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Chapter 11

Chapter 11. Price and Output in Monopoly, Monopolistic Competition, and Perfect Competition. Economic Principles. Price, output and economic profit under conditions of monopoly Price, output and economic profit for the firm in monopolistic competition Normal profit. Economic Principles.

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Chapter 11

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  1. Chapter 11 Price and Output in Monopoly, Monopolistic Competition, and Perfect Competition Gottheil — Principles of Economics, 7e

  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 Gottheil — Principles of Economics, 7e

  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 Gottheil — Principles of Economics, 7e

  4. Economic Principles • The Schumpeterian illustration of low price and high efficiency under conditions of monopoly Gottheil — Principles of Economics, 7e

  5. Monopoly Price and Output Monopolists are distinguished from other types of entrepreneurs by their market position—not by their motivation, morality, strategy or objective. Gottheil — Principles of Economics, 7e

  6. Monopoly Price and Output 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. Gottheil — Principles of Economics, 7e

  7. EXHIBIT 1 MARKET DEMAND FOR ICE Gottheil — Principles of Economics, 7e

  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. Gottheil — Principles of Economics, 7e

  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. Gottheil — Principles of Economics, 7e

  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. Gottheil — Principles of Economics, 7e

  11. Price and Output Under Monopoly Recall the MR = MC Rule: • Expand production if MR > MC. • Profit is maximized when MR = MC. Gottheil — Principles of Economics, 7e

  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. Gottheil — Principles of Economics, 7e

  13. Price and Output Under Monopoly Economic profit • A firm’s total revenue minus its total explicit and implicit costs. Gottheil — Principles of Economics, 7e

  14. EXHIBIT 2 COST AND REVENUE SCHEDULES FOR THE NICK RUDD ICE COMPANY Note: Figures are rounded to the nearest dollar. Gottheil — Principles of Economics, 7e

  15. Exhibit 2: Cost and Revenue Schedule for the Nick RuddIce 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 Gottheil — Principles of Economics, 7e

  16. Exhibit 2: Cost and Revenue Schedule for the Nick RuddIce 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. Gottheil — Principles of Economics, 7e

  17. Exhibit 2: Cost and Revenue Schedule for the Nick RuddIce 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. Gottheil — Principles of Economics, 7e

  18. Exhibit 2: Cost and Revenue Schedule for the Nick RuddIce Company 3. At what output should the company be producing in order to maximize profit? • This is the output level where MR = MC. Gottheil — Principles of Economics, 7e

  19. 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. Gottheil — Principles of Economics, 7e

  20. EXHIBIT 3 PRICE AND OUTPUT DETERMINATION IN MONOPOLY Gottheil — Principles of Economics, 7e

  21. Exhibit 3: 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. Gottheil — Principles of Economics, 7e

  22. Exhibit 3: 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. Gottheil — Principles of Economics, 7e

  23. Exhibit 3: 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 Gottheil — Principles of Economics, 7e

  24. 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. Gottheil — Principles of Economics, 7e

  25. EXHIBIT 4 RUDD’S DEMAND CURVE AS NEW FIRMS ENTER THE MARKET Gottheil — Principles of Economics, 7e

  26. Exhibit 4: 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 Gottheil — Principles of Economics, 7e

  27. Exhibit 4: 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 Gottheil — Principles of Economics, 7e

  28. Exhibit 4: 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. ii. Less elastic Gottheil — Principles of Economics, 7e

  29. EXHIBIT 5 RUDD’S PRICE AND OUTPUT IN A MONOPO- LISTICALLY COMPETITIVE MARKET Gottheil — Principles of Economics, 7e

  30. Exhibit 5: 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. Gottheil — Principles of Economics, 7e

  31. 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. Gottheil — Principles of Economics, 7e

  32. EXHIBIT 6 RUDD’S LONG-RUN EQUILIBRIUM PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Gottheil — Principles of Economics, 7e

  33. Exhibit 6: Rudd’s Long-Run Equilibrium Price and Output in Monopolistic Competition 1. At what output level is profit maximized in Exhibit 6? • Profit is maximized at an output level of 150. Gottheil — Principles of Economics, 7e

  34. Exhibit 6: 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. Gottheil — Principles of Economics, 7e

  35. Exhibit 6: 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 Gottheil — Principles of Economics, 7e

  36. Exhibit 6: 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. Gottheil — Principles of Economics, 7e

  37. 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. Gottheil — Principles of Economics, 7e

  38. 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. Gottheil — Principles of Economics, 7e

  39. 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. Gottheil — Principles of Economics, 7e

  40. EXHIBIT 7A THE COMPETITIVE FIRM’S COST STRUCTURE Gottheil — Principles of Economics, 7e

  41. EXHIBIT 7B THE COMPETITIVE FIRM’S COST STRUCTURE Gottheil — Principles of Economics, 7e

  42. Exhibit 7: The Competitive Firm’s Cost Structure How does ATC change as the firm changes output from 4.5 to 6.0 in Exhibit 7? • 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. Gottheil — Principles of Economics, 7e

  43. 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. Gottheil — Principles of Economics, 7e

  44. Price and Output in Perfect Competition For firms in perfect competition, price always equals marginal revenue (P = MR). Gottheil — Principles of Economics, 7e

  45. EXHIBIT 8A DEMAND AND SUPPLY FOR ICE IN A PERFECTLY COMPETITIVE MARKET Gottheil — Principles of Economics, 7e

  46. EXHIBIT 8B DEMAND AND SUPPLY FOR ICE IN A PERFECTLY COMPETITIVE MARKET Gottheil — Principles of Economics, 7e

  47. Exhibit 8: Demand and Supply for Ice in a Perfectly Competitive Market 1. What is the equilibrium price and quantity demanded in panel a of Exhibit 8? • The equilibrium price is $78 and the quantity demanded is 440. Gottheil — Principles of Economics, 7e

  48. Exhibit 8: 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. Gottheil — Principles of Economics, 7e

  49. Exhibit 8: 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. Gottheil — Principles of Economics, 7e

  50. 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. Gottheil — Principles of Economics, 7e

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