Weeks 8-11

marginal cost formula (8.2)

= change in total cost/change in quantity

marginal revenue formula (8.2)

= change in total revenue/change in quantity

marginal revenue (8.1)

= change in tr/change in q - in perfect comp, selling 1 more unit each time, generates the same amount of revenue each time - so, mr = equilibrium price - industry supply increases when short term sharks enter the market - in the long run a perfectly competitive firms profits are always equal to zero

If a firm is producing so that the point chosen along the production possibility frontier is socially preferred, then that firm is said to have reached its: (8.5)

allocative efficiency

It is said that in a perfectly competitive market, raising the price of a firm's product from the prevailing market price of $179.00 to $199.00, ____________________. (8.1)

could likely result in a notable loss of sales to competitors

Monopolistic competitors in the food industry will often include a recyclable symbol on packaging used for their product as a means to: (11.1)

differentiate their product

A manufacturer would likely make an ___________ in a market following the long-run process of beginning and expanding production in response to ________________ . (8.4)

entry; a sustained pattern of profits

An agreement between a manufacturer and a distributor stipulating that a dealer will only distribute that manufacturer's products would be classified as a form of: (10.1)

exclusive dealings

Which of the following is most likely to be a monopoly? (9.1)

local electricity distributor

The largest cattle rancher in a given region will be unable to have a __________ when sufficient numbers of smaller cattle ranchers provide sources of competition. (9.1)

monopoly

Government ______________ regulations specify that inventors will maintain exclusive legal rights to their respective inventions for ______________ . (9.1)

patent; a limited time

The use of sharp, temporary price cuts as a form of _________________ would enable traditional US automakers to discourage new competition from smaller electric car manufacturers. (9.1)

predatory pricing

When a business adopts a strategy of reducing and/or discontinuing production in response to a sustained pattern of losses, it is: (8.4)

preparing to exit operations

If the quality differences of similar products are mostly imperceptible to the average consumer's eyes, which of the following will most likely play a major role in influencing the decisions of purchasers? (8.1)

price of competing products

In the _________, if profits are not possible, the perfectly competitive firm will seek out the quantity of output where _____________________ . (8.2)

short run; losses are smallest

If a firm's revenues do not cover its average variable costs, then that firm has reached its _________________ . (8.2)

shutdown point

oligopoly (8.1)

- few sellers (maybe 2 or 3) - standardized (copper) or differentiated products (cars) - elastic - BTEs (patents, economies of scale, etc. ) - limited price makers (larger market share)

important lessons of a firm (10.1)

- first, that competition, by providing consumers with lower prices and a variety of innovative products, is a good thing - second, that largescale production can dramatically lower average costs - third, that markets in the real world are rarely perfectly competitive

Whenever there are expansions in an industry, costs of production for the existing and new firms could either stay the same, increase, or even decrease. Therefore, we can categorize an industry as being (8.4)

(1) a constant cost industry (as demand increases, the cost of production for firms stays the same), (2) an increasing cost industry (as demand increases, the cost of production for firms increases), or (3) a decreasing cost industry (as demand increases the costs of production for the firms decreases).

summary (8.2)

- if price < minimum average variable cost, then firm shuts down - price > minimum average variable cost, then firm stays in business

allocative efficiency (8.5)

- Allocative efficiency is producing the mix of goods most desired by society. - Another bonus is that consumer surplus and producer surplus are maximized in the long run in pure competition. - Therefore, in a perfectly competitive market, price will be equal to the marginal cost of production. - This choice is going to be the socially preferred one along the production possibility frontier. - The social benefits the firms receive from producing a good are in line with the social costs of production.

profits (8.2)

- = total revenue - total cost - = (p)(q) - (ac)(quantity produced) - = (price - ac) x quantity

cartel example (11.2)

- A cartel is defined as a group of firms or nations joining together and formally agreeing as to the price they will charge and the output levels of each member. - It is illegal here; however, business with the OPEC cartel is conducted every day. - In the past, OPEC has been successful in increasing the price of the oil they sell by restricting supply. - Because cost and demand differences exist between the members, it will be difficult for all members to charge the same price. - The more firms who are part of the agreement, the harder it is to maintain (incentive to cheat). - This incentive to cheat erodes the cartel's power over time. - Overall demand declines during recessions make cheating more attractive. - New producers (the sharks) will be drawn to the industry because of the greater prices and profits, which will increase market supply and decrease prices. - Finally, there are legal obstacles: there are laws, which prohibit cartels and price collusion. - In the U.S., it is illegal to collude. Airline CEOs cannot meet for lunch and discuss plane ticket prices.

price takers (8.1)

- A firm in a perfectly competitive market that must take the prevailing market price as given. - Price takers have no pricing power; in other words, they have no ability to price their product. These buyers and sellers have all the relevant information about the product. - Relevant information allows firms to decide whether to enter the market, and they are able to because there are no barriers to entry. - Easy entry and exit mean that there are no obstacles to enter or exit the industry (the sharks can easily slide into to eat the profits, and leave when all the profits are gone). - Perfectly elastic demand means that the firm has no power to influence price so the firm merely chooses to produce a certain level of output at the price that is given. - The demand curve is not perfectly elastic for the industry; it only appears that way to the individual firm since they must take the market price, no matter what quantity they produce. - The firm faces a perfectly elastic demand because each individual firm makes up such a small part of the total market and the goods are perfect substitutes. - Note in Figure 2 that this perfectly elastic demand curve is a horizontal line at the price.

prisoner's dilemma (11.2)

- A game in which the gains from cooperation are larger than the rewards from pursuing self-interest. - Strategic pricing behavior refers to how a firm's decisions are based on the actions and reactions of rivals. - With mutual interdependence, each firm's profit depends on its own pricing strategy and that of its rivals. - If there's collusion, there is cooperation with rivals which can benefit the firm. - There is incentive to cheat, as cheating can result in more revenues for the cheater. - The prisoner's dilemma is this. Say for instance the police haul a friend of mine and me into an interrogation room. - She's placed in one and me in another. They tell me she has confessed and that if I confess, I will get a lighter sentence. - In her interrogation room, they tell her I've confessed and that she should too, in order to receive a lighter sentence. - Question: do either of us know if the other has truly confessed? No. So do we confess or stay quiet? That's the prisoner dilemma. - How does it apply to oligopoly? Well, the question is: should a firm raise their price, keep it the same, or lower it? - If the firm raises its price, will the other firms follow? If the firm lowers its price, will other firms follow and decrease their price, too?

patents (9.1)

- A government rule that gives the inventor the exclusive legal right to make, use, or sell the invention for a limited time. - Patents grant the inventor the exclusive right to produce or license a product for 20 years; this exclusive right can earn profits for future research, which results in more patents and monopoly profits. - The Ecke family did not file one, and an agrarian researcher in California figured out how graft poinsettia plants together and released the information in an academic paper.

cartel (11.2)

- A group of firms that collude to produce the monopoly output and sell at the monopoly price. - The most comprehensive form of oligopolists is the cartel, a group of producers that typically creates a formal written agreement specifying how much each member will produce and charge. - In this case, the collusion is overt and open to view. - There are also more commonly covert forms of collusion, which can include such things as conspiracies to fix prices, rig bids, and divide up markets. - By colluding, the producers can get together, talk about it, and agree to charge the same price, which will result in each producer receiving the maximum profit.

point (8.2)

- A higher price would mean that total revenue would be higher for every quantity sold. A lower price would mean that total revenue would be lower for every quantity sold. - What happens if the price drops low enough so that the total revenue line is completely below the total cost curve; that is, at every level of output, total costs are higher than total revenues? - In this instance, the best the firm can do is to suffer losses. - However, a profit-maximizing firm will prefer the quantity of output where total revenues come closest to total costs and thus, where the losses are smallest.

long run equilibrium cont. (8.4)

- Entry of many new firms causes the market supply curve to shift to the right. - As the supply curve shifts to the right, the market price starts decreasing, and with that, economic profits fall for new and existing firms. - As long as there are still profits in the market, entry will continue to shift supply to the right. - This will stop whenever the market price is driven down to the zero-profit level, where no firm is earning economic profits.

imperfectly competitive firms (11.1)

- Firms and organizations that fall between the extremes of monopoly and perfect competition.

key ideas (9.2)

- A monopolist is not a price taker, because when it decides what quantity to produce, it also determines the market price. - Total revenue for a monopolist will start low, rise, and then decline. - Each additional unit a monopolist sells will push down the overall market price, and as it sells more units, this lower price applies to increasingly more units. - The monopolist will select the profit-maximizing level of output where MR = MC, and then charge the price for that quantity of output as determined by the market demand curve. - Monopolists are not productively efficient, because they do not produce at the minimum of the average cost curve. - Monopolists are not allocatively efficient, because they do not produce at the quantity where P = MC. - Monopolists produce less, at a higher average cost, and charge a higher price than would a combination of firms in a perfectly competitive industry. - Monopolists also may lack incentives for innovation, because they need not fear entry.

additional point (10.1)

- A new approach to antitrust regulation involves detailed analysis of specific markets and companies, instead of defining a market and counting up total sales. - A common starting point is for antitrust regulators to use statistical tools and real-world evidence to estimate the demand curves and supply curves the firms proposing a merger face. - A second step is to specify how competition occurs in this specific industry. - Some possibilities include competing to cut prices, to raise output, to build a brand name through advertising, and to build a reputation for good service or high quality. - With these pieces of the puzzle in place, it is then possible to build a statistical model that estimates the likely outcome for consumers if the two firms are allowed to merge. - These models do require some degree of subjective judgment, and so they can become the subject of legal disputes between the antitrust authorities and the companies that wish to merge.

kinked-demand curve (11.2)

- A perceived demand curve that arises when competing oligopoly firms commit to match price cuts, but not price increases. - Oligopolists may choose to act in a way that generates pressure on each firm to stick to its agreed quantity of output. - The kinked-demand model is used for non-collusive oligopolies to explain their behaviors and pricing strategies. - Since the firms do not collude, none of the firms know with certainty what their rivals are going to do. - However, the firms assume that their rivals will match any price reductions in an effort to maintain their customers. - On the other hand, it is reasonable to assume that if a firm raises its price, its rivals will ignore the price change in an effort to steal customers from the firm raising its price in order to increase their profit margins (#1 rule of business: make a profit).

raspberry farmer example (8.2)

- A perfectly competitive firm can sell as large a quantity as it wants, as long as it accepts the offered market price. If the firm sells more output, then total revenue (TR) will increase. If the market price increases, then total revenue (TR) will also increase. It is a direct relationship. In our example of the raspberry farmer, the price is $4. If the farmer sells 1 pack, the total revenue is $4. - Three packs would earn the farmer $12, and four packs would earn the farmer $16. If the price increases to $8, and the farmer sells 1 pack, the total revenue would equal $8 (TR = 8 * 1). If the farmer sold 2 packs, total revenue would equal $16.

differentiated product (11.1)

- A product that is consumers perceive as distinctive in some way. - This type of market experiences some pricing power due to the differentiated product. - If a firm goes to the trouble and expense of differentiating their product, they should let people know about it. - They can do this through advertising about their unbreakable bottle, better location, a money back guarantee, or free delivery. - The concept of differentiated products is closely related to the degree of variety that is available. - The variety of styles, flavors, locations, and characteristics creates product differentiation and monopolistic competition.

bundling (10.1)

- A situation in which multiple products are sold as one. - cable providers putting cable, internet, and phone lines together for a special price

monopoly (9.1)

- A situation in which one firm produces all of the output in a market. - A monopoly means that there is only one producer of the good with no close substitutes being produced by any other firms. - Since a monopoly faces no significant competition, it can charge any price it wishes, subject to the demand curve. - The example I use for this is DeBeers (the diamond people) and the poinsettia plant. - Monopolies are created and sustained due to strong entry barriers that make it very difficult for new firms to enter the industry. - For example, DeBeers for decades would buy out other diamond mines to control the supply of diamonds. - There was a member of the Ecke family whom discovered the technique to graft poinsettia plants together to make a lusher, flowery plant, but did not share the technique. - There is some non-price competition, like advertising, that is merely meant to increase the demand for the good.

tying sales (10.1)

- A situation where a customer is allowed to buy one product only if the customer also buys another product. - a drug maker that required patients to purchase its blood-monitoring services along with its medicine to treat schizophrenia

advertising part 2 (11.2)

- Advertising is a low-cost way of providing information to consumers about different options, and it reduces the consumer's search time for products. - Advertising also enhances competition between firms and thus, aids in economic efficiency. - It speeds up technological progress by introducing new products. - It can help firms obtain economies of scale by reducing long-run average costs. - This is incentive to firms as it increases their profit margins. - When advertising either leads to increased monopoly power or is self-canceling, economic inefficiency results.

advertising part 1 (11.2)

- Advertising is prevalent in oligopolies since there are differentiated goods, and advertising is the best way to communicate product differences. - Product improvements and advertising can be successful because they are less easily duplicated than a price change. - Oligopolists are financially able to advertise due to economic profits earned in the past.

point (11.1)

- Although the process by which a monopolistic competitor makes decisions about quantity and price is similar to the way in which a monopolist makes such decisions, two differences are worth remembering. - First, although both a monopolist and a monopolistic competitor face downward-sloping demand curves, the monopolist's perceived demand curve is the market demand curve, while the perceived demand curve for a monopolistic competitor is based on the extent of its product differentiation and how many competitors it faces. - Second, a monopolist is surrounded by barriers to entry and need not fear entry, but a monopolistic competitor who earns profits must expect the entry of firms with similar, but differentiated, products. - We know if there are profits to be made, the sharks will come in to eat them. - The new firms shift the demand curve for the firms to the left and decrease the price. - As the demand curve shifts to the left, so does the marginal revenue curve.

exclusive dealings (10.1)

- An agreement that a dealer will sell only products from one manufacturer. - Some examples of restrictive practices that we are most familiar with are exclusive dealing (Ford Motor Company selling its cars only to Ford dealers)

key ideas (11.2)

- An oligopoly is a situation where a few firms sell most or all of the goods in a market. - Oligopolists earn their highest profits if they can band together as a cartel and act like a monopolist by reducing output and raising prices. - Game theory shows how, in certain situations, all sides can benefit from cooperative behavior rather than self-interested behavior.

key ideas (10.1)

- Antitrust laws seek to ensure active competition in markets, sometimes by preventing large firms from forming through mergers and acquisitions, sometimes by regulating business practices that might restrict competition, and sometimes by breaking up large firms into smaller competitors. - The forces of globalization and new communications and information technology have increased the level of competition that many firms face by increasing the amount of competition from other regions and countries. - Antitrust firms block authorities from openly colluding to form a cartel that will reduce output and raise prices. - Companies sometimes attempt to find other ways around these restrictions and, consequently, many antitrust cases involve restrictive practices that can reduce competition in certain circumstances, like tie-in sales, bundling, and predatory pricing. - In the case of a natural monopoly, market competition will not work well and so, rather than allowing an unregulated monopoly to raise price and reduce output, the government may wish to regulate price and/or output.

key ideas (8.2)

- As a perfectly competitive firm produces a greater quantity of output, its total revenue steadily increases at a constant rate determined by the given market price. - Profits will be highest (or losses will be smallest) at the quantity of output where total revenues exceed total costs by the greatest amount (or where total revenues fall short of total costs by the smallest amount). - If the market price is equal to average cost at the profit-maximizing level of output, then the firm is making zero profits. - If the market price that a perfectly competitive firm faces is below average variable cost at the profit-maximizing quantity of output, then the firm should shut down operations immediately. - If the market price that a perfectly competitive firm faces is above average variable cost, but below average cost, then the firm should continue producing in the short run, but exit in the long run.

key ideas (9.1)

- Barriers to entry prevent or discourage competitors from entering the market. - These barriers include: economies of scale that lead to natural monopoly; control of a physical resource; legal restrictions on competition; patent, trademark and copyright protection; and practices to intimidate the competition like predatory pricing. - The laws that protect intellectual property include patents, copyrights, trademarks, and trade secrets. - A natural monopoly arises when economies of scale persist over a large enough range of output that if one firm supplies the entire market, no other firm can enter without facing a cost disadvantage.

figure 3 cont. (11.2)

- Consider a member firm in an oligopoly cartel that is supposed to produce a quantity of 10,000 and sell at a price of $500. - The other members of the cartel can encourage this firm to honor its commitments by acting so that the firm faces a kinked demand curve. - If the oligopolist attempts to expand output and reduce price slightly, other firms also cut prices immediately—so if the firm expands output to 11,000, the price per unit falls dramatically, to $300. - On the other side, if the oligopoly attempts to raise its price, other firms will not do so, so if the firm raises its price to $550, its sales decline sharply to 5,000.

point 2 (8.5)

- Dynamic adjustments will occur automatically in pure competition when changes in demand, resource supplies, or technology occur. - Disequilibrium will cause expansion or contraction of the industry until the new equilibrium at P = MC occurs. - "The invisible hand" works in a competitive market system since no explicit orders are given to the industry to achieve the P = MC result. - The profit motivation brings about highly desirable economic outcomes.

perfect competition (8.1)

- Each firm faces many competitors that sell identical products. - These very large numbers of independent sellers, each acting alone, cannot influence the market price by increasing or decreasing their output because each has such a miniscule part of the entire market. - A standardized product is a product for which all other products in the market are identical and thus, are perfect substitutes. I always use the example of toilet paper or oranges. Toilet paper is one of those goods that uses the same resources and methods of production. One orange from Grove A is no different than an orange from Grove B. - The consequence of this is that the many buyers are indifferent as to whom they buy from because there are so many sellers of the product. These sellers are price takers.

natural monopoly (9.1)

- Economic conditions in the industry, for example, economies of scale or control of a critical resource, that limit effective competition. - Public utilities are often natural monopolies because they have economies of scale in the extreme case where one firm is most efficient in satisfying the entire demand. - This happens because the marginal cost of adding an additional customer is very low, once the fixed costs of the overall system are in place. - For example, once a water company lays the main water pipes through a neighborhood, the marginal cost of providing water service to another home is fairly low. - Government usually gives one firm the right to operate a public utility industry in exchange for government regulation of its power, which means public utilities are also legal monopolies. - economies of scale leads to a natural monopoly

additional point (9.2)

- For a monopoly, marginal revenue decreases as it sells additional units of output. - The marginal cost curve is upward-sloping. - The profit-maximizing choice for the monopoly will be to produce at the quantity where marginal revenue is equal to marginal cost: that is, MR = MC. - If the monopoly produces a lower quantity, then MR > MC at those levels of output, and the firm can make higher profits by expanding output. - If the firm produces at a greater quantity, then MC > MR, and the firm can make higher profits by reducing its quantity of output.

another point (8.2)

- For a perfectly competitive firm, the marginal cost curve is identical to the firm's supply curve starting from the minimum point on the average variable cost curve. - This is because producers are always checking the market price and comparing its supply curve to decide what level of output to produce. - This corresponds to the P = MC rule, which states that firms will compare market price to marginal costs to determine the quantity to produce. - They also check that the price is higher than the minimum average variable cost. - In other words, the marginal cost curve above the minimum point on the average variable cost curve becomes the firm's supply curve. - Just like changes in costs shifted the supply curve left or right, those changes cause the marginal cost curve to shift up or down. - For example, if there is an increase in government regulations, the supply curve would shift to the left. - The marginal cost curve would shift up and to the left. - These shifts identify the decrease in supply.

point 4 (8.5)

- Furthermore, real-world markets include many issues that we do not add into our models like pollution, inventions of new technology, or poverty. - Remember, economists like to keep things simple, so utilize ceteris paribus (other things equal). - However, the theoretical efficiency of perfect competition does provide a useful benchmark for comparing the issues that arise from these real-world problems.

example (11.2)

- In 1947, there were 400 independent brewers in the U.S.; by 1967, the number had declined to 124; by 1987, the number was 33. - In 1947, the five largest brewers sold 19% of the nation's beer. - Currently, the big four brewers sell 87% of the total. - Anheuser-Busch and Miller alone sell 69%. - This changed a bit as Anheuser-Busch bought out SABMiller. - The beer oligopoly has developed out of demand and supply changes. - For example, the aluminum can allowed beer to be consumed in mass quantities at home, thanks in part to the new technology for bottling and canning lines for beer production.

constant cost industry (8.4)

- In a constant-cost industry, entry and exit of firms do not affect resource prices and therefore, do not affect per-unit costs, so an increase in demand raises output, but not price. - Similarly, a decrease in demand reduces output, but not price. - There is no increase in price because firms face a perfectly elastic supply of inputs, i.e., firms can easily increase their demand for employees, for example, with no increase to wages. (look at figure 1 if in doubt) - Therefore, the long-run supply curve is horizontal.

increasing cost industry (8.4)

- In an increasing cost industry, when firms enter the industry, input costs will increase; and input costs will fall as firms exit the industry. - This changes the location of the intersection between zero-profit levels and prices. - Companies may have to deal with limited inputs, such as skilled labor. - As the demand for these workers rise, wages rise and this increases the cost of production for all firms. - The industry supply curve in this type of industry is more inelastic. - In an increasing-cost industry, the entry of new firms in response to an increase in demand (D1 to D2) will bid up resource prices and thereby increase unit costs. - As a result, an increased industry output (Q1 to Q2) will be forthcoming only at higher prices. - Notice the long-run supply curve is more upward-sloping.

additional point (9.1)

- In some cases, barriers to entry may lead to monopoly. In other cases, they may limit competition to a few firms. Barriers may block entry even if the firm or firms currently in the market are earning profits. Thus, in markets with significant barriers to entry, it is not necessarily true that abnormally high profits will attract new firms, and that this entry of new firms will eventually cause the price to decline so that surviving firms earn only a normal level of profit in the long run. - the demand curve faced by monopoly is the demand curve of the industry - profit does not go to zero in the long run with monopolies as it does with perfectly competitive markets

point (10.1)

- In some cases, we can view tying sales and bundling as anti-competitive. - However, in other cases they may be legal and even common. - It is common for people to purchase season tickets to a sports team or a set of concerts so to guarantee tickets to the few contests or shows that are most popular and likely to sell out. - Computer software manufacturers may often bundle a number of different programs, even when the buyer wants only a few. - Think about the software that is included in a new computer purchase, for example.

decreasing cost industry (8.4)

- In the decreasing-cost industry, as the number of firms increase or decrease due to entry or exit, the industry costs change inversely. - If demand for their product falls, firms will leave the industry, causing input costs to rise. - If demand for their product increases, firms will enter the industry, causing input costs to fall. - The zero-profit level intersects at a lower price than before. - In this case, the industry and all the firms in it are experiencing falling average total costs. - This can be due to an improvement in technology in the entire industry or an increase in the education of employees. - High tech industries may be a good example of a decreasing cost market. - Notice that the long-run supply curve is more downward-sloping.

example (10.1)

- In the late 1990s, for example, the antitrust regulators prosecuted an international cartel of vitamin manufacturers, including the Swiss firm Hoffman-La Roche, the German firm BASF, and the French firm Rhone-Poulenc. - These firms reached agreements on how much to produce, how much to charge, and which firm would sell to which customers. - Firms bought the high-priced vitamins like General Mills, Kellogg, Purina-Mills, and Proctor and Gamble which pushed up the prices more. - Hoffman-La Roche pleaded guilty in May 1999 and agreed both to pay a fine of $500 million and to have at least one top executive serve four months of jail time.

productive efficiency (8.5)

- Productive efficiency is producing goods in the least costly way, which means that the choice is on the production possibility frontier (now we're stretching back to the first module here). - In the long run in a perfectly competitive market, because of the process of entry and exit, the price in the market is equal to the minimum of the long-run average cost curve. - In other words, firms produce and sell goods at the lowest possible average cost.

another point (11.1)

- In the long run, firms still produce the quantity where MR = MC. - In the long run, firms (the sharks) will enter the industry if economic profits were enjoyed, shifting demand left and profits fall. - In the long run, firms will exit the industry if there are economic losses, shifting demand to the right and losses shrink. - This will continue until the price settles where it just equals AC at the MR = MC output. - At this price, the monopolistically competitive firm earns a normal profit.

key ideas (8.4)

- In the long run, firms will respond to profits through a process of entry, where existing firms expand output and new firms enter the market. - Conversely, firms will react to losses in the long run through a process of exit, in which existing firms cease production altogether. - Through the process of entry in response to profits and exit in response to losses, the price level in a perfectly competitive market will move toward the zero-profit point, where the marginal cost curve crosses the AC curve at the minimum of the average cost curve. - The long-run supply curve shows the long-run output supplied by firms in three different types of industries: constant cost, increasing cost, and decreasing cost.

point 3 (8.5)

- It is important to notate though, that perfect competition is a hypothetical benchmark. - When we discuss efficiency, it is in a particular and specific sense. - This is why you will not see productive and allocative efficiency in the other market structures. - Firms will not always produce at the minimum average cost, nor will they always set price equal to marginal costs.

figure 2 (11.1)

- Let's examine an example monopolistic competitive firm's revenue and cost schedule. - The calculations for the various revenues and costs remain the same. - Total revenue is still equal to price times quantity. - Marginal revenue is still equal to the change in total revenue divided by the change in quantity. - Marginal cost is equal to total cost divided by the change in quantity, and average cost is equal to total cost divided by quantity. - The firm represented in Figure 2 below experiences MR = MC at the quantity of 40 and price of $16.

break-even point (8.2)

- Level of output where the marginal cost curve intersects the average cost curve at the minimum point of AC; if the price is at this point, the firm is earning zero economic profits.

shutdown point (8.2)

- Level of output where the marginal cost curve intersects the average variable cost curve at the minimum point of AVC; if the price is below this point, the firm should shut down immediately. - In the short run the firm only has two choices: produce or shut down. - There is not enough time in the short run for the firm to get out of the business. Given these options, sometimes the firm will produce, but still make a loss. In these situations, the loss from producing is smaller than the loss if the firm shut down, so this is the firm's best choice. It still sounds weird, doesn't it? This is because the firm can reduce variable costs to zero, but has already paid for its fixed costs. The firm has produced nothing, but it would still have to cover the fixed costs like rent and insurance

licenses (9.1)

- Licenses are another form of entry barrier. - Radio and TV stations and taxi companies are examples of government granting licenses where only one or a few firms are allowed to offer the service. - Technological progress and dynamic efficiency may occur in some monopolistic industries, but not in others. - Some monopolies have shown little interest in technological progress. - On the other hand, research can lead to lower unit costs, which help monopolies as much as any other type of firm. - Also, research can help the monopoly maintain its barriers to entry against new firms.

key ideas (8.5)

- Long-run equilibrium in perfectly competitive markets meets two important conditions: allocative efficiency and productive efficiency. - Resources are allocated to their best alternative use, and they provide the maximum satisfaction attainable by society

monopolistic competition (11.1)

- Many firms competing to sell similar but differentiated products. - In monopolistic competition, firms can differentiate their products by the product attributes, by service, with location, or with brand names and packaging. - The example I use here is restaurants. There are many, many restaurants one can eat at, dependent upon your mood: Italian, Mexican, Vietnamese, Korean, American. - They differentiate themselves from the competition on types of ingredients used ("we use the freshest") or quality service. - There is relatively easy entry and exit, just not as easy as with perfect competition. - That is why the number of sellers is not as large as in perfect competition, but it is relatively large. - This type of market experiences some pricing power due to the differentiated product.

monopolistic competition (11.2)

- Monopolistic competition is probably the single most common market structure in the U.S. economy. - It provides powerful incentives for innovation, as firms seek to earn profits in the short run, while entry assures that firms do not earn economic profits in the long run. - However, monopolistically competitive firms do not produce at the lowest point on their average cost curves. - In addition, the endless search to impress consumers through product differentiation may lead to excessive social expenses on advertising and marketing.

key ideas (11.1)

- Monopolistic competition refers to a market where many firms sell differentiated products. - Monopolistic competitive firms face a highly elastic demand curve that is downward-sloping, which shows that it is a price maker and chooses a combination of price and quantity. - Economic profits attract other firms, while losses causes firms to leave the industry. - A monopolistically competitive firm is not productively efficient because it does not produce at the minimum of its average cost curve. - A monopolistically competitive firm is not allocatively efficient because it does not produce where P = MC, but instead produces where P > MC.

more points (11.1)

- Monopolistically competitive producers may be able to postpone the long-run outcome of just normal profits through product development, improvement, and advertising. - Compared with pure competition, this suggests possible advantages for the consumer. - Development, or improved products, can provide the consumer with a diversity of choices. - Product differentiation is at the heart of the trade-off between consumer choice and productive efficiency. - The greater number of choices the consumer has, the greater the excess capacity problem (more capital or factory machinery lying idle).

point (10.1)

- Most true monopolies today in the U.S. are regulated, natural monopolies. - A natural monopoly poses a difficult challenge for competition policy, because the structure of costs and demand makes competition unlikely or costly. - Recall that a natural monopoly arises when average costs are declining over the range of production that satisfies market demand. - This typically happens when fixed costs are large relative to variable costs. - As a result, one firm is able to supply the total quantity demanded in the market at lower cost than two or more firms, so splitting up the natural monopoly would raise the average cost of production and force customers to pay more. - We used the examples of public utilities like water and electricity.

Your company operates in a perfectly competitive market. You have been told that advertising can help you increase your sales in the short run. Would you create an aggressive advertising campaign for your product? (8.1)

- No, because your product is identical to every other product in the market, and customers know this, since they have perfect information. Advertising will not help. - advertising increases costs, which increases price of product - if the price of your product increases, you will lose sales to competitors

long run equilibrium cost part 3 (8.4)

- Now reverse the process for the long-run: demand decreases, causing the market price to decrease. - The existing firms in the industry are now facing a lower price than before, and as it will be below the average cost curve, they will now be making economic losses. - Some firms will continue producing where the new P = MR = MC, as long as they are able to cover their average variable costs. - Some firms will have to shut down immediately as they will not be able to cover their average variable costs, and will then only incur their fixed costs, minimizing their losses. - The exit of many firms causes the market supply curve to shift to the left. - As the supply curve shifts to the left, the market price starts rising, and economic losses start to be lower. - This process ends whenever the market price rises to the zero-profit level, where the existing firms are no longer losing money and are at zero profits again.

figure 1 (11.2)

- Oligopolies tend to collude and the model in Figure 1 shows how collusive oligopolists behave. - Oligopolies are conducive to collusion and the tendency toward joint profit maximization. - If oligopolistic firms face identical or highly similar demand and cost conditions, they may collude to limit their joint output and to set a single, common price. - Thus, each firm acts as if it were a pure monopolist, setting output at Q0 and charging price P0. - This price and output combination maximizes each oligopolist's profit (green area) and, thus, the combined or joint profit of the colluding firms. - Collusion is most likely to occur when the good that is being produced is homogeneous.

oligopoly (11.2)

- Oligopoly is probably the second most common market structure. - When oligopolies result from patented innovations or from taking advantage of economies of scale to produce at low average cost, they may provide considerable benefit to consumers. - Oligopolies are often buffered by significant barriers to entry, which enable the oligopolists to earn sustained profits over long periods of time. - Oligopolists also do not typically produce at the minimum of their average cost curves. - When they lack vibrant competition, they may lack incentives to provide innovative products and high quality service.

key ideas (8.1)

- Perfect competition means that there are many sellers, there is easy entry and exiting of firms, products are identical from one seller to another, and sellers are price takers. - A short-run production period is when firms are producing with some fixed inputs. - Long-run equilibrium in a perfectly competitive industry occurs after all firms have entered and exited the industry and seller profits are driven to zero.

perfect information (8.1)

- Perfect information refers to the fact that each player has the same information that would be available at the end of the game. This is, each player knows or can see other player's moves. A good example would be chess, where each player sees the other player's pieces on the board. - Imperfect information appears when decisions have to be made simultaneously, and players need to balance all possible outcomes when making a decision. A good example of imperfect information games is a card game where each player's card are hidden from the rest of the players. - source: https://policonomics.com/lp-information-economics1-perfect-imperfect-information/

restrictive practices (10.1)

- Practices that reduce competition but that do not involve outright agreements between firms to raise prices or to reduce the quantity produced. - Antitrust cases involving restrictive practices are often controversial, because they delve into specific contracts or agreements between firms that are allowed in some cases but not in others.

another point (11.2)

- Price leadership is an economic model where a dominant firm (like the Deere company for farm machinery) initiates price changes and the others in the industry follow the leader. - The leader communicates price changes through speeches, press releases, or articles in trade journals. - Oligopolies will use limit pricing to block entry of new firms. - This means the price is kept below the short-run profit-maximizing level. - One result is infrequent price changes since the leader is never certain that the other firms will follow, and there is always the threat of a price war.

allocative efficiency (9.2)

- Producing the optimal quantity of some output; the quantity where the marginal benefit to society of one more unit just equals the marginal cost. - Most people criticize monopolies because they charge too high a price, but what economists object to is that monopolies do not supply enough output to be allocatively efficient. - To understand why a monopoly is inefficient, it is useful to compare it with the benchmark model of perfect competition. - In this set of graphs, we will compare the inefficiency of pure monopoly relative to a purely competitive industry.

productive efficiency + allocative efficiency (11.2)

- Productive efficiency is achieved by producing in the least costly way and is evidenced by P = min ATC. - Allocative efficiency is achieved by producing the right amount of output and is evidenced by P = MC. - Foreign competition has increased rivalry in oligopolistic industries. - If the oligopolist leader practices limit pricing, we may get lower prices. - Oligopolies may foster more rapid product development because of the competition in the industry and with the firm's profits, they have a means to invest in new technologies.

monopolists and profits (9.2)

- Profits for monopolists work the same as perfectly competitive firms: Profits = Total Revenues - Total Costs. Therefore, monopolies will also utilize total cost, fixed cost, variable cost, marginal cost, average cost, and average variable cost. However, because a monopoly faces no competition, its situation and its decision process will differ from that of a perfectly competitive firm. - We know that a perfectly competitive firm is a price taker and total revenue is calculated by multiplying price times quantity. - The perceived demand curve for the perfectly competitive individual firm is horizontal. - A monopolist is a price maker. However, they cannot charge any price they want because the demand for the monopolist's product limits the price. - (Remember the law of demand: consumers have to be willing and able to purchase the good.) Their perceived demand curve, which is also the market demand curve, is downward-sloping.

point (10.1)

- Since a merger combines two firms into one, it can reduce the extent of competition between firms. - Therefore, when two U.S. firms announce a merger or acquisition where at least one of the firms is above a minimum size of sales (a threshold that moves up gradually over time, and was at $76.3 million in 2015), or certain other conditions are met, they are required under law to notify the U.S. Federal Trade Commission (FTC).

another point (10.1)

- The U.S. antitrust laws reach beyond blocking mergers that would reduce competition to include a wide array of anticompetitive practices. - For example, it is illegal for competitors to form a cartel to collude to make pricing and output decisions, as if they were a monopoly firm. - The Federal Trade Commission and the U.S. Department of Justice prohibit firms from agreeing to fix prices or output, rigging bids, or sharing or dividing markets by allocating customers, suppliers, territories, or lines of commerce.

marginal revenue (8.2)

- The additional revenue gained from selling one more unit. - Recall that a perfectly competitive firm faces a perfectly elastic demand curve for its product: the firm's demand curve is a horizontal line (as seen in Figure 3) drawn at the market price. - The firm's marginal revenue curve is the same as the firm's demand curve. - Therefore, marginal revenue = price. - refer to figure 3 as needed

intellectual property (9.1)

- The body of law including patents, trademarks, copyrights, and trade secret law that protect the right of inventors to produce and sell their inventions. - implies ownership over an idea, concept, or image, not a physical piece of property like a house or a car - Countries around the world have enacted laws to protect intellectual property, although the time periods and exact provisions of such laws vary across countries. - There are ongoing negotiations, both through the World Intellectual Property Organization (WIPO) and through international treaties, to bring greater harmony to the intellectual property laws of different countries to determine the extent to which those in other countries will respect patents and copyrights.

point (10.1)

- The concept of restrictive practices is continually evolving, as firms seek new ways to earn profits and government regulators define what is permissible. - A situation where the law is evolving and changing is always somewhat troublesome, since laws are most useful and fair when firms know what they are in advance. - In addition, since the law is open to interpretation, competitors who are losing out in the market can accuse successful firms of anti-competitive restrictive practices, and try to win through government regulation what they have failed to accomplish in the market.

entry barriers (11.2)

- The entry barriers in oligopoly are not as great as in monopoly; thus we have a few producers. - There may be homogeneous or standardized oligopolies, like the steel and oil markets. - There may also be differentiated oligopolies like the markets for breakfast cereal, beverages, and automobiles. - Control over price is limited because there are just a few sellers in the market and rivals may respond in a way that would be detrimental to the firm that just changed the price. - Entry barriers are more substantial than in monopolistic competition, which is why there are just a few producers in the market. - Although some firms have become dominant as a result of internal growth, others like the airlines and banking industries have gained dominance through mergers.

figure 1 cont. (11.1)

- The firm's demand curve is highly, but not perfectly, elastic. - It is more elastic than the monopoly's demand curve because the seller has many rivals producing close substitutes. - It is less elastic than in pure competition because the seller's product is differentiated from its rivals, so the firm has some control over price. - In the short-run situation, the firm will maximize profits or minimize losses by producing where marginal cost and marginal revenue are equal, as was true in pure competition and monopoly. - Much like in pure competition, in monopolistic competition the profits in the long run are equal to zero because of free entry and exit into and out of the industry. - Product variety and improvement of said product can sustain profit longer. - As we examine the industry, we will find that it is inefficient.

figure 1 (9.1)

- The graph below in Figure 1 presents a long-run average cost curve for the airplane manufacturing industry. It shows economies of scale up to an output of 8,000 planes per year and a price of P0, then constant returns to scale from 8,000 to 20,000 planes per year, and diseconomies of scale at a quantity of production greater than 20,000 planes per year. - Now consider the market demand curve in the diagram, which intersects the long-run average cost (LRAC) curve at an output level of 5,000 planes per year and at a price P1, which is higher than P0. - In this situation, the market has room for only one producer. - If a second firm attempts to enter the market at a smaller size, say by producing a quantity of 4,000 planes, then its average costs will be higher than those of the existing firm, and it will be unable to compete. - If the second firm attempts to enter the market at a larger size, like 8,000 planes per year, then it could produce at a lower average cost, but it could not sell all 8,000 planes that it produced because of insufficient demand in the market. - In this market, the demand curve intersects the long-run average cost (LRAC) curve at its downward-sloping part. A natural monopoly occurs when the quantity demanded is less than the minimum quantity it takes to be at the bottom of the long-run average cost curve.

barrier to entry (9.1)

- The legal, technological, or market forces that may discourage or prevent potential competitors from entering a market. - Economies of scale can combine with the size of the market to limit competition. - This occurs where the lowest unit costs and, therefore, lowest unit prices for consumers depend on the existence of a small number of large firms or, in the case of a pure monopoly, only one firm. - These economies of scale may be the result of spreading large initial capital cost over a large number of units of output (natural monopoly) or, more recently, spreading product development costs over units of output, and a greater specialization of inputs. - Because a very large firm with a large market share is most efficient, new firms cannot afford to start up in industries with economies of scale.

long run equilibrium (8.4)

- The market is in long-run equilibrium, where all firms earn zero economic profits producing the output level where P = MR = MC and P = AC. - No firm has the incentive to enter or leave the market. Let's say that the product's demand increases, and with that, the market price goes up. The existing firms in the industry are now facing a higher price than before, so they will increase production to the new output level where P = MR = MC. - This will temporarily make the market price rise above the minimum point on the average cost curve, and therefore, the existing firms in the market will now be earning economic profits. - However, these economic profits attract other firms to enter the market.

figure 2 cont. (9.2)

- The monopolist does not charge the highest possible price because the monopolist can't sell much output at that price and profits are too low. - The monopolist is interested in total profit, not per-unit profit. - There is always the possibility that the monopolist will earn losses as they are not protected from changes in demand. - In the real world, a monopolist often does not have enough information to analyze its entire total revenues or total costs curves. - After all, the firm does not know exactly what would happen if it were to alter production dramatically. - However, a monopolist often has fairly reliable information about how changing output by small or moderate amounts will affect its marginal revenues and marginal costs, because it has had experience with such changes over time and because modest changes are easier to extrapolate from current experience. - A monopolist can use information on marginal revenue and marginal cost to seek out the profit-maximizing combination of quantity and price.

figure 4 cont. (9.2)

- The monopoly could seek out the profit-maximizing level of output by increasing quantity by a small amount, calculating marginal revenue and marginal cost, and then either increasing output as long as marginal revenue exceeds marginal cost or reducing output if marginal cost exceeds marginal revenue. - This process works without any need to calculate total revenue and total cost. - Thus, a profit-maximizing monopoly should follow the rule of producing up to the quantity where marginal revenue is equal to marginal cost: MR = MC. - This quantity is easy to identify graphically, where MR and MC intersect.

market share (10.1)

- The percentage of total sales in the market. - Under U.S. antitrust laws, monopoly itself is not illegal. - If a firm has a monopoly because of a newly patented invention, for example, the law explicitly allows a firm to earn higher-than-normal profits for a time as a reward for innovation. - If a firm achieves a large share of the market by producing a better product at a lower price, such behavior is not prohibited by antitrust law.

another point (9.2)

- The problem of inefficiency for monopolies often runs even deeper than these issues, and also involves incentives for efficiency over longer periods of time. - There are counterbalancing incentives here. - On one side, firms may strive for new inventions and new intellectual property because they want to become monopolies and earn high profits, at least for a few years until the competition catches up. - In this way, monopolies may come to exist because of competitive pressures on firms. - However, once a barrier to entry is in place, a monopoly that does not need to fear competition can just produce the same old products in the same old way, while still ringing up a healthy rate of profit.

point (9.2)

- The pure monopolist is the industry and thus, the demand curve is the market demand curve. - It is a down-sloping demand curve, like always. - MR is less than P because the monopolist must lower the price to sell the additional unit. - The added revenue will be the price of the last unit less the sum of the price cuts that must be taken on all prior units of outputs. - Monopolies face the typical upward-sloping marginal cost curve.

figure 2 cont. (8.2)

- The vertical gap between total revenue and total cost is profit, for example, at Q = 60, TR = 240 and TC =165. - The difference is 75, which is the height of the profit curve at that output level. - The firm doesn't make a profit at every level of output. - In this example, total costs will exceed total revenues at output levels from 0 to approximately 30, and so over this range of output, the firm will be making losses. - At output levels from 40 to 100, total revenues exceed total costs, so the firm is earning profits. - However, at any output greater than 100, total costs again exceed total revenues and the firm is making increasing losses. - Maximum profit occurs at an output between 70 and 80, when profit equals $90.

point (11.2)

- There are a few criticisms of the kinked-demand curve. - First, the demand curve was created around the current price that was already being charged, but it never actually explained how the current price was determined. - This is very similar to putting the cart before the horse. - We have seen that prices are rigid for reasons on the demand and cost side, but prices in oligopolies are not nearly as rigid as this model implies. - Lastly, there is always a chance that changing prices could result in a price war, and that would cost the firms profit, which they want to avoid.

long run equilibrium part 4 (8.4)

- Thus, while a perfectly competitive firm can earn profits in the short run, in the long run, the process of entry will push down prices until they reach the zero-profit level. - Conversely, while a perfectly competitive firm may earn losses in the short run, firms will not continually lose money. - In the long run, firms making losses are able to escape from their fixed costs, and their exit from the market will push the price back up to the zero-profit level. - In the long run, this process of entry and exit will drive the price in perfectly competitive markets to the zero-profit point at the bottom of the AC curve, where marginal cost crosses average cost.

What happens in a perfectly competitive industry when economic profit is greater than zero? (8.4)

- existing firms may expand their operations - firms may move along their LRAC curves to new outputs - there may be pressure on the market price to fall - new firms may enter the industry

additional point (11.1)

- We can see the inefficiency of monopolistic competition. - In long-run equilibrium, a monopolistic competitor achieves neither productive nor allocative efficiency. - Productive efficiency means that the firm is producing in the least costly way and is evidenced when P = min AC. - Allocative efficiency means that the firm is producing the right amount of output and is evidenced when P = MC. - The results are an under-allocation of resources, as well as, an efficiency loss and excess production capacity for every firm in the industry. - In monopolistic competition, neither is achieved: P > min AC > MC.

oligopoly (11.2)

- When a few large firms have all or most of the sales in an industry. - Examples of oligopoly abound and include the auto industry, cable television, and commercial air travel. - Oligopolies can choose to work together or against each other. - If oligopolists work against each other, they may end up acting very much like perfect competitors, driving down costs and leading to zero profits for all. - If oligopolists collude with each other, they may effectively act like a monopoly and succeed in pushing up prices and earning consistently high levels of profit. - We typically characterize oligopolies by mutual interdependence where various decisions such as output, price, and advertising depend on other firm(s)' decisions.

point (8.1)

- When a firm charges the same price for each unit of output, the average revenue is just the price of the good. - Therefore, D=MR=AR=P. - Total revenue refers to the total amount of money that the firm collects for the sale of all of the units of their good (yep! It's back!). - Marginal revenue reflects the additional revenue that the firm will receive by producing one more unit of output. - When the firm is deciding how much to produce, the firm considers the marginal revenue in their decision. - Businesses will be comparing MR to MC on whether to produce more, keep producing at the current level, or stop production.

predatory pricing (9.1)

- When an existing firm uses sharp but temporary price cuts to discourage new competition. - Monopolists may use pricing or other strategic barriers such as selective price-cutting, known as predatory pricing, and advertising. - Dentsply, manufacturer of false teeth, controlled about 70% of the market. - In 2005, Dentsply was found to have illegally prevented distributors from carrying competing brands. - Microsoft charged higher prices for its Windows operating system to computer manufacturers featuring Netscape Navigator instead of Microsoft's Internet Explorer. U.S. courts ruled this action illegal.

wrap-up

- When comparing perfect competition to monopolistic competition, it is important to remember that monopolistic competition has some leeway when it comes to pricing. - They can charge a higher price than their competitors by touting their fresher ingredients, their hottest designers, etc. - This is due to product differentiation. In perfect competition, one farmer's oranges is the same as another farmer's so they are price takers.

collusion (11.2)

- When firms act together to reduce output and keep prices high

wrap-up cont.

- When it comes to graphs, remember the steps. - Step 1: Find where MR = MC. - Step 2: From the location of where MR = MC, trace over to find price. - Step 3: From the location of where MR = MC, trace down to the bottom to find the quantity. - Step 4: Compare price to AVC and AC. - As long as price is greater than AVC and AC, you will continue to produce. - If price is less than AVC, but greater than AC, you will continue to produce. - If price is less than AVC and AC, you will shut down. - Do not forget: to calculate total revenue, multiply price times quantity.

point (10.1)

- When monopoly power results in an adverse effect upon the economy, the government may choose to intervene on a case-by-case basis using antitrust laws. - If the government feels that it is more beneficial to society to have a monopoly, then government will regulate it. - Although there are legitimate concerns of the effects of monopoly power on the economy, monopoly power is not widespread. - While research and technology may strengthen monopoly power, over time it is likely to destroy the monopoly position.

acquisition (10.1)

- When one firm purchases another. - An acquisition may not look just like a merger, since the newly purchased firm may continue to operate under its former company name. - However, both mergers and acquisitions lead to two formerly separate firms operating under common ownership, and so they are commonly grouped together.

figure 5 (9.2)

- When reading cost curve graphs, there are rules to follow. - You are familiar with step 1: find where MR = MC. - Rule #2 is from that intersection of MR = MC, trace down to find the quantity. - Rule #3 is from that intersection of MR = MC, trace up to the demand curve and over to the left to find the price. - The graph in Figure 5 demonstrates profit maximization by a pure monopolist. - The pure monopolist maximizes profit by producing at the MR = MC output, here Qm = 5. - Then, as seen from the demand curve, it will charge price Pm = $800. - Average cost will be A = $330, meaning that per-unit profit is Pm - A and total profit is 5 * (800 - 330) = $2350. - Total economic profit is thus represented by the gray rectangle. - Recall that the profit equation is Q(P - AC). - Visually, if you didn't have the numbers, you could see price is above the minimum AC, and therefore, is making a profit. - Note that TR is increasing and MR is positive in the elastic region. - When TR reaches its maximum, MR is zero.

merger (10.1)

- When two formerly separate firms combine to become a single firm. - Mergers can also be lateral, where two firms of similar sizes combine to become one. - However, both mergers and acquisitions lead to two formerly separate firms operating under common ownership, and so they are commonly grouped together.

long-run equilibrium (8.1)

- Where all firms earn zero economic profits producing the output level where P = MR = MC and P = AC. - In the long run, positive economic profits will attract competition as other firms enter the market. - Economic losses will cause firms to exit the market. - Ultimately, perfectly competitive markets will attain long-run equilibrium when no new firms want to enter the market and existing firms do not want to leave the market, as economic profits have been driven down to zero.

for max profit: (8.2)

- change in profit/change in quantity = 0 - also, it can be where mr = mc - when mr < mc, that does not necessarily indicate a loss but just a decrease in profits

monopolistic competition (8.1)

- many firms - differentiated products, such as restaurants and clothing - highly elastic demand - low barriers to entry (BTEs) - easy entry/exit - limited price takers (some market power)

perfect competition (8.1)

- many firms - standardized products, such as tp - perfect elastic demand curve for the individual firm - easy entry/exit - no barriers to entry (BTEs) - mr = ar = p - p = min atc - p = mc

monopoly (8.1)

- one firm - no subs for its product - BTEs - price makers

figure 1 (9.2)

- refer to figure 1 - Figure 1: (a) A perfectly competitive firm perceives the demand curve that it faces to be flat. The flat shape means that the firm can sell either a low quantity (Ql) or a high quantity (Qh) at exactly the same price (P). (b) A monopolist perceives the demand curve that it faces to be the same as the market demand curve, which for most goods is downward-sloping. Thus, if the monopolist chooses a high level of output (Qh), it can charge only a relatively low price (PI). Conversely, if the monopolist chooses a low level of output (Ql), it can then charge a higher price (Ph). The challenge for the monopolist is to choose the combination of price and quantity that maximizes profits.

figure 1 (10.1)

- refer to figure 1 - Figure 1: (a) The number of mergers grew from 2003 to 2007, then fell dramatically during the 2008-2009 Great Recession, before recovering since. (b) In 2012, the greatest number of mergers submitted for review by the Federal Trade Commission was for transactions between $500 million and $1 billion. - The laws that give government the power to block certain mergers, and even in some cases to break up large firms into smaller ones, are called antitrust laws. - Before a large merger happens, the antitrust regulators at the FTC and the U.S. Department of Justice can allow the merger, prohibit it, or allow it if certain conditions are met.

figure 1 (11.1)

- refer to figure 1 - Figure 1: The demand curve that a perfectly competitive firm faces is perfectly elastic, meaning it can sell all the output it wishes at the prevailing market price. The demand curve that a monopoly faces is the market demand. It can sell more output only by decreasing the price it charges. The demand curve that a monopolistically competitive firm faces falls in between.

figure 1 (8.4)

- refer to figure 1 - In (a), demand increased and supply met it. Notice that the supply increase is equal to the demand increase. The result is that the equilibrium price stays the same as quantity sold increases.

figure 10 (8.2)

- refer to figure 10 - Figure 10: In (b), price intersects marginal cost at the minimum point of the average cost curve. Since price is equal to average cost, the firm is breaking even. - When the price falls to $2.75, the farmer could produce a quantity of 75 (labeled as E in graph b). - total economic profit is $0 - economic profit was calculated by using (p - ac) x q

figure 11 (8.2)

- refer to figure 11 - Figure 11: In (c), price intersects marginal cost below the average cost curve. Since price is less than average cost, the firm is making a loss. - When the price falls to $2.00, the farmer could produce a quantity of 65 (labeled as E" in graph c). - total economic profit is -$48.75

figure 12 (8.2)

- refer to figure 12 - If the market price that perfectly competitive firm receives leads it to produce at a quantity where the price is greater than average cost, the firm will earn profits. - If the price the firm receives causes it to produce at a quantity where price equals average cost, which occurs at the minimum point of the AC curve, then the firm earns zero profits. - Finally, if the price the firm receives leads it to produce at a quantity where the price is less than average cost, the firm will earn losses.

figure 13 (8.2)

- refer to figure 13 - In (a), the farm produces at a level of 65. It is making losses of $47.50, but price is above average variable cost, so it continues to operate. If you didn't have the numbers, you could visually see the intersection with the MR and MC curve is above the minimum AVC curve, so that means there is a minimization of losses. - At a price of $2.00 (Figure 13 below), it can produce 65 packs of raspberries, and it will make losses of $48.75. - The alternative would be to shut down and lose all the fixed costs of $62.00. This is why you should still produce because it costs you less money to produce 65 units of output, than it would to shut your door. - The key reason is because price is above average variable cost. This means that at the current price the farm can pay all its variable costs, and have some revenue left over to pay some of the fixed costs. So the loss represents the part of the fixed costs the farm can't pay, which is less than the entire fixed costs.

figure 14 (8.2)

- refer to figure 14 - In (b), total revenues are $90 and total cost is $165, for overall losses of $75. If the farm shuts down, it must pay only its fixed costs of $62. Shutting down is preferable to selling at a price of $1.50 per pack. - This price is below average variable cost for this level of output. If the farmer cannot pay workers (variable cost), then it has to shut down. At this price and output, total revenues would be $90 (quantity of 60 times price of $1.50) and total cost would be $165, for overall losses of $75. - If the farm shuts down, it must pay only its fixed costs of $62, so shutting down is preferable to selling at a price of $1.50 per pack. - In some cases, the market price will not support any production. In this case, the firm will minimize its losses by shutting down as there is no level of output at which the firm can produce and realize a loss smaller than its total fixed cost. - In other words, the $62 fixed cost is the minimum possible loss. If you didn't have the numbers, you could visually see the AVC and the ATC curves are above the intersection with the MR and MC curve, so that means shut it down.

figure 15 (8.2)

- refer to figure 15 - Figure 15 shows a generalized depiction of how the marginal-cost curve becomes the short-run supply curve. - Examine the MC for the competitive firm. If price is below AVC, then the firm should shut down and produce zero. - The firm is not covering their fixed costs. - If the price is equal to or above AVC, the firm should produce. - The MC curve that is above the AVC curve becomes the short-run supply curve. - The break-even point is where the firm earns a normal profit because Price = AC here.

figure 2 (9.1)

- refer to figure 2

figure 2 (8.4)

- refer to figure 2 - In (b), notice that sellers were not able to increase supply as much as demand. Some inputs were scarce, or wages were rising. The equilibrium price rises.

figure 2 (9.2)

- refer to figure 2 - Recall that total costs (TC) rise and the curve grows steeper as output increases, and total revenue (TR) increases at a decreasing rate, reaches a maximum, and then declines. It must lower price on all units sold in order to increase its sales. - Total revenue for the monopoly firm first rises, then falls. - Low levels of output bring in relatively little total revenue, because the quantity is low. High levels of output bring in relatively less revenue, because the high quantity pushes down the market price. - The total cost curve is upward-sloping. - Profits will be highest at the quantity of output where total revenue is most above total cost. - The profit-maximizing level of output is not the same as the revenue-maximizing level of output, which should make sense, because profits take costs into account and revenues do not.

figure 2 (11.2)

- refer to figure 2 - The table in Figure 2 is a payoff matrix for a two-firm oligopoly (duopoly) and is used to show the payoff to each firm that would result from each combination of strategies. Each firm has two possible strategies. - Figure 2: Firm B's strategies are shown in the top margin, and Firm A's in the left margin. Each cell of this four-cell payoff matrix represents one combination of Firm A strategy and Firm B strategy and shows the profit that combination would earn for each. If you look at the top left box, you can see that both firms choose to cooperate, and earn $1000 in profits each. If you look at top right, Firm A chooses to cooperate with Firm B and that earns them $200 in profit while Firm B goes with not cooperating and that earns them $1500 in profits. If neither firm chooses not to cooperate and increases output (lower right), then each firm earns $400. It is important to remember that the number in the box represents PROFIT EARNED , and not the price.

figure 2 (8.1)

- refer to figure 2 - This graph shows a purely competitive firm's demand and revenue curves. The demand curve (D) of a purely competitive firm is a horizontal line (perfectly elastic) because the firm can sell as much output as it wants at the market price. Because each additional unit sold increases total revenue by the amount of the price, the firm's total-revenue (TR) curve is a straight up-sloping line and its marginal-revenue (MR) curve coincides with the firm's demand curve. The average-revenue (AR) curve also coincides with the demand curve.

figure 2 (8.2)

- refer to figure 2 - the horizontal axis shows the quantity of frozen raspberries produced in packs. - The vertical axis shows both total revenue and total costs, measured in dollars. - The total cost curve intersects with the vertical axis at a value that shows the level of fixed costs, and then slopes upward. - Total revenue for a perfectly competitive firm is a straight line sloping up. - The slope is equal to the price of the good. Total cost also slopes up, but with some curvature. - At higher levels of output, total cost begins to slope upward more steeply because of diminishing marginal returns. - The maximum profit will occur at the quantity where the difference between total revenue and total cost is largest. - One way to determine the most profitable quantity to produce is to see at what quantity total revenue exceeds total cost by the largest amount.

figure 3 (8.4)

- refer to figure 3 - In (c), sellers easily increased supply in response to the demand increase. Here, new technology or economies of scale caused the large increase in supply, resulting in declining equilibrium price.

figure 3 (11.1)

- refer to figure 3 - Next, recall the rules for the graphs. - Rule #1: find the MR = MC intersection. - Rule #2 from that intersection, trace down to find quantity. - Rule #3 from that intersection, trace up to the demand curve and over to find the price. - Firms produce the quantity where MR = MC just like in other industries. - It is possible to make a profit in the short run. - Recall that (Price - AC) * Q = Economic profit. - At the profit-maximizing output, price is higher than AC, and the firms enjoy an economic profit in the short run. - Visually, you can see in Figure 3 that Price is above (greater than) the minimum AC, so that means there is a profit. - To maximize profits, the firm would choose a quantity where marginal revenue equals marginal cost, or Q where MR = MC. Here it would choose a quantity of 40 and a price of $16.

figure 3 (9.2)

- refer to figure 3 - Notice in Figure 3 that marginal revenue is zero at a quantity of 7, and turns negative at quantities higher than 7. - It may seem counter-intuitive that marginal revenue could ever be zero or negative: after all, doesn't an increase in quantity sold not always mean more revenue? - For a perfect competitor, each additional unit sold brought a positive marginal revenue, because marginal revenue was equal to the given market price. - However, a monopolist can sell a larger quantity and see a decline in total revenue. - As the quantity sold becomes higher, at some point the drop in price is proportionally more than the increase in greater quantity of sales, causing a situation where more sales bring in less revenue. In other words, marginal revenue is negative.

figure 3 (11.2)

- refer to figure 3 - This graph in Figure 3 shows the kinked-demand curve. - If one firm cuts its price to $300, it will be able to sell only 11,000 seats. - However, if the airline seeks to raise prices, the other oligopolists will not raise their prices, and so the firm that raised prices will lose a considerable share of sales. - For example, if the firm raises its price to $550, its sales drop to 5,000 seats sold. - Thus, if oligopolists always match price cuts by other firms in the cartel, but do not match price increases, then none of the oligopolists will have a strong incentive to change prices, since the potential gains are minimal. - This strategy can work like a silent form of cooperation, in which the cartel successfully manages to hold down output, increase price, and share a monopoly level of profits even without any legally enforceable agreement.

quick point (8.2)

- when a firm breaks even, I noticed that it is a graph where the mc, atc, and mr graphs all intersect at the same point

figure 4 (11.1)

- refer to figure 4 - Figure 4: (a) At P0 and Q0, the monopolistically competitive firm in this figure is making a positive economic profit. This is clear because if you follow the dotted line above Q0, you can see that price is above average cost. Positive economic profits attract competing firms to the industry, driving the original firm's demand down to D1. At the new equilibrium quantity (P1, Q1), the original firm is earning zero economic profits, and entry into the industry ceases. In (b) the opposite occurs. At P0 and Q0, the firm is losing money. If you follow the dotted line above Q0, you can see that average cost is above price. Losses induce firms to leave the industry. When they do, demand for the original firm rises to D1, where once again the firm is earning zero economic profit. - It is possible to make a loss in the short run. - (Price - AC) * Q = Economic profit or loss. - At the profit-maximizing output, Price is below (less than) the minimum AC and therefore, a loss is incurred.

figure 4 (8.2)

- refer to figure 4 - Recall that in pure competition, D = MR = P. - As you can see in the table in Figure 4, the price is $4. - The marginal revenue does not change as output increases, since the price is determined by supply and demand in perfect competition.

figure 4 (9.2)

- refer to figure 4 - notice that at the quantity of output where mr = mc, that is also where you will earn the highest profit (5 units) - also notice that you can still earn a profit by selling up to 7 units, although profits are lower after 5 units - A monopolist can determine its profit-maximizing price and quantity by analyzing the marginal revenue and marginal costs of producing an extra unit. - If the marginal revenue exceeds the marginal cost, then the firm should produce the extra unit.

figure 5 (8.2)

- refer to figure 5 - The equilibrium price of raspberries is determined through the interaction of market supply and market demand at $4.00 (as shown in the graph in Figure 5). - As perfectly competitive firms are price takers, it can sell however many it wants at the market-determined price. Recall that marginal means additional, so therefore, marginal cost is the cost per additional unit sold. - Ordinarily, marginal cost changes as the firm produces a greater quantity.

figure 6 (9.2)

- refer to figure 6 - (a) In a purely competitive industry, entry and exit of firms ensures that price (Pc) equals marginal cost (MC) at the minimum average cost output where Qc is produced. Both productive efficiency (P = minimum AC) and allocative efficiency (P = MC) are obtained (here at Qc).

figure 6 (8.2)

- refer to figure 6 - In this table, marginal cost decreases at first as production increases from 10 to 20 to 30 to 40 packs of raspberries. This area represents the area of increasing marginal returns, which is normal. At some point, you will begin to see marginal costs to increase, displaying the concept of diminishing marginal returns. - The first step you should take is to compare MC and MR at each level of output. - The firm should continue to expand output as long as MR is greater than MC. - The firm will maximize profits by producing the last unit of output where MR still exceeds the MC, or where MR = MC. - For example, if the firm is producing at a quantity where MR > MC, like 40 or 50 packs of raspberries, then it can increase profit by increasing output because the marginal revenue is exceeding the marginal cost. - If the firm is producing at a quantity where MC > MR, like 90 or 100 packs, then it can increase profit by reducing output because the reductions in marginal cost will exceed the reductions in marginal revenue. - The firm's profit-maximizing choice of output will occur where MR = MC (or at a choice close to that point).

figure 7 (9.2)

- refer to figure 7 - (b) In pure monopoly, the MR curve lies below the demand curve. The monopolist maximizes profit at output Qm, where MR = MC, and charges price Pm. Thus, output is lower (Qm rather than Qc) and price is higher (Pm rather than Pc) than they would be in a purely competitive industry. Monopoly is inefficient since output is less than that required for achieving minimum AC (here at Qc) and because the monopolist's price exceeds MC.

figure 8 (8.2)

- refer to figure 8 - For a perfectly competitive firm, the marginal revenue (MR) curve is a horizontal line because it is equal to the price of the good, which is determined by the market, as the graph in Figure 8 illustrates. - The marginal cost (MC) curve is sometimes initially downward-sloping, if there is a region of increasing marginal returns at low levels of output, but is eventually upward-sloping at higher levels of output as diminishing marginal returns kick in. - The marginal cost (MC) curve is sometimes initially downward-sloping, if there is a region of increasing marginal returns at low levels of output, but is eventually upward-sloping at higher levels of output as diminishing marginal returns kick in.

figure 9 (8.2)

- refer to figure 9 - Let's refer back to our raspberry farm example. - We can see three possible scenarios: (a) where price intersects marginal cost at a level above the average cost curve, (b) where price intersects marginal cost at a level equal to the average cost curve, and (c) where price intersects marginal cost at a level below the average cost curve. - Figure 9: In (a), price intersects marginal cost above the average cost curve. Since price is greater than average cost, the firm is making a profit. - Remember the profit-maximizing rule to produce the level of output where P = MR = MC. If the raspberry farmer receives a price of $5, they could produce a quantity of 85 (labeled as E' in graph a).

figure 9 total economic profit (8.2)

- refer to figure 9 - total economic profit = (price x ac) x quantity - (5 - 3.50) x 85 - (1.50) x 85 - 127.50 - The total economic profit is represented by the blue rectangle - If you didn't have the numbers, you could visually see the intersection with the MR and MC curve is above the minimum AC curve, so that means there is a profit.

game theory (11.2)

A branch of mathematics that economists use to analyze situations in which players must make decisions and then receive payoffs based on what decisions the other players make.

agricultural markets (8.1)

A perfectly competitive market is a hypothetical extreme; however, producers in a number of industries do face many competitor firms selling highly similar goods, in which case they must often act as price takers. Economists often use agricultural markets as an example. The same crops that different farmers grow are largely interchangeable. According to the United States Department of Agriculture monthly reports, in 2015, U.S. corn farmers received an average price of $6.00 per bushel. A corn farmer who attempted to sell at $7.00 per bushel, would not have found any buyers. A perfectly competitive firm will not sell below the equilibrium price either. Why should they when they can sell all they want at the higher price? Other examples of agricultural markets that operate in close to perfectly competitive markets are small roadside produce markets and small organic farmers.

duopoly (11.2)

An oligopoly with only two firms.

Why will profits for firms in a perfectly competitive industry tend to vanish in the long run? (8.4)

As long as someone is earning profits, there is an opportunity for a perfectly competitive firm to lower prices and steal all of their customers. The only way to prevent this from happening is to lower prices to the zero profit level.

Suppose the local electrical utility, a legal monopoly based on economies of scale, was split into four firms of equal size, with the idea that eliminating the monopoly would promote competitive pricing of electricity. What do you anticipate would happen to prices? (9.1)

Because of economies of scale, each firm would produce at a higher average cost than before. (They would each have to build their own power lines.) As a result, they would each have to raise prices to cover their higher costs. The policy would fail.

Mary and Raj are the only two growers who provide organically grown corn to a local grocery store. They know that if they cooperated and produced less corn, they could raise the price of the corn. If they work independently, they will each earn $100. If they decide to work together and both lower their output, they can each earn $150. If one person lowers output and the other does not, the person who lowers output will earn $0 and the other person will capture the entire market and will earn $200. The table below represents the choices available to Mary and Raj. What is the best choice for Raj if he is sure that Mary will cooperate? If Mary thinks Raj will cheat, what should Mary do and why? What is the prisoner's dilemma result? What is the preferred choice if they could ensure cooperation? A = Work independently; B = Cooperate and Lower Output. (Each results entry lists Raj earnings first, and Mary's earnings second.) (11.2)

If Raj is sure Mary will cooperate, he should cheat. If Mary thinks Raj will cheat, she should cheat as well. Otherwise, he will capture the entire market and leave her with nothing. The prisoner's dilemma predicts that both will cheat, even though the preferred outcome for both of them is cooperation.

Why will losses for firms in a perfectly competitive industry tend to vanish in the long run? (8.4)

In the long run, firms that experience losses will have to shut down, reducing supply, and raising the price to the point at the minimum of the average costs curve.

short run point (8.1)

In the short run, the perfectly competitive firm will seek the quantity of output where profits are highest or, if profits are not possible, where losses are lowest.

Assuming that the market for cigarettes is in perfect competition, what does allocative and productive efficiency imply in this case? What does it not imply? (8.5)

It implies that producing more cigarettes would require reductions in production elsewhere, and that the market is producing what consumers most want to buy. It does not imply anything about whether cigarette consumption is desirable for society, however.

legal monopolies (9.1)

Legal prohibitions against competition, such as regulated monopolies and intellectual property protection.

point (9.1)

Ownership or control of essential resources is another barrier to entry. International Nickel Co. of Canada (now called Inco) used to control about 90% of the world's nickel reserves and De Beers of South Africa controls most of the world's diamond supply. Professional sports leagues control player contracts and leases on major city stadiums.

how entry and exit lead to zero profits in the long run (8.4)

Profits attract firms (the sharks) from less profitable industries and losses cause them to leave the unprofitable industry to find another more profitable one. This reflects the supply determinant, a change in the number of sellers. The shift in supply for the market as a whole will affect the market price. Entry and exit to and from the market are the driving forces behind a process that, in the long run, pushes the price down to minimum average total costs so that all firms are earning a zero profit.

market structure (8.1)

The conditions in an industry, such as number of sellers, how easy or difficult it is for a new firm to enter, and the type of products that are sold.

entry (8.4)

The long-run process of firms entering an industry in response to industry profits.

exit (8.4)

The long-run process of firms reducing production and shutting down in response to industry losses.

How does the quantity produced and price charged by a monopolist compare to that of a perfectly competitive firm? (9.2)

The monopolist will charge higher prices and produce less output than a perfectly competitive firm.

Many firms in the United States file for bankruptcy every year, yet they still continue operating. Why would they do this instead of completely shutting down? (8.2)

There are costs to shutting down a business, and further cost to resume operations. It is less costly for a firm to file bankruptcy and continue operating than to shut down completely due to the difference between average variable costs and average total costs.

Would you rather have efficiency or variety? That is, one opportunity cost of the variety of products we have is that each product costs more per unit than if there were only one kind of product of a given type, like shoes. Perhaps a better question is, "What is the right amount of variety? Can there be too many varieties of shoes, for example?" (11.1)

There is no definitive answer to this. It depends on how much utility we get from variety versus lower prices, and it essentially comes down to personal preference.

figure 8 cont. (8.2)

This figure shows the short-run profit maximization for a purely competitive firm. The MR = MC output enables the purely competitive firm to maximize profits or to minimize losses. In this case, MR = $4 and MC are equal at an output, Q, of 80 packs. At this output, P equals $4 (MR = P in pure competition). Furthermore, because the marginal revenue received by a perfectly competitive firm is equal to the price P, we can also write the profit-maximizing rule for a perfectly competitive firm as a recommendation to produce at the quantity of output where P = MC. - for the p = mc rule, look at where price and mc intersect on the graph

figure 15 cont.

We can divide the marginal cost curve into three zones, based on where it is crossed by the average cost and average variable cost curves. We call the point where MC crosses AC the break-even point. If the firm is operating where the market price is at a level higher than the break-even point, then price will be greater than average cost and the firm is earning profits. If the price is exactly at the break-even point, then the firm is making zero profits. If price falls in the zone between the shutdown point and the break-even point, then the firm is making losses but will continue to operate in the short run, since it is covering its variable costs, and more if price is above the shutdown-point price. However, if price falls below the price at the shutdown point, then the firm will shut down immediately, since it is not even covering its variable costs.

point 1 (8.5)

When profit-maximizing firms in perfectly competitive markets combine with utility-maximizing consumers, something remarkable happens: the resulting quantities of outputs of goods and services demonstrate both productive and allocative efficiency.

If you were developing a product (like a web browser) for a market with significant barriers to entry, how would you try to get your product into the market successfully? (10.1)

You might use a tie-in contract with a market where you already had power in order to sell it.

The fact that a consumer is not required to buy the goods that a given firm produces, as well as the fact that the consumer might want the goods a firm produces, but may choose to buy from other firms instead: (8.1)

are two stark realities any business firm must recognize

Which of the following would most likely create the setting for an oligopoly? (11.2)

government grants Alex, Trent, and Alyse each a patent for their respective molybdenum based electric car batteries

Refer to the diagram above. In this instance, the range of production possibilities at point d: (8.2)

is a steeper slope reflecting a return to losses due to diminishing returns

Kate's 24-Hour Breakfast Diner menu offers one item, a $5.00 breakfast special. Kate's costs for servers, cooks, electricity, food, etc. average out to $3.95 per meal. Her costs for rent, insurance cleaning supplies and business license average out to $1.25 per meal. Since the market is highly competitive, Kate should: (8.4)

keep the business open in the short-run, but plan to go out of business in the long-run

If the CEO of I'MaBigBank is playing prisoner's dilemma then, from his perspective, the gains to be had from cooperation are: (11.2)

larger than the rewards from pursuing self-interest

The perceived demand curve for a group of competing oligopoly firms will appear kinked as a result of their commitment to: (11.2)

match price cuts, but not price increases

Shopping malls typically lease retail space to a large number of clothing stores. When this group of retailers competes to sell similar but not identical products, they engage in what economists call: (11.1)

monopolistic competition

A __________________ exists when the quantity demanded in the market is less than the quantity at the bottom of the long-run average cost curve. (9.1)

natural monopoly

If monopolistic competitors must expect a process of entry and exit like perfectly competitive firms: (11.1)

they will be unable to earn higher-than-normal profits in the long run

The main challenge for antitrust regulators is: (10.1)

to determine when a merger may hinder competition