Chapter 9. Perfect Competition and Monopoly

Topics to be Discussed

nProfit Maximization

nMarginal Revenue, Marginal Cost, and Profit Maximization

nChoosing Output in the Short Run / Long Run

nPerfectly Competitive Markets

Introduction

nCharacteristics of Perfectly Competitive Markets

1)Identical products

2)Individual firms are too small to impact the market

3)No barriers to entry and exit

Marginal Revenue, Marginal Cost, and Profit Maximization

nDetermining the profit maximizing level of output

•Profit = Total Revenue - Total Cost

•Total Revenue (R) = Pq

•Total Cost (C) = Cq

Profit Maximization in the Short Run

Marginal Revenue, Marginal Cost, and Profit Maximization

nObservations

R(q)

–R(q) slope = marginal revenue

C(q)

–C(q) slope = marginal cost

nMarginal revenue is the additional revenue from producing one more unit of output.

nMarginal cost is the additional cost from producing one more unit of output.

nComparing R(q) and C(q)

–MR > MC
•Indicates higher profit at higher output

Marginal Revenue, Marginal Cost, and Profit Maximization

nComparing R(q) and C(q)

•Output levels

–MR = MC

nTherefore, it can be said:

Profits are maximized when MC = MR.

nThe Competitive Firm : Price Taker

A) The competitive firm’s demand

–Individual producer sells all units for $4 regardless of the producer’s level of output.
–If the producer tries to raise price, sales are zero.
–If the producers tries to lower price he cannot increase sales
–P = D = MR = AR

B) The competitive firm’sProfit Maximization

–MC(q) = MR = P

nSummary of Production Decisions

5. A competitive firm’s short run supply curve is MC above AVC

The Short-Run Market Supply Curve

nProducer Surplus in the Short Run

•Firms earn a surplus on all but the last unit of output.

•The producer surplus is the sum over all units produced of the difference between the market price of the good and the marginal cost of production.

•The consumer surplus is the sum over all units produced of the difference between the market price of the good and the marginal cost of production.

•

DEADWEIGHT LOSS ?Monopoly

1) One seller

2)One product (no good substitutes)

3)Barriers to entry

nThe monopolist is the supply-side of the market and has complete control over the amount offered for sale.

nProfits will be maximized at the level of output where marginal revenue equals marginal cost.

nObservations

1)To increase sales the price must fall

2)MR < P

3)Compared to perfect competition

–No change in price to change sales
–MR = P

nMonopolist’s Output Decision

1)Profits maximized at the output level where MR = MC

2)Cost functions are the same

nA Rule of Thumb for Pricing

•We want to translate the condition that marginal revenue should equal marginal cost into a rule of thumb that can be more easily applied in practice.

: This equation is familiar, isn’t it?

•How does the price set by a monopolist compare with the price under competitive market?

•We saw that P=MC in a competitive market. A monopolist charges a price that exceeds marginal cost, but by an amount that depends inversely on the E.

•If demand is very elastic, there is little benefit to being a monopolist. [WHY ?????]

•REMEMBER THIS

For the competitive market, price equals to marginal cost; for the firm with monopoly power, price exceeds marginal cost.

•Therefore the national way to measure monopoly power is to examine the extent to which the profit-maximizing price exceeds marginal cost. The measure of monopoly power is called the Lerner Index of Monopoly Power

L = (P-MC) / P

The larger L, the greater the degree of monopoly power.

nSources of Monopoly Power

1)E

2)The Number of Firms ( Monopolistic Competition Case)

3)Interaction among Firms.

QUESTION 1.

A firm has two factories, for which costs are given by

Factory #1: C1 = 10Q12

Factory #2: C2 = 20Q22

The firm faces the following demand curve

P=700-5Q

Where Q is total output Q=Q1+Q2

  1. On a diagram, draw the MC, AR, MR curves for two factories, and the total marginal cost curve (i.e., the marginal cost of producing Q (i.e., Q=Q1+Q2)
  2. Indicate the profit-maximizing output for each factory.
  3. Calculate the values of Q1, Q2 and P, that maximize profit.

QUESTION 2.

A monopolist faces the demand curve P=11 -- Q , where P is measured in dollars per unit and Q in thousands of units. The monopolist has a constant average cost of $6 per unit.

  1. On a diagram, draw the AR, MR, AC and MC curves. What are the monopolist’s profit-maximizing price and quantity, and what is the resulting profit?
  2. Calculate the firm’s degree of monopoly power using the Lerner Index.