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101+Class+24+W2009 - Principles of Economics I Economics...

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Unformatted text preview: Principles of Economics I Economics 101 Announcements Readings: Chapter 11: Competitive Markets Chapter 14: Monopoly Discussion Sections this week New problem set available on Ctools Last discussion section this week No quiz Supply shocks How does the competitive market respond to supply shocks? Technological innovation Changes in input prices Environmental changes Dealt with on this week's assignment In the long run, an individual (active) firm's behavior will only vary as a result of supply shocks Dynamics in the competitive industry (identical firms) AC, MC ($) Short run profits MC0 AC0 MC1 AC Min AC 1 P S0SR S1SR S2SR P0 P1 SLR SLR D PSR q0 q1 q Q0 Q1 Q Summary In the long run, competitive markets tend to Offer little or no profit to firms Generate changes in output primarily through entry and exit (rather than individual firms varying output) Prices reflect average costs of production When firms have the same production technology, P = minimum AC Production is efficient Why are there no profits in the competitive industry? Profits forced to zero by free entry and exit Implication: (Supernormal) profits only available if there are barriers to entry If there are barriers to entry, no reason to think that prices reflect average production costs Likelihood of inefficiency Competitive Spectrum Very competitive Not competitive Perfect competition: Free entry and exit, price takers, identical products Monopolistic Competition: Free entry and exit, price setting, differentiated products Oligopoly: Barriers to entry, strategic pricing concerns Monopoly: Barriers to entry, price setting Monopoly Means "one seller" Barrier to entry protects firm from competition Lack of competition gives firm power over price Profits not forced to zero No longer price taker Price-taking Pricetaker believes $ that any quantity can be sold at the given price P If the price is P, then selling an extra unit generates an extra $P. Additional Revenue = P Effective Demand Revenue Q Q+1 Qi Price Setting Pricemaker faces the market demand curve To sell an additional unit the price must fall Extra revenue from selling the marginal unit is lower than the price for which it sells P Decrease in revenue = Q . P Increase in revenue = P1 P0 P1 Demand Q Q+1 Q Marginal Revenue Marginal Revenue (MR) = Increase in revenue generated by selling an additional unit of output If MR > MC increase output If MR < MC decrease output If the firm is a price taker, MR = P If the firm is a price maker, MR < P Deriving Marginal Revenue Inverse demand: P = 8 Q Q 0 1 2 3 4 5 P 8 7 6 5 4 3 Revenue MR 7 5 3 1 1 0 7 12 15 16 15 P, MR ($) 8 7 5 Marginal Revenue Demand: Q = 8 P Inverse Demand: P = 8 Q Marg. Revenue: MR = 8 2Q 3 1 1 Demand 1 2 3 4 5 6 MR 7 8 Q Linear Demand and MR Demand: Q = a b P Inverse demand: P = (a Q)/b Total revenue: TR = Q (a Q)/b TR a2/4b TR Slope = TR/Q = MR Q a/2 a Q Linear Demand and MR MR decreases as Q increases MR is zero when TR is at a maximum Eventually becomes negative Occurs at the midpoint of the demand curve Have previously identified this as the point where = 1 TR Slope = TR/Q = MR Slope = TR/Q = MR=0 a2/4b TR Q a/2 a Q P, MR ($) A/b Marginal Revenue Demand: Q = A b P Inverse demand: P = A/b Q/b Marg. Revenue: MR = A/b 2Q/b Demand A/2 A MR Q P, MR ($) A/b P1 P2 Marginal Revenue Demand: Q = A b P Area A = Q . P A B A Area B = P2 = Area A + Area C Area C = Area B Area A = P Q . P = MR Q P C Q Q+1 D A/2 MR A Q=1 Profit Maximization Marginal Revenue (MR) = Increase in revenue generated by selling an additional unit of output If MR > MC increase output If MR < MC decrease output Profits are maximized when MR = MC P, MR, MC, AC ($) Marginal Revenue Producer Surplus Profits MC P AC AC Demand Q* Q MR Inefficiencies of Monopoly P Gain in producer surplus/profits (transfer from consumers) Deadweight Loss Lost consumer surplus Pmon Pcomp Loss in producer surplus/profits Demand Qmon MC (Supply) Qeff MR Q ...
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