©2017 John M. Abowd and Jennifer P. Wissink, all rights reserved. Unfinished Business from Perfect Competition then onto Simple Monopoly Lecture 21 Dr. Jennifer P. Wissink ©2017 John M. Abowd and Jennifer P. Wissink, all rights reserved. April 19, 2017

External Economies and External Diseconomies If the industry exhibits no external economies or diseconomies, then the industry long run supply curve is perfectly elastic (horizontal). The industry grows by replicating firms at the efficient scale. Entry and exit leaves the position of cost curves intact. This is often called a constant cost industry. If the industry exhibits external diseconomies, then the industry long run supply curve is upward sloping. The minimum average total cost of all firms in the industry rises as the size of the market grows (and falls as it contracts). This is often called an increasing cost industry. If the industry exhibits external economies, then the industry long run supply curve is downward sloping. The minimum average total cost falls as the size of the industry grows (and rises as it contracts). This is often called a decreasing cost industry. Note the difference between EXTERNAL economies/diseconomies and INTERNAL economies/diseconomies of scale

Long Run Market Supply with External Diseconomies $ SRSold SRSnew LRS B C A Dnew Dold 300,000 340,000 Q 330,000 350,000

Long Run Perfectly Competitive Equilibrium - Performance Two Efficiency Definitions The market equilibrium quantity traded (Q) is Pareto/Allocatively Efficient(AE) if net social surplus in the market is maximized. The firm is productively efficient(pe) if its output level (q) is such that the firm’s long-run average total costs are minimized. Question: Do we get either... or both... under perfect competition?

Answer: 1st Fundamental Theorem of Welfare Economics In Pictures THE MARKET a typical firm $ $ lratc SRS w/N* A a mr=δ P* P* D Q* Q q* q

Long Run Perfectly Competitive Equilibrium - Performance Equity: Is the outcome of the competitive process fair? Equitable? Just? Good questions that we do not answer here and now.

RECALL…Various Market Structures Next Batter Up = Monopoly Perfectly Competitive: many firms identical products free entry and exit full and symmetric information Monopoly: single firm no close substitutes, only imperfect substitutes in related markets barriers to entry and possibly exit full and symmetric information, or possibly not

Sources of Monopoly Entry Barriers Technical: Natural monopoly Vital input ownership Technical secrets (the better mousetrap) Legal: Patents Franchises Licenses Strategic: Buy ‘em up Blow ‘em up Let’s make a deal How the Airlines Became Abusive Cartels

Natural Monopoly versus Perfect Competition (& Non-natural Monopoly)

Monopoly Caveats Monopoly does not imply you’re big. Big does not imply you’re a monopoly. Monopoly does not imply you have absolute and unlimited control over price. Monopoly does not imply you must have positive economic profit. Short run profit does not imply monopoly power. Monopoly does not imply a badly behaved firm.

The Classic Simple Monopoly Polar extreme from perfect competition. Monopolist is a “price maker” rather than a “price taker”. Market demand = firm demand Dmarket=δfirm (and it is downward sloping) The simple monopolist abides by the “law of one price.” Everyone pays the same market price for all units purchased, there is no price discrimination... yet. Cost curves are pretty much the same (except in the case of natural monopoly – which we ignore). The big change from before is in the demand side of the profit function.

Relationship Between Price & Marginal Revenue for the Simple Monopolist For all quantities greater than zero, the simple monopolist’s price will be larger than the corresponding marginal revenue. Why? To sell an additional unit, the simple monopolist must lower the price on ALL units sold. Example: Suppose the monopolist is selling 3 units at a price $12 per unit. Total revenue is $36. Suppose to sell 4 units the monopolist must lower his price to $10 per unit. Total revenue is now $40. He picked up $4 in revenue. Notice that his price at 4 units = $10... while his marginal revenue on the 4th unit is only $4. Why? Selling the 4th unit gave him $10 in additional revenue… … but he had to lower the price by $2/unit on the 3 units he used to sell for $12/unit, so he loses $6 in revenue on these units. In the end he picks up $10-$6=$4 in revenue by selling 4 units at $10/unit.