ECON 201 1nd Edition Exam 3 Study Guide Lectures 16 19 Lecture 16 What is perfect competition A perfectly competitive market is one in which economic forces operate unimpeded Characteristics of a perfect competition market a Both buyers and sellers are price takers b The number of firms is large c There are no barriers to entry exit d The firms products are identical e There is complete information f Firms are profit maximizers How is it implied Market demand and supply are as usual demand is downward sloping and supply is upward sloping The firm supply is that portion of its short run marginal cost curve about the average variable cost A perfectly competitive firm s demand schedule is perfectly elastic How does the firm maximize its profit Maximizing profit is the firm s goal Profit Total Revenue Total Cost A firm maximizes profit when the Marginal Cost is equal to the Marginal Revenue a Marginal Revenue MR the change in total revenue associated with a change in quantity b Marginal Cost MC the change in total cost associated with a change in quantity A perfect competitor accepts the market price as given As a result marginal revenue equals price MR P Average Revenue To maximize profits a firm should produce where marginal cost equals marginal revenue which is P a MC MR produce less b MC MR produce more Lecture 17 How do you maximize profit using total cost and total revenue P MR MC condition tells us how much output Profit is maximized where the vertical distance between total revenue and total cost is greatest At that output MR the slope of the total revenue curve and MC the slope of the total cost curve are equal Determining Profit and Loss from a graph a Find output where MC MR b Drop a line down from where MC equals MR and then to the ATC curve i Profit per unit average profit c Extend the line horizontally from Q and ATC intersection to vertical axis total profit d Is it a loss or a profit e Loss when the ATC curve is above the MR curve profit when ATC is below MR What is the shutdown point In the short run the point at which the firms will be better off shutting down than staying in business Continue to produce if P AVC Shut down if P AVC Adjustment from the Long Run to the Short Run a Adjustment process i An increase in demand leads to higher prices and higher profits 1 Existing firms increase output 2 New firms enter the market increasing output more 3 Price falls until all profit is competed away 4 An increase in Demand What is increasing cost industry Factor prices rise as new firms enter the market and existing firms expand capacity LR supply curve is upward sloping What is decreasing cost industry Factor prices fall as industry output expands LR supply curve is downward sloping Lecture 18 What is a monopoly Monopoly is a market structure in which a single firm makes up the entire market Monopolies exist because of barriers to entry into a market that prevent competition What is a barrier A social political or economic impediment that prevents firms from entering the market so monopoly survives What are examples of barriers a Legal patent add the fuel of interest to the fire of genius Originated in 1790 b License Federal radio TV signal state medical care plumbing General garbage bus and taxi electricity cable TV USPS state sells liquor lottery c Natural Economy of scale downward sloping LRAC single firm supplies at low AC i e electricity transmission d Control Key resource Alcoa fore WWII only supply of aluminum control bauxite Sports league Panda What is the difference between a monopolist and perfect competitor For a competitive firm marginal revenue equals price For a monopolist marginal revenue is not price because its production decision can affect price A Model of Monopoly a How much should the monopolistic firm choose to produce is it wants to maximize profit b MR P Q Q Q P Q P Q c MR MC but MR P always Why d To sell more monopolist has to lower price on all units of products e MR MC or where MR MC will yield lower profits The four steps of profit and monopoly a Draw the firm s MR b Determine the output by the intersection of the MC and MR curves extend line vertically c Find the price on demand at that quantity d Determine the ATC and total profit 1 Total profit P ATC Q Lecture 19 What is the Welfare loss from monopoly Monopolies charge a price higher than marginal cost MC if increasing output is lower than the marginal benefit of increasing output What is price discrimination Price discrimination is the ability to charge different prices to different individuals or groups Conditions a Identify groups of customers who have different elasticities of demand b Separate them some way c Limit their ability to resell its product between groups A price discriminating monopolist can increase both output and profit It can charge customers with more inelastic demands a higher price It can charge customers with more elastic demands a lower price What is a natural barrier Size and cost economy of scale No welfare loss There is welfare gain What is an artificial barrier A policy restriction or patent Normative views Is monopoly right or wrong a b c d Higher price lower quantity Dead weight loss Rent seeking But patent encourage R D innovation monopoly may not make large profit with product differentiation output is large with threatening from outside they might charge low price