1. Perfectly Competitive Industry  A large number of small firms  A single firm’s production decision does not significantly affect the price.  MR curve horizontal: MR = Price Monopoly  One large firm  Monopoly produces a quantity and charges a price that lies on the market demand curve.  MR curve lies beneath the market demand curve: MR < Price  MR = MC Profit Maximization Price = MR = MCPrice > MR = MC  Price = MC  Price > MC Question: Why is the relationship between price and marginal cost important? Perfect Competition, Monopoly, and Profit Maximization or Price = MR or Price > MR Efficiency and Pareto

2. Pareto’s Efficiency Question: Are we getting the most from our economy’s finite resources? Could the monopoly be earning negative profit? Why is monopoly bad?P Q D MR MC Q* P* Monopoly: MR curve lies below the demand curve Profit maximization: MR = MC Monopoly: P and Q lie on the demand curve. ATC Monopolies exploit the public by earning obscenely high profits? Question: Can we determine the monopoly’s profit from the information appearing on the diagram? Answer: No, we need to compare the price and the ATC curve. Could the monopoly be earning positive profit? P > ATC P < ATC Profit > 0Profit < 0 Pareto’s Query: Given the state of affairs in question, is it possible to make at least one individual better off without hurting anyone else? Yes  Is the state of affairs getting the most from the economy’s resources? No  State of affairs is inefficient. No  Is the state of affairs getting the most from the economy’s resources? Yes  State of affairs is efficient. Profit = TR – TC = (P – ATC)  Q

3. Question:Would the special deal affect anyone else? Price ($ per hamburger) Quantity (hamburgers) 200 15010050 2.00 1.50 1.00.50 D MC MR How many hamburgers will Mary produce? What price will she charge? What does her marginal cost equal? 50 $1.00 $1.50 State of Affairs Q = 50 P = 1.50 MC = 1.00 Question: Is this state of affairs efficient? Pareto’s Query: Given the state of affairs in question, is it possible to make at least one individual better off without hurting anyone else? Yes: InefficientNo: Efficient Joe: Does not buy a hamburger at the profit maximizing price of $1.50, but would buy a hamburger if the price were $1.40. How do we know that a person like Joe exists? Special Deal: Mary produces another hamburger and sells it to Joe for $1.30. Question:Would the special deal make Joe better off? Question:Would the special deal make Mary better off? No Yes Profit = Total Revenue  Total Cost Up 1.30 Up 1.00 Up.30 Yes Profit maximization: MR = MC 50 Monopoly: P and Q on the demand curve. 1.50 1.00 The demand curve is downward sloping.

4. Yes  Is the state of affairs getting the most does not from the economy’s resources? No.  State of affairs inefficient. No Pareto’s Efficiency Question: Are we getting the most from our economy’s finite resources? Pareto’s Query: Given the state of affairs in question, is it possible to make at least one individual better off without hurting anyone else?  Is the state of affairs getting the most does not from the economy’s resources? Yes.  State of affairs efficient. Intuition: Accurate information, misleading information, and efficiency Price  Consumers base their decisions on the price Marginal Cost  Reflects the costs of the resources needed to produce the good When Price  Marginal Cost  Consumers base their decisions on misleading information When Price = Marginal Cost  Consumers base their decisions on accurate information  Inefficiency results  Efficiency results Intuition

5. Perfectly Competitive Industry  A large number of small firms  A single firm’s production decision does not significantly affect the price.  MR curve horizontal: MR = Price Monopoly  One large firm  Monopoly produces a quantity and charges a price that lies on the market demand curve.  MR curve lies beneath the market demand curve: MR < Price  MR = MC Profit Maximization Price = MR = MCPrice > MR = MC  Price = MC  Price > MC Monopoly is inefficient because price is greater than marginal cost. Perfect Competition, Monopoly, and Profit Maximization or Price = MR or Price > MR Consumers base decisions on misleading information

6. Case 2: When the regulated price is less than $1.25, the price is less than marginal cost; consequently, the production of fewer hamburgers would allow us to make at least one individual better off without hurting anyone else. Case 1: When the regulated price is greater than $1.25, the price exceeds marginal cost; consequently, the production of more hamburgers would allow us to make at least one individual better off without hurting anyone else. Price ($ per hamburger) Quantity (hamburgers) 200 15010050 2.00 1.50 1.00.50 D MC MR Regulating Mary’s Firm: To justify our preview consider the following scenario in which the local government regulates Mary’s business. Suppose that the local government regulates Mary’s fast food restaurant: The government regulates the price of hamburgers (the government sets the price of hamburgers). Mary is required to produce a hamburger for all consumers that wish to purchase one at the regulated price. Claim: Efficient State of Affairs: Q = 75P = $1.25MC = $1.25 1.25 75

7. Price ($ per hamburger) Quantity (hamburgers) 200 15010050 2.00 1.50 1.00.50 D MC Case 1: When the regulated price is greater than $1.25, the price exceeds marginal cost; consequently, the production of more hamburgers would allow us to make at least one individual better off without hurting anyone else. Suppose that the regulated price equals $1.50. 50 1.50 How many hamburgers would consumers demand? How many hamburgers would produce? What would Mary’s marginal cost equal? State of Affairs Q = 50 P = $1.50 MC = $1.00 Joe does not purchase a hamburger at a price of $1.50, but would purchase a hamburger if the price were $1.40 How do we know that a consumer like Joe exists? Special Deal: Mary produces one more hamburger and sells it to Joe for $1.30. Is Joe better off? Is Mary better off? 1.00 50 $1.00 Yes Would the special deal affect anyone else? Pareto’s Query: Given the state of affairs in question, is it possible to make at least one individual better off without hurting anyone else? No Profit = Total Revenue  Total Cost Up 1.30 Up 1.00 Up.30 Yes: InefficientNo: Efficient Generalization: When the price is greater than marginal cost (Price > Marginal Cost) : Are consumers decisions based on a price that overstates or understate production costs? Is the state of affairs inefficient? Should more of less output be produced? The quantity of output is inefficiently low. Yes More Overstates

8. Price ($ per hamburger) Quantity (hamburgers) 200 15010050 2.00 1.50 1.00.50 D MC Case 2: When the regulated price is less than $1.25, the price is less than marginal cost; consequently, the production of fewer hamburgers would allow us to make at least one individual better off without hurting anyone else. Suppose that the regulated price equals $.75. 125.75 How many hamburgers would consumers demand? How many hamburgers would produce? What would Mary’s marginal cost equal? State of Affairs Q = 125 P = $.75 MC = $1.75 Joan does purchase a hamburger at a price of $.75, but would not purchase a hamburger if the price were $1.00 How do we know that a consumer like Joan exists? Special Deal: Mary produces one less hamburger and gives Joan $.50 on the condition she will not buy a hamburger. Is Joan better off? Is Mary better off? 1.75 125 $1.75 Yes Would the special deal affect anyone else? Pareto’s Query: Given the state of affairs in question, is it possible to make at least one individual better off without hurting anyone else? No Profit = Total Revenue  Total Cost Down.75 Down 1.75 Up.50 Yes: InefficientNo: Efficient.50+.75= 1.25 Down 1.25 Generalization: When the price is less than marginal cost (Price < Marginal Cost) : Are consumers decisions based on a price that overstates or understate production costs? Is the state of affairs inefficient? Should more of less output be produced? The quantity of output is inefficiently high. Yes Less Understates

9. Case 1: When the regulated price is greater than $1.25, the price is greater than marginal cost; consequently, the production of more hamburgers would allow us to make at least one individual better off without hurting anyone else. Case 2: When the regulated price is less than $1.25, the price is less than marginal cost; consequently, the production of fewer hamburgers would allow us to make at least one individual better off without hurting anyone else. Price > Marginal CostPrice = Marginal CostPrice < Marginal Cost  Consumption decisions based on information that overestimates real production costs  Consumption decisions based on information that accurately reflects real production costs  Consumption decisions based on information that underestimates real production costs  Consumers demand too little.  Consumers demand too much  Firm produces too little.  Firm produces too much  Inefficiently low quantity.  Inefficiently high quantity Efficient quantity Efficient State of Affairs: Q = 75P = $1.25MC = $1.25 P Q D MC 1.25 75