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study notes ch6-8

Course Code
Junchul Kim
Study Guide

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Chapter 6:
With increasing returns/economies of scale (e.g. monopoly, oligopoly, where doubling
the inputs to an industry will more than double the industry’s production), markets
usually become imperfectly competitive—thus economies of scale provide an incentive
for international trade.
-to get the labour to expand its production of some goods, country A must decrease
or abandon the production of others
-these goods will then be produced in country B instead, using the labour formerly
employed in the industries whose production has expanded in country A
* international trade makes it possible for each country to produce a restricted
range of goods and to take +ve of economies of scale without sacrificing variety in
consumption; thus leads to an increase in the variety of goods available
External Economies of Scale:
-when the cost per unit depends on the size of the industry but not necessarily on
the size of any one firm
-e.g. the efficiency of firms is increased by having a larger industry, even though
each firm is the same size as before
-many small firms, thus perfectly competitive
Internal Economies of Scale:
-when the cost per unit depends on the size of an individual firm but not
necessarily on that of the industry
-e.g. when the costs of production fall, a firm is more efficient if its output is larger
-cost +ve to large firms, thus imperfectly competitive
Perfectly Competitive Market: a market in which there are many buyers and sellers,
nobody represents a large part of the market, thus all firms are price takers
Imperfect Competition: firms are aware that they can influence the price of their
products, they can sell more only by reducing their price, thus each firm is a price setter
Monopoly: Marginal Revenue/MR is always less than the price, b/c to sell an additional
unit the firm must lower the price of all units, not just the marginal one:
1) depends on how much output the firm is already selling: a firm that’s not selling
very many units will not lose much by cutting the price it receives on those units
2) also the slope of demand curve: if flat, then monopolist can sell an additional unit
with only a small price cut, MR will be close to the price per unit; if steep, selling
an additional unit will require a large price cut, thus MR much less than price
Linear Cost Function: C= F+ c* Q

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-F: fixed costs, independent of the firm’s output
-c: marginal cost
-Q: the firm’s output
* the F gives rise to economies of scale, b/c the larger the firm’s outputs, the less is the
fixed cost per unit
Average Cost/AC=C/Q=F/Q+ c
* this AC declines as Q increases b/c F is spread over a larger output
Profit Maximization: MR=MC
when P >AC, the monopolist is earning some monopoly profits
Oligopoly: several firms, each of them large enough to affect prices, but non with an
uncontested monopoly (characterized by internal economies of scale)
-pricing policies of firms are interdependent
-when setting price, each firm will consider the responses of consumers and
expected responses of competitors
-collusive behavior : each firm may keep its price higher than the apparent profit-
maximizing level as part of an understanding that other firms will do the same;
thus profits of all the firms could increase (one firm as a price leader)
-strategic behavior : may do things that seem to lower profits but affect the
behavior of competitors in a desirable way; e.g. build extra capacity not to use it
but to deter potential rivals from entering its industry
Monopolistic Competition: (a special case of oligopoly)
1) each firm is assumed to be able to differentiate its product from that of its rivals,
thus product differentiation
2) each firm is assumed to take the prices charged by its rivals as given, it ignores
the impact of its own price on the prices of other firms
-thus even though each firm is in fact facing competition from other firms, it
behaves as if it were a monopolist
-e.g. automobile industry in Europe, with Ford, General Motors, Volkswagen, etc
-assumes that firms can gain customers only at each others’ expenses
-the more firms there are in the industry, the higher is average cost, b/c the less
each firm produces
-the more firms there are, the more intense will be the competition among them,
thus the lower the price
-if P> AC, the industry makes profits and additional firms will enter the industry
-if P >AC, losses, thus firms will leave the industry
* Equilibrium: P= AC, zero profit
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