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Chapter 12

Chapter 12 Reading Notes.docx

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Michael H O

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Chapter 12 Reading Notes Market Structure Industry Characteristics Perfect competition • Many small firms • Sells identical products • Free entry and exit • Zero profits in long run equilibrium • Price = MC Monopolistic competition • Many small firms • Differentiated products • Each firm has some power to set price • Free entry and exit • Zero profits in long run • Price>MC; less output than in perf comp; excess Oligopoly • few firms that are large • follow strategic behaviour • differentiated products and are price setters • often significant entry barriers • usually economies of scale • profits depends on the nature of firm rivalry and on entry barriers • price is usually > MC; output usually less than in perfect competition Monopoly • single firm faces the entire market demand • firm is a price setter • profits persist if sufficient entry barriers • price > MC; less output than in perfect competition Here are three examples of inefficiency in the use of fully employed resources 1. if firms don't use the least cost method, they are being inefficient. EXAMPLE: producing something at a certain price when you could've produced it at a lower price. 2. if marginal costs of production are not the same for every firm in an industry, the industry is being inefficient. EXAMPLE: having to produce something at a higher price than other firms. 3. Having too much or too little of one product. Productive Efficiency • has two aspects, one concerning production within each firm and one concerning the allocation of production among the firms in an industry. • productive efficiency for the firm requires that the firm produce any given level of output at the lowest possible cost. • productive efficiency for the firm requires the firm to be producing its output at the lowest possible cost. • productive efficiency for industry requires the industry's total output be allocated among its individual firms in such a way that the total cost in the industry is minimized. It requires that the marginal cost be the same for each firm. Productive Efficiency and the Production possibilities Boundary (PPB) • if firms are productively efficient, they are minimizing their costs; there is no way for them to increase output without using more resources. • A firm that is producing inside the PPB is being productively inefficient - it could produce more of one good without producing less of the other. This inefficiency may occur because individual firms aren't minimizing their costs or because marginal costs aren't equalized across the various firms. • If firms and industries are productively efficient, the economy will be on, rather than inside the PPB. Allocative efficiency (MORE ON PAGE 282) • This concerns the quantities of the various products to be produced. • When the combination of goods produced is allocatively efficient, economists say that the economy is PARETO EFFICIENT. • The economy is allocatively efficient when, for each good produced, its marginal cost of production is equal to its price (marginal value). • If the level of output of some product is such that marginal cost to producers exceeds marginal value to consumers, too much of that product is being produced, because the cost to society of the last unit produced exceeds the benefits of consuming it. If level of output is less that the marginal value, too little of that product is produced, because the cost to society of producing the next unit is less thatn the benefits that would be gained from consuming it. Allocative Efficiency and the PPB (READ ON 283-284) • Allocative efficiency requires that all goods be produced to the point where the marginal cost to producers quals the marginal value to consumers. • Any point on the PPB is efficient, and if it's inside then it isn't • LOOOOOOOOOOOOK AT THE GRAAAAAAAAAAAAPHS. Which Market Structures are efficient? - in each industry, for allocative efficiency, marginal cost should be equal to price in each industry Perfect Competition • In the long run each firm produces at the lowest point on its long-run average cost curve. Therefore, no one firm can reduce its costs by altering its own production. Every firm in perf comp is productively efficient. • All firms in this face the same price and they equate marginal cost to that price. • Perf comp firms maximize their profits by choosing an output level such that marginal cost equals market price. Thus, when perfect competition is the market structure for the whole economy, price is equal to marginal cost in each industry, resulting in allocative efficiency. Monopoly • Monopolists have an incentive to be productively efficient because their profits will be maximized when they adopt the lowest- cost production method. Hence, profit-maximizing monnopolists will operate on the LRAC curves and thus the productively efficient. • Monopoly is not allocatively efficient because the monopolist's price is always exceeds its marginal cost • Monopolist will choose a level of output that is too low to achieve allocative efficiency (but they're still being productively efficient). The monopolist chooses an output at which the price charged is greater than marginal cost. Oligopoly - 286 • The allocative inefficiency of monopoly extends to other imperfectly competitive market structures. • Whenever a firm has any market power, in the sense that it faces a negatively sloped demand curve, its marginal revenue will be less than its price. When it equates marginal cost to marginal revenue as all profit-maximizing firms do, marginal cost will also be less than price. • This inequality implies an allocative inefficiency. Thus, oligopoly and monopolistic competition are also allocatively inefficient. • Oligopoly is an important market structure in today's economy because in many industries the minimum efficient scale is simply too high to s
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