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Unformatted text preview: inefficiency. We will continue in this spirit by thinking about some additional sources of economic inefficiency arising from institutional constraints such as monopoly power, government policies, and regulations. With this context in mind, we will look at some of the potential pitfalls when conducting economic policy by examining the "theory of second best". 269 MONOPOLY We already know that monopoly and perfect competition are the two ends of the spectrum of market structures. [Perfect Competition]
Market Structure [Monopoly] Let's refresh our memory by comparing the salient features of these two extreme theoretical models of market structure side-by-side. PERFECT COMPETITION Many individual firms make up the supply side of the market. None of these firms has any significant influence on the market. Both free entry and exit are allowed. All competitive firms face horizontal demand curves. MONOPOLY One single firm controls the supply side of the market. This single firm (called the monopolist) has a large influence on the market. There is no free entry, but free exit is sometimes still allowable. The monopolist faces a downward sloping demand curve and a corresponding marginal revenue curve. Profits can be positive, negative or zero depending on how high or low the demand curve is. The optimal level of output for a monopolist is determined by the rule MR = MC Which is the intersection point of (a) marginal revenue curve MR (b) marginal cost curve MC There are zero profits in the long run due to free entry and exit. The optimal output level of a competitive firm is determined by the rule P = MC Which is the intersection point of (a) horizontal price line PC (b) marginal cost curve MC (c) average cost curve AC 270 P MC AC P MC PM PC
D MR QM Q QC Q There is a very close relationship between the firm's demand curve and its marginal revenue curve. Consider the following demand curve: P = f(Q) where P and Q denote the price and quantity, respectively. The total revenue is define...
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This note was uploaded on 05/25/2010 for the course ECON 301 taught by Professor Sning during the Spring '10 term at University of Warsaw.
- Spring '10