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Chapter 8: Economics of Big Business

Chapter 8: Economics of Big Business. Market Structure. Perfect Competition Monopolistic Competition Oligapoly Monopoly. Degree of Market Power. Concentration Ratio percentage of the market sale by the largest four (or eight) firms CR > 0.70 indicates significant market power.

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Chapter 8: Economics of Big Business

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  1. Chapter 8: Economics of Big Business

  2. Market Structure • Perfect Competition • Monopolistic Competition • Oligapoly • Monopoly

  3. Degree of Market Power • Concentration Ratio • percentage of the market sale by the largest four (or eight) firms • CR > 0.70 indicates significant market power

  4. Perfect Competition • Many buyers and many sellers • Homogeneous product • No barriers to enter the market • Firms are price takers: • Market price is set by D & S • Firms produce all they can at the market price

  5. Profit Maximization • Business firms try to make the highest possible profit • Profit = Total Revenue – Total Cost • Profit is maximized when MC = MR • MC = additional cost of producing an extra unit • MR = additional revenue from selling an extra unit

  6. Price-Taker Firms: P=MR=MC Price Firm Price Market S D S = MC D = MR P P MC=MR S D q Q Quantity Quantity

  7. Monopoly • Many buyers, but only one seller • Product maybe unique or differentiated • Barriers to enter the market • Firms are price-makers, facing the market demand

  8. Reasons for Monopoly • Control the supply of raw materials • Investment / R&D requirements • Government licensing • Natural Monopoly

  9. Price-Maker Firms: P>MC=MR Price D MC P MC=MR MC D MR Quantity Q

  10. Perfect Competition vs. Monopoly • Monopoly price is higher than the competitive price • Monopoly output is lower than the competitive output • Since monopoly causes resource misallocation it is outlawed by the Anti Trust Law

  11. Price-Output Comparison Pc = competitive price Qc = competitive output Pm = monopoly price Qm = monopoly output Pm>Pc but Qm<Qc Price D Dead Weight Loss=ABC MC A P=MC Pm C MC=MR Pc B D MR Quantity Qm Qc

  12. Natural Monopoly • A firm that experiences “economies of scale” so that it operates with a declining average cost • It is less costly to have one large firm than several small firms • Government permits natural monopoly, but regulates its price to minimize the DW-loss

  13. Long-run Average Cost $ Cost Diseconomies of scale Economies of scale 4 1 25 100 Quantity

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