1. © 2005 Thomson C hapter 11 Price and Output in Monopoly, Monopolistic Competition, and Perfect Competition

2. © 2005 Thomson 2 Gottheil - Principles of Economics, 4e Economic Principles Price, output and economic profit under conditions of monopoly Price, output and economic profit for the firm in monopolistic competition Normal profit

3. © 2005 Thomson 3 Gottheil - Principles of Economics, 4e 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

4. © 2005 Thomson 4 Gottheil - Principles of Economics, 4e Economic Principles The Schumpeterian illustration of low price and high efficiency under conditions of monopoly

5. © 2005 Thomson 5 Gottheil - Principles of Economics, 4e Monopoly Price and Output Monopolists are distinguished from other types of entrepreneurs by their market position—not by their motivation, morality, strategy or objective.

6. © 2005 Thomson 6 Gottheil - Principles of Economics, 4e 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. Monopoly Price and Output

7. © 2005 Thomson 7 Gottheil - Principles of Economics, 4e EXHIBIT 1MARKET DEMAND FOR ICE

8. © 2005 Thomson 8 Gottheil - Principles of Economics, 4e 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. Exhibit 1: Market Demand for Ice

9. © 2005 Thomson 9 Gottheil - Principles of Economics, 4e 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. Exhibit 1: Market Demand for Ice

10. © 2005 Thomson 10 Gottheil - Principles of Economics, 4e 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.

11. © 2005 Thomson 11 Gottheil - Principles of Economics, 4e Recall the MR = MC Rule: Expand production if MR > MC. Profit is maximized when MR = MC. Price and Output Under Monopoly

12. © 2005 Thomson 12 Gottheil - Principles of Economics, 4e 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. Price and Output Under Monopoly

13. © 2005 Thomson 13 Gottheil - Principles of Economics, 4e Price and Output Under Monopoly Economic profit A firm’s total revenue minus its total explicit and implicit costs.

14. © 2005 Thomson 14 Gottheil - Principles of Economics, 4e EXHIBIT 2COST AND REVENUE SCHEDULES FOR THE NICK RUDD ICE COMPANY Note: Figures are rounded to the nearest dollar.

15. © 2005 Thomson 15 Gottheil - Principles of Economics, 4e Exhibit 2: Cost and Revenue Schedule for the Nick Rudd Ice 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.

16. © 2005 Thomson 16 Gottheil - Principles of Economics, 4e Exhibit 2: Cost and Revenue Schedule for the Nick Rudd Ice 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.

17. © 2005 Thomson 17 Gottheil - Principles of Economics, 4e Exhibit 2: Cost and Revenue Schedule for the Nick Rudd Ice 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.

18. © 2005 Thomson 18 Gottheil - Principles of Economics, 4e Exhibit 2: Cost and Revenue Schedule for the Nick Rudd Ice Company 3. At what output should the company be producing in order to maximize profit? This is the output level where MR = MC.

19. © 2005 Thomson 19 Gottheil - Principles of Economics, 4e 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.

20. © 2005 Thomson 20 EXHIBIT 3PRICE AND OUTPUT DETERMINATION IN MONOPOLY

21. © 2005 Thomson 21 Gottheil - Principles of Economics, 4e 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.

22. © 2005 Thomson 22 Gottheil - Principles of Economics, 4e Exhibit 3: Price and Output Determination in Monopoly At quantity 300, the price (read off the demand curve) is $150. The average total cost (read off the ATC curve) is $52. What is the total profit for the profit maximizing firm in Exhibit 4?

23. © 2005 Thomson 23 Gottheil - Principles of Economics, 4e 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.

24. © 2005 Thomson 24 Gottheil - Principles of Economics, 4e 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.

25. © 2005 Thomson 25 EXHIBIT 4RUDD’S DEMAND CURVE AS NEW FIRMS ENTER THE MARKET

26. © 2005 Thomson 26 Gottheil - Principles of Economics, 4e 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

27. © 2005 Thomson 27 Gottheil - Principles of Economics, 4e 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

28. © 2005 Thomson 28 Gottheil - Principles of Economics, 4e 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

29. © 2005 Thomson 29 EXHIBIT 5RUDD’S PRICE AND OUTPUT IN A MONOPO- LISTICALLY COMPETITIVE MARKET

30. © 2005 Thomson 30 Gottheil - Principles of Economics, 4e 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.

31. © 2005 Thomson 31 Gottheil - Principles of Economics, 4e Exhibit 5: Rudd’s Price and Output in a Monopolistically Competitive Market 2. Is Rudd’s better off or worse off in the monopolistically competitive market? Rudd’s is worse off. Under monopolistic competition, economic profit declines.

32. © 2005 Thomson 32 Gottheil - Principles of Economics, 4e Exhibit 5: Rudd’s Price and Output in a Monopolistically Competitive Market 3. Are consumers better off or worse off in the monopolistically competitive market? Consumers are better off. The price they pay is lower and the quantities they buy are greater.

33. © 2005 Thomson 33 Gottheil - Principles of Economics, 4e 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.

34. © 2005 Thomson 34 EXHIBIT 6RUDD’S LONG-RUN EQUILIBRIUM PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION

35. © 2005 Thomson 35 Gottheil - Principles of Economics, 4e 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.

36. © 2005 Thomson 36 Gottheil - Principles of Economics, 4e 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.

37. © 2005 Thomson 37 Gottheil - Principles of Economics, 4e 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.

38. © 2005 Thomson 38 Gottheil - Principles of Economics, 4e 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.

39. © 2005 Thomson 39 Gottheil - Principles of Economics, 4e 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.

40. © 2005 Thomson 40 Gottheil - Principles of Economics, 4e 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.

41. © 2005 Thomson 41 Gottheil - Principles of Economics, 4e 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.

42. © 2005 Thomson 42 Gottheil - Principles of Economics, 4e EXHIBIT 7ATHE COMPETITIVE FIRM’S COST STRUCTURE

43. © 2005 Thomson 43 EXHIBIT 8BTHE COMPETITIVE FIRM’S COST STRUCTURE

44. © 2005 Thomson 44 Gottheil - Principles of Economics, 4e 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 8? 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.

45. © 2005 Thomson 45 Gottheil - Principles of Economics, 4e 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.

46. © 2005 Thomson 46 Gottheil - Principles of Economics, 4e Price and Output in Perfect Competition For firms in perfect competition, price always equals marginal revenue (P = MR).

47. © 2005 Thomson 47 Gottheil - Principles of Economics, 4e EXHIBIT 8ADEMAND AND SUPPLY FOR ICE IN A PERFECTLY COMPETITIVE MARKET

48. © 2005 Thomson 48 Gottheil - Principles of Economics, 4e EXHIBIT 8BDEMAND AND SUPPLY FOR ICE IN A PERFECTLY COMPETITIVE MARKET

49. © 2005 Thomson 49 Gottheil - Principles of Economics, 4e 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.

50. © 2005 Thomson 50 Gottheil - Principles of Economics, 4e 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.

51. © 2005 Thomson 51 Gottheil - Principles of Economics, 4e 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.

52. © 2005 Thomson 52 Gottheil - Principles of Economics, 4e 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.

53. © 2005 Thomson 53 Gottheil - Principles of Economics, 4e Short-Run Equilibrium Price and Output for the Firm in Perfect Competition Each producer must adjust its output to maximize profit at the new equilibrium price.

54. © 2005 Thomson 54 Gottheil - Principles of Economics, 4e EXHIBIT 9ATHE PERFECTLY COMPETITIVE FIRM IN THE SHORT RUN

55. © 2005 Thomson 55 EXHIBIT 9BTHE PERFECTLY COMPETITIVE FIRM IN THE SHORT RUN

56. © 2005 Thomson 56 Gottheil - Principles of Economics, 4e Exhibit 9: The Perfectly Competitive Firm in the Short-Run 1. How does a price-taker know what output maximizes profit? The price-taker uses the MR = MC rule. Since MR is always equal to price, the firm must determine the output where MC is equal to price.

57. © 2005 Thomson 57 Gottheil - Principles of Economics, 4e Exhibit 9: The Perfectly Competitive Firm in the Short-Run 2. What is the economic profit received by the firm in Exhibit 9? Economic profit = $(78 - 51) × 5.5 = $148.50.

58. © 2005 Thomson 58 Gottheil - Principles of Economics, 4e EXHIBIT 10EFFECTS OF A SHIFT IN MARKET SUPPLY

59. © 2005 Thomson 59 Gottheil - Principles of Economics, 4e Exhibit 10: Effects of a Shift in Market Supply 1. How does the equilibrium price change as the supply curve shifts from S 1 to S 2 to S 3 in Exhibit 10? The short-run equilibrium price changes from $78 at S 1 to $60 at S 2 and to $47 at S 3.

60. © 2005 Thomson 60 Gottheil - Principles of Economics, 4e Exhibit 10: Effects of a Shift in Market Supply 2. How does the change in price affect the economic profit of firms? With each decrease in price, economic profit decreases. At an output of 4.5 tons, price equals ATC. Economic profit is zero.

61. © 2005 Thomson 61 Gottheil - Principles of Economics, 4e Long-Run Equilibrium Price and Output for the Firm in Perfect Competition The long-run equilibrium position of firms in perfect competition is identified by P = MR = MC = ATC.

62. © 2005 Thomson 62 Gottheil - Principles of Economics, 4e EXHIBIT 11THE MARKET AND FIRM IN LONG-RUN EQUILIBRIUM

63. © 2005 Thomson 63 Gottheil - Principles of Economics, 4e Exhibit 11: The Market and Firm in Long-Run Equilibrium At what point along the ATC curve does the firm in perfect competition end up producing in the long run? The firm produces at the lowest point on its ATC curve.

64. © 2005 Thomson 64 EXHIBIT 12ANATOMY OF THE FIRM’S LONG-RUN SUPPLY CURVE

65. © 2005 Thomson 65 Gottheil - Principles of Economics, 4e Exhibit 12: Anatomy of the Firm’s Long-Run Supply Curve Where does the supply curve begin for the firm in Exhibit 13? The supply curve begins at the point where MC = ATC on its marginal cost curve. Any point on the supply curve below that point will result in loss to the firm.

66. © 2005 Thomson 66 Gottheil - Principles of Economics, 4e Long-Run Equilibrium Price and Output for the Firm in Perfect Competition The market supply curve is the aggregation of the long-run MC curves of the firms in the market.

67. © 2005 Thomson 67 Gottheil - Principles of Economics, 4e EXHIBIT 13ANATOMY OF THE MARKET SUPPLY CURVE

68. © 2005 Thomson 68 Gottheil - Principles of Economics, 4e Exhibit 13: Anatomy of the Market Supply Curve When P = $100, what is the total market supply? At P = $100, 150 firms are willing to supply 6 tons each. Market supply = 150 firms × 6 tons = 900 tons.

69. © 2005 Thomson 69 Gottheil - Principles of Economics, 4e EXHIBIT 14THE INNOVATOR FIRM IN PERFECT COMPETITION

70. © 2005 Thomson 70 Gottheil - Principles of Economics, 4e Exhibit 14: The Innovator Firm in Perfect Competition Complete this sentence: Innovation results in _____ economic profit in the long-run. i. Higher ii. The same iii. Lower

71. © 2005 Thomson 71 Gottheil - Principles of Economics, 4e Exhibit 14: The Innovator Firm in Perfect Competition Complete this sentence: Innovation results in _____ economic profit in the long-run. i. Higher ii. The same iii. Lower

72. © 2005 Thomson 72 Gottheil - Principles of Economics, 4e Exhibit 14: The Innovator Firm in Perfect Competition Complete this sentence: Innovation results in _____ economic profit in the long-run. i. Higher ii. The same —Economic profit may initially rise, but it will return to zero in the long-run. iii. Lower

73. © 2005 Thomson 73 Gottheil - Principles of Economics, 4e EXHIBIT 15CONSTANT AND INCREASING RETURNS TO SCALE

74. © 2005 Thomson 74 Gottheil - Principles of Economics, 4e Exhibit 15: Constant and Increasing Returns to Scale How does ATC change between panel a and panel b in Exhibit 15? In panel a, constant returns to scale, the minimum ATC is the same for small and large firms. In panel b, increasing returns to scale, ATC falls as firm size and output increase.

75. © 2005 Thomson 75 Gottheil - Principles of Economics, 4e The Schumpeter Hypothesis According to economist Joseph Schumpeter, bigness can be an advantage for an innovating firm. The economies of scale and low average costs of production available to big firms may allow them to charge prices that are actually lower than those charged by small, competitive firms.

76. © 2005 Thomson 76 Gottheil - Principles of Economics, 4e The Schumpeter Hypothesis Monopoly profits permit these firms to experiment with new technologies that ultimately lead to more efficient production.

77. © 2005 Thomson 77 Gottheil - Principles of Economics, 4e The Schumpeter Hypothesis Other economists, such as Alfred Marshall, disagree. They contend that the large number of small firms that undertake innovation will lead to the greatest efficiency in production over time.

78. © 2005 Thomson 78 Gottheil - Principles of Economics, 4e EXHIBIT 16MONOPOLY AND PERFECT COMPETITION: SCHUMPETER’S VIEW

79. © 2005 Thomson 79 Gottheil - Principles of Economics, 4e 1. What is price and quantity for the competitive firm in panel a? Price is $25. With 200 firms in the market, quantity supplied to the market is 4,000. Exhibit 16: Monopoly and Perfect Competition: Schumpeter’s View

80. © 2005 Thomson 80 Exhibit 16: Monopoly and Perfect Competition: Schumpeter’s View 2. How does the competitive firm’s price and quantity compare to the monopoly in panel b? The monopoly’s price is $20—$5 less than the competitive firm’s price. The monopoly’s output quantity is 10,000 — 6,000 greater than the competitive firm’s output.