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Chapter 10

Economics 101: Chapter 10

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ECON 101
Robert Gateman

Economics 101: Principles of Microeconomics Chapter 10 10.1 A Single-Price Monopolist Revenue Concepts for a Monopolist:  Short run average cost curve originates from production not market structure o Curve the same for monopoly as perfect competition  Demand curve monopolies face is the original demand curve (of a particular product) o Total quantity consumers would like to purchase at a given price  Monopolies face a negatively sloped demand curve (unlike a perfectly competitive firm) Average Revenue:  Monopolists selling all units for the same price o  Average revenue for all products sold at the same price o  Demand curve is also the monopolist's average revenue curve Marginal Revenue:  Revenue resulting from the sale of one more unit of a product  A firm must reduce price on all units in order to sell one more unit o Marginal revenue is equal to price minus revenue lost  Monopolist's marginal revenue is less than the price at which it sells its output o Marginal revenue curve is below its demand curve   Marginal revenue is always less than price for a monopolist o Important contrast with perfect competition o Perfect competition firm's marginal revenue from an extra unit = market price  Perfectly competitive firms are price takers, monopolists face negatively sloped demand curve o Monopolists must reduce the market price to increase sales  Net change in total revenue is the difference between the initial revenue minus revenue at the new price  Total revenue reaches a maximum when marginal revenue = 0 o Total revenue falls when marginal revenue < 0 o Total revenue increases when marginal revenue > 0 o Monopolists will always produce where marginal revenue > 0 Short-Run Profit Maximization:  Firms should not produce at all unless price (average revenue) exceeds average variable cost  If the firm does produce, it should produce an output level so marginal revenue = marginal cost  Intersection of MR and MC curve that determined the firm's profit maximizing quantity Economics 101: Principles of Microeconomics o Price charged to consumers is determined by the demand curve  Size of monopolists profits depend on the average total cost curve  No guarantee that monopolists make positive profits in the short-run o If it suffers persistent losses, it will eventually go out of business No Supply Curve for a Monopolist:  In perfect competition the supply curve is the marginal cost curve o Unique relationship between market price and Qs by a single firm o Increase in market price leads to an increase in Qs  A monopolist does not have a supply curve because it is not a price taker o Chooses its profit-maximizing price-quantity combination from possible combinations on the market demand curve o The combination on the market demand curve is chosen to maximize profits  Marginal cost curve intersects the marginal revenue curve Firm and Industry:  Monopolists is the only firm, therefore the firm and the industry are the same  Short-run profit maximizing position is also the short-run equilibrium in the industry Competition and Monopoly Compared:  Equilibrium output: price is greater than marginal cost o Gap between price and marginal cost implies the level of output is less than the level of output that would have been produced if it were a price taking industry  Perfectly competitive industry produces a level of output where price = marginal cost  Monopolist produces a lower level of output, with price exceed marginal cost  As price exceeds marginal cost, society would benefit if more units were produced o Marginal value to society of extra units, as reflected by price, exceeds marginal cost of producing the extra units o Economic surplus would be increased with increased production  Monopolists decision to restrict output below the competitive level creates deadweight loss o Leads to market inefficiency Entry Barriers and Long-Run Equilibrium:  Losses and profits provide incentives to exit or enter the industry  Monopolists suffering a loss in the short-run will continue to produce o In the long-run it will leave the industry unless it can cover total costs  If more than one firm enters the industry, it is no longer considered a monopoly o The former monopolist now has to compete with the new firm(s)  If monopolist profits are to persist in the long-run it must prevent other firms from entering  Entry barrier: anything that prevents a new firm from entering an industry (natural or created) Natural Entry Barriers:  Natural barriers commonly arise as a result of economies of scale  Larger firms have a significantly lower average total cost than smaller/newer firms Economics 101: Principles of Microeconomics  Minimum efficient scale: the smallest-size firm that reaps all the economies of large-scale production o Only one firm is able to produce close to or near MES o New entrants have higher unit costs than existing firms  Natural monopoly: industry's demand curve allows one firm to cover its cost while at MES  Set up costs: cost of a new firm entering the industry, development, branding, image etc. Created Entry Barriers:  Many entry barriers are created by conscious government action o Patent laws prevent other firms from producing as the patent holder has the sole legal right to produce (over a specific time period)  A firm may also be granted a charter or franchise that prohibits competition by law o Canada post has a government sanctioned monopoly on fist-class mail o Regulation or licensing of firms severely restricts entry o Professional organizations like dental and engineers restricts the number of firms  Firms already in the market can create barrier to entry o Threats or sabotage can deter entry into the industry (organized crime) o Legal firms attempt to increase setup costs in order to prevent entry  Price cutting, heavy advertising increases losses to new firms in the industry Significance of Entry Barriers:  Freedom of entry/exit in perfect competition (no barriers) means future profits cannot persist  In monopolized industries, profits can persist in the long-run if there are effective barriers  In competitive industries, profits attract entry and entry erodes profits  In monopolized industries, positive profits can persist as long as there are effective barriers Very Long Run and Creative Destruction:  Technology changes and new ways of producing old products are invented o New products are also created to satisfy both familiar and new wants  Monopolies that succeed in preventing the entry of new firms will eventually be circumvented by innovation o Firms may be able to develop a new production process that circumvents a patent  New firms can invent a technology that produces a low MES and covers total costs  Monopolist's entry barriers are often circumvented by innovation of production processes, and the development of new goods/services o Innovation explains why monopolies rarely persist over long periods o If other barriers are not broken new product innovation will circumvent all barriers  Creative Destruction: replacement of o
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