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C hapter 11 Price and Output in Monopoly, Monopolistic Competition, and Perfect Competition © 2002 South-Western.

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Presentation on theme: "C hapter 11 Price and Output in Monopoly, Monopolistic Competition, and Perfect Competition © 2002 South-Western."— Presentation transcript:

1 C hapter 11 Price and Output in Monopoly, Monopolistic Competition, and Perfect Competition © 2002 South-Western

2 2 Economic Principles Price, output and economic profit under conditions of monopoly Price, output and economic profit for the firm in monopolistic competition Normal profit

3 3 Economic Principles Price, output and economic profit for the firm in perfect competition The perfectly competitive firm’s supply curve Market supply in perfect competition

4 4 Economic Principles The Schumpeterian illustration of low price and high efficiency under conditions of monopoly

5 5 Price and Output Under Monopoly Monopolists are distinguished from other types of entrepreneurs by their market position -- not by their motivation, morality, strategy or objective.

6 6 Price and Output Under Monopoly Price-maker A firm conscious of the fact that its own activity in the market affects price. The firm has the ability to choose among combinations of price and output.

7 7 EXHIBIT 1MARKET DEMAND FOR ICE

8 8 Exhibit 1: Market Demand for Ice Which price and quantity choices does the ice company have available in Exhibit 1? The ice company has unlimited choices. It is a price maker and can choose any combination of price and output it wants.

9 9 Exhibit 1: Market Demand for Ice Which price and quantity choices does the ice company have in Exhibit 1? Although the ice company can charge higher prices, the company must recognize that at higher prices, fewer tons of ice will be demanded.

10 10 Exhibit 1: Market Demand for Ice Which price and quantity choices does the ice company have in Exhibit 1? The company uses the MR=MC rule to determine what combination of price and output will maximize profit.

11 11 Price and Output Under Monopoly Recall the MR=MC Rule: Expand production if MR>MC. Profit is maximized when MR=MC.

12 12 Price and Output Under Monopoly Marginal cost (MC) is the increase in total cost when an additional unit of output is added to production. Marginal revenue (MR) is the change in total revenue generated by the sale of one additional unit of goods and services.

13 13 EXHIBIT 2PRICE AND REVENUE SCHEDULE FOR THE NICK RUDD ICE COMPANY

14 14 Exhibit 2: Price and Revenue Schedule for the Nick Rudd Ice Company What is the marginal revenue per ton when the ice company increases production of ice from 200 to 250 tons? The marginal revenue per ton is $75.

15 15 Exhibit 2: Price and Revenue Schedule for the Nick Rudd Ice Company What is the marginal revenue per ton when the ice company increases production of ice from 200 to 250 tons? Marginal revenue=(change in total revenue)/(change in quantity).

16 16 Exhibit 2: Price and Revenue Schedule for the Nick Rudd Ice Company What is the marginal revenue per ton when the ice company increases production of ice from 200 to 250 tons? Marginal revenue=[$(43,750- 40,000)]/(250-200)=$3,750/50=$75.

17 17 Price and Output Under Monopoly Economic profit A firm’s total revenue minus its total explicit and implicit costs.

18 18 EXHIBIT 3COST AND REVENUE SCHEDULES FOR THE NICK RUDD ICE COMPANY Note: Figures are rounded to the nearest dollar.

19 19 Exhibit 3: Cost and Revenue Schedule for the Nick Rudd Ice Company 1. What is the company’s economic profit when 50 tons of ice are produced? Economic profit = total revenue- total cost = $(13,750-8,500)=$5,250.

20 20 Exhibit 3: Cost and Revenue Schedule for the Nick Rudd Ice Company 2. Since the company is a price- maker, should it charge the highest price possible? No. The highest price possible does not necessarily generate the most profit.

21 21 Exhibit 3: Cost and Revenue Schedule for the Nick Rudd Ice Company 3. At what output should the company be producing in order to maximize profit? The company should be producing 300 tons of ice in order to maximize profit.

22 22 Exhibit 3: Cost and Revenue Schedule for the Nick Rudd Ice Company 3. At what output should the company be producing in order to maximize profit? This is the output level where MR=MC.

23 23 Maximum Profit, but Less than Maximum Efficiency The profit-maximizing output is not necessarily the most efficient output. There may be output levels that have a lower average total cost (ATC). The firm is interested in maximum profit, however, not maximum efficiency.

24 24 EXHIBIT 4PRICE AND OUTPUT DETERMINATION IN MONOPOLY

25 25 Exhibit 4: Price and Output Determination in Monopoly What is the total profit for the profit- maximizing firm in Exhibit 4? The profit-maximizing firm produces where MR=MC. This point is at a quantity of 300 in Exhibit 4.

26 26 Exhibit 4: Price and Output Determination in Monopoly What is the total profit for the profit maximizing firm in Exhibit 4? At quantity 300, the price (read off the demand curve) is $150. The average total cost (read off the ATC curve) is $52.

27 27 Exhibit 4: Price and Output Determination in Monopoly What is the total profit for the profit maximizing firm in Exhibit 4? Total profit=$(150-52)*300 =$29,400.

28 28 Price and Output in Monopolistic Competition One way that a new firm can break into a market is through product differentiation. The trick is to differentiate the product enough to claim uniqueness, yet keep it close enough to existing competition.

29 29 EXHIBIT 5RUDD’S DEMAND CURVE AS NEW FIRMS ENTER THE MARKET

30 30 Exhibit 5: Rudd’s Demand Curve as New Firms Enter the Market As new firms enter a market, the demand curve for the existing firms becomes: i. More elastic. ii. Less elastic.

31 31 Exhibit 5: Rudd’s Demand Curve as New Firms Enter the Market As new firms enter a market, the demand curve for the existing firms becomes: i. More elastic.

32 32 Exhibit 5: Rudd’s Demand Curve as New Firms Enter the Market As new firms enter a market, the demand curve for the existing firms becomes: i. More elastic. More substitutes become available, which increases the price elasticity of demand.

33 33 EXHIBIT 6RUDD’S PRICE AND OUTPUT IN A MONOPO- LISTICALLY COMPETITIVE MARKET

34 34 Exhibit 6: Rudd’s Price and Output in a Monopolistically Competitive Market 1. How does the ice company determine the best output level to produce after new firms have entered the market? The ice company determines its production level the same way it did before -- it uses the MR=MC rule.

35 35 Exhibit 6: Rudd’s Price and Output in a Monopolistically Competitive Market 2. Is Rudd’s better off or worse off in the monopolistically competitive market? Rudd’s is worse off. Under monopolistic competition, economic profit declines.

36 36 Exhibit 6: Rudd’s Price and Output in a Monopolistically Competitive Market 3. Are consumers better off or worse off in the monopolistically competitive market? Consumers are better off. The price they pay is lower and the quantities they buy are greater.

37 37 Price and Output in Monopolistic Competition As long as there is economic profit to be made, firms will continue to enter a market. The limit to further entry is the point where the demand curve is tangent to the ATC curve.

38 38 EXHIBIT 7RUDD’S LONG-RUN EQUILIBRIUM PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION

39 39 Exhibit 7: Rudd’s Long-Run Equilibrium Price and Output in Monopolistic Competition 1. At what output level is profit maximized in Exhibit 7? Profit is maximized at an output level of 150.

40 40 Exhibit 7: Rudd’s Long-Run Equilibrium Price and Output in Monopolistic Competition 2. What are price and average total cost at this output level? Both price and average total cost are $82. The demand curve is tangent to the ATC curve.

41 41 Exhibit 7: Rudd’s Long-Run Equilibrium Price and Output in Monopolistic Competition 3. What is Rudd’s economic profit at this output level? Economic profit = $(82-82)*150=0.

42 42 Exhibit 7: Rudd’s Long-Run Equilibrium Price and Output in Monopolistic Competition 4. If economic profit is zero, should Rudd’s produce at some other output? No. The MR=MC rule always signals the firm’s most profitable output level, even if the profit is zero. Every other output level in this case would yield a loss.

43 43 Price and Output in Monopolistic Competition Normal profit The entrepreneur’s opportunity cost. It is equal to or greater than the income an entrepreneur could receive employing his or her resources elsewhere. Normal profit is included in the firm’s costs.

44 44 Price and Output in Monopolistic Competition Even though the economic profit of a firm may be zero, the firm still generates a normal profit -- a wage -- for the entrepreneur. The normal profit is at least as much as the entrepreneur can earn elsewhere.

45 45 Price and Output in Perfect Competition There is no product differentiation in a perfectly competitive market. Firms in perfect competition are typically modest in size.

46 46 EXHIBIT 8ATHE COMPETITIVE FIRM’S COST STRUCTURE

47 47 EXHIBIT 8BTHE COMPETITIVE FIRM’S COST STRUCTURE

48 48 Exhibit 8: The Competitive Firm’s Cost Structure How does ATC change as the firm changes output from 4.5 to 6.0 in Exhibit 8? At an output of 4.5, the firm achieves its minimum ATC of $47. ATC increases to $55 when the firm increases output to 6.0.

49 49 Price and Output in Perfect Competition Price-taker A firm that views market price as a given and considers any activity on its own part as having no influence on that price.

50 50 Price and Output in Perfect Competition For firms in perfect competition, price always equals marginal revenue (P=MR).

51 51 EXHIBIT 9ADEMAND AND SUPPLY FOR ICE IN A PERFECTLY COMPETITIVE MARKET

52 52 EXHIBIT 9BDEMAND AND SUPPLY FOR ICE IN A PERFECTLY COMPETITIVE MARKET

53 53 Exhibit 9: Demand and Supply for Ice in a Perfectly Competitive Market 1. What is the equilibrium price and quantity demanded in panel a of Exhibit 9? The equilibrium price is $78 and the quantity demanded is 440.

54 54 Exhibit 9: Demand and Supply for Ice in a Perfectly Competitive Market 2. Why is the firm’s demand curve horizontal? The firm is a price-taker. The firm must charge the equilibrium price regardless of the quantity it produces.

55 55 Exhibit 9: Demand and Supply for Ice in a Perfectly Competitive Market 3. Should a firm in perfect competition increase its price in order to generate more profit? No. If the firm increases its price by even a penny, then the firm will not be able to sell any product.

56 56 Short-Run Equilibrium Price and Output for the Firm in Perfect Competition Economic profit will attract new producers to a market. As new producers enter the market, the supply curve shifts to the right, forcing the equilibrium price to fall.

57 57 Short-Run Equilibrium Price and Output for the Firm in Perfect Competition Each producer must adjust its output to maximize profit at the new equilibrium price.

58 58 EXHIBIT 10ATHE PERFECTLY COMPETITIVE FIRM IN THE SHORT RUN

59 59 EXHIBIT 10BTHE PERFECTLY COMPETITIVE FIRM IN THE SHORT RUN

60 60 Exhibit 10: The Perfectly Competitive Firm in the Short-Run 1. How does a price-taker know what output maximizes profit? The price-taker uses the MR=MC rule. Since MR is always equal to price, the firm must determine the output where MC is equal to price.

61 61 Exhibit 10: The Perfectly Competitive Firm in the Short-Run 2. What is the economic profit received by the firm in Exhibit 10? Economic profit =$(78-51)*5.5=$148.50.

62 62 EXHIBIT 11EFFECTS OF A SHIFT IN MARKET SUPPLY

63 63 Exhibit 11: Effects of a Shift in Market Supply 1. How does the equilibrium price change as the supply curve shifts from S 1 to S 2 to S 3 in Exhibit 11? The short-run equilibrium price changes from $78 at S 1 to $60 at S 2 and to $47 at S 3.

64 64 Exhibit 11: Effects of a Shift in Market Supply 2. How does the change in price affect the economic profit of firms? With each decrease in price, economic profit decreases. At an output of 4.5 tons, price equals ATC. Economic profit is zero.

65 65 Long-Run Equilibrium Price and Output for the Firm in Perfect Competition The long-run equilibrium position of firms in perfect competition is identified by P=MR=MC=ATC.

66 66 EXHIBIT 12THE MARKET AND FIRM IN LONG-RUN EQUILIBRIUM

67 67 Exhibit 12: The Market and Firm in Long-Run Equilibrium At what point along the ATC curve does the firm in perfect competition end up producing in the long run? The firm produces at the lowest point on its ATC curve.

68 68 EXHIBIT 13ANATOMY OF THE FIRM’S LONG-RUN SUPPLY CURVE

69 69 Exhibit 13: Anatomy of the Firm’s Long-Run Supply Curve Where does the supply curve begin for the firm in Exhibit 13? The supply curve begins at the point where MC=ATC on its marginal cost curve. Any point on the supply curve below that point will result in loss to the firm.

70 70 Long-Run Equilibrium Price and Output for the Firm in Perfect Competition The market supply curve is the aggregation of the long-run MC curves of the firms in the market.

71 71 EXHIBIT 14ANATOMY OF THE MARKET SUPPLY CURVE

72 72 Exhibit 14: Anatomy of the Market Supply Curve When P=$100, what is the total market supply? At P=$100, 150 firms are willing to supply 6 tons each. Market supply = 150 firms * 6 tons = 900 tons.

73 73 EXHIBIT 15THE INNOVATOR FIRM IN PERFECT COMPETITION

74 74 Exhibit 15: The Innovator Firm in Perfect Competition Complete this sentence: Innovation results in _____ economic profit in the long-run. i. Higher. ii. The same. iii.Lower.

75 75 Exhibit 15: The Innovator Firm in Perfect Competition Complete this sentence: Innovation results in _____ economic profit in the long-run. ii. The same.

76 76 Exhibit 15: The Innovator Firm in Perfect Competition Complete this sentence: Innovation results in _____ economic profit in the long-run. ii. The same. Economic profit may initially rise, but it will return to zero in the long-run.

77 77 EXHIBIT 16CONSTANT AND INCREASING RETURNS TO SCALE

78 78 Exhibit 16: Constant and Increasing Returns to Scale How does ATC change between panel a and panel b in Exhibit 16? In panel a, constant returns to scale, the minimum ATC is the same for small and large firms. In panel b, increasing returns to scale, ATC falls as firm size and output increase.

79 79 The Schumpeter Hypothesis According to economist Joseph Schumpeter, bigness can be an advantage for an innovating firm. The economies of scale and low average costs of production available to big firms may allow them to charge prices that are actually lower than those charged by small, competitive firms.

80 80 The Schumpeter Hypothesis Monopoly profits permit these firms to experiment with new technologies that ultimately lead to more efficient production.

81 81 The Schumpeter Hypothesis Other economists, such as Alfred Marshall, disagree. They contend that the large number of small firms that undertake innovation will lead to the greatest efficiency in production over time.

82 82 EXHIBIT 17PRICE AND PRODUCTION IN MONOPOLY AND PERFECT COMPETITION: SCHUMPETER’S VIEW

83 83 Exhibit 17: Price and Production in Monopoly and Perfect Competition: Schumpeter’s View 1. What is price and quantity for the competitive firm in panel a? Price is $25. With 200 firms in the market, quantity supplied to the market is 4,000.

84 84 Exhibit 17: Price and Production in Monopoly and Perfect Competition: Schumpeter’s View 2. How does the competitive firm’s price and quantity compare to the monopoly in panel b? The monopoly’s price is $20 -- $5 less than the competitive firm’s price. The monopoly’s output quantity is 10,000 - - 6,000 greater than the competitive firm’s output.


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