Econ 661 - Ch 8
Two strategies to persuade consumers product superiority in monopolistically competitive firm
- Advertising Campaigns - introduce new products into the market to differentiate products from other firms
At the point where the cost curve C(Q) and the revenue line R(Q) are the farthest vertical distance apart, the marginal cost (MC) is ________ marginal revenue (MR).
equal to
A perfectly competitive firm maximizes profits at the level of output such that market price ____ marginal cost (MC)
equals
The profit-maximizing level of output occurs where marginal revenue (MR) ____ marginal cost (MC).
equals
When firms in a competitive industry sustain losses, they will ___ the industry in the long run.
exit
When firms in monopolistic competition sustain economic losses, firms tend to ___ (one word) the market.
exit
A monopolist charges a ________ price and produces ________ output than a perfectly competitive industry.
higher; less
If MR is greater than MC, a profit-maximizing monopolist should ___.
ncrease output to maximize profits
For a perfectly competitive firm, marginal revenue is equal to the market
price
In a perfectly competitive market, the individual producer's demand curve is the market
price
Perfectly competitive market earns how many economic profits?
zero because of free entry and exit
A firm in monopolistic competition faces a demand curve with own-price elasticity equal to -5 and an advertising elasticity equal to 0.15.This firm should devote __% of its revenues to advertising.
0.15/ - (-5) = 0.03 or 3%
A firm in monopolistic competition faces a demand curve with own-price elasticity equal to -2 and an advertising elasticity equal to 0.2.This firm should devote ___ % of its revenues to advertising.
0.2/ -(-2) = 0.1 or 10%
comparative advertising
A form of advertising where a firm attempts to increase the demand for its brand by differentiating its product from competing brands.
green marketing
A form of niche marketing where firms target products toward consumers who are concerned about environmental issues.
brand myopic
A manager or company that rests on a brand's past laurels instead of focusing on emerging industry trends or changes in consumer preferences.
Perfectly competitive markets
A market in which (1) there are many buyers and sellers (each of which is small relative to the market), (2) each firm produces a homogeneous (identical) product, (3) buyers and sellers have perfect information, (4) there are no transaction costs, and (5) there is free entry and exit.
monopolistic competition
A market in which (1) there are many buyers and sellers, (2) each firm produces a differentiated product (close substitutes), and (3) there is free entry and exit. Differs from perfect competition because produces slightly different product. P > MC so produce less output than socially desirable like monopolies. P = ATC earn zero economic profits like perfectly competitive firms Cannot take full advantage of economies of scale in production. Too many firms.
Monopoly
A market structure in which a single firm serves an entire market for a good that has no close substitutes.
niche marketing
A marketing strategy where goods and services are tailored to meet the needs of a particular segment of the market.
How much advertising should occur in monopolistic competitive firm?
Advertise up to point where incremental revenue from advertising equals incremental costs. Use profit-maximizing advertising-to-sales ratio (A/R) A/R = E(qa) / - E(qp) A= firms expenditures on advertising R = PQ revenues The more elastic demand for product, the lower optimal A/R ratio If perfectly elastic, A/R is zero The greater the advertising elasticity, the greater the optimal A/R ratio
Long-Run Equilibrium in Monopolistically Competitive Market
Can earn short-run profits, but additional firms will enter to capture some profits. If losses, firms will leave. Impact is that entry and exit occurs to a point that no firm earns long-term economic profits. Monopolistically competitive firms produce a level of output such that 1. P > MC 2. P = ATC > minimum of average costs
Demand curve for monopoly
Demand curve for industry is the demand curve for monopoly firm's product D(f) = D(m) Monopoly can choose price or quantity but not both.
Define the competitive firm's demand.
Df = P = MR
Profits of a perfectly competitive firm:
Difference between revenues and costs. Profits = PQ - C(Q) Geometrically, are given by vertical distance between cost function and the revenue line. Profit-maximizing level of output is level of greatest vertical distance.
Slope of Revenue in Perfectly Competitive Firm
Equals MR which equals P
Slope of Costs in Perfectly Competitive Firm
Equals Marginal Cost
Cost Complementarity
Exist when the marginal cost of producing one output is reduced when the output of another product is increased.
Economies of Scope
Exist when the total cost of producing two products within the same firm is lower than when the products are produced by separate firms.
Economies of Scale
Exist whenever long-run average costs decline as output increases.
Diseconomies of Scale
Exist whenever long-run average costs increase as output increases.
True or false: A perfectly competitive firm's short-run supply curve is its marginal cost above the minimum point of the average cost (AC) curve.
False
True or false: In the long-run, firms in a monopolistically competitive market earn positive economic profits.
False
What would happen to research and development of new products and technologies if the U.S. eliminated the current patent system?
Firms would have less incentive to develop new products.
Monopoly Pricing Rule
Given the level of output, Q^M, that maximizes profits, the monopoly price is the price on the demand curve corresponding to the Q^M units produced P^M = P(Q^M)
How does the U.S. patent system create monopolies?
Grants an inventor exclusive right to sell the product
When to shut down in perfectly competitive firm?
If P(e) = MC and is below AVC. For each unit sold, firm would lose: (Losses) = PQ - C(Q) If shut down, losses would equal fixed costs. [ATC(Q*) - AVC(Q*)]Q*
Determine a key difference between monopolistic competition and monopoly.
In monopolist competition, there are other firms that sell similar products.
Perfect competition, free entry and exit affect on the supply/demand curves and long-run effects.
Industry supply curve shifts right with more entry. P(e) goes down. Industry demand curve for individual firm's product shifts down which lowers product. As exit occurs (when firms not covering opportunity costs in long run), P(e) increases and industry supply curve shifts left. Firm demand curve shifts up, increasing firm price. Continues until P(e) = MC = minimum AC. Firms make enough to cover AC (no AFC or AVC bc long run all are variable) and economic profits are zero and economies of scale have been exhausted. If economic profits positive, entry occurs. Negative, exit occurs.
A firm in monopolistic competition faces a demand function equal to:P = 200 - 2Q,and a cost function equal toC(Q) = 10 + 4Q.The profit-maximizing level of output equals ___ units.
MC = 4 MR = 200 - 2(2)Q 4 = 200 - 4Q -196 = -4Q Q = 49
In a multiplant setting, where (Q1) is output from plant 1, and (Q2) is output from plant 2, profits are maximized where
MC1(Q1) = MC2(Q2)
Profit maximization for monopolistic competitive firm
MR = MC MR lies below demand curve Prices not based on market demand for product but for demand on individual firm's product. P(max) = P(Qmax)
Given a revenue function: R(Q) = P(Q)Q The monopolist's marginal revenue (MR) is given by
MR = P(1+E/E) MR = dR/dQ MR = (dP/dQ)Q + P
Marginal Revenue for Linear Inverse Demand
MR = a + 2bQ
What is the marginal revenue (MR) of the inverse linear demand function, P(Q) = a + bQ?
MR = a + 2bQ
Given a revenue function, R = R(Q), what is the marginal revenue (MR)?
MR = dR/dQ
Profit maximization for the two-plant monopolist occurs when the monopolist uses resources such that
MR(Q) = MC1(Q1) and MR(Q) = MC2(Q2) MC1(Q1) = MC2(Q2)
Implication of Entry Barriers
Monopoly can earn positive economic profits due to presence of barriers, preventing other firms from entering. Firm will continue to earn so long as maintain monopoly power.
Perfectly competitive markets and price
No single firm exerts any influence on price. Price is determined by interaction of all buyers and sellers in the market
Long-run properties of perfect competition include:
P = MC P = min AC
Competitive Output Rule
P = MC(Q)
In the long run, firms in monopolistic competition produce a level of output where
P > MC P = ATC > minimum average costs
Monopolists determine how much to produced based on:
P > MR = MC There is no supply curve for monopoly firm.
To maximize profits, a perfectly competitive firm should produce in the range of increasing marginal cost where P = MC and
P ≥ AVC
Which of the following is a linear inverse demand curve?
P(Q) = 100 - 2Q
Linear Inverse Demand Function
P(Q) = a + bQ where a>0 and b<0
Monopoly profits are prescribed by:
P(m) - ATC (Qm)
What is the fundamental difference between monopolistic competition and perfect competition?
Products in monopolistic competition are differentiated
As firms exit a perfectly competitive industry in the long run, what happens to the profits of the remaining firms?
Profits increase due to increased market price.
Total revenue formula
R = Market Price (P) x Output of the Firm (Q)
In perfect competition, profit equals
Revenues - Costs
Principle: Firm's Short-Run Supply Curve in Perfectly Competitive Market
Short run supply curve is its marginal cost curve above the minimum point on the AVC curve
At point of profit-maximizing level of output in perfectly competitive market
Slope of cost curve equals slope of revenue line Since slope of cost = MC and slope of revenue = MR, and MR=P, then P=MC or MB=MC.
Minimizing losses in perfectly competitive firm?
Sometimes, short-run losses are inevitable. Try to minimize losses. If losses persist into long run, firm needs to exit industry. P(e) lies below ATC curve but above AVC curve. Produce Q* where P(e) = MC. Since producing above AVC, each unit sold generates more revenue than cost per unit of variable inputs. Should continue to produce in short run because enough to cover VC of producing and some of the FC. If not producing, would lose on FC regardless.
What happens to the industry supply as firms exit a perfectly competitive industry in the long run?
Supply decreases
Marginal Revenue in a Perfectly Competitive Firm
The change in revenue attributable to the last unit of output; for a competitive firm, MR is the market price. MR = dR/dQ = P
Deadweight loss of monopoly
The consumer and producer surplus that is lost due to the monopolist charging a price in excess of marginal cost. Sum the vertical distance for all units between Q(M) and Q(C) to find shaded area.
Firm demand curve in perfectly competitive market
The demand curve for an individual firm's product; in a perfectly competitive market, it is simply the market price. Given by a horizontal line at P(e). It is perfectly elastic. D(f) = P = MR Pricing decisions are trivial since firms will charge what the industry charges. Decisions that remain how how much output should be produced to maximize profits. The market price is the competitive firm's marginal revenue.
What is the industry supply curve in a perfectly competitive market?
The horizontal sum of all individual marginal costs above their respective AVC curves. It is flatter than the supply curve of an individual firm.
What does the free entry and exit assumption imply for a perfectly competitive market?
- New firms will enter when profits exist. - New firms will leave if they incur losses. - In the long run, economic profits are zero.
If P exceeds AVC but is less than ATC, the firm
- should remain open. - is sustaining a loss.
The inverse demand function for a monopolist is given by P = 50 - 4Q. If the profit-maximizing output level is 5 (QM = 5), the monopoly price is
30
Which of the following is NOT a source of monopoly power?
Free entry and exit
Suppose a spinach farmer operates in perfect competition. At the market price of $3.00 per bunch, the farmer sells 125 bunches per day. If the farmer increases her price to $3.01, she will sell ___ bunches.
MP = 3 = MR Q = 125 MP = 3.01 = MP zero
Monopoly Multiplant Output Rule
MR (Q) = MC1 (Q1) [for plant one] MR (Q) = MC2 (Q2) [for plant two] MC1(Q1) = MC2(Q2) MR(Q) is the MR of producing Q1 + Q2
A firm in monopolistic competition faces a demand function equal to:P = 200 - 2Q,and a cost function equal toC(Q) = 10 + 4Q.The profit-maximizing price equals $___
MR = 200 - 2(2)Q MC = 4 4 = 200 - 4Q Q = 49 200 - 2(49) = P P = 102
A monopolist's linear inverse demand curve is P(Q) = 750 - 3Q. Which of the following is the monopolist's marginal revenue?
MR = 750 - 6Q
A monopolist's marginal revenue (MR) is given by:
MR = P(1 + E/E)
brand equity
The additional value added to a product because of its brand.
What is the key difference in determining the profit-maximizing price and output under monopoly versus monopolistic competition?
There is no difference.
A perfectly competitive firm's short-run supply curve is its marginal cost above the minimum point of the _______ curve.
average variable cost (AVC)
If consumers are willing to pay more for "Roper's Rice" than they are for "Rice by Russell", then "Roper's Rice" is enjoying additional value due to _______.
brand equity
Four sources of monopoly of power...
These sources create a barrier to entry that prevents other firms from entering the market: - Economies of Scale - Economies of Scope - Cost Complementarity - Patents and Other Legal Barriers
Short-run output decision under perfect competition
To max short-run profits, firm should produce in range of increasing marginal cost where P=MC, provided that P >=AVC. If P<AVC, firm should shut down its plant to minimize its losses.
True or false: P(Q) = 1,000 - 6Q is a linear inverse demand curve.
True
True or false: There is no supply curve in markets served by firms with market power.
True
Alternative way to express optimal output in perfectly competitive market
Where P(e) - market price intersects the MC marginal cost curve. At Q* where P and MC intersect, find ATC(Q). The shaded square of these points represent max profits of the firm. Area of this rectangle is: Profits = PQ - C(Q) This is the definition of profits. ATC(Q*) = C(Q*)/Q*
Since each producer in a perfectly competitive market has no influence on market price, the demand curve for the individual firm is
a horizontal line equal to the market price.
The monopolist is restricted to price-quantity combinations that lie on the demand curve as a result of decisions made by ___
consumers
When increasing the output of one product reduces the marginal cost of another product, it is called
cost complementarity
The welfare loss to society due to the level of output produced by a monopolist is called the ___ loss of monopoly.
deadweight
If MR is less than MC, a profit-maximizing monopolist should:
decrease output to maximize profits
For a monopolist, it is necessary to _______ price to increase output by one unit. As a result, the price received from all previous units _________.
decrease; decreases
Given a profit-maximizing level of output, QM, the monopoly price is the price on the _____ curve that corresponds to QM units of output.
demand
When long-run average costs rise as output increases, we say that the firm experiences ____ of scale.
diseconomies
When long-run average costs fall as output increases, we say that the firm experiences ___ of scale.
economies
When the total cost of producing two goods within the same firm is less than the cost of producing them in separate firms, Blank______ exist.
economies of scope
When firms in monopolistic competition earn positive economic profits, other firms tend to ___ the market.
enter
In order to maximize profits, a monopolist should produce where marginal revenue is ________ marginal cost.
equal to
A perfectly competitive firm maximizes profits at a point where P ___ MC over the range where MC is _________.
equals; increasing
The demand curve for a perfectly competitive firm is a ______ line at the market _____
horizontal; price
When a monopolist increases output by one unit, total revenue
increases by less than price.
In monopolistic competition, each firm uses the ___________ demand curve and the marginal revenue curve to establish output and price. In monopoly, the firm uses the __________ demand curve and the marginal revenue curve to establish output and price.
individual; market
Economies of scope tend to encourage ___ firms.
larger
In a perfectly competitive firm, in the short run, a firm will shut down to minimize losses when price is ______ average variable cost.
less than
Multiproduct firms that have cost complementarities tend to have ______ marginal costs than firms producing a single product.
lower
When many buyers and sellers freely enter and exit a market having similar, yet differentiated products, it is called ________.
monopolistic competition
Fast-food hamburgers are characterized by a large group of sellers producing slightly different goods. What type of market is this?
monopolistically competitive
Economies of scale and scope, cost complementarity, and patents are all sources of _____ (one word) power.
monopoly
Suppose a market contains one supplier of a good that has no close, available substitutes. What type of market structure is this?
monopoly
The market structure where a firm has a large degree of market power is called
monopoly
When price (P) exceeds minimum average variable cost (AVC), each unit of output sold generates ____ revenue than the cost per unit of the variable inputs.
more
Which is a strategy firms use to tailor goods and services to meet the needs of a particular segment of the market?
niche marketing
In order to maximize profits in the short run, a manager must determine how much output should be produced, given
only variable inputs within his or her control.
A market with many "small" buyers and sellers, identical products, no transaction costs, and free entry and exit where buyers and sellers have perfect information is called __________.
perfect competition
If the market for corn contains many buyers and sellers (none of whom can influence price), a homogeneous product, and free entry in the market, we consider the market to be _________.
perfectly competitive
In general, agriculture is considered a ___________ market.
perfectly competitive
An individual firm in perfect competition has a price elasticity that is ________.
perfectly elastic
π = P(Q) - C(Q) defines
profits
On a graph, profits are given by the vertical distance between the cost function and the ___ line.
revenue
A period of time during which at least one input is fixed is called the ___ run.
short
Marginal revenue is the ___ of the total revenue curve.
slope/derivative
In a monopoly, where the firm chooses output based on marginal revenue (which is less than price),
supply curves do not exist.
Marginal Revenue
the change in total revenue attributable to the last unit of output. The slope of the total revenue curve. Lies halfway between demand curve and vertical axis. For monopolist, it's less than the price charged for the good. It's negative for outputs in excess of optimal Q where demand elastic is unitary. MR = P [ (1+E)/E ]
The price an individual producer in a perfectly competitive market faces is determined by:
the market supply and market demand
The demand curve faced by a monopolist is
the same as the market demand curve
In perfect competition, profits are maximized at a level of output such that
the vertical distance between the revenue line and the cost curve is greatest.
In the long run, profits in a perfectly competitive industry are ________.
zero