Unit 4: Imperfect Competition 1 What do you remember about? 1. The candy market simulation. How did it work? What did we see? 2. The different markets. What were some of the differences? Supafast Review 1. If a firm is making normal economic profits, is their accounting profit positive, zero, or negative? Why? 2. Where is the shut down point for a firm? Why is the shutdown point located there? 3. What’s the difference between a lump-sum & per-unit tax & subsidy. Which costs are affected by each? Accounting & Economic Profit Remember, all of the costs and profits we’ve been examining are economic profit, meaning we are considering opportunity costs (like foregone wages, capital depreciation, etc.) If a firm is making economic profit or normal profit, then they are definitely making accounting profit. Accounting & Economic Profit Economic Profit = TR – (Explicit Costs + Implicit Costs) EP = $1,000 – ($400 + $600) EP = $1,000 - $1,000 EP = $0 = Normal Profits Accounting Profit = TR – Explicit Costs AP = $1,000 - $400 AP = $600 (+) Cost and Revenue SHUT DOWN! Produce Zero MC $9 8 7 6 5 4 3 2 1 ATC AVC Minimum AVC is shut down point 1 2 3 4 5 6 7 8 9 10 Q 6 Lump Sum v. Per Unit Definition Change ATC? Change MC? Lump Sum Subsidy One-time Decreases fixed payment from the costs government regardless of Decreases ATC production Decreases fixed costs Lump Sum Tax One-time charge paid to the government regardless of production Increases fixed costs Increases fixed costs Increases ATC No change on MC No change on MC Lump Sum v. Per Unit Definition Change ATC? Change MC? Per-Unit Subsidy Payment from the Decreases variable Decreases variable government that costs costs changes depending on Decreases ATC Decreases MC production Per-Unit Tax Charges paid to the government that change depending on production Increases variable costs Increases variable costs Increases ATC Increases MC 4 Market Structures 9 FOUR MARKET STRUCTURES Perfect Competition Monopolistic Competition Oligopoly Pure Monopoly Imperfect Competition Every product is sold in a market that can be considered one of the above market structures. For example: •Fast Food Market •The Market for Cars •Market for Operating Systems (Microsoft) •Strawberry Market •Cereal Market 10 Characteristics of Monopolies 11 Discuss 1. What do you think might be some characteristics of monopolies? Can you come up with 5? 2. What examples of a monopoly can you think of? 5 Characteristics of a Monopoly 1. Single Seller • One Firm controls the vast majority of a market • The Firm IS the Industry 2. Unique good with no close substitutes 3. “Price Maker” The firm can manipulate the price by changing the quantity it produces (ie. shifting the supply curve to the left). Ex: California electric companies 13 5 Characteristics of a Monopoly 4. High Barriers to Entry • New firms CANNOT enter market • No immediate competitors • Firm can make profit in the long-run 5. Some “Nonprice” Competition • Despite having no close competitors, monopolies still advertise their products in an effort to increase demand. 14 Examples of Monopolies 15 What do you already know about monopolies? True or False? 1. 2. 3. 4. 5. All monopolies make a profit. Monopolies are usually efficient. All monopolies are bad for the economy. All monopolies are illegal. Monopolies charge the highest price possible 6. The government never prevents monopolies from forming. 16 17 Four Origins of Monopolies 1. Geography is the Barrier to Entry Ex: Nowhere gas stations, De Beers Diamonds, sports teams, Cable TV… -Location or control of resources limits competition and leads to one supplier. 2. The Government is the Barrier to Entry Ex: Water Company, Firefighters, The Army, Pharmaceutical drugs, rubix cubes… -Government allows monopoly for public benefits or to stimulate innovation. -The government issues patents to protect inventors and forbids others from using their invention. (They last 20 years) 18 Four Origins of Monopolies 3. Technology or Common Use is the Barrier to Entry Ex: Microsoft, Intel, Frisbee, Band-Aide… -Patents and widespread availability of certain products lead to only one major firm controlling a market. 4. Mass Production and Low Costs are Barriers to Entry Ex: Electric Companies If there were three competing electric companies they would have higher costs. • Having only one electric company keeps prices low -Economies of scale make it impractical to have smaller firms. Natural Monopoly- It is NATURAL for only one firm to produce because they can produce at the lowest cost. 19 Drawing Monopolies 20 Good news… 1.Only one graph because the firm IS the industry. 2.The cost curves are the same 3.The MR= MC rule still applies 4.Shut down rule still applies 21 The Main Difference • Monopolies (and all Imperfectly competitive firms) have downward sloping demand curve. • Which means, to sell more a firm must lower its price. • This changes MR… THE MARGINAL REVENUE DOESN’T EQUAL THE PRICE! 22 Combine the Demand of an industry with the costs of a firm. MC Price ATC What about MR? D Quantity 23 Combine the Demand of an industry with the costs of a firm. MC Price ATC D MR Quantity 24 Why is MR less than Demand? P Qd $11 0 TR MR 0 - 25 Why is MR less than Demand? $10 P Qd $11 0 $10 1 TR MR 0 10 10 26 Why is MR less than Demand? $10 $9 P Qd $11 0 $10 1 $9 2 TR MR 0 10 10 18 8 $9 27 Why is MR less than Demand? $10 $9 $9 $8 $8 P Qd $11 0 $10 1 $9 2 $8 3 TR MR 0 10 10 18 8 24 6 $8 28 Why is MR less than Demand? $10 $9 $9 $8 $8 $8 $7 $7 $7 P Qd $11 0 $10 1 $9 2 $8 3 $7 4 TR MR 0 10 10 18 8 24 6 28 4 $7 29 Why is MR less than Demand? $10 $9 $9 $8 $8 $8 $7 $7 $7 $7 $6 $6 $6 $6 P Qd $11 0 $10 1 $9 2 $8 3 $7 4 $6 5 TR MR 0 10 10 18 8 24 6 28 4 30 2 $6 30 Why is MR less than Demand? $10 $9 $9 $8 $8 $8 $7 $7 $7 $7 $6 $6 $6 $6 $6 $5 $5 $5 $5 $5 P Qd $11 0 $10 1 $9 2 $8 3 $7 4 $6 5 $5 6 TR MR 0 10 10 18 8 24 6 28 4 30 2 30 0 $5 31 Why is MR less than Demand? $10 $9 $9 $8 $8 $8 $7 $7 $7 $7 $6 $6 $6 $6 $6 $5 $5 $5 $5 $5 $5 $4 $4 $4 $4 $4 $4 P Qd $11 0 $10 1 $9 2 $8 3 $7 4 $6 5 $5 6 $4 7 TR MR 0 10 10 18 8 24 6 28 4 30 2 30 0 28 -2 $4 32 Why is MR less than Demand? $10 $9 $9 $8 $8 $8 $7 $7 $7 $7 $6 $6 $6 $6 $6 $5 $5 $5 $5 $5 $5 $4 $4 $4 $4 $4 $4 P Qd $11 0 $10 1 $9 2 $8 3 $7 4 $6 5 $5 6 $4 7 TR MR 10 10 18 8 24 6 28 4 30 2 30 0 28 -2 $4 33 Why is MR less than Demand? $10 $9 $9 $8 $8 $7 $7 $6 $6 $6 $6 $6 $5 $5 $5 $5 $5 $5 $4 $4 $4 $4 $4 $4 P Qd $11 0 $10 1 $9 2 $8 3 $7 4 $6 5 $5 6 $4 7 TR MR 10 10 18 8 24 6 28 4 30 2 30 0 28 -2 MR $8 IS LESS THAN $7 $7 PRICE $4 34 Why is MR below Demand? P $10 9 8 7 6 5 4 3 2 D 1 1 2 3 4 5 6 7 Q MR 35 Why is MR below Demand? At price $10, TR = $10 When price falls to $9, MR =$8 What happens to MR when price falls to $8? P $10 9 8 7 6 5 4 3 2 D 1 1 2 3 4 5 6 7 Q MR 36 Why is MR below Demand? At price $10, TR = $10 When price falls to $9, MR =$8 What happens to MR when price falls to $8? P $10 9 8 7 6 5 4 3 2 MR CURVE IS LESS THAN DEMAND CURVE!!! 1 1 2 3 4 5 6 7 D Q MR 37 Calculating Marginal Revenue 38 Calculate TR and Marginal Revenue Quantity 0 1 2 3 4 5 6 7 8 9 10 Price $16 15 14 13 12 11 10 9 8 7 6 TR MR 39 Calculate TR and Marginal Revenue Quantity 0 1 2 3 4 5 6 7 8 9 10 Price $16 15 14 13 12 11 10 9 8 7 6 TR 0 15 28 39 48 55 60 63 64 63 60 MR 40 Calculate TR and Marginal Revenue Quantity 0 1 2 3 4 5 6 7 8 9 10 Price $16 15 14 13 12 11 10 9 8 7 6 TR 0 15 28 39 48 55 60 63 64 63 60 MR 15 13 11 9 7 5 3 1 -1 -3 41 Calculate TR and Marginal Revenue Quantity 0 1 2 3 4 5 6 7 8 9 10 Price $16 15 14 13 12 11 10 9 8 7 6 TR 0 15 28 39 48 55 60 63 64 63 60 MR 15 13 11 9 7 5 3 1 -1 -3 42 Plot the Demand, Marginal Revenue, and Total Revenue Curves P $15 10 5 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Q TR $64 40 20 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Q 43 Demand and Marginal Revenue Curves What happens to TR when MR hits zero? P $15 10 5 D 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Q TR $64 40 20 MR Total Revenue is at it’s peak when MR hits zero TR 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Q 44 Elastic vs. Inelastic Range of Demand Curve 45 Elastic and Inelastic Range P Total Revenue Test If price falls and TR increases then demand is elastic. Elastic Inelastic $15 10 5 D 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 TR Total Revenue Test If price falls and TR falls then demand is inelastic. $64 40 20 1 2 3 4 5 6 7 8 Q A monopoly MR will only produce in the elastic range TR Q 46 9 10 11 12 13 14 15 16 17 18 Maximizing Profit 47 What output should this monopoly produce? MR = MC How much is the TR, TC and Profit or Loss? P MC $9 8 ATC 7 Profit =$6 6 TR =$42 5 TC =$36 4 3 2 D MR 1 2 3 4 5 6 7 8 9 10 Q 48 Conclusion: A monopolists produces where MR=MC, buts charges the price consumer are willing to pay identified by the demand curve. P $9 8 MC ATC 7 6 5 4 3 2 D MR 1 2 3 4 5 6 7 8 9 10 Q 49 What if cost are higher? How much is the TR, TC, and Profit or Loss? MC P ATC $10 AVC 9 8 7 6 D 5 4 TR= $90 TC= $100 Loss=$10 MR 3 6 7 8 9 10 Q 50 Identify and TR= Calculate: TC= Profit/Loss= Profit/Loss per Unit= P $70 $56 $14 $2 MC ATC $10 9 8 7 D 6 5 MR 4 1 2 3 4 5 6 7 8 9 10 Q 51 Review 1. Partner up. Have 1 partner draw a monopoly graph. Have the other partner explain the graph, and make any necessary changes. Are Monopolies Efficient? 53 What do you remember about? 1. What are different ways to measure efficiency? 2. What is deadweight loss? How does deadweight loss affect efficiency? 3. In perfect competition, what was productive efficiency? Monopolies vs. Perfect Competition S = MC P CS In perfect competition, CS and PS are maximized. Ppc PS D Qpc Q 55 Monopolies vs. Perfect Competition S = MC P At MR=MC, A monopolist will produce less and charge a higher price Pm Ppc D MR Qm Qpc Q 56 Monopolies vs. Perfect Competition Where is CS and PS for a monopoly? P S = MC CS Total surplus falls. Now there is DEADWEIGHT LOSS Pm PS Monopolies underproduce and over D charge, decreasing CS and increasing PS. MR Qm Q 57 Are Monopolies Productively Efficient? Does Price = Min ATC? P $9 8 No. They are not producing at the lowest cost (min ATC) MC ATC 7 6 5 4 3 2 D MR 1 2 3 4 5 6 7 8 9 10 Q 58 Are Monopolies Allocatively Efficiency? Does Price = MC? P $9 8 No. Price is greater. The monopoly is under producing. MC ATC 7 6 5 4 D Monopolies are NOT efficient! 3 2 MR 1 2 3 4 5 6 7 8 9 10 Q 59 Monopolies are inefficient because they… 1. Charge a higher price 2. Don’t produce enough • Not allocatively efficiency 3. Produce at higher costs • Not productively efficiency 4. Have little incentive to innovate Why? Because there is little external pressure to be efficient 60