MICRO reference

To maximize profit, choose quantity of output such that MR=LMC P=LMC

Produce Q* as long as P*≥LAC(Q*)

Exit the market otherwise.

At any price above P* firm makes positive profit

AT P*, profit is 0: normal profit

If firm is making positive profit in the SR, in the LR it can add fixed inputs (build another factory, rent more space…) and increase output.

If price is low and firm is making negative profit (loss) in the SR, in the LR it may decrease its fixed inputs or exit the industry.

Entry: in perfect competition – free (long run decision), other new firms join industry when economic profit >0.

Thus, in equilibrium last firm that enters (marginal firm) has economic profit = 0.

Exit: Existing firms shut down when economic profit <0.

If firms have the same technology, then all firms make 0 profits.

Equilibrium

in competitive industry keeping all else fixed

SR: market price equates the quantity demanded to the total quantity supplied by the given number of firms in the industry when each firm produces on its short-run supply curve

LR: market price equates the quantity demanded to the total quantity supplied when each firm produces on its long-run supply curve, and the marginal firm makes only normal (zero) profits

Comparative statics for a competitive industry

Change some of the all else fixed: input prices or technology or prices of other goods or consumer incomes …

Model changes to the industry equilibrium in the SR and in the LR

Firm when zero profits

Industry SRS = horizontal sum of the SRS curves of individual (existing) firms. Industry LRS = horizontal sum of the LRS curves of existing firms and firms that might potentially enter the industry.

LRS curve is flatter than the SRS curve.

at firm level: inputs are more flexible in the LR

at industry level: entry and exit, number of firms is flexible

Upward-sloping Supply curve

Many firms with possibly different costs

at P<P*, in the SR some firms make negative profits, but still produce

in the LR, marginal firm breaks even at P=P*, makes normal profit

higher price induces entry of less technologically efficient firms (with higher costs)

to produce more output firms demand more inputs → input prices increase with Q

industry, SRS curve shifts down. The equilibrium moves from B to C. Q ↑, P ↓

Monopoly

1 large supplier (both current and potential)

maximize profit: MR=MC

firm’s downward-sloping demand curve coincides with the whole market demand curve

MR(Q)<P(Q), since P’(Q)<0: can sell an additional unit only by cutting price on all units

typically makes an economic profit in the short run and in the long-run (since no free entry)

MC>0 for all levels of output MR(Q)>0 when |ε| > 1

never produces on the inelastic part of the demand curve

economies of scale over the entire range of output

no supply curve as quantity produced depends on demand

produce Q* if C*=AC(Q*) < P*

maximize profit if produce Q*: MC(Q*)=MR(Q*), charge P*=P(Q*)

welfare is highest with Qc such that Pс = MC (competitive output)

monopoly is inefficient: Qm < Qc

Monopoly vs. Efficiency: Two cases

Artificial Monopoly: Monopolization of competitive industry

constant ac competitive industry

produces Q1 where P=LMC=SMC for each firm monopoly takes over

in the SR produces Q2 where MR=SMC in the LR produces Q3 where MR=LMC deadweight loss.

regulate: break-up.

Natural Monopoly (large economies of scale or network economies)

meets the entire demand from a single plant monopolist chooses QM, where MR=LMC inefficient, DWL

Q* is efficient quantity (P=LMC) but: loss

if break-up, lose economies of scale

1)Order to produce Q at price P: cover LAC, smaller DWL

2)Order to produce Q* at price P*, cover losses via subsidy

3)Two-part tariff: per unit price P* plus fixed sum to cover the fixed costs.

Common carriage, open access: competing firms are allowed and pay to provide goods or services via the same infrastructure, provided by a regulated firm. Competitors pay for use of infrastructure.

Problems:

-Private monopoly: Cost are private information.

-State monopoly: Poor incentives to reduce costs.

Public Policy towards Monopoly

antitrust laws and state regulation (monopoly, merger control, pricing limitations, predatory practices)

state ownership

Price Discrimination

a discriminating monopoly can charge different prices to different consumers

1.1st degree (perfect price) discrimination

makes the MR curve coincide with demand curve (MRPD)

hurdle method of price discrimination – the practice by which a seller offers a discount to all buyers who overcome some obstacle (mail-in rebates, coupons, sales)

2.2nd degree price discrimination

price varies by quantity demanded. larger quantities are offered at a lower unit price.

3.3rd degree price discrimination

price varies by consumer attributes (location, segment) (student or senior discounts)

Price discrimination can be beneficial to both buyers and the monopolist: total surplus is larger.

good points

natural monopolies: production at lower average costs

potential profits provide incentives for r&d: patents and licenses

bad points

monopolist restricts output and drives up prices (bad)

it creates a deadweight loss (lower with price discrimination)