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Chapter 11 Pure competition in the short run
Divided into 4 groups
1. Pure competition
2. Pure monopoly
3. Monopolistic
4. Oligopoly
In this chapter we focus on pure/perfect competition. It is the market that have many number of
sellers, standardised product, have no power to control the price, and free to enter and exit.
The price will be determined by the market demand and market supply in which the point that
intersect.
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Demand in this chapter will be horizontal or perfectly elastic because once price is determined by
the market, consumers will only buy at that price.
Perfect competition divided into 2 situations.
Short run and long run
In short run we have both fix cost and variable cost but in long run there is only variable cost
because in long run we have enough time and capital to adjust.
When firms want to produce outputs, they will produce at the point at which profit maximization.
There are 2 ways to do by comparing TR-TC and MR-MC.
We will choose at the point which have maximize profit.
We will stop at the point MR=MC because everything is already maximized.
We can take MC curve as a supply curve as well but we will take only the part which MC is above
AVC. MC intersects at the lower point of AVC, we will take it as the shut down point.
When firms reach shut down point, there are 2 alternatives to choose.
1. Compare the loss
2. Compare between TR and VC, or P and AVC.
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Chapter 12 : Pure Competition in the Long Run
-
In the short run:
• PC firms are fixed in the number of seller and plant size.
-
In the long run:
• Firms can expand or contract capacity
• Firms have free entry and exit in the industry
Profit Maximization in the Long Run
• Easy entry and exit
• The only long run adjustment we consider
• Identical costs
• All firms in the industry have identical costs
• Constant-cost industry
• Entry and exit do not affect resource prices
Entry Eliminates Economic Profits
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Exit Eliminates Losses
Long-Run
Equilibrium
• Entry eliminates profits
• Firms enter
• Supply increases
• Price falls
• Exit eliminates losses
• Firms exit
• Supply decreases
• Price rises
Long Run Supply
• Constant cost industry
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• Entry/exit does not affect LR ATC
• Constant resource price
• Special case
• Increasing cost industry
• Most industries
• LR ATC increases with expansion
• Specialized resources
• Decreasing cost industry
Pure Competition and Efficiency
• In the long run, efficiency is achieved
• Productive efficiency
• Producing at the least cost way.
• Producing where P = min. ATC
• Allocative efficiency
• Producing the mix of goods most desired by society.
• Producing where P = MC
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P= min ATC = MC does not occur in decreasing cost industry
Pure Competition and Efficiency
• Consumer surplus and producer surplus are maximized in the long run in pure
competition
Dynamic Adjustments
• Purely competitive market has the ability to restore the efficiency by changes in
the economy.
• PC markets will automatically adjust to:
• Changes in consumer tastes
• Resource supplies
• Technology
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• Recall the “Invisible Hand”
Technological Advance: Competition
• Entrepreneurs would like to increase profits beyond just a normal profit
• Decrease costs by innovating
• New product development
Creative Destruction
• Competition and innovation may lead to “creative destruction”
• Creation of new products and methods destroys the old products and
methods
• The creation of new products and new production methods
destroys the market positions of firms committed to existing
products and old ways of doing business
Efficiency Gains from Entry
• Patent protected prescription drugs which earn substantial economic profits for
the pharmaceutical company.
• Patents give firms 20 years exclusive rights to a product
• Generic drugs become available as the patent expires on the existing drug.
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• Patents are used to encourage research and development of new
drugs and provide the pharmaceutical company enough time to
recoup the R&D expenditures invested in the drug
• Results in a 30-40% reduction in price
• Create greater consumer surplus and efficiency
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Chapter 13: Pure Monopoly
An Introduction to Pure Monopoly
• Pure monopoly exits when a single firm is the sole producer of a product which there is no
close substitute:
– Single seller – a sole producer
– No close substitutes – unique product
– Price maker – control over price
– Blocked entry – strong barriers to entry to block potential competition
– Non-price competition – mostly PR or advertising the product
Examples of Monopoly
• Public utility companies
• Natural Gas
• Electricity
• Water
• Near monopolies
• Intel
• Wham-O
• Professional Sports Teams
• Barrier to Entry: a factor that keeps firms from entering an industry.
– Economies of Scale
– Legal Barriers: Patents and Licenses
– Ownership of Essential Resources
– Pricing
Monopoly Demand
• The pure monopolist is the industry
• Demand curve is the market demand curve
– Downsloping demand curve
• Marginal revenue is less than price
P > MR (not like PC: P = MC
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Revenue and Cost Data of a Pure Monopolist
Revenue Data
Cost Data
(1)
Quantity
of
Output
(2)
Price
(Average
Revenue)
(3)
Total
Revenue
(1) X (2)
0
$ 172
$0
1
162
162
$ 162
$ 190.00
190
$ 90
-28
2
152
304
142
135.00
270
80
+34
3
142
426
122
113.33
340
70
+86
4
132
528
102
100.00
400
60
+128
5
122
610
82
94.00
470
70
+140
6
112
672
62
91.67
550
80
+122
7
102
714
42
91.43
640
90
+74
8
92
736
22
93.75
750
110
-14
9
82
738
2
97.78
880
130
-142
10
72
720
-18
103.00
1030
150
-310

(4)
Marginal
Revenue
(5)
Average
Total Cost
(6)
Total
Cost
(1) X (5)
(7)
Marginal
Cost
$ 100
All customers must pay the same price
(8)
Profit (+) or
Loss (-)
$ -100
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$142
132
122
112
102
9
8
0
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Loss = $30
Gain = $132
1
2
3
4
5
6
Monopoly Demand
• Marginal Revenue < Price
• Monopolist is a price maker.
Monopolist sets prices in elastic region of demand curve where MR is positive
Output and Prices Determination
Steps for Graphically Determining the Profit-Maximizing Output, Profit-Maximizing
Price, and Economic Profits (if Any) in Pure Monopoly
Step 1
Determine the profit-maximizing output by finding where MR=MC.
Step 2
Determine the profit-maximizing price by extending a vertical line upward
from the output determined in step 1 to the pure monopolist’s demand
curve.
Step 3
Determine the pure monopolist’s economic profit by using one of two
methods:
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Method 1. Find profit per unit by subtracting the average total cost of the
profit-maximizing output from the profit-maximizing price. Then multiply
the difference by the profit-maximizing output to determine economic
profit (if any).
Method 2. Find total cost by multiplying the average total cost of the
profit-maximizing output by that output. Find total revenue by multiplying
the profit-maximizing output by the profit-maximizing price. Then subtract
total cost from total revenue to determine the economic profit (if any).
Misconceptions of Monopoly Pricing
• Not highest price
–
Although monopoly is the only producer, it does not need to set the highest price but
instead they set the price at MC=MR.
• Total profit
–
Not all level of output yield profit for monopoly. Thus they set put at MC=MR.
• Possibility of losses
–
Monopoly does not need to always have profits. In the SR, monopoly can go under
losses.
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Economic Effects of Monopoly
Monopoly increase the price and reduces the output to Qm. Monopoly create Dead
weight loss area D which is less efficient than that of purely competitive firms.
• Income transfer
– Reduce the income transfer to other units
• Cost complications
– Economies of scale
– X-Inefficiency
• Not producing at EOS
– Rent seeking expenditures
• Red tapes
– Technological advance
• Limited advancement
Assessment and Policy Options
• Antitrust laws
• Break up the firm
• Reducing monopoly power
• Regulate it
• Government determines price and quantity
• Ignore it
• Let time and markets get rid of monopoly
Regulated Monopoly
• When monopoly power results in an adverse effect upon the economy, the government may
choose to intervene on a case-by-case basis.
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Natural monopolies
– Socially optimal price
• Set price = marginal cost
• most efficient but may result in losses
– Fair return price
• Set price = ATC
• does not achieve allocative efficiency, but does insure a fair return
Price Discrimination
• Price discrimination
• Charging different buyers different prices
• Price differences are not based on cost differences
• Conditions for success:
• Monopoly power; Pricing power
• Market segregation
• No resale; not able to buy low and sell high.
Examples of Price Discrimination
• Business travel
– Inelastic demand due to time limitation
• Electric utilities
– Different prices to different level of consumption
• Movie theaters
– higher prices for the evening show than afternoon show
• Golf courses
• Railroad companies
• Coupons
– who have the time and take the time to clip coupons and manage coupons are the
price sensitive group.
• International trade
Graphical Analysis
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The price-discriminating monopolist represented here maximizes its total profit by dividing the
market into two segments based on differences in elasticity of demand. Both produces and sells at the
MR = MC output in each market segment but sets a different price for each market.
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Chapter 14: Monopolistic Competition and Oligopoly
Monopolistic Competition
Monopolistic competition is a combination of monopoly and pure competition. It main
characteristics are:
1. Large numbers of producers
Purely Competitive
2. Differentiated products
Monopoly
3. Easy for entry and exit
Purely Competitive
Four-firm concentration ratio
Helps you identify whether the company is an oligopoly or a monopolistic. The formula is as
follows:
𝑓𝑜𝑢𝑟 𝑓𝑖𝑟𝑚 𝑐𝑜𝑛𝑐𝑒𝑛𝑡𝑟𝑎𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑖𝑜 =
𝑜𝑢𝑡𝑝𝑢𝑡 𝑜𝑓 4 𝑙𝑎𝑟𝑔𝑒𝑠𝑡 𝑓𝑖𝑟𝑚𝑠
𝑡𝑜𝑡𝑎𝑙 𝑜𝑢𝑡𝑝𝑢𝑡 𝑜𝑓 𝑡ℎ𝑒 𝑖𝑛𝑑𝑢𝑠𝑡𝑟𝑦
Interpretation
40% and more = oligopoly
40% and less = monopolistic
Herfindahl index
This is another way to identify if an industry is oligopoly or a monopolistic. In this method, you
will need to square the percentage of market share of each company and sum all of them.
Interpretation
1000 and more = oligopoly
1000 and less = monopolistic
Short run
Maximizing profits and minimizing loss are the same method as purely competitive market and
monopolistic markets which uses the MC=MR golden rule.
Long run
Monopolistic competitors will only earn normal profit.
Monopolistic Competition and Efficiency
It doesn’t have productive efficiency and allocative efficiency. In monopolistic competition, firms
tend to create product variety instead of price competition, but the increasing cost of changes may
cause diseconomies of scales which later on, the firm may be able to compensate the loss because of
the increasing number of consumers in the newly changed product.
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Oligopoly
Its characteristics includes:
1. Homogeneous products
2. Having control over the prices
3. Barriers in entering this market model
In this market, we will have no allocative or productive efficiency and they don’t compete on prices but
they compete in advertising because competing in price will create a price war.
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Chapter 15: The Demand of Resources
This chapter emphasizes on the demand of raw materials for productions. Firstly, Derived
Demand: means, the want or the need to produce the finished product, but in order to do that, you will
need to also need the materials and the raw materials in order to get the final product. In other words,
it is the indirect demand of raw materials or the components of the production
Demand of the resources depends on:
The “Productivity” of the resource in helping the company create a better service or
product.
𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡𝑜𝑡𝑎𝑙 𝑟𝑒𝑣𝑒𝑛𝑢𝑒
𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑟𝑒𝑣𝑒𝑛𝑢𝑒 𝑝𝑟𝑜𝑑𝑢𝑐𝑡 =
𝑢𝑛𝑖𝑡 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑟𝑒𝑠𝑜𝑢𝑟𝑐𝑒 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦
𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑟𝑒𝑠𝑜𝑢𝑟𝑐𝑒 𝑐𝑜𝑠𝑡 =
𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡
𝑢𝑛𝑖𝑡 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑟𝑒𝑠𝑜𝑢𝑟𝑐𝑒 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦
Determinants of resource demand
Changes in product demand: if the final product demand has a high demand, the resource
demand will also be high.
Changes in productivity: the more productive a resource is, the demand will also be high.
Substitute resources and complementary resources
Substitute resources: when a substitute resource decreases its price, people tend to buy the
cheaper substitute.
Complementary resources: When the price of an ingredient falls, people will stock more of that
ingredient, but they will also need to stock more of the complementary ingredients in order to produce
the final product.
Elasticity of resource demand
These are some determinants of elasticity of resource demand:
1. Ease of resource substitutability: the more substitute it has, the more elastic it is.
2. Elastic of final product: if the final product is elastic, the resources or ingredients are also
elastic
3. Ratio of resource cost to total cost: if the resource has a greater part in the production, the
elasticity will also be greater.
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Chapter 16 Wage Determination
Labor, Wages and Earnings
•
Labor : All type of worker
–
•
Wages
–
•
amount of money received per hour, day, or year
Real wage
–
•
Price paid for labor; direct payment plus fringe benefits
Wage rate or Nominal wage
–
•
blue-collar, white-collar, hourly, salaried, professional, etc.
quantity of goods and services a worker can obtain with nominal wages or the
“purchasing power” of nominal wages.
General level of wages
–
Wage rates differ among nations, regions, and individuals
Role of Productivity
•
Labor demand depends on productivity
•
U.S. labor is highly productive
–
Plentiful capital
–
Access to abundant natural resources
–
Advanced technology
–
Labor quality
–
Other factors
Competitive Labor Market
•
What determines the wage rate?
–
Market demand for labor
•
Sum of firm demand for labor
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•
–
–
Example: carpenters
Market supply for labor
•
Upward sloping supply curve; the higher the pay the higher the supply of worker
•
Competition among industries
Labor market equilibrium
•
Intersection of market labor demand curve and the market labor supply curve
•
MRP = MRC rule
In a purely competitive labor market, the labor supply curve is a horizontal line because it is
perfectly elastic. The labor demand curve for the individual firm is downward sloping reflecting the fact
that to attract more workers, the firm must pay more. The firm will maximize profits by hiring workers
up to where
MRP = MRC