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Introduction to Economics. Microeconomics The US Economy. Market Power and Monopoly. Is monopoly a good thing or not? How about Microsoft, is this firm good or bad for consumers?. Market Power & Market Structure. No market power: competition many producers firms are price takers

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Introduction to economics

Introduction to Economics

Microeconomics

The US Economy


Market power and monopoly
Market Power and Monopoly

  • Is monopoly a good thing or not?

  • How about Microsoft, is this firm good or bad for consumers?


Market power market structure
Market Power & Market Structure

  • No market power: competition

    • many producers

    • firms are price takers

    • no excess profit

    • price to consumer = long run average cost

  • Market power: monopoly

    • one producer

    • monopolist is price setter

    • monopolist makes profits at expense of the consumer


The brief for competition
The Brief for Competition

  • .... and against monopoly


Outline lecture thirteen
Outline: Lecture Thirteen

  • Competitive Industries

    • agriculture

    • construction

  • Market Supply in the Short Run

  • The Optimal Plant Size

  • Market Supply in the Long Run


Competitive markets
Competitive Markets

  • In the long run, resources will flow to a competitive market if firms are making excess profits

    • new firms will enter the industry

      • if returns to scale are constant, then price will be driven down to long run average total cost

      • if returns to scale first increase and then decrease, price will be driven down to minimum long run average cost

  • Consumers benefit from the efficient, lowest cost use of resources and the lowest price for the product

  • Excess Profits are driven to Zero


Competitive industries agriculture
Competitive Industries: Agriculture

source: Census of Agriculture, 1987


Competitive industries
Competitive Industries

sources: Census of Manufactures, 1987

Census of Construction Industries, 1987


Short run
Short Run

  • Plant Size of a firm is fixed


Short Run Market Supply: Two Firm Industry

Market

Supply

MC,

AVC

MCII

MCI

AVCI

AVCII

QI + QII

QI

QII

Quantity


Market Supply and Demand in the Short Run

Supply

Demand

MC,

Market

Price

pM

QM

Quantity


Short Run Market Supply: Two Firm Industry

MC,

AVC,

ATC

Market

Supply

MCII

MCI

ATCI

ATCII

AVCI

PM

AVCII

Market

Demand

Quantity

QI + QII

QI

QII

In the short run, both firms are making excess profits. This may

motivate them to find the lowest cost size for plant and

equipment.


Short run world supply copper
Short Run* World Supply: Copper

* Existing Mines Fixed

Source: Minerals Yearbook, 1985


Canada

Peru

US

Chile

Zaire

Zambia


Long run
Long Run

  • What is the optimal plant size?

    • constant returns to scale

    • increasing, then decreasing returns

    • increasing returns to scale


Optimal Size of the Firm: Constant Returns to Scale

MC, ,

ATC

SMCII

SMCI

SATCII

SATCI

pM

LATC, LMC

Quantity

If market price is above long run marginal cost, the firm will

make the same excess profit per unit of output in a large plant as

in a small plant. The firm may prefer larger to smaller. As long as

firms are making excess profits, other firms will enter the industry,

increasing supply, and driving price down to LMC.


Long Run Equilibrium Supply with the Free Entry of Firms:

Constant Returns to Scale

Short Run Supply

Market

Price

Demand

Supply after

Entry of Profit

Seeking Firms

PM

PM = LMC =

LATC

Long Run Supply

Quantity


Optimal Size of the Firm: Constant Returns to Scale

MC, ,

ATC

SMCII

SMCI

SATCII

SATCI

LATC, LMC

pM

Quantity

If market price is above long run marginal cost, the firm will

make the same excess profit per unit of output in a large plant as

in a small plant. The firm may prefer larger to smaller. As long as

firms are making excess profits, other firms will enter the industry,

increasing supply, and driving price down to LMC.


Optimal Size of Plant with Variable Returns to Scale

LMC

LATC

Market

Price

LATC

SMCIV

SATCI

SATCIV

SATCII

SMCIII

SATCIII

pM

Quantity

If market price is above long run average cost, then firms with

efficient scale of plant, SATCIII ,will make an excess profit. In the

long run other firms in the industry will move to this efficient size

plant. As long as there are excess profits to be made, new firms

will enter the industry, driving market price down to minimum

long run average total cost, LATC.


Long Run Equilibrium Supply with the Free Entry of Firms:

Variable Returns to Scale, Deceasing and then Increasing

Short Run Supply

Market

Price

Demand

Supply after

Entry of Profit

Seeking Firms

PM

PM = LMC =

Minimum

LATC

Long Run Supply

Quantity


Optimal Size of Plant with Variable Returns to Scale

LMC

LATC

Market

Price

LATC

SMCIV

SATCI

SATCIV

SATCII

SMCIII

SATCIII

pM

Quantity

If market price is above long run average cost, then firms with

efficient scale of plant, SATCIII ,will make an excess profit. In the

long run other firms in the industry will move to this efficient size

plant. As long as there are excess profits to be made, new firms

will enter the industry, driving market price down to minimum

long run average total cost, LATC.


Competitive markets1
Competitive Markets

  • In the long run, resources will flow to a competitive market if firms are making excess profits

    • new firms will enter the industry

      • if returns to scale are constant, then price will be driven down to long run average total cost

      • if returns to scale first increase and then decrease, price will be driven down to minimum long run average cost

  • Consumers benefit from the efficient, lowest cost use of resources and the lowest price for the product

  • Excess Profits are driven to Zero


Natural monopoly
Natural Monopoly

  • Increasing Returns to Scale

    • optimal size of the firm

      • larger is better

  • Constant Returns to Scale

    • optimal size of the firm: indeterminate

      • LAC = LMC = same at all outputs

  • Increasing then Decreasing Returns to Scale

    • optimal size of the firm: minimum LAC

      • minimum LAC where LAC = LMC


Optimal Size of Plant with Increasing Returns to Scale:

Bigger is Better

Price

LATC

SATCI

SATCII

LATC

Quantity

LMC


Market power size in 1994
Market Power: Size in 1994

source: World Bank & Fortune 500



How does a monopolist use power to maximize profits
How does a monopolist use power to maximize profits?

  • marginal principle: increase output until marginal revenue = marginal cost


Monopoly Sales

Price

Market Demand

A

$10

B

0

0

Quantity

Revenue

$25,000

A

B

0

Quantity



Maximum Monopoly Profits: Marginal Revenue = Marginal Cost

Revenue

$

LTC

R

LTC

Quantity

$

Excess

Profit

Quantity

0


Monopoly Profits with Increasing Returns to Scale

Price

Market Demand

Quantity

MR


Monopoly Profits with Increasing Returns to Scale

Price

LATC

Market Demand

PM

LATC

Quantity

LMC

MR

Q


Maximum Monopoly Profits: Marginal Revenue = Marginal Cost

Revenue

$

LTC

R

LTC

Quantity

$

Excess

Profit

Quantity

0


The Social Cost of Monopoly: Example, Constant Returns to Scale

Competition

Monopoly

Market Demand

Market Demand

Consumer Surplus

PM

LATC = LMC

LATC = LMC

PM

MR

QCOMP

QMONOP

Under monopoly, consumers pay a higher price and consume less


The Social Cost of Monopoly: Example, Constant Returns to Scale

Competition

Monopoly

Market Demand

Market Demand

Consumer Surplus

Dead Weight Loss

PM

Profit

LATC = LMC

LATC = LMC

PM

MR

QCOMP

QMONOP

Under monopoly, some consumer surplus is redistributed to the

monopolist as profit, and some is lost to society


Social policy
Social Policy Scale

  • If returns to scale are constant

    • regulate

      • make the monopolist charge a price equal to marginal cost

        • obtain the competitive solution

  • If returns to scale are increasing

    • regulation is not so easy

      • can not set monopolist’s price equal to marginal cost: monopolist will suffer losses

        • because marginal cost is less than average cost

      • could socialize the industry and the government could subsidize the losses

      • could live with monopoly


Society Scale

How can we control it?

Regulation,

Franchises,

Patents

Higher Prices

Less Goods

Excess Profits

MONOPOLY POWER

Political

Influence

Strategic Planning

Entrepreneurs

How do we get it?


Strategic planning brand names
Strategic Planning: Brand Names Scale

source: USA Today , 1992


Advertising cost of a car
Advertising Cost of a Car Scale

source: Fortune


Strategic action advertising
Strategic Action: Advertising Scale

source: Advertising Age


Classification of us industry
Classification of US Industry Scale

source: Survey of Current Business


Summary vocabulary concepts

competitive industries Scale

short run

short run marginal cost

optimal plant size

long run

long run marginal cost

constant returns to scale

free entry

long run equilibrium

variable returns to scale

excess profits

increasing returns to scale

natural monopoly

market share

marginal revenue

monopoly profit

social cost of monopoly

consumer surplus

dead weight loss

regulation of monopoly

brand names

strategic planning

Summary-Vocabulary-Concepts


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