FINAL REVIEW
CHAPTER 14
• Explicit vs. implicit costs
• Accounting vs. economic profit
• Production function
• Marginal product
• Diminishing marginal product
• Marginal cost
• Fixed vs. variable costs
• Average total cost
• Long run vs. short run
• Efficient scale
• Economies of scale
• Constant returns to scale
• Diseconomies of scale
EXPLICIT VS. IMPLICIT COSTS
• Explicit costs require an outlay of money, e.g., paying
wages to workers.
• Implicit costs do not require a cash outlay, e.g., the
opportunity cost of the owner’s time.
ECONOMIC PROFIT VS. ACCOUNTING PROFIT
• Accounting profit
= total revenue minus total explicit costs
• Economic profit
= total revenue minus total costs (including explicit and implicit costs)
Accounting profit ignores implicit costs, so it’s higher than economic profit.
PRODUCTION
• A production function shows the relationship between the
quantity of inputs used to produce a good and the quantity of
output of that good.
• The marginal product of any input is the increase in output
arising from an additional unit of that input, holding all other
inputs constant.
• Diminishing marginal product:
The marginal product of an input declines as the quantity of the
input increases (other things equal).
EXAMPLE 1: MPL = SLOPE OF PROD FUNCTION
Q
(no. of (bushels MPL
workers) of wheat)
0
0
1000
1
1000
800
2
1800
600
3
4
5
2400
2800
3000
400
200
MPL
3,000
Quantity of output
L
equals the
slope of the
2,500
production function.
2,000
Notice that
MPL diminishes
1,500
as L increases.
1,000
This explains why
500 production
the
function
gets flatter
0
as L0 increases.
1
2
3
4
No. of workers
5
COST
• Fixed costs (FC) do not vary with the quantity of output produced.
• Variable costs (VC) vary with the quantity produced.
• Total cost (TC) = FC + VC
• Average total cost (ATC) equals total cost divided by the quantity of
𝑇𝐶
output 𝐴𝑇𝐶 =
𝑄
• Marginal Cost (MC) is the increase in Total Cost from producing one
∆TC
more unit:
MC =
∆Q
THE VARIOUS COST CURVES TOGETHER
$200
$175
ATC
AVC
AFC
MC
Costs
$150
$125
$100
$75
$50
$25
$0
0
1
2
3
4
Q
5
6
7
EFFICIENCY SC ALE
As Q rises:
$200
Initially, falling AFC
pulls ATC down.
$175
Eventually, rising AVC
pulls ATC up.
$125
Efficient scale:
The quantity that minimizes
ATC.
Costs
$150
$100
$75
$50
$25
$0
0
1
2
3
4
Q
5
6
7
A TYPICAL LRATC CURVE
In the real world,
factories come in many
sizes, each with its own
SRATC curve.
ATC
LRATC
So a typical LRATC curve
looks like this:
Q
HOW ATC CHANGES AS
THE SCALE OF PRODUCTION CHANGES
Economies of scale: ATC
falls as Q increases.
Constant returns to scale:
ATC stays the same as Q
increases.
Diseconomies of scale:
ATC rises
as Q increases.
ATC
LRATC
Q
PRACTICE PROBLEM
Consider the following table of long-run total costs for three different firms:
Quantity
1
2
3
5
6
6
7
Firm A
$60
$70
$80
$90
$100
$110
$120
Firm B
11
24
39
56
75
96
119
Firm C
21
34
49
66
85
106
129
Does each of these firms experience economies of scale or diseconomies of scale?
Firm A
Firm B
ATC
TC
Firm C
Quantity
TC
ATC
TC
1
$60.00
$11.00
$21.00
2
70.00
24.00
34.00
3
80.00
39.00
49.00
4
90.00
56.00
66.00
5
100.00
75.00
85.00
6
110.00
96.00
106.00
7
120.00
119.00
129.00
ATC
Firm A
Firm B
Firm C
Quantity
TC
ATC
TC
ATC
TC
1
$60.00
$60.00
$11.00
$21.00
2
70.00
35.00
24.00
34.00
3
80.00
26.67
39.00
49.00
4
90.00
22.50
56.00
66.00
5
100.00
20.00
75.00
85.00
6
110.00
18.33
96.00
106.00
7
120.00
17.14
119.00
129.00
ATC
Firm A
Firm B
Firm C
Quantity
TC
ATC
TC
ATC
TC
1
$60.00
$60.00
$11.00
$11.00
$21.00
2
70.00
35.00
24.00
12.00
34.00
3
80.00
26.67
39.00
13.00
49.00
4
90.00
22.50
56.00
14.00
66.00
5
100.00
20.00
75.00
15.00
85.00
6
110.00
18.33
96.00
16.00
106.00
7
120.00
17.14
119.00
17.00
129.00
ATC
Firm A
Firm B
Firm C
Quantity
TC
ATC
TC
ATC
TC
ATC
1
$60.00
$60.00
$11.00
$11.00
$21.00
$21.00
2
70.00
35.00
24.00
12.00
34.00
17.00
3
80.00
26.67
39.00
13.00
49.00
16.33
4
90.00
22.50
56.00
14.00
66.00
16.50
5
100.00
20.00
75.00
15.00
85.00
17.00
6
110.00
18.33
96.00
16.00
106.00
17.67
7
120.00
17.14
119.00
17.00
129.00
18.43
PRACTICE PROBLEM
A difference between explicit and implicit costs is that
a) explicit costs must be greater than implicit costs.
b) explicit costs do not require a direct monetary outlay by the firm,
whereas implicit costs do.
c) implicit costs do not require a direct monetary outlay by the firm,
whereas explicit costs do.
d) implicit costs must be greater than explicit costs.
PRACTICE PROBLEM
Which of the following could explain why the
total product curve would shift from TP1 to TP2?
a)
There is less capital equipment available to the
firm.
b) Labor skills have become rusty and outdated in
the firm.
c)
The firm has developed improved production
technology.
d) The firm is now receiving a higher price for its
product.
PRACTICE PROBLEM
When a firm's only variable input is labor, then the slope of the
production function measures the
a) quantity of labor.
b) quantity of output.
c) total cost.
d) marginal product of labor.
PRACTICE PROBLEM
If long-run average total cost decreases as the quantity of
output increases, the firm is experiencing
a) economies of scale.
b) diseconomies of scale.
c) coordination problems arising from the large size of the firm.
d) fixed costs greatly exceeding variable costs.
PRACTICE PROBLEM
If a firm experiences constant returns to scale at all output
levels, then its long-run average total cost curve would
a) slope downward.
b) be horizontal.
c) slope upward.
d) slope downward for low output levels and upward for high
output levels.
PRACTICE PROBLEM
Listed in the table are the long-run total costs for three different firms.
Quantity
Firm A
Firm B
Firm C
1
100
100
100
2
100
200
300
3
100
300
600
Which firm is experiencing diseconomies of scale?
a)
Firm A only
b)
Firm B only
c)
Firm C only
d)
Firm A and Firm B only
4
100
400
1,000
5
100
500
1,500
PRACTICE PROBLEM
Listed in the table are the long-run total costs for three different firms.
Quantity
Firm A
Firm B
Firm C
1
100
100
100
2
100
200
300
3
100
300
600
Which firm is experiencing constant returns to scale?
a)
Firm A only
b)
Firm B only
c)
Firm C only
d)
Firm A and Firm B only
4
100
400
1,000
5
100
500
1,500
CHAPTER 15
• Perfect competition and price takers
• Average revenue (AR) vs. marginal revenue (MR)
• Firm’s supply decision
• Shutdown (short run) vs. Exit (long run)
• Sunk cost
• Short run market supply curve
• Long run market supply curve
• Long-run equilibrium in competitive markets
PERFECT COMPETITION
1. Many buyers and many sellers.
2. The goods offered for sale are largely the same.
3. Firms can freely enter or exit the market.
 Because of 1 & 2, each buyer and seller is a “price
taker” – takes the price as given.
REVENUE
• Total revenue (TR)
TR = P x Q
• Average revenue (AR)
TR
=P
AR =
Q
• Marginal revenue (MR):
The change in TR from
selling one more unit.
∆TR
MR =
∆Q
MC AND THE FIRM’S SUPPLY DECISION
Rule: MR = MC at the profit-maximizing Q.
At Qa, MC < MR.
Costs
So, increase Q to raise profit.
MC
At Qb, MC > MR.
So, reduce Q to raise profit.
At Q1, MC = MR.
MR
P1
Changing Q would lower profit.
Qa Q1 Qb
Q
SHUTDOWN VS. EXIT
• Shutdown:
A short-run decision not to produce anything because of
market conditions.
• Exit:
A long-run decision to leave the market.
• A key difference:
• If shut down in SR, must still pay FC.
• If exit in LR, zero costs.
A COMPETITIVE FIRM’S SR SUPPLY CURVE
The firm’s SR supply curve is
the portion of its MC curve
above AVC.
If P > AVC, then
firm produces Q
where P = MC.
If P < AVC, then
firm shuts down
(produces Q = 0).
Costs
MC
ATC
AVC
Q
SUNK COST
• Sunk cost: a cost that has already been committed and
cannot be recovered
THE COMPETITIVE FIRM’S SUPPLY CURVE
Costs
The firm’s LR supply curve
is the portion of its MC
curve above LRATC.
MC
LRATC
Q
THE SR MARKET SUPPLY CURVE
Example: 1000 identical firms
At each P, market Qs = 1000 x (one firm’s Qs)
P
One firm
MC
P
P3
P3
P2
P2
AVC
P1
Market
S
P1
10 20 30
Q
(firm)
Q
(market)
10,000
20,000
30,000
LONG-RUN EQUILIBRIUM
• Long-run equilibrium:
The process of entry or exit is complete—
remaining firms earn zero economic profit.
𝑃 = 𝑚𝑖𝑛𝑖𝑚𝑢𝑚 𝐴𝑇𝐶
THE LR MARKET SUPPLY CURVE
The LR market supply
curve is horizontal at
P = minimum ATC.
In the long run,
the typical firm
earns zero profit.
P
One firm
MC
P
Market
LRATC
P=
min.
ATC
long-run
supply
Q
(firm)
Q
(market)
SR & LR EFFECTS OF AN INCREASE IN DEMAND
…but then an increase in
A firm begins in
profits
to zero
…leadingeq’m…
to…driving
SR
Over time,
profits
induce
demand
raisesentry,
P,…
long-run
and
restoring
long-run
profits for the
firm.
shifting
S to eq’m.
the right, reducing P…
P
One firm
Market
P
S1
MC
Profit
S2
ATC
P2
P2
P1
P1
Q
(firm)
B
A
C
long-run
supply
D1
Q1 Q2
Q3
D2
Q
(market)
PRACTICE PROBLEM
If a firm in a perfectly competitive market triples the quantity of
output sold, then total revenue will
a)
more than triple.
b) less than triple.
c)
exactly triple.
d) Any of the above may be true depending on the firm’s labor productivity.
PRACTICE PROBLEM
Quantity Total Revenue
For this firm, the marginal revenue is
0
$0
a) $39.
1
$13
b) $26.
2
$26
c) $13.
3
$39
d) $0.
4
$52
PRACTICE PROBLEM
Suppose a firm in a competitive market earned $1,000 in total
revenue and had a marginal revenue of $10 for the last unit produced
and sold. What is the average revenue per unit, and how many units
were sold?
a)
$5 and 50 units
b) $5 and 100 units
c)
$10 and 50 units
d) $10 and 100 units
PRACTICE PROBLEM
If the market elasticity of demand for potatoes is -0.3 in a perfectly
competitive market, then the individual farmer's elasticity of demand
a) will also be -0.3.
b) depends on how large a crop the farmer produces.
c) will range between -0.3 and -1.0.
d) will be infinite.
PRACTICE PROBLEM
At the profit-maximizing level of output,
a) marginal revenue equals average total cost.
b) marginal revenue equals average variable cost.
c) marginal revenue equals marginal cost.
d) average revenue equals average total cost.
PRACTICE PROBLEM
If a competitive firm is selling 900 units of its product at a price of
$10 per unit and earning a positive profit, then
a) its total cost is more than $9,000.
b) its marginal revenue is less than $10.
c) its average total cost is less than $10.
d) the firm cannot be a competitive firm because competitive firms
cannot earn positive profits.
PRACTICE PROBLEM
Robin owns a horse stables and riding academy and gives riding lessons for
children at “pony camp.” Her business operates in a competitive industry.
Robin gives riding lessons to 20 children per month. Her monthly total
revenue is $4,000. The marginal cost of pony camp is $200 per child. In order
to maximize profits, Robin should
a)
give riding lessons to more than 20 children per month.
b) give riding lessons to fewer than 20 children per month.
c)
continue to give riding lessons to 20 children per month.
d) We do not have enough information to answer the question.
PRACTICE PROBLEM
Price
Quantity Total Cost
In order to maximize profits, the firm
should stop producing after it makes
the
$6
0
$4
$6
1
$6
$6
2
$9
$6
3
$13
b) second unit.
$6
4
$18
c) fourth unit.
$6
5
$24
d) fifth unit.
$6
6
$31
a) first unit.
PRACTICE PROBLEM
Price Quantity
If the firm is producing 3 units of output, it should
produce
$6
0
Total
Cost
$4
$6
1
$6
$6
2
$9
b) fewer units of output because its marginal revenue
is less than its marginal cost.
$6
3
$13
c)
$6
4
$18
$6
5
$24
$6
6
$31
a)
more units of output because its marginal revenue is
greater than its marginal cost.
more units of output because its marginal revenue is
less than its marginal cost.
d) fewer units of output because its marginal revenue
is greater than its marginal cost.
PRACTICE PROBLEM
When total revenue is less than variable costs, a firm in a competitive
market will
a) continue to operate as long as average revenue exceeds marginal cost.
b) continue to operate as long as average revenue exceeds average fixed
cost.
c) shut down.
d) raise its price.
PRACTICE PROBLEM
In the long run, a profit-maximizing firm will choose to exit a market
when
a) average fixed cost is falling.
b) variable costs exceed sunk costs.
c) marginal cost exceeds marginal revenue at the current level of production.
d) total revenue is less than total cost.
PRACTICE PROBLEM
Number of Workers
Output
Fixed Cost
Variable Cost
Total Cost
0
1
2
3
4
0
90
170
230
240
$50
$50
$50
$50
$50
$0
$20
$40
$60
$80
$50
$70
$90
$110
$130
• What is the marginal product of the fourth worker?
• At which number of workers does diminishing marginal product begin?
• If the firm can sell its output for $1 per unit, what is the profit-maximizing
level of output?
PRACTICE PROBLEM
Alicia’s Apple Pies is a small food truck business in a perfectly competitive market. Alicia
must pay $9.00 each day to park her truck on Wayne State Campus. In addition, it costs her
$1.00 to produce the first pie of the day, and each subsequent pie costs 50% more to
produce than the one before it. For example, the second pie costs $1.00*1.5 = $1.50 to
produce, and so on.
• Calculate Alicia’s marginal cost, variable costs, average total cost, average variable cost and
average fixed costs as her daily pie output rises from 0 to 6.
• Indicate the range of pies for which Alicia’s production exhibits increasing returns to scale
and the range for which production exhibits decreasing returns.
• What is Alicia’s efficiency scale level of production?
• What would Alicia’s marginal revenue have to be for her food truck to remain in the
market in the long run at the efficiency scale level of production?
• Indicate the range of prices for which Alicia would stay open in the short run at the
efficiency scale level of production.
PRACTICE PROBLEM
Alicia’s Apple Pies is a small food truck business in a perfectly competitive market. Alicia must pay $9.00 each day
to park her truck on Wayne State Campus. In addition, it costs her $1.00 to produce the first pie of the day, and
each subsequent pie costs 50% more to produce than the one before it. For example, the second pie costs
$1.00*1.5 = $1.50 to produce, and so on.
• Calculate Alicia’s marginal cost, variable costs, average total cost, average variable cost and average fixed costs
as her daily pie output rises from 0 to 6.
Output
0
1
2
3
4
5
6
Fixed
Cost
per pie
Variable
Cost
Total
Cost
Average Average
Marginal
Total
Variable
Cost
Cost
Cost
PRACTICE PROBLEM
Alicia’s Apple Pies is a small food truck business in a perfectly competitive market. Alicia must pay $9.00 each day
to park her truck on Wayne State Campus. In addition, it costs her $1.00 to produce the first pie of the day, and
each subsequent pie costs 50% more to produce than the one before it. For example, the second pie costs
$1.00*1.5 = $1.50 to produce, and so on.
• Calculate Alicia’s marginal cost, variable costs, average total cost, average variable cost and average fixed costs
as her daily pie output rises from 0 to 6.
Output
Fixed
Cost
0
1
2
3
4
5
6
9
9
9
9
9
9
9
per pie
Variable
Cost
Total
Cost
Average Average
Marginal
Total
Variable
Cost
Cost
Cost
PRACTICE PROBLEM
Alicia’s Apple Pies is a small food truck business in a perfectly competitive market. Alicia must pay $9.00 each day
to park her truck on Wayne State Campus. In addition, it costs her $1.00 to produce the first pie of the day, and
each subsequent pie costs 50% more to produce than the one before it. For example, the second pie costs
$1.00*1.5 = $1.50 to produce, and so on.
• Calculate Alicia’s marginal cost, variable costs, average total cost, average variable cost and average fixed costs
as her daily pie output rises from 0 to 6.
Output
Fixed
Cost
per pie
0
1
2
3
4
5
6
9
9
9
9
9
9
9
1
1.5
2.3
3.4
5.1
7.6
Variable
Cost
Total
Cost
Average Average
Marginal
Total
Variable
Cost
Cost
Cost
PRACTICE PROBLEM
Alicia’s Apple Pies is a small food truck business in a perfectly competitive market. Alicia must pay $9.00 each day
to park her truck on Wayne State Campus. In addition, it costs her $1.00 to produce the first pie of the day, and
each subsequent pie costs 50% more to produce than the one before it. For example, the second pie costs
$1.00*1.5 = $1.50 to produce, and so on.
• Calculate Alicia’s marginal cost, variable costs, average total cost, average variable cost and average fixed costs
as her daily pie output rises from 0 to 6.
Output
Fixed
Cost
per pie
Variable
Cost
0
1
2
3
4
5
6
9
9
9
9
9
9
9
1
1.5
2.3
3.4
5.1
7.6
1
2.5
4.8
8.1
13.2
20.8
Total
Cost
Average Average
Marginal
Total
Variable
Cost
Cost
Cost
PRACTICE PROBLEM
Alicia’s Apple Pies is a small food truck business in a perfectly competitive market. Alicia must pay $9.00 each day
to park her truck on Wayne State Campus. In addition, it costs her $1.00 to produce the first pie of the day, and
each subsequent pie costs 50% more to produce than the one before it. For example, the second pie costs
$1.00*1.5 = $1.50 to produce, and so on.
• Calculate Alicia’s marginal cost, variable costs, average total cost, average variable cost and average fixed costs
as her daily pie output rises from 0 to 6.
Output
Fixed
Cost
0
1
2
3
4
5
6
9
9
9
9
9
9
9
per pie
Variable
Cost
Total
Cost
1
1.5
2.3
3.4
5.1
7.6
1
2.5
4.8
8.1
13.2
20.8
9
10.0
11.5
13.8
17.1
22.2
29.8
Average Average
Marginal
Total
Variable
Cost
Cost
Cost
PRACTICE PROBLEM
Alicia’s Apple Pies is a small food truck business in a perfectly competitive market. Alicia must pay $9.00 each day
to park her truck on Wayne State Campus. In addition, it costs her $1.00 to produce the first pie of the day, and
each subsequent pie costs 50% more to produce than the one before it. For example, the second pie costs
$1.00*1.5 = $1.50 to produce, and so on.
• Calculate Alicia’s marginal cost, variable costs, average total cost, average variable cost and average fixed costs
as her daily pie output rises from 0 to 6.
Output
Fixed
Cost
0
1
2
3
4
5
6
9
9
9
9
9
9
9
per pie
Variable
Cost
Total
Cost
1
1.5
2.3
3.4
5.1
7.6
1
2.5
4.8
8.1
13.2
20.8
9
10.0
11.5
13.8
17.1
22.2
29.8
Average Average
Marginal
Total
Variable
Cost
Cost
Cost
10.0
5.8
4.6
4.3
4.4
5.0
1.0
1.3
1.6
2.0
2.6
3.5
1.0
1.5
2.3
3.4
5.1
7.6
PRACTICE PROBLEM
Alicia’s Apple Pies is a small food truck business in a perfectly competitive market. Alicia must pay $9.00 each day
to park her truck on Wayne State Campus. In addition, it costs her $1.00 to produce the first pie of the day, and
each subsequent pie costs 50% more to produce than the one before it. For example, the second pie costs
$1.00*1.5 = $1.50 to produce, and so on.
• Indicate the range of pies for which Alicia’s production exhibits increasing returns to scale and the range for
which production exhibits decreasing returns.
Output
Fixed
Cost
0
1
2
3
4
5
6
9
9
9
9
9
9
9
per pie
Variable
Cost
Total
Cost
1
1.5
2.3
3.4
5.1
7.6
1
2.5
4.8
8.1
13.2
20.8
9
10.0
11.5
13.8
17.1
22.2
29.8
Average Average
Marginal
Total
Variable
Cost
Cost
Cost
10.0
5.8
4.6
4.3
4.4
5.0
1.0
1.3
1.6
2.0
2.6
3.5
1.0
1.5
2.3
3.4
5.1
7.6
PRACTICE PROBLEM
Alicia’s Apple Pies is a small food truck business in a perfectly competitive market. Alicia must pay $9.00 each day
to park her truck on Wayne State Campus. In addition, it costs her $1.00 to produce the first pie of the day, and
each subsequent pie costs 50% more to produce than the one before it. For example, the second pie costs
$1.00*1.5 = $1.50 to produce, and so on.
• What is Alicia’s efficiency scale level of production?
Output
Fixed
Cost
0
1
2
3
4
5
6
9
9
9
9
9
9
9
per pie
Variable
Cost
Total
Cost
1
1.5
2.3
3.4
5.1
7.6
1
2.5
4.8
8.1
13.2
20.8
9
10.0
11.5
13.8
17.1
22.2
29.8
Average Average
Marginal
Total
Variable
Cost
Cost
Cost
10.0
5.8
4.6
4.3
4.4
5.0
1.0
1.3
1.6
2.0
2.6
3.5
1.0
1.5
2.3
3.4
5.1
7.6
PRACTICE PROBLEM
Alicia’s Apple Pies is a small food truck business in a perfectly competitive market. Alicia must pay $9.00 each day
to park her truck on Wayne State Campus. In addition, it costs her $1.00 to produce the first pie of the day, and
each subsequent pie costs 50% more to produce than the one before it. For example, the second pie costs
$1.00*1.5 = $1.50 to produce, and so on.
• What would Alicia’s marginal revenue have to be for her food truck to remain in the market in the long run at
the efficiency scale level of production?
Output
Fixed
Cost
0
1
2
3
4
5
6
9
9
9
9
9
9
9
per pie
Variable
Cost
Total
Cost
1
1.5
2.3
3.4
5.1
7.6
1
2.5
4.8
8.1
13.2
20.8
9
10.0
11.5
13.8
17.1
22.2
29.8
Average Average
Marginal
Total
Variable
Cost
Cost
Cost
10.0
1.0
1.0
5.8
1.3
1.5
4.6
1.6
2.3
4.3
2.0
3.4
4.4
2.6
5.1
5.0
3.5
7.6
PRACTICE PROBLEM
Alicia’s Apple Pies is a small food truck business in a perfectly competitive market. Alicia must pay $9.00 each day
to park her truck on Wayne State Campus. In addition, it costs her $1.00 to produce the first pie of the day, and
each subsequent pie costs 50% more to produce than the one before it. For example, the second pie costs
$1.00*1.5 = $1.50 to produce, and so on.
• Indicate the range of prices for which Alicia would stay open in the short run at the efficiency scale level of
production.
Output
Fixed
Cost
0
1
2
3
4
5
6
9
9
9
9
9
9
9
per pie
Variable
Cost
Total
Cost
1
1.5
2.3
3.4
5.1
7.6
1
2.5
4.8
8.1
13.2
20.8
9
10.0
11.5
13.8
17.1
22.2
29.8
Average Average
Marginal
Total
Variable
Cost
Cost
Cost
10.0
1.0
1.0
5.8
1.3
1.5
4.6
1.6
2.3
4.3
2.0
3.4
4.4
2.6
5.1
5.0
3.5
7.6
PRACTICE PROBLEM
The market for fertilizer is perfectly competitive. Firms in the market are producing
output but are currently incurring economic losses.
a) How does the price of fertilizer compare to the average total cost, the
average variable cost, and the marginal cost of producing fertilizer?
b) Draw two graphs, side by side, illustrating the present situation for the
typical firm and for the market.
c) Assuming there is no change in either demand or the firms’ cost curves,
explain what will happen in the long run to the price of fertilizer, marginal
cost, average total cost, the quantity supplied by each firm, and the total
quantity supplied to the market.
PRACTICE PROBLEM
The market for fertilizer is perfectly competitive. Firms in the market are
producing output but are currently incurring economic losses.
a) How does the price of fertilizer compare to the average total cost, the
average variable cost, and the marginal cost of producing fertilizer?
If firms are currently incurring losses, price must be less than average total cost.
However, because firms in the industry are currently producing output, price must be
greater than average variable cost. If firms are maximizing profits, price must be equal
to marginal cost.
PRACTICE PROBLEM
The market for fertilizer is perfectly competitive. Firms in the market are
producing output but are currently incurring economic losses.
Draw two graphs, side by side, illustrating the present situation for the
typical firm and for the market.
Assuming there is no change in either demand or the firms’ cost curves,
explain what will happen in the long run to the price of fertilizer, marginal
cost, average total cost, the quantity supplied by each firm, and the total
quantity supplied to the market.
PRACTICE PROBLEM
The market for fertilizer is perfectly competitive. Firms in the market are
producing output but are currently incurring economic losses.
CHAPTER 16
•
•
•
•
•
•
•
•
Monopoly
Market power and barriers to entry
Natural monopoly
Marginal revenue of monopoly
Output vs. price effect
Monopolist production decision
Welfare cost of monopoly
Price discrimination
MONOPOLY
• A monopoly is a firm that is the sole seller of a product
without close substitutes.
• A monopoly firm has market power, the ability to influence
the market price of the product it sells.
• The main cause of monopolies is barriers to entry—other
firms cannot enter the market.
• Natural monopoly: a single firm can produce the entire
market Q at lower cost than could several firms.
COMMON GROUNDS’ D AND MR CURVES
Q
P
0 $4.50
1
4.00
2
3.50
3
3.00
4
2.50
5
2.00
6
1.50
MR
$4
3
2
1
0
–1
P, MR
$5
4
3
2
1
0
-1
-2
-3
0
Demand curve (P)
MR
1
2
3
4
5
6
7
Q
OUTPUT VS. PRICE EFFECT
• Output effect: higher output raises revenue
• Price effect: lower price reduces revenue
MONOPOLY PRODUCTION DECISION
• A monopolist maximizes profit by producing the
quantity where MR = MC.
Profit-Maximization
1. The profitmaximizing Q
is where
MR = MC.
Costs and
Revenue
MC
P
2. Find P from
the demand curve
at this Q.
D
MR
Q
Quantity
Profit-maximizing output
CASE STUDY: MONOPOLY VS. GENERIC DRUGS
Patents on new drugs give a
temporary monopoly to the
seller.
Price
The market for
a typical drug
PM
When the patent expires,
the market becomes competitive, PC = MC
generics appear.
D
MR
QM
Quantity
QC
THE WELFARE COST OF MONOPOLY
Competitive equilibrium:
Price
quantity = QC
P = MC
total surplus is maximized
Deadweight
MC
loss
P
P = MC
MC
Monopoly equilibrium:
D
quantity = QM
P > MC
deadweight loss
MR
QM QC
Quantity
THE WELFARE COST OF MONOPOLY
Competitive equilibrium:
Price
quantity = QC
P = MC
total surplus is maximized
Monopoly equilibrium:
Consumer surplus
MC
P
P = MC
MC
D
Monopoly Profit
quantity = QM
P > MC
deadweight loss
MR
QM QC
Quantity
THE WELFARE COST OF MONOPOLY
Competitive equilibrium:
Price
MC
quantity = QC
P = MC
total surplus is maximized
P
P = MC
MC
D
MR
QM QC
Quantity
PRICE DISCRIMINATION
• Price discrimination: selling the same good at different prices
to different buyers.
• Perfect price discrimination occurs when the monopolist
produces the competitive quantity, but charges each buyer his or
her WTP.
PRACTICE PROBLEM
Patents, copyrights, and trademarks
a) are examples of government-created monopolies.
b) are examples of barriers to entry.
c) allow their owners to charge higher prices.
d) All of the above are correct.
PRACTICE PROBLEM
Which of the following is a characteristic of a natural
monopoly?
a) Average cost exceeds marginal cost over large regions of
output.
b) Increasing the number of firms increases each firm’s average
total cost.
c) One firm can supply output at a lower cost than two firms.
d) All of the above are correct.
PRACTICE PROBLEM
Monopoly firms have
a)
downward-sloping demand curves, so they can sell as much output as they desire at
the market price.
b) downward-sloping demand curves, so they can sell only the specific price-quantity
combinations that lie on the demand curve.
c)
horizontal demand curves, so they can sell as much output as they desire at the
market price.
d) horizontal demand curves, so they can sell only a limited quantity of output at each
price.
PRACTICE PROBLEM
Suppose a firm has a monopoly on the sale of a computer game and faces a
downward-sloping demand curve.
When selling the 50th game, the firm will always receive
a) less marginal revenue on the 50th game than it received on the 49th
game.
b) more average revenue on the 50th game than it received on the 49th
game.
c) more total revenue on the 50 games than it received on the first 49
games.
d) Both b and c are correct.
PRACTICE PROBLEM
For a monopoly firm,
a) price always exceeds average revenue.
b) price always exceeds marginal revenue.
c) any price-quantity combination will maximize profits.
d) All of the above are correct.
PRACTICE PROBLEM
What price will the monopolist
charge?
a) A
b) C
c) K
d) L
PRACTICE PROBLEM
How much output will the
monopolist produce?
a) O
b) T
c) W
d) Z
PRACTICE PROBLEM
Which area represents the deadweight loss from
monopoly?
a)
A+B
b)
C+F
c)
G
d)
A+B+C+F
PRACTICE PROBLEM
Which area represents consumer surplus in this
monopoly market ?
a)
A+B
b)
C+F
c)
G
d)
A+B+C+F
PRACTICE PROBLEM
Which area represents monopoly profit?
a)
A+B
b)
C+F
c)
G
d)
A+B+C+F
PRACTICE PROBLEM
Suppose the book-printing industry is competitive and begins in a long-run
equilibrium.
a. Draw a diagram showing the average total cost, marginal cost, marginal
revenue, and supply curve of the typical firm in the industry.
b. Hi-Tech Printing Company invents a new process that sharply reduces the
cost of printing books. What happens to Hi-Tech’s profits and to the price
of books in the short run when Hi-Tech’s patent prevents other firms from
using the new technology?
c. What happens in the long run when the patent expires and other firms are
free to use the technology?
PRACTICE PROBLEM
Suppose the book-printing industry is competitive and begins in a long-run equilibrium.
a. Draw a diagram showing the average total cost, marginal cost, marginal revenue, and supply
curve of the typical firm in the industry.
P
MC
ATC
P1
Q1
Q
PRACTICE PROBLEM
Suppose the book-printing industry is competitive and begins in a long-run equilibrium.
a. Hi-Tech Printing Company invents a new process that sharply reduces the cost of printing
books. What happens to Hi-Tech’s profits and to the price of books in the short run when
Hi-Tech’s patent prevents other firms from using the new technology?
P
MC
MC2
ATC
ATC2
P1
Q1
Q2
Q
PRACTICE PROBLEM
Suppose the book-printing industry is competitive and begins in a long-run equilibrium.
a. What happens in the long run when the patent expires and other firms are free to use the
technology?
P
MC
MC2
ATC
ATC2
P1
P2
Q1
Q2
Q
POP QUIZ
A small town is served by many competing supermarkets, which have the
same constant marginal cost.
• Using a diagram of the market for groceries, show the consumer surplus,
producer surplus, and total surplus.
• Now suppose that the independent supermarkets combine into one
chain. Using a new diagram, show the new consumer surplus, producer
surplus, and total surplus. Relative to the competitive market, what is the
transfer from consumers to producers? What is the deadweight loss?
GRADE SCALE
• NOTE: this is approximate and subject to change.
Grades on canvas have been adjusted for excused
homework/participation grades.
85+
A range
70-84 B range
50-69 C range