Econ 102 Ch 23; 24.1-24.3 (perfect competition & monopoly)

Legal or governmental restrictions

Governments and legislatures can also erect barriers to entry. These include licenses, franchises, patents, tariffs, and specific regulations that tend to limit entry.

perfectly competitive firm

a firm that is such a small part of the total industry that it cannot affect the price of the product it sells

signals

compact ways of conveying to economic decision makers information needed to make decisions. An effective signal not only conveys information but also provides the incentive to react appropriately. Economic profits and economic losses are such signals.

media reports

contended that more businesses have been exiting U.S. industries since 2008 than the number of newly opened businesses. These reports have induced other media commentators to worry about the possibility that U.S. businesses have "lost their mojo" and to speculate about a potential "crisis in American enterprise." The reports that have generated these worries, however, have focused on an incorrect measure of the number of firms in the United States. Nevertheless, the appropriate data do indeed reveal that many U.S. firms permanently close each year, and many new firms also open their doors. As you will learn, regular entries and exits are particularly common in certain types of industries, such as perfectly competitive industries

behavioral economics

has provided some evidence that subjects who exhibit less trustworthy characteristics are more likely, when offered a choice, to engage in competition. These people reveal less than fully honest behavior while competing, and they also supply fewer units. Nevertheless, studies reveal that many honest people also elect to compete, and these trustworthy people supply more units. (That is, honest people are more productive) Thus, behavioral evidence indicates that individuals with greater degrees of dishonesty are more likely to seek to engage in competition, but these people are less productive than honest individuals. Firms that engage in intense competition have discovered that individuals who are altruistic and trustworthy are more productive, so they seek to hire and retain such people.

marginal revenue

the change in total revenues resulting from a one-unit change in output (and sale) of the product in question

total revenues

the price per unit times the total quantity sold

how much should the perfect competitor produce?

As we have shown, from the perspective of a perfectly competitive firm deciding how much to produce, the firm has to accept the price of the product as a given. If the firm raises its price, it sells nothing. If it lowers its price, it earns lower revenues per unit sold than it otherwise could. The firm has one decision left: How much should it produce? We will apply our model of the firm to this question to come up with an answer. *We'll use the profit-maximization model, which assumes that firms attempt to maximize their total profits—the positive difference between total revenues and total costs* - This also means that firms seek to minimize any losses that arise in times when total revenues may be less than total costs. Total Revenues: - *Every firm has to consider its total revenues*. Total revenues are defined as the quantity sold multiplied by the price per unit. (They are the same as total receipts from the sale of output.) The perfect competitor must take the price as a given. Look at Figure 23-2. The information in panel (a) comes from panel (a) of Figure 22-2, but we have added some essential columns for our analysis. Column 3 is the market price, P, of $5 per portable power bank. Column 4 shows the total revenues, or TR, as equal to the market price, P, times the total output per hour, or Q. Thus, *TR = P × Q*

factors that influence the industry supply curve

As you have just seen, the industry supply curve is the horizontal summation of all of the individual firms' marginal cost curves at and above their respective minimum average variable cost points This means that anything that affects the marginal cost curves of the firm will influence the industry supply curve. *Therefore, the individual factors that will influence the supply schedule in a competitive industry can be summarized as the factors that cause the variable costs of production to change* These are factors that affect the individual marginal cost curves, such as changes in the individual firm's productivity, in factor prices (such as wages paid to labor and prices of raw materials), in per-unit taxes, and in anything else that would influence the individual firm's marginal cost curve. You learned in an earlier chapter that all of these are ceteris paribus conditions of supply. Because they affect the position of the marginal cost curve for the individual firm, they affect the position of the industry supply curve. A change in any of these will shift the firms' marginal cost curves and thus shift the industry supply curve. (the supply curve here is the marginal cost curve)

the perfect competitor's short-run supply curve

As you learned in Chapter 3, the relationship between a product's price and the quantity produced and offered for sale is a supply curve. What does the supply curve for the individual firm look like? Actually, we have been looking at it all along. We know that when the price of portable power banks is $5, the firm will supply seven or eight of them per hour. If the price falls to $3, the firm will supply five or six portable power banks per hour. If the price falls below the minimum point along the average variable cost, the firm will shut down Hence, in Figure 23-6, the firm's supply curve is the marginal cost curve above the short-run shutdown point. This is shown as the solid part of the marginal cost curve. fig. explanation: - The individual firm's short-run supply curve is the portion of its marginal cost curve at and above the minimum point on the average variable cost curve. - By definition, then, a firm's short-run supply curve in a competitive industry is its marginal cost curve at and above the point of intersection with the average variable cost curve.

decreasing-cost industries

(An expansion in the number of firms in an industry can lead to a reduction in input costs and a downward shift in the ATC and MC curves). When this occurs, the long-run industry supply curve will slope downward. An example, SʺL, is given in panel (c) of Figure 23-9. This is a decreasing-cost industry

tendency toward equilibrium

*Market adjustment to changes in demand will occur regardless of the wishes of the managers of firms in less profitable markets*. They can either attempt to adjust their product line to respond to the new demands, be replaced by managers who are more responsive to new conditions, or see their firms go bankrupt. In addition, when we say that in a competitive long-run equilibrium situation firms will be making zero economic profits, *we must realize that at a particular point in time it would be pure coincidence for a firm to be making exactly zero economic profits.* Real-world information is not as precise as the curves we use to simplify our analysis. Things change all the time in a dynamic world, and firms, even in a very competitive situation, may for many reasons not be making exactly zero economic profits. ///We say that there is a tendency toward that equilibrium position, but firms are adjusting constantly to changes in their cost curves and in the market demand curves.////

an example of zero economic profits

A manufacturer of homogeneous nanotube chips sells chips at some price. The owners of the firm have supplied all the funds in the business. They have not borrowed from anyone else, and they explicitly pay the full opportunity cost to all factors of production, including any managerial labor that they themselves contribute to the business. - Their salaries show up as a cost in the books and are equal to what they could have earned in the next-best alternative occupation. At the end of the year, the owners find that after they subtract all explicit costs from total revenues, accounting profits are $100,000. If their investment was $1 million, the rate of return on that investment is 10 percent per year. We will assume that this turns out to be equal to the market rate of return. This $100,000, or 10 percent rate of return, is actually, then, a competitive, or normal, rate of return on invested capital in all industries with similar risks. If the owners had made only $50,000, or 5 percent on their investment, they would have been able to make higher profits by leaving the industry. The 10 percent rate of return is the opportunity cost of capital. Accountants show it as a profit. Economists call it a cost. We include that cost in the average total cost curve, similar to the one shown in Figure 23-5. At the short-run break-even price, average total cost, including this opportunity cost of capital, will just equal that price. *The firm will be making zero economic profits but a 10 percent accounting profit*

patents

A patent is issued to an inventor to provide protection from having the invention copied or stolen for a period of *20 years*. Suppose that engineers working for Apple discover a way to build a digital device that requires half the parts of a regular device and weighs only half as much. If Apple is successful in obtaining a patent on this discovery, it can (in principle) prevent others from copying it. The patent holder has a monopoly. It is the patent holder's responsibility to defend the patent, however. *This means that Apple—like other patent owners—must expend resources to prevent others from imitating its invention* - *If the costs of enforcing a particular patent are greater than the benefits, though, the patent may not bestow any monopoly profits on its owner. The policing costs would be too high*

the phenomenon of economies of scale

A situation in which demand is insufficient to allow for more than one producer in a market may arise because of economies of scale. Recall that economies of scale exist whenever proportional increases in output yield proportionately smaller increases in total costs, and per-unit costs drop. When economies of scale exist, larger firms (with greater output) have an advantage. These larger firms experience lower per-unit costs. Their lower expenses enable them to charge lower prices and thereby drive smaller firms out of business.

short-run break-even price

the price at which a firm's total revenues equal its total costs. At the break-even price, the firm is just making a normal rate of return on its capital investment. (it is covering its explicit and implicit costs)

industry supply curve

the set of points showing the minimum prices at which given quantities will be forthcoming; also called the market supply curve

what if short-run shutdown prices differ across the firms that constitute a perfectly competitive industry?

the utilization of varying mixes of inputs and technologies commonly causes the positions of firms' average and marginal cost curves to differ somewhat. As a consequence, the points at which the firms' marginal cost curves cross through the minimum points of their average variable cost curves will not always yield the same short-run shutdown price. Thus, when the market clearing price faced by firms in a perfectly competitive industry declines sufficiently to induce some firms to shut down in the short run, other firms typically continue to produce.

profit-maximizing choices of a perfectly competitive firm

we assume that the perfectly competitive firm is producing a homogeneous (indistinguishable across all of the industry's firms) commodity that has perfect substitutes. *That means that if the individual firm raises its price one penny, it will lose all of its business* This, then, is how we characterize the demand schedule for a perfectly competitive firm: *It is the going market price as determined by the forces of market supply and market demand—that is, where the market demand curve intersects the market supply curve* *The demand curve for the product of an individual firm in a perfectly competitive industry is perfectly ELASTIC at the going market price* - Remember that with a perfectly elastic demand curve, any increase in price leads to zero quantity demanded. Figure: - We show the market demand and supply curves in panel (a) of Figure 23-1. Their intersection occurs at the price of $5. - The commodity in question is portable power banks. Assume for the purposes of this exposition that all of these portable power banks are perfect substitutes for all others. At the going market price of $5 apiece, the demand curve for portable power banks produced by an individual firm that sells a very, very small part of total industry production is shown in panel (b) - *At the market price, this firm can sell all the hourly output it wants. At the market price of $5 each*, which is where the demand curve for the individual producer lies, consumer demand for the portable power banks of that one producer is perfectly elastic. (b/c every other firm that sells PPB sell at $5, if this one particular firm sells it for higher, it will end up selling none, consumers will go for the cheaper substitute) Add. figure explanation: - At $5—where market demand, D, and market supply, S, intersect—the INDIVIDUAL firm faces a perfectly elastic demand curve, d. - If the firm raises its price even one penny, it will sell no portable power banks. [Notice the difference in the quantities of portable power banks represented on the horizontal axes of panels (a) and (b).] (one is for the market which is larger b/c it contains all quantities for each substitute of PPB for all firms that supply it and consumers that demand it, the other is simply for the INDIVIDUAL firm) This can be seen by noting that if the firm raises its price, consumers, who are assumed to know that this supplier is charging more than other producers, will buy elsewhere, and the producer in question will have no sales at all. Thus, the demand curve for that producer is perfectly elastic. - *We label the individual producer's demand curve d, whereas the market demand curve is always labeled D*

characteristics of perfect competition

why a firm in a perfectly competitive industry is a price taker: 1. There are large numbers of buyers and sellers. When this is the case, the quantity demanded by one buyer or the quantity supplied by one seller is negligible (insignificant) relative to the market quantity. No one buyer or seller has any influence on price. 2. The product sold by the firms in the industry is homogeneous—that is, indistinguishable across firms. The product sold by each firm in the industry is a perfect substitute for the product sold by every other firm. Buyers are able to choose from a large number of sellers of a product that the buyers regard as being the same. 3. Both buyers and sellers have access to all relevant information. Consumers are able to find out about lower prices charged by competing firms. Firms are able to find out about cost-saving innovations that can lower production costs and prices, and they are able to learn about profitable opportunities in other industries. (ex. features of the gas, propane prices, range of propane substitutes, and other relevant data are readily available) 4. Any firm can enter or leave the industry without serious impediments. Firms in a competitive industry are not hampered in their ability to get resources or redistribute resources. In pursuit of profit-making opportunities, they reallocate labor and capital to whatever business venture gives them their highest expected rate of return on their investment.

constructing the industry supply curve

Consider doing this for a hypothetical world in which there are only two producers of portable power banks in the industry, firm A and firm B. These two firms' marginal cost curves are given in panels (a) and (b) of Figure 23-7 These two firms' marginal cost curves are given in panels (a) and (b) of Figure 23-7. The marginal cost curves for the two separate firms are presented as MCA in panel (a) and MCB in panel (b) *Those two marginal cost curves are drawn only for prices above the minimum average variable cost for each respective firm* - In panel (a), for firm A, at a price of $6 per unit, the quantity supplied would be 7 units. At a price of $10 per unit, the quantity supplied would be 12 units - In panel (b), we see the two different quantities that would be supplied by firm B corresponding to those two prices. --------- Now, at a price of $6, we add horizontally the quantities 7 and 10 to obtain 17 units. This gives us one point, F, in panel (c), for our short-run industry supply curve, S. We obtain the other point, G, by doing the same horizontal adding of quantities at a price of $10 per unit. Figure explanation: - Marginal cost curves at and above minimum average variable cost are presented in panels (a) and (b) for firms A and B. We horizontally sum the two quantities supplied, 7 units by firm A and 10 units by firm B, at a price of $6. This gives us point F in panel (c). We do the same thing for the quantities supplied at a price of $10. This gives us point G. When we connect those points, we have the industry supply curve, S, which is the horizontal summation—represented by the Greek letter sigma (Σ)—of the firms' marginal cost curves above their respective minimum average variable costs. When we connect all points such as F and G, we obtain the industry supply curve S, which is also marked ΣMC (where the capital Greek sigma, Σ, is the symbol for summation), indicating that it is the horizontal summation of the marginal cost curves (at and above the respective minimum average variable cost of each firm). - Because the law of diminishing marginal product makes marginal cost curves rise as output rises, the short-run supply curve of a perfectly competitive industry must be upward sloping.

real-world informational limitations

Don't get the impression that just because we are able to draw an exact demand curve in Figures 24-4 and 24-5, real-world monopolists have such perfect information. The process of price searching by a less-than-perfect competitor is just that—a process. *A monopolist can only estimate the actual demand curve and therefore can make only an educated guess when it sets its profit-maximizing price* This is not a problem for the perfect competitor because price is given already by the intersection of market demand and market supply. *The monopolist, in contrast, reaches the profit-maximizing output-price combination by trial and error*

the firm's long run situation

Figure 23-10 shows the long-run equilibrium of the perfectly competitive firm. Given a price of P and a marginal cost curve, MC, the firm produces at output qe. Because economic profits must be zero in the long run, the firm's short-run average costs (SAC) must equal P at qe, which occurs at minimum SAC In addition, because we are in long-run equilibrium, any economies of scale must be exhausted, so we are on the minimum point of the long-run average cost curve (LAC) In other words, the long-run equilibrium position is where "everything is equal," which is at point E in Figure 23-10. There, *price equals marginal revenue equals marginal cost equals average cost (minimum, short-run, and long-run)* - d=MR=P Figure explanation: - In the long run, the firm operates where price, marginal revenue, marginal cost, short-run minimum average cost, and long-run minimum average cost are all equal. This condition is satisfied at point E.

price searching to maximize monopoly profits

For the pure monopolist, we must seek a profit-maximizing price-output combination because *the monopolist is a price searcher* We can determine this profit-maximizing price-output combination with either of two equivalent approaches—by looking at *total revenues and total costs* or by looking at *marginal revenues and marginal costs.* We shall examine both approaches.

maximizing profits (monopoly)

Here the monopolist's marginal revenue is at A, but marginal cost is at B. Here the monopolist's marginal revenue is at A, but marginal cost is at B. Marginal revenue exceeds marginal cost on the last unit sold. The profit for that particular unit, Q1, is equal to the vertical difference between A and B, or the difference between marginal revenue and marginal cost The monopolist would be foolish to stop at output rate Q1 because if output is expanded, marginal revenue will still exceed marginal cost, and therefore total profits will be increased by selling more In fact, the profit-maximizing monopolist will continue to expand output and sales until marginal revenue equals marginal cost, which is at output rate Qm. Figure explanation: - The profit-maximizing production rate is Qm, and the profit-maximizing price is Pm. The monopolist would be unwise to produce at the rate Q1 because here marginal revenue would be the vertical distance to point A, and marginal cost would be the vertical distance to point B. Marginal revenue would exceed marginal cost. *The firm will keep producing until the point Qm, where marginal revenue just equals marginal cost* - It would be foolish to produce at the rate Q2, for here marginal cost exceeds marginal revenue. It would behoove the monopolist to cut production back to Qm. The monopolist won't produce at rate Q2 because here, as we see, marginal costs are C and marginal revenues are F. *The difference between C and F represents the reduction in total profits from producing that additional unit* - Total profits will rise as the monopolist reduces its rate of output back toward Qm.

the profit-maximizing output rate

How much should the firm, then, produce? *It should produce at point E in panel (c) of Figure 23-2, where the marginal cost curve intersects the marginal revenue curve from BELOW* *The firm should continue production until the cost of increasing output by one more unit is just equal to the revenues obtainable from that extra unit* - This is a fundamental rule in economics: *Profit maximization occurs at the rate of output at which marginal revenue equals marginal cost* (for the individual competitive firm) For a perfectly competitive firm, this rate of output is at the intersection of the demand schedule, d, which is identical to the MR curve, and the marginal cost curve, MC. When MR exceeds MC, each additional unit of output adds more to total revenues than to total costs, so the additional unit should be produced. When MC is greater than MR, each unit produced adds more to total cost than to total revenues, so this unit should not be produced. = THEREFORE, *profit maximization occurs when MC equals MR* In our particular example, our profit-maximizing, perfectly competitive producer of portable power banks will produce at a rate of between seven and eight portable power banks per hour. (7-8) on the total output column

the short-run industry supply curve

In Chapter 3, we indicated that the market supply curve was the summation of individual supply curves. At the beginning of this chapter, we drew a market supply curve in Figure 23-1. - Now we want to derive more precisely a market, or industry, supply curve to reflect individual producer behavior in that industry determining the industry: - First we must ask, *What is an industry*? It is merely a collection of firms producing a particular product. - Therefore, we have a way to figure out the total supply curve of any industry: As discussed in Chapter 3, we add the quantities that each firm will supply at every possible price. In other words, we sum the individual supply curves of all the competitive firms horizontally. The individual supply curves, as we just saw, are simply the marginal cost curves of each firm.

a graphical depiction of maximum profits

In Figure 23-3, the lower boundary of the rectangle labeled "Profits" is determined by the intersection of the profit-maximizing quantity line represented by vertical dashes at the point at which MR = MC and on the average total cost curve. - Why? Because the ATC curve gives us the cost per unit, whereas the price ($5), represented by d, gives us the revenue per unit. The difference is profit per unit. (TR - TC) Thus, the height of the rectangular box representing profits equals profit per unit, and the length equals the amount of units produced. (quantity) - *When we multiply these two quantities, we get total profits*. Note, as pointed out earlier, that we are talking about economic profits because a normal rate of return on investment plus all opportunity costs is included in the average total cost curve, ATC.

the short-run break even price and the short-run shutdown price

In Figure 23-4, the firm is sustaining economic losses. Will it go out of business? In the long run it will, but *in the short run the firm will not necessarily go out of business* In the short run, *as long as the total revenues from continuing to produce output exceed the associated total variable costs, the firm will remain in business and continue to produce* *A firm goes out of business when the owners sell its assets to someone else. A firm temporarily shuts down when it stops producing, but it still is in business* Now how can a firm that is sustaining economic losses in the short run tell whether it is still worthwhile not to shut down? The firm must compare the total revenues that it receives if it continues producing with the resulting total variable costs that it thereby incurs - Looking at the problem on a per-unit basis, as long as average variable cost (AVC) is covered by average revenues (price), the firm is better off continuing to produce. - If average variable costs are exceeded even a little bit by the price of the product, staying in production produces some revenues in excess of variable costs. The logic is fairly straightforward: - *As long as the price per unit sold exceeds the average variable cost per unit produced, the earnings of the firm's owners will be higher if it continues to produce in the short run than if it shuts down*

competitive pricing: marginal cost pricing

In a perfectly competitive industry, each firm produces where its marginal cost curve intersects its marginal revenue curve from below. Thus, perfectly competitive firms always sell their goods at a price that just equals marginal cost. *This is said to be the optimal price of this good because the price that consumers pay reflects the opportunity cost to society of producing the good* Recall that marginal cost is the amount that a firm must spend to purchase the additional resources needed to expand output by one unit. Given competitive markets, the amount paid for a resource will be the same in all of its alternative uses. Thus, *MC reflects relative resource input use* - That is, if the MC of good 1 is twice the MC of good 2, one more unit of good 1 requires twice the resource input of one more unit of good 2.

short-run supply under perfect competition

In a perfectly competitive market, the quantity supplied is determined along an industry supply curve, *which in turn depends on the supply curves of all the firms in the market* To understand how to obtain supply curves for perfectly competitive firms and for the industry as a whole, you first must understand the determination of firms' economic profits.

market equilibrium and the individual firm

In a purely competitive industry, the individual producer takes price as a given and chooses the output level that maximizes profits. (This is also the equilibrium level of output from the producer's standpoint.) We see in panel (b) of Figure 23-8 that this is at qe. If the producer's average costs are given by AC1, the short-run break-even price arises at qe. If its average costs are given by AC3, then at qe, AC exceeds price, and the firm is incurring losses. (we would expect, over time, that some firms will cease production (exit the industry), causing supply to shift inward) Alternatively, if average costs are given by AC2, the firm will be making economic profits at qe (we would expect new firms to enter the industry to take advantage of the economic profits, thereby causing supply to shift outward) *supply = MC ////We now turn to these long-run considerations/////

long-run industry supply curves

In panel (a) of Figure 23-8, we drew the summation of all of the portions of the individual firms' marginal cost curves at and above each firm's respective minimum average variable costs as the upward-sloping supply curve of the entire industry. *We should be aware that a relatively inelastic supply curve may be appropriate only in the short run* - After all, one of the prerequisites of a competitive industry is freedom of entry. Remember that our definition of the long run is a period of time in which all adjustments can be made. *The long-run industry supply curve is a supply curve showing the relationship between quantities supplied by the entire industry at different prices after firms have been allowed to either enter or leave the industry, depending on whether there have been positive or negative economic profits* Also, the long-run industry supply curve is drawn under the assumption that firms are identical and that entry and exit have been completed. *This means that along the long-run industry supply curve, firms in the industry earn zero economic profits* ///The long-run industry supply curve can take one of three shapes, depending on whether input prices stay constant, increase, or decrease as the number of firms in the industry changes/// To this point, we have assumed that input prices remained constant to the firm regardless of the firm's rate of output. When we look at the entire industry, however, *when all firms are expanding and new firms are entering, they may simultaneously bid up input prices*

equalizing marginal revenue and marginal cost

In panel (c) of Figure 23-2, the marginal cost curve intersects the marginal revenue curve somewhere between seven and eight portable power banks per hour. The firm has an incentive to produce and sell until the amount of the additional revenue received from selling one more portable power bank just equals the additional costs incurred for producing and selling that portable power bank. *This is how the firm maximizes profit. Whenever marginal cost is less than marginal revenue, the firm will always make more profit by increasing production* Now consider the possibility of producing at an output rate of 10 portable power banks per hour. The marginal cost at that output rate is higher than the marginal revenue. The firm would be spending more to produce that additional output than it would be receiving in revenues. It would be foolish to continue producing at this rate.

constant-cost industries

In principle, there are industries that use such a small percentage of the total supply of inputs required for industrywide production, that firms can enter the industry WITHOUT bidding up input prices. In such a situation, we are dealing with a constant-cost industry. *Its long-run industry supply curve is therefore horizontal* and is represented by SL in panel (a) of Figure 23-9. Figure explanation: - Panel A - In panel (a), we show a situation in which the demand curve shifts from D1 to D2. Price increases from P1 to P2. In time, the short-run supply curve shifts outward because entry occurs in response to positive profits, and the equilibrium changes from E2 to E3. The market clearing price is again P1. If we connect points such as E1 and E3, we come up with the long-run supply curve SL. This is a constant-cost industry. - Panel B - In panel (b), costs are increasing for the industry, and therefore the long-run supply curve, S'L, slopes upward and long-run prices rise from P1 to P2 - Panel C - In panel (c), costs are decreasing for the industry as it expands, and therefore the long-run supply curve, S'L, slopes downward such that long-run prices decline from P1 to P2. We can work through the case in which constant costs prevail. We start out in panel (a) with demand curve D1 and supply curve S1. The equilibrium price is P1. Market demand shifts rightward to D2. In the short run, the equilibrium price rises to P2. This generates positive economic profits for existing firms in the industry. Such economic profits induce capital to flow into the industry. The existing firms expand or new firms enter (or both). The short-run supply curve shifts outward to S2. The new intersection with the new demand curve is at E3. The new equilibrium price is again P1 The long-run supply curve, labeled SL, is obtained by connecting the intersections of the corresponding pairs of demand and short-run supply curves, E1 and E3. *In a constant-cost industry, long-run supply is perfectly elastic. Any shift in demand is eventually met by just enough entry or exit of suppliers that the long-run price is constant at P1*. (Retail trade is often given as an example of such an industry because output can be expanded or contracted without affecting input prices. Banking is another example)

a graphical depiction of minimum losses

It is also certainly possible for the competitive firm to make short-run losses, as shown in Figure 23-4 following a shift in the firm's demand from d1 to d2. The going market price has fallen from $5 to $3 per portable power bank because of changes in market demand conditions. *The firm will still do the best it can by producing where marginal revenue equals marginal cost* (MR = MC) = profit maximization Fig. explanation: - In situations in which average total costs exceed price, which in turn is greater than or equal to average variable cost, profit maximization is equivalent to loss minimization - Losses are minimized at the output rate at which marginal cost equals marginal revenue. Losses are shown in the red-shaded area. We see in Figure 23-4 that the marginal revenue (d2) curve is intersected (from below) by the marginal cost curve at an output rate of about 512 portable power banks per hour. The firm is clearly not making profits because average total costs at that output rate are greater than the price of $3 per portable power bank. The losses are shown in the shaded area. By producing where marginal revenue equals marginal cost, however, the firm is minimizing its losses. - That is, losses would be greater at any other output.

Licenses, franchises, and certificates of convenience

It is illegal to enter many industries without a government license, or a "certificate of convenience and public necessity." For example, in some states you cannot form an electrical utility to compete with the electrical utility already operating in your area. You would first have to obtain a certificate of convenience and public necessity from the appropriate authority, which is usually the state's public utility commission. Yet public utility commissions in these states rarely, if ever, issue a certificate to a group of investors who want to compete directly in the same geographic area as an existing electrical utility. *Hence, entry into the industry in a particular geographic area is prohibited, and long-run monopoly profits conceivably could be earned by the electrical utility already serving the area* To enter interstate (and also many intrastate) markets for pipelines, television and radio broadcasting, and transmission of natural gas, to cite a few such industries, it is often necessary to obtain similar permits. Because these franchises or licenses are restricted, long-run monopoly profits might be earned by the sellers already in the industry.

using marginal analysis to determine the profit-maximizing rate of production

It is possible—indeed, preferable—to use marginal analysis to determine the profit-maximizing rate of production. We end up with the same results derived in a different manner, one that focuses more on where decisions are really made—on the margin. Managers examine changes in costs and relate them to changes in revenues. In fact, whether the question is how much more or less to produce, how many more workers to hire or fire, or how much more to study or not study, *we compare changes in costs with changes in benefits, where change is occurring at the margin* Marginal revenue: - The change in total revenues attributable to changing production of an item by one unit - *In a perfectly competitive market, the marginal revenue curve is exactly equivalent to the price line (a line horizontal at the market clearing price), which is the individual firm's demand curve* - Each time the firm produces and sells one more unit, total revenues rise by an amount equal to the (constant) market price of the good ($5). Thus, in Figure 23-1, the demand curve, d, for the individual producer is at a price of $5—the price line is coincident with the demand curve. So is the marginal revenue curve, for marginal revenue in this case also equals $5. The marginal revenue curve for our competitive producer of portable power banks is shown as a line at $5 in panel (c) of Figure 23-2. Notice again that the marginal revenue curve is the price line, which is the firm's demand curve, d. - *The fact that MR, P, and d are identically equal for an individual firm is a general feature of a perfectly competitive industry* - *The price line shows the quantity that consumers desire to purchase from this firm at each price—which is any quantity that the firm provides at the market price—and hence is the demand curve, d, faced by the firm* - *The market clearing price per unit does NOT change as the firm varies its output*, {so the average revenue and marginal revenue also are equal to this price}. Thus, MR is identically equal to P along the firm's demand curve.

calculating the short-run break-even price

Look at demand curve d1 in Figure 23-5. It just touches the minimum point of the average total cost curve, which is exactly where the marginal cost curve intersects the average total cost curve. At that price, which is about $4.30, the firm will be making exactly zero short-run economic profits = That price is called the *short-run break-even price*, and point E1 therefore occurs at the short-run break-even price for a competitive firm. = It is the point at which marginal revenue, marginal cost, and average total cost are all equal *(that is, at which P = MC and P = ATC)*. The break-even price is the one that yields zero short-run economic profits or losses. Figure explanation: - We can find the short-run break-even price and the short-run shutdown price by comparing price with average total costs and average variable costs - *If the demand curve is d1, profit maximization occurs at output E1, where MC equals marginal revenue (the d1 curve). Because the ATC curve includes all relevant opportunity costs, point E1 is the break-even point, and zero economic profits are being made* (The firm is earning a normal rate of return) - If the demand curve falls to d2, profit maximization (loss minimization) occurs at the intersection of MC and MR (the d2 curve), or E2. Below this price, it does not pay for the firm to continue in operation because its average variable costs are not covered by the price of the product.

the marginal revenue - marginal cost approach

Profit maximization will also occur where marginal revenue equals marginal cost. This is as true for a monopolist as it is for a perfect competitor, *although the monopolist will charge a price in excess of marginal revenue*

media reports revisited

Recent media reports have claimed a significant rise in the percentage of U.S. firms closing each year. A stream of additional commentary has seized on these reports to express worries that U.S. industries are in decline. These reports, however, have focused on an incorrect measure of the number of independently owned and operated firms in the United States Consideration of correct data reveals that large numbers of U.S. firms do open and close each year. *Only rarely, however, have total industry exits exceeded entrances*

total revenues - total costs approach (monopoly)

Suppose that the government of a small town located in a remote desert area grants a single satellite television company the right to offer services within its jurisdiction. It enforces rules that prevent other firms from offering television services. We show demand (weekly rate of output and price per unit), revenues, costs, and other data in panel (a) of Figure 24-4. In column 3, we see total revenues for this TV service monopolist, and in column 4, we see total costs. We can transfer these two columns to panel (b). *The fundamental difference between the total revenue and total cost diagram in panel (b) and one we showed for a perfect competitor in an earlier chapter is that the total revenue line is no longer straight* - Rather, it curves - For any given demand curve, in order to sell more, the monopolist must lower the price. - This reflects the fact that the basic difference between a monopolist and a perfect competitor has to do with the demand curve for the two types of firms. *The monopolist faces a downward-sloping demand curve* Figure explanation: - As shown in panel (b), the satellite TV monopolist *maximizes profits where the positive difference between TR and TC is greatest* - This is at an output rate of between 9 and 10 units per week. Put another way, profit maximization occurs where marginal revenue equals marginal cost, as shown in panel (c). This is at the same weekly service rate of between 9 and 10 units. *(The MC curve must cut the MR curve from below.)* Profit maximization involves maximizing the positive difference between total revenues and total costs. This occurs at an output rate of between 9 and 10 units per week.

tariffs

Taxes on imported goods are special taxes that are imposed on certain imported goods. Tariffs make imports more expensive relative to their domestic counterparts, encouraging consumers to switch to the relatively cheaper domestically made products. If the tariffs are high enough, domestic producers may be able to act together like a single firm and gain monopoly advantage as the sole suppliers. Many countries have tried this protectionist strategy by using high tariffs to shut out foreign competitors.

the meaning of zero economic profits

The fact that we labeled point E1 in Figure 23-5 the break-even point may have disturbed you. At point E1, price is just equal to average total cost. If this is the case, why would a firm continue to produce if it were making no profits whatsoever? Accounting Profits Versus Economic Profits: - If we again make the distinction between accounting profits and economic profits, you will realize that at that price, the firm has zero economic profits but positive accounting profits. Recall that accounting profits are total revenues minus total explicit costs. Such accounting, however, ignores the reward offered to investors—the opportunity cost of capital—plus all other implicit costs. - *In economic analysis, the average total cost curve includes the full opportunity cost of capital* - Indeed, the average total cost curve includes the opportunity cost of all factors of production used in the production process. At the short-run break-even price, economic profits are, by definition, zero. *Accounting profits at that price are not, however, equal to zero. They are positive*

the market clearing price

The market demand schedule, D, in panel (a) of Figure 23-8 represents the demand schedule for the entire industry, and the supply schedule, S, represents the supply schedule for the entire industry. The market clearing price, Pe, is established by the forces of supply and demand at the intersection of D and the *short-run* industry supply curve, S. Even though each individual firm has no control or effect on the price of its product in a competitive industry, *the interaction of all the producers and buyers determines the price at which the product will be sold* Figure Explanation: - The industry demand curve is represented by D in panel (a). The short-run industry supply curve is S and is equal to ΣMC. The intersection of the demand and supply curves at E determines the equilibrium or market clearing price at Pe. The demand curve faced by the individual firm in panel (b) *is perfectly elastic at the market clearing price* determined in panel (a). If the producer has a marginal cost curve MC, its profit-maximizing output level is at qe. For AC1, economic profits are zero. For AC2, profits are positive. For AC3, profits are negative. The resulting (individual firm) DEMAND curve, d, is shown in panel (b) of Figure 23-8 at the price Pe.

allocation of capital and market signals

The price system therefore allocates capital according to the relative expected rates of return on alternative investments. Hence, *entry restrictions (such as limits on the numbers of taxicabs and banks permitted to enter the taxi service and banking industries) will hinder economic efficiency by not allowing resources to flow to their highest-valued use* Similarly, exit restrictions (such as laws that require firms to give advance notice of closings) will act to trap resources (temporarily) in sectors in which their value is below that in alternative uses. Such laws will also inhibit the ability of firms to respond to changes in both the domestic and international marketplaces. Not every industry presents an immediate source of opportunity for every firm. In a brief period of time, it may be impossible for a firm that produces tractors to switch to the production of digital devices, even if there are very large profits to be made. Over the long run, however, we would expect to see owners of some other resources switch to producing digital devices In a market economy, investors supply firms in the more profitable industry with more investment funds, which they take from firms in less profitable industries. (Also, positive economic profits induce existing firms to use internal investment funds for expansion.) - Consequently, resources useful in the production of more profitable goods, such as labor, will be bid away from lower-valued opportunities. Investors and other suppliers of resources respond to market *signals* about their highest-valued opportunities.

no guarantee of profits

The term monopoly conjures up the notion of a greedy firm ripping off the public and making exorbitant profits. -*The mere existence of a monopoly, however, does not guarantee high profits* - Numerous monopolies have gone bankrupt. Figure 24-7 shows the monopolist's demand curve as D and the resultant marginal revenue curve as MR. *It does not matter at what rate of output this particular monopolist operates. Total costs cannot be covered* fig. explanation: - Some monopolists face the situation shown here. The average total cost curve, ATC, is everywhere above the demand curve, D. In the short run, the monopolist will produce where MC = MR at point A. Output Qm will be sold at price Pm, but average total cost per unit is C1. Losses are the red-shaded rectangle. *Eventually, the monopolist will go out of business* - *Look at the position of the average total cost curve. It lies everywhere above D*. Thus, there is no price-output combination that will allow the monopolist even to cover costs, much less earn profits - This monopolist will, in the short run, suffer economic losses as shown by the red-shaded area. The graph in Figure 24-7, which applies to many inventions, depicts a situation of resulting monopoly. - The owner of a patented invention or discovery has a pure legal monopoly, but the demand and cost curves are such that production is not profitable. - *Every year at inventors' conventions, one can see many inventions that have never been put into production because they were deemed "uneconomic" by potential producers and users*

defining and explaining the existence of monopoly

The word monopoly probably brings to mind notions of a business that gouges the consumer and gets rich in the process. If we are to succeed in analyzing and predicting the behavior of imperfectly competitive firms, however, we will have to be more objective in our definition. Although most monopolies in the United States are relatively large, our definition will be equally applicable to small businesses: A monopolist is the single supplier of a good or service for which there is *NO CLOSE SUBSTITUTE*. (unlike in a perfect competition where there are plenty of close substitutes)

how do economists measure entrances and exists of firms?

There are 2 ways to try to measure the ebbs and flows of firm activity in terms of numbers of "businesses." A measure commonly discussed in the media is the number of (establishments). - This measure includes business outlets of ALL types, including company-owned and franchise-operated retail stores and restaurants. Consequently, the measure includes all 36,000 restaurants selling McDonald's food items instead of counting just the single McDonald's firm and a few thousands of franchise firms that operate restaurants under authorization from the company *Using the establishment measure, therefore, overcounts the number of businesses in the United States*. - Indeed, the more than 7 million U.S. establishments in business each year typically exceed the number of operating U.S. firms by 40 percent. *Thus, the establishment measure most commonly utilized by the media to measure the number of U.S. "businesses" is inappropriate.* From an economic standpoint, *the correct measure of the number of businesses is the number of separately owned and operated firms* - By this measure, more than 5 million independently functioning businesses operate in the United States each year.

costs and monopoly profit maximization

To find the rate of output at which the perfect competitor would maximize profits, we had to add cost data. We will do the same now for the monopolist. We assume that profit maximization is the goal of the pure monopolist, just as it is for the perfect competitor The perfect competitor, however, has only to decide on the profit-maximizing rate of output because price is given. The perfect competitor is a price taker.

short-run profits

To find what our competitive individual producer of portable power banks is making in terms of profits in the short run, we have to add the average total cost curve to panel (c) (MC & P = MR = d) of Figure 23-2 We take the information from column 6 in panel (a) (which is the ATC) and add it to panel (c) to get Figure 23-3. Again the profit-maximizing rate of output is between seven and eight portable power banks per hour. If we have production and sales of seven per hour, total revenues will be $35 per hour. Total costs will be $30 per hour, leaving a profit of $5 per hour (35-30). If the rate of output and sales is eight portable power banks per hour, total revenues will be $40 and total costs will be $35, again leaving a profit of $5 per hour (40-35). fig. explanation: - Profits are represented by the blue-shaded area. The height of the profit rectangle is given by the difference between average total costs and price ($5), where *price is also equal to average revenue*. This is found by the vertical difference between the ATC curve and the price, or average revenue, line d, at the profit-maximizing rate of output of between seven and eight portable power banks per hour. P = AR

numerous annual firm entrances and exists are the norm

To measure overall entry into and exit from U.S. industries during a given year, economists examine the percentage of the more than 5 million independent U.S. firms that are new entrants within the year and the percentage of firms that halted operations during that year. Figure 23-11 displays these percentages since 1978. This figure shows that between 8 and 10 percent of all firms that were operating at the beginning of any given year end up exiting their industries by the close of the year. In the vast majority of years, though, a larger percentage of new firms enter than the share that exits. These data show that it is normal for large percentages of firms that operate during a given year to have just entered during that year or to exit by the end of the year. The substantial numbers of firms that regularly enter and exit industries indicate that ease of entry and exit exists in many U.S. industries. *Nevertheless, the percentages of independent firms exiting U.S. industries have exceeded the shares entering those industries only during a couple of brief stretches, such as during sharp business contractions in the early 1980s and late 2000s* In all other years, the total number of independent firms in operation has increased. Hence, concerns about a potential "crisis" for U.S. industries appear to be misplaced.

comparing total costs with total revenues

Total costs are given in column 2 of panel (a) of Figure 23-2 and plotted in panel (b). *Remember, the firm's costs always include a normal rate of return on investment* So, whenever we refer to total costs, we are talking not about accounting costs but about economic costs. When the total cost curve is above the total revenue curve, the firm is experiencing losses. When total costs are less than total revenues, the firm is making profits. By comparing total costs with total revenues, we can figure out the number of portable power banks the individual competitive firm should produce per hour. Our analysis rests on the assumption that the firm will attempt to maximize total profits. - In panel (a) of Figure 23-2, we see that total profits reach a maximum at a production rate of between seven and eight portable power banks per hour (the bolded 5). We can see this graphically in panel (b) of the figure. - The firm will maximize profits where the total revenue curve lies above the total cost curve by the greatest amount. - That occurs at a rate of output and sales of between seven and eight portable power banks per hour. This rate is called the *profit-maximizing rate of production* - (If output were continuously divisible or there were extremely large numbers of portable power banks, we would get a unique profit-maximizing output.) We can also find the profit-maximizing rate of production for the individual competitive firm by looking at marginal revenues and marginal costs.

the graphical depiction of monopoly profits

We have actually shown total profits in column 5 of panel (a) in Figure 24-4. We can also find total profits by adding an average total cost curve to panel (c) of that figure, as shown in Figure 24-6. When we add the average total cost curve, we find that the profit a monopolist makes is equal to the green-shaded area—or [total revenues (P × Q) minus total costs (ATC × Q)] Given the demand curve and that all units are sold at the same price, a monopolist cannot make greater profits than those shown by the green-shaded area. *The monopolist is maximizing profits where marginal cost equals marginal revenue* - If the monopolist produces less than that, it will forfeit some profits. If the monopolist produces more than that, it will also forfeit some profits.

calculating monopoly profit

We have talked about the monopolist's profit. We have yet to indicate how much profit the monopolist makes, which we do in Figure 24-6. Figure explanation: - We find monopoly profit by subtracting total costs from total revenues at a quantity of satellite TV services of between 9 and 10 units per week, labeled Qm, which is the profit-maximizing rate of output for the satellite TV monopolist. The profit-maximizing price is therefore slightly more than $6 per week and is labeled Pm. - Monopoly profit is given by the green-shaded area, which is equal to total revenues (P × Q) minus total costs (ATC × Q). This diagram is similar to panel (c) of Figure 24-4, with the short-run average total cost curve (ATC) added.

the efficiency of marginal cost pricing

When an individual pays a price equal to the marginal cost of production, the cost to the user of that product is equal to the sacrifice or cost to society of producing that quantity of that good as opposed to more of some other good. (We are assuming that all marginal social costs are accounted for.) - *The competitive solution, then, is called efficient, in the economic sense of the word* Economic efficiency means that it is impossible to increase the output of any good without lowering the value of the total output produced in the economy. - No juggling of resources, such as labor and capital, will result in an output that is higher in total value than the value of all of the goods and services already being produced. *In an efficient equilibrium, it is impossible to make one person better off without making someone else worse off* All resources are used in the most advantageous way possible, and society therefore enjoys an efficient allocation of productive resources. All goods and services are sold at their opportunity cost, and *marginal cost pricing prevails throughout*

natural monopoly

When economies of scale occur over a wide range of outputs, a natural monopoly may develop A natural monopoly is the first firm to take advantage of persistent declining long-run average costs as scale increases. The natural monopolist is able to underprice its competitors and eventually force all of them out of the market. Figure 24-1 shows a downward-sloping long-run average cost curve (LAC). Recall that when average costs are falling, marginal costs are less than average costs. Thus, when the long-run average cost curve slopes downward, the long-run marginal cost curve (LMC) will be below the LAC. fig. explanation - Whenever long-run marginal costs (LMC) are less than long-run average costs (LAC), then long-run average costs will be falling. A natural monopoly might arise when this situation exists over most output rates. The first firm to establish low-average-cost capacity would be able to take advantage of declining average total costs. *This firm would drive out all rivals by charging a lower price than the others could sustain at their higher average costs* (cost them much less to produce therefore, other firms cannot keep up and are forced out of rivalry) In our example, long-run average costs are falling over such a large range of production rates that we would expect only one firm to survive as a natural monopolist. It would be the first one to take advantage of the decreasing average costs. - That is, it would construct the large-scale facilities first. As its average costs fell, it would lower prices and get an ever-larger share of the market. *Once that firm had driven all other firms out of the industry, it would raise its price to maximize profits* (this firm would dominate the industry = monopolistic)

natural monopoly

a monopoly that arises from the peculiar production characteristics in an industry. It usually arises when there are large economies of scale relative to the industry's demand such that one firm an produce at a lower average cost than can be achieved by multiple firms

perfect competition

def. a market structure in which the decisions of individual buyers and sellers have no effect on market price each firm is such a small part of the total industry that it cannot affect the price of the product in question. That means that each *perfectly competitive firm* in the industry is a *price taker*—*the firm takes price as a given, something determined outside the individual firm*

the monopolist as the industry

*In a monopoly market structure, the firm (the monopolist) and the industry are one and the same* Occasionally, there may be a problem in identifying an industry and therefore determining if a monopoly exists. For example, should we think of aluminum and steel as separate industries, or should we define the industry in terms of basic metals? Our answer depends on the extent to which aluminum and steel can be substituted in the production of a wide range of products. As we shall see in this chapter, *a seller prefers to have a monopoly rather than to face competitors. In general, we think of monopoly prices as being higher than prices under perfect competition and of monopoly profits as typically being higher than profits under perfect competition* (which are, in the long run, merely equivalent to a normal rate of return). How does a firm obtain a monopoly in an industry? *Basically, there MUST be barriers to entry that enable firms to receive monopoly profits in the long run*. Barriers to entry are restrictions on who can start a business or who can stay in a business.

price searcher

A firm that must determine the price-output combination that maximizes profit because it faces a downward-sloping demand curve.

marginal cost pricing (def)

A system of pricing in which the price charged is equal to the opportunity cost to society of producing one more unit of the good or service in question. The opportunity cost is the marginal cost to society.

market failure

Although perfect competition does offer many desirable results, situations arise when perfectly competitive markets cannot efficiently allocate resources. Either too many or too few resources are used in the production of a good or service. These situations are instances of market failure *Externalities arising from failures to fully assign property rights and public goods are examples*. For reasons discussed in later chapters, perfectly competitive markets cannot efficiently allocate resources in these situations, and alternative allocation mechanisms may be called for. *In some cases, alternative market structures or government intervention may improve the economic outcome*

decreasing-cost industry

An industry in which an increase in output leads to a reduction in long-run per-unit costs, such that the long-run industry supply curve slopes downward.

barriers to entry

For any amount of monopoly power to continue to exist in the long run, the market must be closed to entry in some way. Either legal means or certain aspects of the industry's technical or cost structure may prevent entry. We will discuss several of the barriers to entry that have allowed firms to reap monopoly profits in the long run (even if they are not pure monopolists in the technical sense).

what price to charge for output?

How does the monopolist set prices? *We know the quantity is set at the point at which marginal revenue equals marginal cost* The monopolist then finds out how much can be charged—how much consumers are willing and able to pay—for that particular quantity, Qm, in Figure 24-5 The monopolist does so by identifying the price corresponding to the quantity Qm on its demand curve

PRICE determination under perfect competition

How is the market, or "going," price established in a competitive market? This price is established by the interaction of all the suppliers (firms) and all the demanders (consumers).

why produce where marginal revenue equals marginal cost?

If the monopolist produces past the point where marginal revenue equals marginal cost, marginal cost will exceed marginal revenue. That is, the incremental cost of producing any more units will exceed the incremental revenue. - It would not be worthwhile, as was true also in perfect competition. Furthermore, just as in the case of perfect competition, if the monopolist produces less than that, it is not making maximum profits.

the long-run industry situation: exit and entry

In the long run in a competitive situation, firms will be making zero economic profits. (Actually, this is true only for identical firms. Throughout the remainder of the discussion, we assume firms have the same cost structures.) We surmise, therefore, that *in the long run a perfectly competitive firm's marginal revenue curve—which is horizontal at the market clearing price—will just touch its average total cost curve*. How does this occur? - It comes about through an adjustment process that depends on economic profits and losses.

long-run equilibrium

In the long run, the firm can change the scale of its plant, adjusting its plant size in such a way that it has no further incentive to change. It will do so until profits are maximized.

when are profits maximized?

Now we add the marginal cost curve, MC, taken from column 8 in panel (a) of Figure 23-2. As shown in panel (c) of that figure, because of the law of diminishing marginal product, the marginal cost curve first falls and then starts to rise, eventually intersecting the marginal revenue curve and then rising above it. Notice that the numbers for both the marginal cost schedule, column 8 in panel (a), and the marginal revenue schedule, column 9 in panel (a), are printed between the rows on which the quantities appear. This indicates that we are looking at a change between one rate of output and the next rate of output. (ex. from 1-2 then 2-3, then 3-4)

perfect competition and minimum average total cost

Look again at Figure 23-10. In long-run equilibrium, the perfectly competitive firm finds itself producing at output rate qe. At that rate of output, the price is just equal to the minimum long-run average cost as well as the minimum short-run average cost. In this sense, perfect competition results in the production of goods and services *using the least costly combination of resources* *This is an important attribute of a perfectly competitive long-run equilibrium, particularly when we wish to compare the market structure of perfect competition with other market structures that are less than perfectly competitive*

ownership of resources without close substitutes

Preventing a newcomer from entering an industry is often difficult. Indeed, some economists contend that no monopoly acting without government support has been able to prevent entry into an industry *unless that monopoly has had the control of some essential natural resource* Consider the possibility of one firm's owning the entire supply of a raw material input that is essential to the production of a particular commodity. - The exclusive ownership of such a vital resource serves as a barrier to entry until an alternative source of the raw material input is found or an alternative technology not requiring the raw material in question is developed A good example of control over a vital input is the Aluminum Company of America (Alcoa), a firm that prior to World War II owned most world stocks of bauxite, the essential raw material in the production of aluminum. Such a situation is rare, though, and is ordinarily temporary.

figure 23-2

Profit maximization occurs where marginal revenue equals marginal cost. Panel (a) indicates that this point occurs at a rate of sales of between seven and eight portable power banks per hour. In panel (b), we find maximum profits where total revenues exceed total costs by the largest amount. This occurs at a rate of production and sales per hour of seven or eight portable power banks. In panel (c), the marginal cost curve, MC, intersects the marginal revenue curve at the same rate of output and sales of somewhere between seven and eight portable power banks per hour. NOTICE: P (all firms that provide perfect substitutes for one item) = MR (marginal revenue) = d (individual firm) [P = MR = d] We are assuming that the market supply and demand schedules intersect at a price of $5 and that this price holds for all the firm's production. We are also assuming that because our maker of portable power banks is a small part of the market, it can sell all that it produces at that price. Thus, panel (b) of Figure 23-2 shows the total revenue curve as a straight green line. *For every additional portable power bank sold, total revenue increases by $5*

economies of scale

Sometimes it is not profitable for more than one firm to exist in an industry. This is true if one firm would have to produce such a large quantity in order to realize lower unit costs that there would not be sufficient demand to warrant a second producer of the same product.

what it means for a firm to be a price taker

The definition of a perfectly competitive firm is obviously idealized, for in one sense the individual firm has to set prices. How can we ever have a situation in which firms regard prices as set by forces outside their control? The answer is that even though every firm sets its own prices, a firm in a perfectly competitive situation will find that it will eventually have no customers at all if it sets its price above the competitive price. The best example is in agriculture. Although the individual farmer can set any price for a bushel of wheat, if that price doesn't coincide with the market price of a bushel of similar-quality wheat, no one will purchase the wheat at a higher price. Nor would the farmer be inclined to reduce revenues by selling below the market price. The firm can sell all the units that it wishes to produce at the market price.

exit and entry of firms

The existence of either profits or losses is a signal to owners of capital both inside and outside the industry. If an industry is characterized by firms showing economic profits as represented in Figure 23-3, *these economic profits signal owners of capital elsewhere in the economy that they, too, should enter this industry* In contrast, if some firms in an industry are suffering economic losses as represented in Figure 23-4, *these economic losses signal resource owners outside the industry to stay out* - In addition, these economic losses signal resource owners within the industry not to reinvest and if possible to leave the industry. It is in this sense that we say that profits direct resources to their highest-valued use. ////In the long run, capital will flow into industries in which profitability is highest and will flow out of industries in which profitability is lowest////

marginal cost pricing

The perfectly competitive firm produces up to the point at which the market price just equals the marginal cost. Herein lies the element of the optimal nature of a competitive solution, which is called marginal cost pricing

short-run shutdown price

The price that just covers average variable costs (AVC). It occurs just below the intersection of the marginal cost curve and the average variable cost curve Below this price, the firm would be paying out more in variable costs than it is receiving in revenues from the sale of its product. Each unit it sold would generate losses that could be avoided if it shut down operations.

regulations

Throughout the twentieth century and to the present, government regulation of the U.S. economy has increased, especially along the dimensions of safety and quality. U.S. firms incur hundreds of billions of dollars in expenses each year to comply with federal, state, and local government regulations of business conduct relating to workplace conditions, environmental protection, product safety, and various other activities. These large fixed costs of complying with regulations can be spread over a greater number of units of output by larger firms than by smaller firms, thereby putting the smaller firms at a competitive disadvantage. (they wouldn't be able to cover these large costs with not enough revenue compared to larger firms) Entry will also be deterred to the extent that the scale of operation of a potential entrant must be sufficiently large to cover the average fixed costs of compliance.

calculating the short-run shutdown price

To calculate the firm's shutdown price, we must introduce the average variable cost (AVC) to our graph. In Figure 23-5, we have plotted the AVC values from column 7 in panel (a) of Figure 23-2 For the moment, consider two possible demand curves, d1 and d2, which are also the firm's respective marginal revenue curves. - If demand is d1, the firm will produce at E1, where that curve intersects the marginal cost curve If demand falls to d2, the firm will produce at E2. The special feature of the hypothetical demand curve, d2, is that it just touches the average variable cost curve at the latter's minimum point, which is also where the marginal cost curve intersects it. - *This price is the short-run shutdown price*. Why? Below this price, the firm would be paying out more in variable costs than it is receiving in revenues from the sale of its product. Each unit it sold would generate losses that could be avoided if it shut down operations. *The intersection of the price line, the marginal cost curve, and the average variable cost curve is labeled E2. The resulting short-run shutdown price is valid only for the short run* because, of course, in the long run the firm will not stay in business if it is earning less than a normal rate of return (zero economic profits).

matching the consumer's marginal benefit

Under marginal cost pricing, the marginal benefit to consumers, given by the price that they are willing to pay for the last unit of the good purchased, just equals the marginal cost to society of producing the last unit. If the marginal benefit exceeds the marginal cost—that is, if P > MC—too little is being produced in that people value additional units more than the cost to society of producing them. If P < MC, the opposite is true. Thus, the perfectly competitive firm sells its product at a price that just equals the cost to society—the opportunity cost—for that is what the marginal cost curve represents. But note here that it is the self-interest of firm owners that causes price to equal the marginal cost to society.

the monopoly price

We know that the demand curve shows the maximum price for which a given quantity can be sold. This means that our monopolist knows that to sell Qm, it can charge only Pm because that is the price at which that specific quantity, Qm, is demanded. This price is found by drawing a vertical line from the quantity, Qm, to the market demand curve. Where that line hits the market demand curve, the price is determined. *We find that price by drawing a horizontal line from the demand curve to the price axis. Doing that gives us the profit-maximizing price, Pm* In our example, at a profit-maximizing quantity of satellite TV services of between 9 and 10 units in Figure 24-4, the firm can charge a maximum price of just over $6 and still sell all the services it provides, all at the same price. The basic procedure for finding the profit-maximizing price-quantity combination for the monopolist is first to determine the profit-maximizing rate of output, by either the total revenue-total cost method or the marginal revenue-marginal cost method. Then it is possible to determine by use of the demand curve, D, the maximum price that can be charged to sell that output.

equalizing marginal revenue and marginal cost

When we transfer marginal cost and marginal revenue information from columns 6 and 7 in panel (a) to panel (c) in Figure 24-4, we see that marginal revenue equals marginal cost at a weekly quantity of satellite TV services of between 9 and 10 units. *Profit maximization must occur at the same output as in panel (b)* - just go by panel b to find profit max. output, because obviously, its not in the numbers quite nicely

long- run industry supply curve

a market supply curve showing the relationship between prices and quantities after firms have been allowed the time to enter into or exit from an industry, depending on whether there have been positive or negative economic profits

price taker

a perfectly competitive firm that must take the price of its product as given b/c the firm cannot influence its price

constant-cost industries (def.)

an industry whose total output can be increased without an increase in long-run per-unit costs. Its long-run supply curve is horizontal

increasing-cost industries

def. an industry in which an increase in industry output is accompanied by an increase in long-run per-unit costs, such that the long-run industry supply curve slopes upward (expansion by existing firms and the addition of new firms) cause the price of inputs specialized to that industry to be bid up. As costs of production rise, the ATC curve and the firms' MC curves shift upward, causing short-run supply curves (each firm's marginal cost curve) to shift vertically upward. Hence, industry supply shifts out by less than in a constant-cost industry. The result is a long-run industry supply curve that slopes upward, as represented by S'L in panel (b) of Figure 23-9 Examples are residential construction and coal mining—both use specialized inputs that cannot be obtained in ever-increasing quantities without causing their prices to rise.