unit 3 lesson 1 introduction, pure competition, costs...
TRANSCRIPT
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Unit 3 Lesson 1 Introduction, Pure competition, costs, product
Total Revenue = Price * Quantity Costs: Profits = Revenue – Cost PURE COMPETITION: very large number of sellers producing a standardized type of product. Each seller is a PRICE TAKER in that it can not influence the price. There is free entry and exit to this market. No firm can influence the market because if they attempt to change the price the buyer will just take their business elsewhere. This is because all the products are the same. It does not matter where the buyer goes.
The Costs of Production ECONOMIC COSTS: costs in economics deal with forgoing. The opportunity to produce alternative goods and services. This is the same thing as opportunity costs. EXPLICIT COSTS: payment to non-owners Ex: Payments for factors of production IMPLICIT COSTS: what the resources could have earned in their best alternative employment. Ex: A computer programmer that starts his own business could have made 100,000 in another job as opposed to being in business for himself. The $100,000 is an implicit cost. NORMAL PROFIT: minimum amount of money needed to keep the business operating. The implicit costs are included here. Implicit costs are included here. (Also called zero economic profit) Total Revenue: 200,000 Explicit Costs: 100,000 Implicit Costs: 100,000 Economic Profit 0 ECONOMIC PROFIT: TOTAL REVENUE (TR) - (All costs implicit and explicit) This is also called pure profit. Notice it includes normal profit.
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Total Revenue: 200,000 Explicit Costs: 90,000 Implicit Costs: 100,000 Economic Profit 10,000 (This means you are making $10,000 more than you would have made in your next best alternative. Economic profit is not the same thing as accounting profit. Accounting profit is TR - Explicit costs. It does not build in any profits. Short Run: A time period that is too short to vary the size of production. They can not expand their plant... Long Run period of time extensive enough for the firm to change quantities of all resources employed in production (Plant, Labor...) Law of Diminishing Marginal Returns: as successive units of a variable resource are added to a fixed resource, beyond some point the extra, or marginal, product attributable to each additional unit of variable resource will decline. Total Product: combined output from each level of labor and fixed capital goods.
Quantity of Labor (Ql)
Total Product (Q)
Marginal Product (MP)
Average Product (AP)
0 0 - 0
1 15 15 15
2 34 17
3 48 14
4 60 15
5 62 2 12.4
6 60 -2 10
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Notice that graphically the total product 1) Rises at an increasing rate. (Additional workers help a lot.) 2) Increases at a decreasing rate. The slope has changed. (Additional workers help but not as much as they did.) 3) Reaches the maximum and then declines. (Additional workers actually hinder production.) MARGINAL PRODUCT: change in total output with each additional input of labor. Notice that graphically the Marginal Product curve is the slope of the Total product curve. It measures the degree of change associated with each additional worker. This means it will go through the same three stages. 1) It will rise when the Total Product is increasing at an increasing rate. 2) It will begin to decrease when the Total Product starts increasing at a decreasing rate. 3) It will be below zero when Total product starts declining. When Total product is at its maximum the Marginal Product is at zero. AVERAGE PRODUCT: OUTPUT PER WORKER. TP/# OF WORKERS When the marginal product is rising the average product must also be rising. The change in total product is positive therefore the average product must also be increasing. When marginal product is below average product the average product must be declining.
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Unit 3 Lesson 2 Costs, revenue
Fixed Costs: Those costs which in total do not vary with changes in output. These costs are the same no matter how many of the products that are produced. This is because the firm has had to buy things for production. They are paying for them. (Ex. plant, equipment...) These can only be changed in the long run.
Variable Costs: Those costs which change with the level of output. (Ex. Labor) The variable costs do not increase at a constant rate in relation to the increase in production. This also goes back to the Law of Diminishing Marginal Returns. The early units add more to Total product than the later units but still cost the same. Once total product starts to decrease it takes more and more variable resources (which cost more) to obtain the same increase in product.
Total Costs: Sum of fixed and variable costs at each level of output.
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Average Fixed Costs: TFC/Q (AFC declines as Q Increases)
Average Variable Costs: TVC/Q It declines, reaches a minimum and then increases. The average variable cost is at first high because the firm is understaffed and each worker is costly because the firm is understaffed (workers will work slower because they have to go from machine to machine, they may not be able to work the machines as well... As you add more workers they specialization kicks in and production gets more efficient. This leads to lower costs. Eventually the production gets so crowded that workers are waiting in line to produce. This means that each worker costs more per unit produced.
Average Total Costs: TC/Q = AFC + AVC
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Marginal Costs: Additional cost (change in cost) of producing one more unit. MC = Δ TC/ Δ Q OR Δ VC/ Δ Q Δ VC/ Δ Q works because fixed costs do not change in the short run! It is the Marginal Cost that determines if a firm wants to produce an additional unit. The total cost will increase.
If the marginal cost is below the average cost what will happen to the average cost? It is like a test score. If the change in your score is less than your average what happens.
Take a few minutes to complete the following chart. To calculate VC you take AVC and multiply it by Q. From this VC you can then get change in VC = MC To calculate FC you take AFC and multiply by Q.
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Total Product
Average Fixed Cost
Average Variable Cost
Variable Cost Average
Total Cost
Fixed Cost
Marginal Cost
0 1 100 90.00 190 100 90 2 50 85.00 135 100 80 3 33.33 80.00 240 113.33 100 70
4 75.00 100 100 60
5 74.00 94 100 70
6 16.67 75.00 91.67 100 80 7 14.29 77.14 539 91.43 100 90 8 12.50 81.25 650 93.75 100 110 9 11.11 86.67 780 97.78 100 130
10 10.00 93.00 930 103 100 150 If labor is the only variable resource and each unit of labor was paid $100, what is the marginal cost at each level of production?
Remember MC = Δ TC/ Δ Q
Quantity of Labor Total Product Marginal Product Average Product Marginal Cost
0 0 0 1 15 15 15 2 34 19 17 3 48 14 16 4 60 12 15 5 62 2 12.4 6 60 -2 10
Since the only cost is labor and every unit adds $100, the change in TC is $100. The change in Q is the same as MP.
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Now let’s look at MP and MC together. If each additional unit of labor added is done so at the same price the MC will fall as long as the MP is rising. This is because marginal cost is simply the (constant) price or cost of an extra worker divided by his or her marginal product. This means that as long as MP is rising the MC will be falling. However, we know that the Law of Diminishing Returns will eventually take over and the MP will begin to fall. When this happens the MC curve will rise. This means that MP and MC are mirror images of each other.
The MC curve will intersect the ATC and AVC at their minimum point. This is because when the change in cost is less than ATC the ATC will fall. If it is more than ATC than ATC will rise. Total Revenue: PRICE X Q. AVERAGE REVENUE: TR / Q. If all units are sold at the same price it is equal to that price.
AR = P*Q/Q = P
MARGINAL REVENUE: The extra revenue that results in selling one more unit.
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Marginal Revenue = Δ TR/ Δ Q = P*Q2 - P*Q1 = P (Q2 - Q1) = Price (Q2 - Q1) (Q2 - Q1)
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Lesson 3: Perfect Competition in the Short Run Characteristics of a perfectly competitive market. 1. Very large number of sellers 2. Standardized product 3. Price taker 4. Free entry and exit. If I am an individual firm in a perfectly competitive market what price can I get for my good? Ex. If the price is 131 dollars per unit I can only get 131 for each unit. If I am an individual firm in a perfectly competitive market how many of my product can I sell at the market price? If you want to determine the point upon which a company would want to produce there are two ways to doing this. We want to look at the information and decide if the firm will produce and if so how much.
Total Revenue - Total Cost Approach: It stands to reason that a firm would want to produce so that it maximizes profits or minimizes losses. Total Revenue: PRICE X Q. The Total Revenue is nothing more than the total amount of money brought in to the cash register.
The total revenue is a straight line because each additional unit adds the same amount to revenue in a perfectly competitive market. If we add total cost we can see if a firm should produce or not. The area between the TR and TC curve is the profit obtained by producing that quantity of goods.
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SHOULD IT PRODUCE? If a firm shuts down what are its costs? 1) A firm should produce if in the short run it can realize either a profit or a loss less than its fixed costs. HOW MUCH SHOULD IT PRODUCE? 2) In the short run the firm should produce that output at which it maximizes profits or minimizes losses.
Profit-Maximization Point:
Total Product Total Revenue Total Fixed Cost Total Variable Cost Total Cost Total Economic Profit or Loss
0 0 100 0 100 -100 1 131 100 90 190 -59 2 262 100 170 270 -8 3 393 100 240 340 53 4 524 100 300 400 124 5 655 100 370 470 185 6 786 100 450 550 236 7 917 100 540 640 277 8 1048 100 650 750 298 9 1179 100 780 880 299
10 1310 100 930 1030 280 TR - TC = profit or loss . It is easy to see that in this table the firm should produce 9 units. It is at this point that it maximizes its profits. At 9 units the vertical distance between TR and TC is the total profits. Notice the break-even points: Why is the lower break even point where it is? Why is the upper break even point where it is?
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Loss-Minimizing Case:
Suppose we faced a situation similar to the above table. In this the price of our product has fallen to $81 dollars. This lowers our profit. In fact, we never get a gain. Should the firm produce? YES it will produce because it is covering its variable costs. If it were to close down it would lose more money. It will attempt to minimize its losses. Would you rather lose $100 or $64?
Total Product Total Revenue Total Fixed Cost Total Variable Cost Total Cost Total Economic Profit or Loss
0 0 100 0 100 -100 1 81 100 90 190 -109 2 162 100 170 270 -108 3 243 100 240 340 -97 4 324 100 300 400 -76 5 405 100 370 470 -65 6 486 100 450 550 -64 7 567 100 540 640 -73 8 648 100 650 750 -102 9 729 100 780 880 -151
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Close-down Case:
Total Revenue Total Cost Total Economic Profit or Loss 0 100 -100 71 190 -119
142 270 -128 213 340 -127 284 400 -116 355 470 -115 426 550 -124 497 640 -143 568 750 -182 639 880 -241
If the price were to drop to $71 dollars the firm would then close down. (See table 23-4) At this point they are no longer covering their variable costs.
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Unit 3 Part 3 day 2
2) Marginal Revenue- Marginal Cost Approach:
What does the demand curve look like for the individual firm? What does the demand curve look like for the market? Total Revenue: Price X Q. The Total Revenue is nothing more than the total amount of money brought in to the cash register. Average Revenue TR / Q. If all units are sold at the same price it is equal to that price. AR = P*Q/Q = P Since the individual firms demand curve is elastic that means that each and every price will be the same. This means that the AR is the same for each unit sold. Draw the AR curve = Demand curve MARGINAL REVENUE: The extra revenue that results in selling one more unit.
Marginal Revenue = Δ TR/ Δ Q = P*Q2 - P*Q1 = P (Q2 - Q1) = Price (Q2 - Q1) (Q2 - Q1)
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The marginal revenue will be the same for all units sold. It will just be equal to the price.
D= MR= AR = P To look at the MR=MC approach you will want to find the point where MR = MC. The reason is that if MR is greater than MC you are making more money from each extra unit produced than you it is costing you. (Notice that MC is the thing that the firm has the most control over. It knows what the cost is for each additional unit. If the cost is greater than the revenue from that additional unit the firm will not produce.) THE FIRM WILL MAXIMIZE PROFITS OR MINIMIZE LOSSES BY PRODUCING AT THAT POINT WHERE MARGINAL REVENUE EQUALS MARGINAL COSTS. This involves Three Things: 1) The MR=MC point exceeds average variable costs. If it does not then the firm will shut down. 2) This rule applies for all types of firms. Not just pure competition. 3) We know that in a perfectly competitive market the firm can sell as much of the product that it wants. This means the MR curve is the same as the price (The change in revenue is equal to the price since the D curve is elastic). This means that in a perfectly competitive market they will produce where P = MC.
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Profit Maximization Case:
Total Product Average Fixed Cost
Average Variable Cost
Average Total Cost Marginal Cost Price = Marginal
Revenue Total Economic profit or loss
0 -100 1 100 90.00 190 90 131 -59 2 50 85.00 135 80 131 -8 3 33.33 80.00 113.33 70 131 53 4 25 75.00 100 60 131 124 5 20 74.00 94 70 131 185 6 16.67 75.00 91.67 80 131 236 7 14.29 77.14 91.43 90 131 277 8 12.50 81.25 93.75 110 131 298 9 11.11 86.67 97.78 130 131 299 10 10.00 93.00 103 150 131 280
From the data in the above table we see that we will produce 9 units of the good. (The tenth unit adds more to MC than to MR (price). To calculate economic profits you take the TR (Price * output) and subtract the TC from this (ATC 8 output) 131 * 9 = 1179 and 97.78 * 9 = 880. 1179 - 880 = 299 economic profit.
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Graphically you look at the point where MR = MC. From there you can look at the profit by taking that point down to the ATC line. The area in between in profit.
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Loss-Minimizing Case:
Total Product Average Fixed Cost
Average Variable Cost
Average Total Cost Marginal Cost Price = Marginal
Revenue Total Economic profit or loss
0 -100 1 100 90.00 190 90 81 -109 2 50 85.00 135 80 81 -108 3 33.33 80.00 113.33 70 81 -92 4 25 75.00 100 60 81 -76 5 20 74.00 94 70 81 -65 6 16.67 75.00 91.67 80 81 -64 7 14.29 77.14 91.43 90 81 -72.98 8 12.50 81.25 93.75 110 81 -102 9 11.11 86.67 97.78 130 81 -151.03 10 10.00 93.00 103 150 81 -220 If the price is $81 dollars we can see from the above table that we should produce 6 units. It is at this point that MC = MR. However, we are losing money. Does that mean we go out of business? No because our profit is greater than our fixed costs. We lose 64 dollars but that is better than losing $100.
Graphically we will produce where MR = MC. The difference between this point and the ATC line represents a loss.
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The difference between this point and the AVC line is the amount of the fixed costs that we are covering..
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Close Down Case: If the price were to drop to $71 dollars we can not even cover the variable costs. This means the firm would be better off not producing,
It is clear that if MR = MC is lower than AVC the firm should just shut down
Now look at all of the above prices we have for this firm. From it we can graph multiple MR curves. From this we can label the close-down point and the break-even points. If we look at this MC curve above P2 (the close-down point we can see that this is just a supply curve for this market.
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You can now look back at the determinants of supply and see how each of these will affect cost. Any change in cost of the product will shift the supply curve (move the MC curve).
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LONG RUN FOR THE COMPETITIVE FIRM What determines the market price? In the long run: The individual firms that make up the industry can adjust their fixed factors of production. (Ex. plant size....) Firms can enter and exit the market. There are no fixed costs. Everything can be adjusted.
As firms expand their operation new ATC curves can be drawn. They will have shifted to the right. The lowest point of each of these ATC curves represents the place that these firms can produce at the lowest costs. When the firm gets to these points it will shift to the new cost curve. From these points we can develop a long run ATC for the firm.
In the long run there is no law of diminishing returns because the firms can just expand. If this is the case WHY IS THE LONG RUN ATC CURVE U SHAPED? 1) Economies of Scale: a) Labor specialization: workers are more efficient if they can specialize in production. b) In small firms the manager manages a small number of people and usually does several jobs. If the firm gets larger that person will manage more people and will specialize in their job tasks. c) The larger the firm the easier it is to have the best machinery. In addition to this when it expands it can purchase more up to date machinery.
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d) The by-products of production can be utilized by the larger firms (lowering costs) rather than being thrown away. 2) Eventually Diseconomies of Scale will take over. a) The hierarchy will cause the people making the decisions from being in the thick of things. They will only make decision based on numbers, not on actual production factors. The following three graphs are just examples of what long run ATC could look like.
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PROFIT MAXIMIZATION IN THE LONG RUN The perfectly competitive market consists of: - Easy entry and exit - Identical costs (similar), if I have high costs I will be forced out. If my costs are lower than everybody else they will just copy me. - Entry and exit does not affect the cost of resources. In the long run the price and the production will be equal to the firms minimum average total cost. The reason for this is that firms will seek profits and therefore will leave the industry in the long run if they are not getting them.
Assume that the price is $50 dollars. At this price the firm is at the lowest ATC. It is also where MR = MC. Now suppose that Demand increases from D1 to D2. This would drive the price up. However, this would only be in the short run. The increased profits from the driven up price would attract new suppliers which would drive the price back down to the original.
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This shows the effects of a decrease in demand. Firms leave because in the long run they can make money elsewhere and the price is driven back up. We can see that in a free market like this, firms will come and go according to the profit they earn. This means that in the long run the industry supply curve will actually be a perfectly elastic. Up to this point we have assumed that the entry and exit of firms did not affect the AC curve. If it did the analysis would not be valid. (Constant Cost Industry) This is true when the industry in question does not require the significant portion of the major resource in question. If the demand for this resource is affected then the AC curve for the industry would be affected. Few industries are really like this, Most are increasing cost industries). This means that their AC curve shifts upward as production expands and downward as production decreases. The reason is that if new firms enter the demand for a primary production source drive up the price of that good. This then drives up the AC for the firm. In the long run firms will produce such that they make maximum use of scarce resources. They will produce where MR=MC which is at the lowest AC.
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The firm produces where P = Minimum AC. This represents Productive efficiency. The firm produces where P = MC This marginal cost bring in the fact that the cost of resources depends on what those resources could be used for in other areas. This means that a firm produces such that they are allocating the resources in such a manner that they are getting the most out of the resources. This is allocative efficiency.
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(6) Change in Variable Costs TC = VC + FC ATC = TC/Q = AFC+AVC AVC = VC/Q MC = ∆TC/ ∆Q Given a perfectly competitive situation, what happens if a firms variable costs change? Given that variable costs are variable they will not change consistently across the board. Knowing this if we have a decrease in Variable costs we know that Marginal costs will decrease. (Shift down). AVC also decreases (shifts down) and ATC = AVC + AFC must also shift down if AVC decreased.
Q TFC TVC TC MC AFC AVC ATC FC’ AFC’ ATC’ TC’ MC’ 0 10 0 10 15 15 1 10 5 15 5 10 5 15 15 15 20 20 5 2 10 8 18 3 5 4 9 15 7.5 11.5 23 3 3 10 10 20 2 3033 3.33 6.67 15 5 8.33 25 2 4 10 11 21 1 2.50 2.75 5.25 15 3.75 6.5 26 1 5 10 13 23 1 2.0 2.60 4.60 15 3 5.6 28 2 6 10 16 26 3 1.67 2.67 4.3 15 2.5 5.06 31 3 7 10 20 30 4 1.43 2.86 4.28 15 2.14 5 35 4 8 10 25 35 5 1.25 3.13 4.38 15 1.87 5 40 5
A decrease in VC causes ATC to decrease (shift down). It causes AVC to decrease (shift down). It causes MC to decrease (shift down). A decrease in FC only causes FC to change but it is a constant change. Therefore, only ATC decreases. AVC and MC do not change.
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Unit 3 Lesson 4 The Monopoly Firm
Pure Monopoly: 1) Single Seller 2) No Close substitute 3) Price Maker (Downward sloping demand curve) 4) Blocked entry: Barriers are economic, technological, legal... 5) Advertising: will advertise if a luxury but not if it is a necessity. Barriers to Entry: 1) Economies of Scale: efficient low cost production can only be achieved if producers are extremely large both absolutely and in relation to the market. (ATC must be large and Q large.) When it is required for a firm to be so big that without economies of scale they would not be able to stay in business this is a Natural Monopoly. : utilities, cable companies, MARTA... 2) Legal Barriers: patents, licenses... 3) Ownership of resources: diamond mines, Aluminum deposits... (Notice this is not a natural monopoly)
Q P TR AR MR TC ATC MC Profit 0 14 0 2 0 1 12 12 12 6 6 2 10 10 8 4 2 3 8 24 2 12 4 4 12 4 6 6 0 20 5 8 4 5 4 20 4 -4 35 7 15 -15
In order to increase sales the monopoly must lower its price. When it lowers its price the MR will be lower than the price!!! When the price is lowered, the gain in total revenue (change in MR) is the price of that unit less the difference in between the old and new price. EX: If it could have sold 2 units at $10 it would have total revenue of $20. If it wants to sell more it has to lower its price. Suppose it lower the price to $8. It can now sell 3 units. The total revenue is now $24 dollars. This represents the 8 dollars times the 3 units. However, you will notice the gain is not 3 units * $10 = 30 but rather the $30 - (3 units * $2) = $24.
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This means that as each successive unit is sold the marginal revenue from each unit will decline. It will decline by the change in price times the quantity sold. IN ORDER TO SELL ANOTHER UNIT THE MONOPOLY MUST LOWER THE PRICE ON NOT ONLY THAT UNIT BUT ALL OTHER UNITS!!! In a monopoly the firms demand curve is the industry demand curve. It will be downwardly sloping. (A perfectly competitive industry demand curve is downwardly sloping but not the individual firms.)
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Earlier we learned that: On the elastic portion of the D curve a decline in price will increase total revenue. (Marginal Revenue is positive) What happens when Marginal Revenue is zero? The demand curve is unitary elastic. On an inelastic portion of the D curve a decline in price will decrease total revenue. (Marginal Revenue is negative)
With this in mind the Monopolist will product as far down the elastic D curve as it can. Will a monopoly every produce in the inelastic portion of the demand curve?
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Monopoly Day 2
Now that you see the shape of the MR and the D curves lets add in the ATC and the MC curves. Both of these are the same for a monopoly as they are for the individual firm. What then in the point at which the firm will produce? The monopolist will still produce where MR=MC. It is at this point on the D curve that the greatest profit will be made.
Q P TR MR ATC TC MC Profit 0 172 0 100 -100 1 162 162 162 190 190 90 -28 2 152 304 142 135 270 80 34 3 142 426 122 113.33 340 70 86 4 132 528 102 100 400 60 128 5 122 610 82 94 470 70 140 6 112 672 62 91.67 550 80 122 7 102 714 42 91.43 640 90 74 8 92 736 22 93.73 750 110 -14 9 82 738 2 97.78 880 130 -142 10 72 720 -18 103 1030 150 -310
Given the above information you should be able to find the profit maximizing point using both MR=MC and TR - TC.
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What is the profit per unit? 122 - 94 = 28 What is the total profit? 5 units * 28 = $140 (see shaded region)
A pure monopolist has no supply curve. It produces at a single point. There is no relation between price and quantity supplied. This is why we say a monopolist is a price maker. The monopolist depends on the slope of the demand curve (and the MR curve that results to determine its output.) A monopoly will not necessarily produce in order to get the highest price. This is not the optimum point on the D curve. They look at TR - TC = profits. The monopolist is interested in total profits not per unit profits. This is because they have a downwardly sloping demand curve.
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If demand is weak the monopoly may suffer a loss. As long as it is covering its AVC it will continue to do business
When working with a NATURAL MONOPOLY you will find that the curves are different. A natural monopoly is one in which the quantity produced must be very high in order to accommodate the costs. In other words, the ATC continues down over a large quantity. This means that the Demand curve will intersect the ATC before the minimum of the ATC. If someone tries to enter the market the Natural Monopolist can lower the price way down and still keep earning a profit.
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From this we can see that a monopoly does not produce at the most efficient point. Instead, it limits its output. This drives up the price. This means people want the product more that it costs to make. This is not allocative efficiency. In order to achieve efficiency you must achieve equality between price, marginal cost and average cost. Price and Marginal cost for allocative. Price and average cost for productive efficiency.
Regulation of a Monopoly
Socially Optimal Price (P = MC) This would be achieved by placing a ceiling on the price. When this is done the regulation will achieve allocative efficiency. This would take away the firms desire to restrict output. The problem is that it does not allow the firm to maximize profits. In some cases it will cause them to obtain a loss.
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Allocative Efficiency: P = MC Right goods for consumers. (Use resources for what people want them to be used for. $ value of a good is society’s measure of the worth of the good. MC is the measure of value of other products the resources could have been used for.
Fair Return; (P = ATC) By allowing the monopoly to charge where P = ATC they will then earn a normal profit. This however, does not achieve efficiency
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Consumer Surplus for a Monopoly
Producer Surplus When you are working with a monopoly the producer surplus is the area between the MC curve and the price
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Deadweight Loss Because the monopoly charges a price above marginal cost, not all consumers who value the good at more than its cost buy it. The result is a Deadweight Loss.
This is represented by the shaded triangle
If you compare the consumer surplus and producer surplus of a monopolist to the consumer surplus and producer surplus of a perfect competitor you will see that the monopolist transfers some consumer surplus to themselves.
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Price Discrimination When a company can charge one customer a different price than another customer this is known as price discrimination. The result is that the MR achieved from selling another unit is the same as price. The monopolist does NOT have to lower the price on previous units. The effect of this is that the company takes the consumer profit.
When a company can perfectly price discriminate it can set the price where MC= D. This allows them to produce more units than they would otherwise have produced. The net effect is that they now have taken the consumer surplus and the dead weight loss. They have turned this into economic profit.
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Practice Free Response for (Natural) Monopoly Use the labeling on the graph to answer the questions.
1. Suppose the firm produces at the profit-maximizing output. Identify the following a. level of output. Explain. b. price 2. At the output you identified in number 1, is the firm earning a profit or loss. 3. Using the labeling on the graph, indicate the area of the profit or loss. 4. At the profit maximizing level of output, indicate the area of consumer surplus. 5. Suppose the firm produces at the revenue-maximizing output. Identify the following. a. Level of output. Explain. b. Price 6. Socially efficient output. 7. At the Socially efficient output, is the monopoly making a profit or a loss? Use the labeling on the graph to identify the area of the profit or loss. 8. At the socially optimal output, identify the area of dead weight loss. 9. Suppose the government regulates the firm’s price to produce at the allocatively efficient level of output. Using the labeling on the graph, identify each of the following. a. The price the government would require the firm to set b. The allocatively efficient level of output 10. Suppose the regulators establish a price that allows the firm to just cover all its opportunity costs. Identify the price the regulators would set to achieve this objective.
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Monopolistic Competition 1) Relatively large number of small producers 2) Similar but not identical products. Product differentiation may be due to: The workmanship (Big Mac v Whopper) Service Location Promotion and packaging (Gap jeans v. Wal Mart Jeans) 3) Each firm has a small market share (limited control over price) 4) Easy entry and Exit
The demand curve for a monopolistic Competitive firm is highly elastic but not perfectly elastic. (Not the same as perfect competition because few rivals and differentiated product) The elasticity of the demand curve depends on the number of competitors. Since the firm faces a downwardly sloping demand curve it will have profit maximization and loss minimization situations similar to a monopoly
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However, since the firm has easy entry and exit the long run will be similar to a perfectly competitive market. This means that if they are earning economic profits other firms will enter. To understand this change in the Demand curve we need to go back to two things we learned earlier. Hence in theory the Demand curve shifts and rotates.
The Monopolistic Competitor does not reach allocative efficiency because the price is not equal to the Marginal Cost in the long run. The Monopolistic Competitor does not reach productive efficiency because it does not produce where unit costs (average costs) are the lowest.
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Game Theory Prisoners' Dilemma Mark is first number and Sam is second number. Mark
Confess Remain Silent Confess Mark gets 8 years
Sam gets 8 years
Mark gets 20 years Sam goes Free Sa
m
Remain Silent
Mark goes free Sam gets 20 years
Mark gets 1 year Sam gets 1 year
Two students are arrested by the police. The police have enough evidence to put both in jail for one year. The police suspect both of being involved in a series of robberies. They put both students in separate rooms and present them with the following option. If both of you remain silent they will both get 1 year jail on the gun charge. If only you confess and implicate your partner we will cut a deal to allow you to go free and your partner will get 20 years. If you do not confess and your partner does and implicates you then you will get 20 years. If both of you confess and implicate your partner then you both will get 8 years. What are both thinking? What is the best thing for them to do? This is knows as the game theory.
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Dominant Strategy: The Strategy that would serve you best given what the other person (company) does. What is the dominant strategy of our prisoners’ dilemma? Mark
Confess Remain Silent Confess Mark gets 8 years
Sam gets 8 years
Mark gets 20 years Sam goes Free Sa
m
Remain Silent
Mark goes free Sam gets 20 years
Mark gets 1 year Sam gets 1 year
The oligopoly operates on the Game Theory: There is much price strategy in deciding what price to charge. Leapers
High Low High $12, $12 $15, $6
Jum
pers
Low $6, $15 $8, $8
Leapers is the first number and Jumpers is the second number. If both price high they will both make a good profit. However if one decided it wants more profit it will lower the price. If this happens they make great profit and the other firm makes poor profit. Each firms profits depends on both its pricing strategy and the pricing strategy of its rivals. What is the dominant strategy of each company?
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Nash Equilibrium: Neither side has a desire to switch strategies given what the other is doing. What is the Nash Equilibrium of our two cases? Mark
Confess Remain Silent Confess Mark gets 8 years
Sam gets 8 years
Mark gets 20 years Sam goes Free Sa
m
Remain Silent
Mark goes free Sam gets 20 years
Mark gets 1 year Sam gets 1 year
Leapers
High Low High $12, $12 $15, $6
Jum
pers
Low $6, $15 $8, $8
Final Test: John and Sarah are in love! Here is their pay off matrix for going to the mall and going to a football game. The first number is for John and the second number is for Sarah. The measurement is the utils they derive from each. Sarah
Mall Football Game Mall 20, 30
9,4
John
Football Game
10,16 40,27
What is the dominant strategy for each person? What is the Nash Equilibrium?
47
Mutual Interdependence: Oligopolies are dependent on the other one. If one lowers prices the other one must lower prices. There is a mutual interdependence between them. Some problems of collusion: 1) Demand and Cost differences: this makes it hard to agree on a price. 2) number of firms: the more firms the harder it is to agree. 3) Cheating: If any firm cheats the others must follow suit 4) Recession: This increases average prices. 5) Potential Entry: 6) Legal obstacles Price Leadership: when the firms just follow the pricing of the largest firm in the oligopoly. Cost- Plus Pricing: Firms just take their costs and add a percentage to it.