Class 2 and 3

Figure 2.1 Short-run relationship between total, marginal and average product of labour

Figure 2.2 Short-run total cost, marginal cost, average variable and fixed cost, and short-run average cost

Figure 2.3 Increasing, constant and decreasing returns to scale

Figure 2.4 Long-run average cost and long-run marginal cost

Figure 2.5 Short-run and long-run average cost functions

Figure 2.6 Isoquant and isocost functions

Figure 2.7 Surface area and volume of small and large storage tanks

Figure 2.8 Long-run average cost functions with constant returns to scale

Figure 2.9 Total, average and marginal revenue

Theory of Perfect Competition and Monopoly Theory of the firm Edwin Chamberlein and Joan Robinson (1939) Alfred Marshall (1890) Augustin Cournot (1830) Adam Smith (1770) Developments in theory was built on the preceding analysis.

Profit Maximization The coherent body of theory that explains the determination of price and output for both the industry and the firm based on the assumption of profit maximization: Neoclassical theory of the firm. Two most extreme cases: –Perfect competition –Monopoly

The Neoclassical Theory of the Firm Perfect Competition –Many firms, free entry, identical products Imperfect Competition Monopolistic Competition –Many firms, free entry, some differentiation Oligopoly –Few firms, barriers to entry, some differentiation Monopoly –One firm, no entry, complete differentiation

Perfect Competition Large numbers of buyers and sellers: Atomistic Firms are free to enter and exit Identical goods Perfect information No transport costs Firms act independently

Price taking behavior, i.e. horizontal firm- level demand function, located at the current market price. Perfectly elastic demand. Firm’s demand function is its average revenue function. AR=P. Given that the firm’s demand or AR function is horizontal, AR=MR=P

Figure 2.10 Short-run pre-entry and post-entry equilibrium in perfect competition

Figure 2.11 Long-run post-entry equilibrium in perfect competition

Monopoly Large number of atomistic buyers, there is only one seller. The selling firm’s demand function is the market demand function and firm’s output decision determine the market price. There are barriers to entry Good or service produced and sold is unique Buyers and sellers have imperfect information Geographical location Seek to max prifit.

Figure 2.12 Long-run equilibrium in monopoly

Mathematical Representation For profit maximizing equilibrium for the case where LRAC and LRMC are horizontal (and equal): constant returns to scale. See appendix 1 for formal mathematical derivation (from the text book)

Efficiency and Welfare Properties Comparison between long run industry equilibrium under perfect competition and long run profit maximization under monopoly: –Under monopoly, market price is higher and output is lower. –The monopolist fails to produce at the minimum efficient scale and therefore fails tp produce at the minimum attinable LRAC. The perfectly competitive firm produces atthe minimum efficient scale. –The monopoly earns an abnormal profit in the long run.

Lerner Index for Market Power The degree to which price exceeds marginal cost provides a useful indicator of market power. Lerner Index L=(P-MC)/P In perfect competition P=MC and L=0 In monopoly, P>MC and if MC>0, 0>L>1 For a profit maximizing firm MR=MC, Lerner index can be written as the recipricon of the firm’s price elasticity of demand.

Welfare Properties of the Two Models Allocative efficiency Productive efficiency –Technical efficiency –Economic efficiency Allocative efficiency: AE is achieved when there is no possible reallocation of resources that could make one agent better off without making one other worse off Necessary condition for allocative efficiency: MB=MC

If market price is considered as a measure of the value society as a whole places in the marginal unit of output produced, P=MC If P>MC; value (WTP) exceeds cost (produce more) If P>MC; value (WTP) is less than cost (produce less)

Productive Efficiency Technical efficiency: Producing maximum quantity of output that is technologically feasible, given the quantities of the factor inputs it is currently employing (operate on its production function).. X-efficiency. Economic efficiency: Producing by selecting the combination of factor inputs that enable it to produce its current output level at the lowest cost.

Figure 2.13 Allocative inefficiency in monopoly

Figure 2.14 Allocative inefficiency and productive inefficiency in monopoly

Figure 2.15 Natural monopoly

Monopolistic Competition Robinson (1933); Chamberlein (1933) Theory of imperfect competitiın Monopolistic competition –Large number of atomistic buyers and sellers –Firms are free to enter and exit. No additional cost –Goods and services provided are similar but not identical –Perfect or imperfect information –Geography –Each selling firm seek to maximize profit.

Figure 2.16 Short-run pre-entry and post-entry equilibrium in monopolistic competition