensing and market efficiency

A policy that limits entry into a market Increases price, decreases quantity, and causes inefficiency in the market In evaluating such a policy, we must compare the possible benefits from controlling nuisances to the losses of consumer and producer surplus

Short-Run Total Cost Variable cost (VC)

Cost that varies with the quantity produced

Efficiency

A situation in which people do the best they can, given their limited resources

Economies of Scale

A situation in which the long-run average cost of production decreases as output increases

Diseconomies of Scale

A situation in which the long-run average cost of production increases as output increases

Expansion and Replication Constant returns to scale

A situation in which the long-run total cost increases proportionately with output, so average cost is constant

Principle of voluntary exchange

A voluntary exchange between two people makes both people better off

Increasing-cost industry

An industry in which the average cost of production increases as the total output of the industry increases; the long-run supply curve is positively sloped

Constant-cost industry

An industry in which the average cost of production is constant; the long-run supply curve is horizontal In a constant-cost industry, input prices do not change as the industry grows Therefore, the average production cost is constant and the long-run supply curve is horizontal

Reducing Output with Indivisible Inputs Indivisible input

An input that cannot be scaled down to produce a smaller quantity of output

Implicitly cost

An opportunity cost that does not involve a monetary payment Ex. Opportunity cost of entrepreneur's time Ex. Opportunity cost of funds

Tax Burden and Deadweight Loss Excess burden of a tax

Another name for deadweight loss

Production and Marginal Product Diminishing returns

As one input increases while the other inputs are held fixed, output increases at a decreasing rate

The Demand Curve and Consumer Surplus

Consumer surplus equals the maximum amount a consumer is willing to pay (shown by the demand curve) minus the price paid Ex. Juan is willing to pay $22, so if the price is $10, his consumer surplus is $12 The market consumer surplus equals the same of the surpluses earned by all consumers in the market

Government Intervention in Efficient Markets

In most modern economics, governments take an active role For a market that meets the four efficiency conditions, the market equilibrium generates the largest possible total surplus, so government intervention can only decrease the surplus and cause inefficiency

The term monopolistic competition actually conveys the two key features of the market:

Each firm is the market produces a good that is slightly different from the goods of other firms, so each firm has a narrowly defined monopoly The products sold by different firms in the market are close substitutes for one another, so there is intense competition between firms for consumers

Economic cost

Economic cost = explicit cost + implicit cost

The total approach: computing total revenue and total cost

Economic profit is shown by the vertical distance between the total revenue curve and the total-cost curve To maximize profit, the firm chooses the quantity of output that generates the largest vertical difference between the two curves

Short-Run Average Costs Average fixed cost (AFC)

Fixed cost divided by the quantity produced AFC = FC/Q

Monopoly and public policy

Give the social costs of monopoly, the government uses a number of policies to intervene in markets dominated by a single firm or likely to become a monopoly

Setting maximum prices

Here are some examples of goods that have been subject to maximum prices or may be subject to maximum prices in the near future: Rental housing, gasoline, medical goods and services In all three cases, a maximum price will cause excess demand and reduce the total surplus of the market

Tax shifting and the price elasticity of demand

If demand is inelastic, a tax will increase the market price by a large amount, so consumers will bear a large share of the tax If demand is elastic, the price will increase by a small amount and consumers will bear a small share of the tax

Market equilibrium

In the market equilibrium, the total surplus is the area between the demand curve and the supply curve

The average cost of production increases as the total output increases, for two reasons:

Increasing input price -- As an industry grows, it competes with other industries for limited amounts of various inputs, and this competition drives up the prices of these inputs Less productive inputs -- A small industry will use only the most productive inputs, but as the industry grows, firms may be forced to use less productive inputs

Scaling down and labor specialization

Labor specialization makes works more productive because of continuity and repetition When we reduce the workforce each worker will become less specialized, performing a wider variety of production tasks The loss of specialization will decrease labor productivity, leading to higher average cost

Under a market structure called monopolistic competition, firms will continue to enter the market until economic profit is zero. Here are the features of monopolistic competition:

Many firms A differentiated product

A formula for marginal revenue

Marginal revenue = new price + (slope of demand curve x old quantity) The first part of the formula is the good news, the money received for the extra unit sold The second part is the bad news from selling one more unit, the revenue lost by cutting the price for the original customers The revenue change equals the price change required to sell one more unit -- the slope of the demand curve, which is a negative number--times the number of original customers who get a price cut

Total revenue, variable cost, and the shut down decision

Operate if total revenue > variable cost Shut down if total revenue < variable cost

The Supply Curve and Producer Surplus

Producer surplus equals the market price minus the producer's willingness to accept, or marginal cost (shown by the supply curve) Ex. Abe's marginal cost is $2, so if the price is $10, his producer surplus is $8 The market producer surplus equals the same of the surpluses earned by all producers in the market

Setting minimum prices

Recall that when government sets a minimum price above the equilibrium price, the result is permanent excess supply Governments around the world establish minimum prices for agricultural goods Under a price-support program, a government sets a minimum price for an agricultural product and then buys any resulting surpluses at that price

Short-Run Average Costs Short-run average total cost (ATC)

Short-run total cost divided by the quantity produced; equal to AFC plus AVC ATC = TC/Q = FC/Q + VC/Q = AFC + AVC

Barrier to entry

Something that prevents firms from entering a profitable market

Market power

The ability of a firm to affect the price of its product

Short-Run Average Costs

The short-run average-total-cost curve (ATC) is U-shaped As the quantity produced increases, fixed costs are spread over more and more units, pushing down the average total cost In contrast, as the quantity increases, diminishing returns eventually pulls up the average total cost The gap between ATC and AVC is the averaged fixed cost (AFC)

Expansion and Replication Long-run marginal cost (LMC)

The change in long-run cost resulting from a one-unit increase in output

Production and Marginal Product Marginal product of labor

The change in output from one additional unit of labor

Short-Run Marginal Cost Short-run marginal cost (MC)

The change in short-run total cost resulting from a one-unit increase in output MC = change in TC / change in output

Marginal revenue

The change in total revenue from selling one more unit of output Marginal revenue = price To maximize profit, produce the quantity where price = marginal cost

Deadweight loss

The decrease in the total surplus of the market that results from a policy such as rent control

Short-run versus Long-run average cost

The difference between the short run and long run is a firm's flexibility in choosing inputs

Tax Burden and Deadweight Loss Deadweight loss from taxation

The difference between the total burden of a tax and the amount of revenue collected by the government

Patent

The exclusive right to sell a new good for some period of time

Accounting cost

The explicit cost of production Accounting cost = explicit cost

Expansion and Replication Long-run average cost (LAC)

The long-run cost divided by the quantity produced

Drawing the long-run market supply curve

The long-run market supply curve shows the relationship between the price and quantity supplied in the long run, when firms can enter or leave the industry At each point on the supply curve, the market price equals the long-run average cost of production Because this is an increasing-cost industry, the long-run market supply curve is positively sloped

The relationship between marginal cost and average cost

The marginal-cost curve (MC) is negatively sloped for small quantities of output, because of the benefits of labor specialization, and positively sloped for large quantities, because of diminishing returns

Efficiency and the Invisible Hand

The market equilibrium maximizes the total surplus of the market because it guarantees that all mutually beneficial transactions will happen Instead of using a bureaucrat to coordinate the actions of everyone in the market, we can rely on the actions of individual consumers and individual producers, each guided only by self-interest. This is Adam Smith's invisible hand in action

The Demand Curve and Consumer Surplus Willingness to pay

The maximum amount a consumer is willing to pay for a product

The Supply Curve and Producer Surplus Willingness to accept

The minimum amount a producer is willing to accept as payment for a product; equal to the marginal cost of production

The Demand Curve and Consumer Surplus Consumer surplus

The mount a consumer is willing to pay for a product minus the price the consumer actually pays

Principle of opportunity cost

The opportunity cost of something is what you sacrifice to get it

Economic cost

The opportunity cost of the inputs used in the production process; equal to explicitly cost plus implicit cost

Economies of Scale Minimum efficient scale

The output at which scale economies are exhausted

Price discrimination

The practice of selling a good at different prices to different consumers

The Supply Curve and Producer Surplus Producer Surplus

The price a producer receives for a product minus the marginal cost of production

Break-Even Price

The price at which economic profit is zero; price equals average total cost

Shut-down price

The price at which the firm is indifferent between operating and shutting down; equal to the minimum average variable cost

Rent seeking

The process of using public policy to gain economic profit

Product differentiation

The process used by firms to distinguish their products from the products of competing firms No artificial barriers to entry

The long-run response to an increase in demand

The short-run supply curve is steeper than the long-run supply curve because of diminishing returns in the short run The large upward jump in price after the increase in demand is followed by a downward slide to the new long-run equilibrium price

Short-Run Total Cost

The short-run total-cost curve shows the relationship between the quantity of output and production costs, given a fixed production facility

Total surplus

The sum of consumer surplus and producer surplus The total surplus of the market equals consumer surplus (the lightly shaded areas) plus producer surplus (the darkly shaded areas)

Short-Run Total Cost Short-run total cost (TC)

The total cost of production when at least one input is fixed; equal to fixed cost plus variable cost

Expansion and Replication Long-run total cost (LTC)

The total cost of production where a firm is perfectly flexible in choosing its inputs

Production and Marginal Product

The total-product curve shows the relationship between the quantity of labor and the quantity of output given a fixed production facility

Network externalities

The value of a product to a consumer increases with the number of other consumers who use it

Accounting profit

Total revenue minus accounting cost Accounting profit = total revenue - accounting cost

Economic profit

Total revenue minus economic cost Economic profit = total revenue - economic cost

Short-Run Average Costs Average variable cost (AVC)

Variable cost divided by the quantity produced AVC = VC/Q

Tax burden and deadweight loss

When the supply curve is horizontal, a tax increases the equilibrium price by the tax

Winners and losers from licensing

Who benefits and who loses from licensing programs such as a taxi medallion policy The losers are consumers, who pay more for taxi rides The winners are the people who receive a free medallion and the right to change an artificially high price for taxi service

Economic profit

economic profit = (price - average cost) x quantity produced