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C hapter 11. Price and Output in Monopoly, Monopolistic Competition, and Perfect Competition. Economic Principles. Price, output and economic profit under conditions of monopoly Price, output and economic profit for the firm in monopolistic competition Normal profit. Economic Principles.

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C hapter 11

Chapter 11

Price and Output in Monopoly, Monopolistic Competition, and Perfect Competition


Economic principles
Economic Principles

  • Price, output and economic profit under conditions of monopoly

  • Price, output and economic profit for the firm in monopolistic competition

  • Normal profit

Gottheil - Principles of Economics, 4e


Economic principles1
Economic Principles

  • Price, output and economic profit for the firm in perfect competition

  • The perfectly competitive firm’s supply curve

  • Market supply in perfect competition

Gottheil - Principles of Economics, 4e


Economic principles2
Economic Principles

  • The Schumpeterian illustration of low price and high efficiency under conditions of monopoly

Gottheil - Principles of Economics, 4e


Monopoly price and output
Monopoly Price and Output

Monopolists are distinguished from other types of entrepreneurs by their market position—not by their motivation, morality, strategy or objective.

Gottheil - Principles of Economics, 4e


Monopoly price and output1
Monopoly Price and Output

Price-maker

  • A firm conscious of the fact that its own activity in the market affects price. The firm has the ability to choose among combinations of price and output.

Gottheil - Principles of Economics, 4e


EXHIBIT 1 MARKET DEMAND FOR ICE

Gottheil - Principles of Economics, 4e


Exhibit 1 market demand for ice
Exhibit 1: Market Demand for Ice

Which price and quantity choices does the ice company have available in Exhibit 1?

  • The ice company has unlimited choices. It is a price maker and can choose any combination of price and output it wants.

Gottheil - Principles of Economics, 4e


Exhibit 1 market demand for ice1
Exhibit 1: Market Demand for Ice

Which price and quantity choices does the ice company have in Exhibit 1?

  • Although the ice company can charge higher prices, the company must recognize that at higher prices, fewer tons of ice will be demanded.

Gottheil - Principles of Economics, 4e


Exhibit 1 market demand for ice2
Exhibit 1: Market Demand for Ice

Which price and quantity choices does the ice company have in Exhibit 1?

  • The company uses the MR = MC rule to determine what combination of price and output will maximize profit.

Gottheil - Principles of Economics, 4e


Price and output under monopoly
Price and Output Under Monopoly

Recall the MR = MC Rule:

  • Expand production if MR > MC.

  • Profit is maximized when MR = MC.

Gottheil - Principles of Economics, 4e


Price and output under monopoly1
Price and Output Under Monopoly

Marginal cost (MC) is the increase in total cost when an additional unit of output is added to production.

Marginal revenue (MR) is the change in total revenue generated by the sale of one additional unit of goods and services.

Gottheil - Principles of Economics, 4e


Price and output under monopoly2
Price and Output Under Monopoly

Economic profit

  • A firm’s total revenue minus its total explicit and implicit costs.

Gottheil - Principles of Economics, 4e


EXHIBIT 2 COST AND REVENUE SCHEDULES FOR THE NICK RUDD ICE COMPANY

Note: Figures are rounded to the nearest dollar.

Gottheil - Principles of Economics, 4e


Exhibit 2 cost and revenue schedule for the nick rudd ice company
Exhibit 2: Cost and Revenue Schedule for the Nick Rudd Ice Company

1. What is the company’s economic profit when 50 tons of ice are produced?

  • Economic profit = total revenue - total cost = $(13,750 - 8,500) = $5,250.

Gottheil - Principles of Economics, 4e


Exhibit 2 cost and revenue schedule for the nick rudd ice company1
Exhibit 2: Cost and Revenue Schedule for the Nick Rudd Ice Company

2. Since the company is a price-maker, should it charge the highest price possible?

  • No. The highest price possible does not necessarily generate the most profit.

Gottheil - Principles of Economics, 4e


Exhibit 2 cost and revenue schedule for the nick rudd ice company2
Exhibit 2: Cost and Revenue Schedule for the Nick Rudd Ice Company

3. At what output should the company be producing in order to maximize profit?

  • The company should be producing 300 tons of ice in order to maximize profit.

Gottheil - Principles of Economics, 4e


Exhibit 2 cost and revenue schedule for the nick rudd ice company3
Exhibit 2: Cost and Revenue Schedule for the Nick Rudd Ice Company

3. At what output should the company be producing in order to maximize profit?

  • This is the output level where MR = MC.

Gottheil - Principles of Economics, 4e


Maximum profit but less than maximum efficiency
Maximum Profit, but Less than Maximum Efficiency Company

  • The profit-maximizing output is not necessarily the most efficient output.

  • There may be output levels that have a lower average total cost (ATC).

  • The firm is interested in maximum profit, however, not maximum efficiency.

Gottheil - Principles of Economics, 4e


EXHIBIT 3 CompanyPRICE AND OUTPUT DETERMINATION IN MONOPOLY


Exhibit 3 price and output determination in monopoly
Exhibit 3: Price and Output Determination in Monopoly Company

What is the total profit for the profit-maximizing firm in Exhibit 4?

  • The profit-maximizing firm produces where MR = MC. This point is at a quantity of 300 in Exhibit 4.

Gottheil - Principles of Economics, 4e


Exhibit 3 price and output determination in monopoly1
Exhibit 3: Price and Output Determination in Monopoly Company

What is the total profit for the profit maximizing firm in Exhibit 4?

  • At quantity 300, the price (read off the demand curve) is $150. The average total cost (read off the ATC curve) is $52.

Gottheil - Principles of Economics, 4e


Exhibit 3 price and output determination in monopoly2
Exhibit 3: Price and Output Determination in Monopoly Company

What is the total profit for the profit maximizing firm in Exhibit 4?

  • Total profit = $(150-52) × 300 = $29,400.

Gottheil - Principles of Economics, 4e


Price and output in monopolistic competition
Price and Output in Monopolistic Competition Company

  • One way that a new firm can break into a market is through product differentiation.

  • The trick is to differentiate the product enough to claim uniqueness, yet keep it close enough to existing competition.

Gottheil - Principles of Economics, 4e


EXHIBIT 4 CompanyRUDD’S DEMAND CURVE AS NEW FIRMS ENTER THE MARKET


Exhibit 4 rudd s demand curve as new firms enter the market
Exhibit 4: Rudd’s Demand Curve as New Firms Enter the Market

As new firms enter a market, the demand curve for the existing firms becomes:

i. More elastic

ii. Less elastic

Gottheil - Principles of Economics, 4e


Exhibit 4 rudd s demand curve as new firms enter the market1
Exhibit 4: Rudd’s Demand Curve as New Firms Enter the Market

As new firms enter a market, the demand curve for the existing firms becomes:

i. More elastic

ii. Less elastic

Gottheil - Principles of Economics, 4e


Exhibit 4 rudd s demand curve as new firms enter the market2
Exhibit 4: Rudd’s Demand Curve as New Firms Enter the Market

As new firms enter a market, the demand curve for the existing firms becomes:

i. More elastic—More substitutes become available, which increases the price elasticity of demand.

ii. Less elastic

Gottheil - Principles of Economics, 4e


EXHIBIT 5 MarketRUDD’S PRICE AND OUTPUT IN A MONOPO- LISTICALLY COMPETITIVE MARKET


Exhibit 5 rudd s price and output in a monopolistically competitive market
Exhibit 5: Rudd’s Price and Output in a Monopolistically Competitive Market

1. How does the ice company determine the best output level to produce after new firms have entered the market?

  • The ice company determines its production level the same way it did before—it uses the MR=MC rule.

Gottheil - Principles of Economics, 4e


Exhibit 5 rudd s price and output in a monopolistically competitive market1
Exhibit 5: Rudd’s Price and Output in a Monopolistically Competitive Market

2. Is Rudd’s better off or worse off in the monopolistically competitive market?

  • Rudd’s is worse off. Under monopolistic competition, economic profit declines.

Gottheil - Principles of Economics, 4e


Exhibit 5 rudd s price and output in a monopolistically competitive market2
Exhibit 5: Rudd’s Price and Output in a Monopolistically Competitive Market

3. Are consumers better off or worse off in the monopolistically competitive market?

  • Consumers are better off. The price they pay is lower and the quantities they buy are greater.

Gottheil - Principles of Economics, 4e


Price and output in monopolistic competition1
Price and Output in Monopolistic Competition Competitive Market

  • As long as there is economic profit to be made, firms will continue to enter a market.

  • The limit to further entry is the point where the demand curve is tangent to the ATC curve.

Gottheil - Principles of Economics, 4e


EXHIBIT 6 Competitive MarketRUDD’S LONG-RUN EQUILIBRIUM PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION


Exhibit 6 rudd s long run equilibrium price and output in monopolistic competition
Exhibit 6: Rudd’s Long-Run Equilibrium Price and Output in Monopolistic Competition

1. At what output level is profit maximized in Exhibit 6?

  • Profit is maximized at an output level of 150.

Gottheil - Principles of Economics, 4e


Exhibit 6 rudd s long run equilibrium price and output in monopolistic competition1
Exhibit 6: Rudd’s Long-Run Equilibrium Price and Output in Monopolistic Competition

2. What are price and average total cost at this output level?

  • Both price and average total cost are $82. The demand curve is tangent to the ATC curve.

Gottheil - Principles of Economics, 4e


Exhibit 6 rudd s long run equilibrium price and output in monopolistic competition2
Exhibit 6: Rudd’s Long-Run Equilibrium Price and Output in Monopolistic Competition

3. What is Rudd’s economic profit at this output level?

  • Economic profit = $(82-82) × 150 = 0.

Gottheil - Principles of Economics, 4e


Exhibit 6 rudd s long run equilibrium price and output in monopolistic competition3
Exhibit 6: Rudd’s Long-Run Equilibrium Price and Output in Monopolistic Competition

4. If economic profit is zero, should Rudd’s produce at some other output?

  • No. The MR = MC rule always signals the firm’s most profitable output level, even if the profit is zero. Every other output level in this case would yield a loss.

Gottheil - Principles of Economics, 4e


Price and output in monopolistic competition2
Price and Output in Monopolistic Competition Monopolistic Competition

Normal profit

  • The entrepreneur’s opportunity cost. It is equal to or greater than the income an entrepreneur could receive employing his or her resources elsewhere. Normal profit is included in the firm’s costs.

Gottheil - Principles of Economics, 4e


Price and output in monopolistic competition3
Price and Output in Monopolistic Competition Monopolistic Competition

Even though the economic profit of a firm may be zero, the firm still generates a normal profit—a wage—for the entrepreneur. The normal profit is at least as much as the entrepreneur can earn elsewhere.

Gottheil - Principles of Economics, 4e


Price and output in perfect competition
Price and Output in Perfect Competition Monopolistic Competition

  • There is no product differentiation in a perfectly competitive market.

  • Firms in perfect competition are typically modest in size.

Gottheil - Principles of Economics, 4e


EXHIBIT 7A Monopolistic CompetitionTHE COMPETITIVE FIRM’S COST STRUCTURE

Gottheil - Principles of Economics, 4e


EXHIBIT 8B Monopolistic CompetitionTHE COMPETITIVE FIRM’S COST STRUCTURE


Exhibit 7 the competitive firm s cost structure
Exhibit 7: The Competitive Firm’s Cost Structure Monopolistic Competition

How does ATC change as the firm changes output from 4.5 to 6.0 in Exhibit 8?

  • At an output of 4.5, the firm achieves its minimum ATC of $47.

  • ATC increases to $55 when the firm increases output to 6.0.

Gottheil - Principles of Economics, 4e


Price and output in perfect competition1
Price and Output in Perfect Competition Monopolistic Competition

Price-taker

  • A firm that views market price as a given and considers any activity on its own part as having no influence on that price.

Gottheil - Principles of Economics, 4e


Price and output in perfect competition2
Price and Output in Perfect Competition Monopolistic Competition

For firms in perfect competition, price always equals marginal revenue (P = MR).

Gottheil - Principles of Economics, 4e


EXHIBIT 8A Monopolistic CompetitionDEMAND AND SUPPLY FOR ICE IN A PERFECTLY COMPETITIVE MARKET

Gottheil - Principles of Economics, 4e


EXHIBIT 8B Monopolistic CompetitionDEMAND AND SUPPLY FOR ICE IN A PERFECTLY COMPETITIVE MARKET

Gottheil - Principles of Economics, 4e


Exhibit 8 demand and supply for ice in a perfectly competitive market
Exhibit 8: Demand and Supply for Ice in a Perfectly Competitive Market

1. What is the equilibrium price and quantity demanded in panel a of Exhibit 8?

  • The equilibrium price is $78 and the quantity demanded is 440.

Gottheil - Principles of Economics, 4e


Exhibit 8 demand and supply for ice in a perfectly competitive market1
Exhibit 8: Demand and Supply for Ice in a Perfectly Competitive Market

2. Why is the firm’s demand curve horizontal?

  • The firm is a price-taker. The firm must charge the equilibrium price regardless of the quantity it produces.

Gottheil - Principles of Economics, 4e


Exhibit 8 demand and supply for ice in a perfectly competitive market2
Exhibit 8: Demand and Supply for Ice in a Perfectly Competitive Market

3. Should a firm in perfect competition increase its price in order to generate more profit?

  • No. If the firm increases its price by even a penny, then the firm will not be able to sell any product.

Gottheil - Principles of Economics, 4e


Short run equilibrium price and output for the firm in perfect competition
Short-Run Equilibrium Price and Output for the Firm in Perfect Competition

  • Economic profit will attract new producers to a market.

  • As new producers enter the market, the supply curve shifts to the right, forcing the equilibrium price to fall.

Gottheil - Principles of Economics, 4e


Short run equilibrium price and output for the firm in perfect competition1
Short-Run Equilibrium Price and Output for the Firm in Perfect Competition

  • Each producer must adjust its output to maximize profit at the new equilibrium price.

Gottheil - Principles of Economics, 4e


EXHIBIT 9A Perfect CompetitionTHE PERFECTLY COMPETITIVE FIRM IN THE SHORT RUN

Gottheil - Principles of Economics, 4e


EXHIBIT 9B Perfect CompetitionTHE PERFECTLY COMPETITIVE FIRM IN THE SHORT RUN


Exhibit 9 the perfectly competitive firm in the short run
Exhibit 9: The Perfectly Competitive Firm in the Short-Run Perfect Competition

1. How does a price-taker know what output maximizes profit?

  • The price-taker uses the MR = MC rule. Since MR is always equal to price, the firm must determine the output where MC is equal to price.

Gottheil - Principles of Economics, 4e


Exhibit 9 the perfectly competitive firm in the short run1
Exhibit 9: The Perfectly Competitive Firm in the Short-Run Perfect Competition

2. What is the economic profit received by the firm in Exhibit 9?

  • Economic profit = $(78 - 51) × 5.5 = $148.50.

Gottheil - Principles of Economics, 4e


EXHIBIT 10 Perfect CompetitionEFFECTS OF A SHIFT IN MARKET SUPPLY

Gottheil - Principles of Economics, 4e


Exhibit 10 effects of a shift in market supply
Exhibit 10: Effects of a Shift Perfect Competitionin Market Supply

1. How does the equilibrium price change as the supply curve shifts from S1 to S2 to S3in Exhibit 10?

  • The short-run equilibrium price changes from $78 at S1 to $60 at S2 and to $47 at S3.

Gottheil - Principles of Economics, 4e


Exhibit 10 effects of a shift in market supply1
Exhibit 10: Effects of a Shift Perfect Competitionin Market Supply

2. How does the change in price affect the economic profit of firms?

  • With each decrease in price, economic profit decreases. At an output of 4.5 tons, price equals ATC. Economic profit is zero.

Gottheil - Principles of Economics, 4e


Long run equilibrium price and output for the firm in perfect competition
Long-Run Equilibrium Price and Output Perfect Competitionfor the Firm in Perfect Competition

The long-run equilibrium position of firms in perfect competition is identified by P = MR = MC = ATC.

Gottheil - Principles of Economics, 4e


EXHIBIT 11 Perfect CompetitionTHE MARKET AND FIRM IN LONG-RUN EQUILIBRIUM

Gottheil - Principles of Economics, 4e


Exhibit 11 the market and firm in long run equilibrium
Exhibit 11: The Market and Firm Perfect Competitionin Long-Run Equilibrium

At what point along the ATC curve does the firm in perfect competition end up producing in the long run?

  • The firm produces at the lowest point on its ATC curve.

Gottheil - Principles of Economics, 4e


EXHIBIT 12 Perfect CompetitionANATOMY OF THE FIRM’S LONG-RUN SUPPLY CURVE


Exhibit 12 anatomy of the firm s long run supply curve
Exhibit 12: Anatomy of the Firm’s Long-Run Supply Curve Perfect Competition

Where does the supply curve begin for the firm in Exhibit 13?

  • The supply curve begins at the point where MC = ATC on its marginal cost curve.

  • Any point on the supply curve below that point will result in loss to the firm.

Gottheil - Principles of Economics, 4e


Long run equilibrium price and output for the firm in perfect competition1
Long-Run Equilibrium Price and Output Perfect Competitionfor the Firm in Perfect Competition

The market supply curve is the aggregation of the long-run MC curves of the firms in the market.

Gottheil - Principles of Economics, 4e


EXHIBIT 13 Perfect CompetitionANATOMY OF THE MARKET SUPPLY CURVE

Gottheil - Principles of Economics, 4e


Exhibit 13 anatomy of the market supply curve
Exhibit 13: Anatomy of the Market Supply Curve Perfect Competition

When P = $100, what is the total market supply?

  • At P = $100, 150 firms are willing to supply 6 tons each.

  • Market supply = 150 firms × 6 tons = 900 tons.

Gottheil - Principles of Economics, 4e


EXHIBIT 14 Perfect CompetitionTHE INNOVATOR FIRM IN PERFECT COMPETITION

Gottheil - Principles of Economics, 4e


Exhibit 14 the innovator firm in perfect competition
Exhibit 14: The Innovator Firm in Perfect Competition Perfect Competition

Complete this sentence: Innovation results in _____ economic profit in the long-run.

i. Higher

ii. The same

iii. Lower

Gottheil - Principles of Economics, 4e


Exhibit 14 the innovator firm in perfect competition1
Exhibit 14: The Innovator Firm in Perfect Competition Perfect Competition

Complete this sentence: Innovation results in _____ economic profit in the long-run.

i. Higher

ii. The same

iii. Lower

Gottheil - Principles of Economics, 4e


Exhibit 14 the innovator firm in perfect competition2
Exhibit 14: The Innovator Firm in Perfect Competition Perfect Competition

Complete this sentence: Innovation results in _____ economic profit in the long-run.

i. Higher

ii. The same—Economic profit may initially rise, but it will return to zero in the long-run.

iii. Lower

Gottheil - Principles of Economics, 4e


EXHIBIT 15 Perfect CompetitionCONSTANT AND INCREASING RETURNS TO SCALE

Gottheil - Principles of Economics, 4e


Exhibit 15 constant and increasing returns to scale
Exhibit 15: Constant and Increasing Returns to Scale Perfect Competition

How does ATC change between panel a and panel b in Exhibit 15?

  • In panel a, constant returns to scale, the minimum ATC is the same for small and large firms.

  • In panel b, increasing returns to scale, ATC falls as firm size and output increase.

Gottheil - Principles of Economics, 4e


The schumpeter hypothesis
The Schumpeter Hypothesis Perfect Competition

  • According to economist Joseph Schumpeter, bigness can be an advantage for an innovating firm.

  • The economies of scale and low average costs of production available to big firms may allow them to charge prices that are actually lower than those charged by small, competitive firms.

Gottheil - Principles of Economics, 4e


The schumpeter hypothesis1
The Schumpeter Hypothesis Perfect Competition

  • Monopoly profits permit these firms to experiment with new technologies that ultimately lead to more efficient production.

Gottheil - Principles of Economics, 4e


The schumpeter hypothesis2
The Schumpeter Hypothesis Perfect Competition

  • Other economists, such as Alfred Marshall, disagree.

  • They contend that the large number of small firms that undertake innovation will lead to the greatest efficiency in production over time.

Gottheil - Principles of Economics, 4e


EXHIBIT 16 Perfect CompetitionMONOPOLY AND PERFECT COMPETITION: SCHUMPETER’S VIEW

Gottheil - Principles of Economics, 4e


Exhibit 16: Monopoly and Perfect Competition: Schumpeter’s View

1. What is price and quantity for the competitive firm in panel a?

  • Price is $25.

  • With 200 firms in the market, quantity supplied to the market is 4,000.

Gottheil - Principles of Economics, 4e


Exhibit 16 monopoly and perfect competition schumpeter s view
Exhibit 16: Monopoly and Perfect Competition: Schumpeter’s View

2. How does the competitive firm’s price and quantity compare to the monopoly in panel b?

  • The monopoly’s price is $20—$5 less than the competitive firm’s price.

  • The monopoly’s output quantity is 10,000 —6,000 greater than the competitive firm’s output.


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