2. 1 © ©1999 South-Western College Publishing PowerPoint Slides prepared by Ken Long Principles of Economics 2nd edition by Fred M Gottheil

3. 2 Chapter 11 Price & Output in Monopoly, Monopolistic Competition, & Perfect Competition 1/15/2015 © ©1999 South-Western College Publishing

4. 3 Price and output in monopoly Recall monopoly, single firm, no close substitutes, barriers to entry

5. 4 In monopoly, firm is a price maker

6. 5 What is a Price Maker? A firm that has the ability to choose among combinations of price and output, attempting to find the profit maximizing combination

7. 6 How does a Monopoly determine Price & Output to maximize profits? MR = MC © ©1999 South-Western College Publishing

8. 7 Why are profits maximized MR = MC? MR > MC (keep producing) MR < MC (stop producing) MR = MC (no $ gained or lost on the last unit) © ©1999 South-Western College Publishing

9. 8 What does the Demand Curve look like for a Monopoly? It is the same as the market demand curve

10. 9 D Demand curve in Monopoly, same as the market demand P 9 Q

11. 10 What is Marginal Revenue? TR Q © ©1999 South-Western College Publishing MR =

12. 11 Recall that in perfect competition, MR = P, but this is not the case in monopoly. The firm cannot sell any amount at the same price, but must lower price in order to sell more

13. 12 Price Q $50 2 $40 3 $30 4 $20 5 $10 6 What is TR at the 3rd unit? $120 12

14. 13 Price Q $50 2 $40 3 $30 4 $20 5 $10 6 What is MR at the 3rd unit? $20 13

15. 14 Price Q $50 2 $40 3 $30 4 $20 5 $10 6 What is MR at the 5th unit? -$20 14

16. 15 Why is MR < P for all but the first unit of output for a Monopoly? To sell additional units the firm not only has to lower price on the last unit, but on all previous units © ©1999 South-Western College Publishing

17. 16 Demand Marginal Revenue MR < P for all but the first unit of output P 16 Q

18. 17 Profit maximization in monopoly Put in the marginal cost curve, best output is where MR=MC, best price for that output is found by going up to the demand curve

19. 18 Best price and output for monopoly Q $ MR MC D 18 Q P

20. 19 Short run profit possibilities As always in the short run, can make positive profits, losses, or zero economic profits-to show profit, must add in the average total cost curve.

21. 20 Monopoly: Positive Profit Q $ MR ATC MC D 20 Q P Profit P ATC

22. 21 Monopoly: Loss Case Q $ MR ATC MC D ATC 21 Q P P Loss

23. 22 Monopoly: Zero Profits Case Q $ MR ATC MC D ATC 22 Q P P

24. 23 When will a firm continue to operate even when making a loss? When its losses are less than its fixed costs: in other words, as long as Price exceeds AVC, can stay in business in the short run

25. 24 When will a firm shut down when making a loss? When its losses are greater than its fixed costs © ©1999 South-Western College Publishing

26. 25 How does Monopoly compare to Perfect Competition ? Higher prices & less output under monopoly Long run profits possible in monopoly due to barriers to entry © ©1999 South-Western College Publishing

27. 26 Move from monopoly to monopolistic competition Recall the characteristics of monopolistic competition: many firms, producing similar yet differentiated products, relatively free entry

28. 27 What does the graphic model look like for Monopolistic Competition compared to Monopoly? It looks very similar because both face a downward sloping demand curve—possibly more elastic in monopolistic competition due to more close substitutes.

29. 28 Why are demand curves downward sloping in Monopolistic Competition? Because a firm can distinguish itself from competitors and therefore has some control over price © ©1999 South-Western College Publishing

30. 29 What happens to the demand curve with more competition? The demand curve for an existing firm will become more elastic and shift to the left as entry occurs © ©1999 South-Western College Publishing

31. 30 More Elastic More Elastic P Q 30 © ©1999 South-Western College Publishing D2 More Inelastic D1D1

32. 31 What is Normal Profit? The minimum profit a business owner will accept to continue operating the business ( same as zero economic profit)

33. 32 What is Economic Profit? Money made above and beyond a normal profit © ©1999 South-Western College Publishing

34. 33 In Monopolistic Competition, can Economic Profit be made in the short run? Yes! Positive or negative economic profit can be made in the short run

35. 34 Why is Normal Profit the long run equilibrium in Monopolistic Competition? Because when positive economic profit is made, firms will enter the industry eliminating the economic profit

36. 35 In monopolistic competition, what happens as more firms enter in search of profits? The demand curve of other firms shifts to the left © ©1999 South-Western College Publishing

37. 36 Now move from monopolistic competition to perfect competition Recall the characteristics of perfect competition: many firms, each a tiny share of the market, producing identical products, free entry and perfect information

38. 37 Why does a Perfectly Competitive firm face a horizontal demand curve? Because it can sell all it brings to market at the market price, therefore P always equals MR © ©1999 South-Western College Publishing

39. 38 Why is a firm that is a part of a Perfectly Competitive Market a price taker? Because if the firm charges higher than the market price it will not sell one unit © ©1999 South-Western College Publishing

40. 39 Why is this so? Because consumers will buy the same thing at a lower price from its competitors © ©1999 South-Western College Publishing

41. 40 The Market and the firm in Perfect Competition The Market P S D Individual firm P P=MR 40

42. 41 Q MC MR1=P1 MR1=MC MR2=P2 Profits are maximized where MR = MC MR2=MC P 41 Q1Q2

43. 42 Why is a firm’s MC curve above its AVC curve its Supply Curve? Because it always produces where MR = MC © ©1999 South-Western College Publishing

44. 43 Why don’t we include the MC curve below its AVC curve as a part of its Supply Curve? Because below the AVC the firm will close down © ©1999 South-Western College Publishing

45. 44 What is the Market’s Supply Curve? It is the aggregation of the long-run MC curves of the firm’s in the market © ©1999 South-Western College Publishing

46. 45 In Perfect Competition, can Economic Profit be made in the short run? Yes! Positive or negative economic profit can be made in the short run

47. 46 Why is a Normal Profit (zero economic profits) made in the long run? Because of the easy entry - easy exit feature in a Perfectly Competitive Market © ©1999 South-Western College Publishing

48. 47 ATC MC Zero Profits in Perfect Competition 47 P Q1 P = MR P = ATC

49. 48 What happens when a firm makes more than a Normal Profit? More firms enter the industry pushing prices down toward a normal profit © ©1999 South-Western College Publishing

50. 49 S1 S2 P1 Right Shift in Supply P2 Q2 Q1 D 4949 © ©1999 South-Western College Publishing

51. 50 What happens when a firm makes less than a Normal Profit? Some firms leave the industry pushing prices up toward a normal profit © ©1999 South-Western College Publishing

52. 51 S2 S1 P2 Left Shift in Supply P1 Q1 Q2 D 5151 © ©1999 South-Western College Publishing

53. 52 The Long Run adjustments in Perfect Competition The Market Individual firm 52 P S D P P=MR MC ATC D1 S1 P P1 QQ1

54. 53 Explanation of long run adjustments  Start at price P, typical firm making zero profits  Suppose demand increases to D 1  Price rises to P1  Typical firm making positive profits  What happens in the long run?  Assuming perfect information and free entry, new firms enter the market  Supply shifts right until profits eliminated  Price comes down—but how far depends on whether costs are affected

55. 54 Long Run, continued  Constant cost industry: no change in costs as new firms enter the market, price returns to P, original price  Increasing cost industry: all firms experience rising costs as new firms enter the market, final price will be higher than original price P  Decreasing cost industry: all firms experience lower costs as new firms enter the market, final price will be lower than original price

56. 55 ATC MC Zero Profits in Perfect Competition 55 P Q1 P = MR P = ATC

57. 56 Whats so “perfect” about Perfect Competition?  Note that Q1 output is the output which minimizes ATC, sometimes called the technically efficient output level  Also, at Q1, P = MC, price equals marginal cost, sometimes called the allocative or social efficiency condition

58. 57 According to Joseph Schumpeter why are monopolies more innovative than perfect competition? Because of its deeper financial pockets, can afford more for research and development

59. 58 Are big firms necessarily more innovative? Not necessarily: some small firms are very innovative- this is still a controversial area in economics.

60. 59 Why are profits maximized where MR = MC?Why are profits maximized where MR = MC? Why is MR < P for all but the first unit of output for a Monopoly?Why is MR < P for all but the first unit of output for a Monopoly? What does the Demand Curve look for a Monopoly?What does the Demand Curve look for a Monopoly? When will a firm continue to operate even when making a loss?When will a firm continue to operate even when making a loss?

61. 60 What is Normal Profit? What is Economic Profit? Why do firms tend to make a Normal Profit when others enter the market?Why do firms tend to make a Normal Profit when others enter the market? Why does a Perfectly Competitive firm face a horizontal demand curve?Why does a Perfectly Competitive firm face a horizontal demand curve? Why is a firm’s MC curve above its AVC curve its Supply Curve?Why is a firm’s MC curve above its AVC curve its Supply Curve?

62. 61 ENDEND © ©1999 South-Western College Publishing