1. ENTREPRENEUR A person who comes up with an idea for a business and coordinates the production and sale of goods and services:A person who comes up with an idea for a business and coordinates the production and sale of goods and services: The entrepreneur builds the production facility, buys raw materials and hires workers.The entrepreneur builds the production facility, buys raw materials and hires workers. An entrepreneur takes risks, committing time and money to a business without any guarantee that the business will be profitable.An entrepreneur takes risks, committing time and money to a business without any guarantee that the business will be profitable.

2. The entry of a second firm would make the market price less than the average cost of production, so a single firm will serve the entire market.The entry of a second firm would make the market price less than the average cost of production, so a single firm will serve the entire market. A single firm is profitable, but a pair of firms would lose money.A single firm is profitable, but a pair of firms would lose money. Classic examples are public utilities (sewerage, water, and electricity generation) and transportation services (railroad freight and mass transit).Classic examples are public utilities (sewerage, water, and electricity generation) and transportation services (railroad freight and mass transit). NATURAL MONOPOLY

3. 8.20 6.20 4.60 3 m c n Long-Run Average Cost Long-Run Marginal Cost Monopolist’s demand (Market demand) Marginal Revenue Billions of Kilowatt Hours Dollars per 1,000KilowattHours

4. THE MARGINAL PRINCIPLE The marginal principle is satisfied at point n, with 3 billion kilowatt hours (kwh) of electricity. The marginal principle is satisfied at point n, with 3 billion kilowatt hours (kwh) of electricity. The price associated with this quantity is $8.20 (shown at point m) and the average cost is $6.20 (shown at point c). The price associated with this quantity is $8.20 (shown at point m) and the average cost is $6.20 (shown at point c). The profit per unit of electricity is $2.00. The profit per unit of electricity is $2.00. The price exceeds the average cost, so the electric company will earn a profit. The price exceeds the average cost, so the electric company will earn a profit.

5. WHAT IF A SECOND FIRM ENTERED THE MARKET ? Entry of a second firm would shift the demand curve for the first firm to the left, from D 1 to D 2 :Entry of a second firm would shift the demand curve for the first firm to the left, from D 1 to D 2 : At each price, the first firm will sell a smaller quantity of electricity, because it now shares the market with another firm.At each price, the first firm will sell a smaller quantity of electricity, because it now shares the market with another firm. In general, the larger the number of firms, the lower the demand curve facing the typical firm in a two-firm market.In general, the larger the number of firms, the lower the demand curve facing the typical firm in a two-firm market.

6. 8.20 6.20 3 m c Long-Run Average Cost Monopolist’s demand (Market demand) Billions of Kilowatt Hours Dollars per 1,000KilowattHours Firm’s Demand Curve with two firms D1D1D1D1 D2D2D2D2

7. WILL A SECOND FIRM ENTER A NATURAL MONOPOLY ? The demand curve for a typical firm in a two-firm market lies entirely below the long- run average-cost curve.The demand curve for a typical firm in a two-firm market lies entirely below the long- run average-cost curve. There is no quantity at which the price exceeds the average cost of production.There is no quantity at which the price exceeds the average cost of production. No matter what price is charged, the firm will lose money.No matter what price is charged, the firm will lose money. A SECOND FIRM WILL NOT ENTER THE MARKET!

8. 8.20 6.20 3 m c Long-Run Average Cost Monopolist’s demand (Market demand) Billions of Kilowatt Hours Dollars per 1,000KilowattHours Firm’s Demand Curve with two firms D1D1D1D1 D2D2D2D2 1.5

9. PRICE CONTROLS FOR A NATURAL MONOPOLY When a monopoly is inevitable, the government often sets a maximum price for the monopolist.When a monopoly is inevitable, the government often sets a maximum price for the monopolist. Local governments regulate utilities and firms that provide water, electricity, and local telephone service.Local governments regulate utilities and firms that provide water, electricity, and local telephone service. State governments use public utility commissions (PUCs) to regulate the electric-power industry.State governments use public utility commissions (PUCs) to regulate the electric-power industry.

10. AVERAGE-COST PRICING POLICY The government picks the price at which the demand curve intersects the average-cost curve.The government picks the price at which the demand curve intersects the average-cost curve.

11. 8.20 3 m Monopolist’s demand (Market demand) Billions of Kilowatt Hours Dollars per 1,000KilowattHours Unregulated Monopoly 5.20 i Original Average Cost Average Cost w / regulation 6.00 5 r Regulated Monopoly

12. Effect of Regulatory Pricing On Firm’s Production Costs Under average-cost pricing, a change in the firm’s production cost will not affect the firm’s profit because the government will adjust the regulated price to keep the price equal to the average cost.Under average-cost pricing, a change in the firm’s production cost will not affect the firm’s profit because the government will adjust the regulated price to keep the price equal to the average cost. Because there is no reward for cutting its costs and no penalty for higher costs, the firm has little incentive to control its cost.Because there is no reward for cutting its costs and no penalty for higher costs, the firm has little incentive to control its cost. Costs will increase, pulling up regulated price.Costs will increase, pulling up regulated price.

13. MONOPOLISTIC COMPETITION MANY FIRMS,MANY FIRMS, DIFFERENTIATED PRODUCT,DIFFERENTIATED PRODUCT, SLIGHT CONTROL OVER PRICE,SLIGHT CONTROL OVER PRICE, NO ARTIFICIAL BARRIERS TO ENTRYNO ARTIFICIAL BARRIERS TO ENTRY

14. MONOPOLISTIC COMPETITION Many Firms:Many Firms: Relatively small economies of scale; small firms can produce at about same average cost as large firms; market can support many firms. Relatively small economies of scale; small firms can produce at about same average cost as large firms; market can support many firms. Differentiated Product:Differentiated Product: Firms sell slightly different products; differentiation with respect to physical characteristics, location, services, and aura or image associated with good. Firms sell slightly different products; differentiation with respect to physical characteristics, location, services, and aura or image associated with good.

15. MONOPOLISTIC COMPETITION Slight control over price:Slight control over price: When a firm increases its price, some of its customers will switch to other firms that sell slightly different products. When a firm increases its price, some of its customers will switch to other firms that sell slightly different products. No artificial barriers to entryNo artificial barriers to entry In a market subject to monopolistic competition, each firm has a monopoly in selling its own differentiated product, but competes with other firms selling similar products. In a market subject to monopolistic competition, each firm has a monopoly in selling its own differentiated product, but competes with other firms selling similar products.

16. HOW FIRMS DIFFERENTIATE THEIR PRODUCT Physical Characteristics:Physical Characteristics: Different size, color, shape, texture, or taste; Examples: athletic shoes, toothpaste, dress shirts, appliances, and pens; Location:Location: Differentiated by where products are sold; Examples: gas stations, music stores, grocery stores, movie theaters, and ice- cream parlors;

17. HOW FIRMS DIFFERENTIATE THEIR PRODUCTS Services:Services: Helpful sales people versus self-service, home delivery, free technical assistance; Aura or Image:Aura or Image: Use of advertising to make products stand out from group of virtually identical products, Examples: aspirin, designer jeans, and motor oil

18. 19 8 300640 m n Monopolist’s demand (market demand) Long-run average cost or long-run marginal cost Marginal Revenue DollarsperCD CDs Sold Per Hour SHORT-RUN EQUILIBRIUM WITH MONOPOLISTIC COMPETITION: A SINGLE MUSIC STORE

19. SHORT-RUN EQUILIBRIUM The marginal principle is satisfied at point n (MR =MC).The marginal principle is satisfied at point n (MR =MC). Monopolist sells 640 CDs per hour.Monopolist sells 640 CDs per hour. Price of CD is $19 (point m), average cost is $8 (point c).Price of CD is $19 (point m), average cost is $8 (point c). Monopolist’s profit per CD is $11.Monopolist’s profit per CD is $11.

20. 19 8 440640 m Monopolist’s demand (market demand) Long-run average cost or long-run marginal cost New Marginal Revenue DollarsperCD CDs Sold Per Hour SHORT-RUN EQUILIBRIUM WITH MONOPOLISTIC COMPETITION: ENTER A SECOND STORE 18 e f D1D1D1D1 D2D2D2D2 Firm’s Demand Curve with two Firms

21. ENTER A SECOND STORE Entry of a second firm shifts the demand curve facing the typical firm left from D 1 to D 2.Entry of a second firm shifts the demand curve facing the typical firm left from D 1 to D 2. The marginal principle is satisfied at point f (MC = new MR).The marginal principle is satisfied at point f (MC = new MR). Each firm will produce 440 CDs per hour at a price of $18 (point e) and an average cost of $8 (point f).Each firm will produce 440 CDs per hour at a price of $18 (point e) and an average cost of $8 (point f). Price of CDs decreases.Price of CDs decreases. Profit per CD decreases from $11 ($19 -$8) to $10 ($18 -$8).Profit per CD decreases from $11 ($19 -$8) to $10 ($18 -$8).

22. 8 Long-run average cost Long-run marginal cost DollarsperCD CDs Sold Per Hour LONG-RUN EQUILIBRIUM WITH MONOPOLISTIC COMPETITION: MUSIC STORES 14 70 h e Demand Curve for Typical Store MarginalRevenue

23. LONG-RUN EQUILIBRIUM WITH MONOPOLISTIC COMPETITION With no artificial barriers to entry, firms will continue to enter market until each music store makes zero economic profit.With no artificial barriers to entry, firms will continue to enter market until each music store makes zero economic profit. As firms enter market, demand curve shifts left.As firms enter market, demand curve shifts left. Typical firm satisfies marginal principle at point g and sells 70 CDs per hour.Typical firm satisfies marginal principle at point g and sells 70 CDs per hour. Price is $14 (point h) and average cost is $14 -- zero economic profit.Price is $14 (point h) and average cost is $14 -- zero economic profit.

24. As the number of firms increases, the profit per CD decreases for two reasons: Lower Price -Lower Price - The stores compete for customers by cutting prices. The stores compete for customers by cutting prices. Higher Average Cost -Higher Average Cost - As more firms enter market, eventually move upward along negatively-sloped portion of average-cost curve to higher average cost (fewer CDs sold per store). As more firms enter market, eventually move upward along negatively-sloped portion of average-cost curve to higher average cost (fewer CDs sold per store). LONG-RUN EQUILIBRIUM WITH MONOPOLISTIC COMPETITION

25. TRADEOFFS WITH MONOPOLISTIC COMPETITION Good News: Lower Price -Good News: Lower Price - Competition decreases the price of a product. Competition decreases the price of a product. Good News: Lower Travel Cost -Good News: Lower Travel Cost - With larger number of competitors, the shorter the distance each customer must travel to the nearest store. With larger number of competitors, the shorter the distance each customer must travel to the nearest store. Bad News: Higher Average Cost -Bad News: Higher Average Cost - As output per store decreases, the average cost of a typical store increases. As output per store decreases, the average cost of a typical store increases.