Topic 1 - Perfect competition, monopoly, dominant firms & welfare

Topic 1 - Perfect competition, monopoly, dominant firms & welfare

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Fall 2011 Overview of course Aim : Apply optimization & equilibrium analysis to study markets in which firms have market power. Market power refers to the ability of firms to raise price above marginal cost. Topic 1: Perfect competition, monopoly, dominant Outline Profit maximization, elasticity and the Lerner index Efficiency, welfare and deadweight loss Perfect competition Dominant firm model Reading ch.2 (pp. 19-40) ch.4 (pp. 111-45) Lectures : 1- 2 EC620 Topic 1: Perfect competition, monopoly, dominant firms 1 of 12
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Fall 2011 Elasticity and marginal revenue Price elasticity of demand is given by Marginal revenue equals… …the gain in revenue from serving new buyers which is given by the price …and the lost revenues from lowering price to existing customers which are… …small if η is large as then only a small P cut is needed to attract new buyers EC620 Topic 1: Perfect competition, monopoly, dominant firms 2 of 12
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Fall 2011 Profit maximization The profit maximizing output level… …satisfies the first order condition (FOC), i.e. …i.e. satisfies (Marginal profit = 0) …i.e. satisfies (MR = MC) ...implies the following mark-up under monopoly η - 2 - 3 - 4 - 5 L 50 % 33 % 25 % 20 % ...satisfies the second order condition (SOC) …i.e. satisfies 2 π / q 2 < 0 …i.e. satisfies (slope MR < slope MC) A profit maximizing firm will stay in an industry… …provided revenues exceed opportunity costs …i.e. P ≥ AC …i.e. economic profits are non-negative EC620 Topic 1: Perfect competition, monopoly, dominant firms 3 of 12
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Fall 2011 Efficiency, Welfare and Deadweight Loss An allocation is efficient if it maximizes Welfare which is equal to… …Benefit minus cost …Consumer surplus (Benefit – Spending) + Producer surplus (Revenue – Variable cost) + Tax revenue – Fixed costs
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Topic 1 - Perfect competition, monopoly, dominant firms &amp; welfare

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