Download Recitation 5 – Lecture Outline

Recitation 5 Notes
1. Exam
a. Explain exam sheet
b. Answer questions about exam
c. Invite anyone who is looking to improve to come to office hours PA 202 2pm – 4pm
2. Market Power
a. Optimal supply rule: Keep expanding production as long as MR>MC and stop where
MR=MC. Special case is for perfectly comp. firms: MR=P and so rule becomes MR=P=MC.
b. Perfect competition: large number of firms producing homogenous products. They have
no market power (i.e. no influence on market price) and as a result the firm is a price taker.
An individual firm’s demand curve is horizontal. It can sell as much as it wants at the
prevailing market price. It can increase the quantity without reducing the price of its product.
Under perfect competition the firms demand curve, average revenue curve and marginal
revenue curve are all the same.
c. Monopolist: It is the only supplier of a unique product with no close substitutes. It has
market power (i.e. influence on market price) and as a result the firm is a price setter. Ability
to raise its price without losing all its sales. Downward sloping demand curve. More market
power the steeper demand curve. In order to increase output produced, it has to lower the
price, which is then applied to all units, not just the additional unit. Thus the marginal
revenue is the price minus the revenue loss on all previous units that could have been sold at a
higher price had the extra unit not added. MR from expansion is less than the price at which
the output is sold while in Perfect compt. MR equals to price.
Example 1: Monopoly
Quantity Price
Total
Total
Revenue cost
0
0
0
50
1
50
50
55
55
-5
50
5
2
45
90
65
32.50
25
40
10
3
40
120
80
26.67
40
30
15
4
35
140
100
25
40
20
20
5
30
150
125
25
25
10
25
6
26
156
156
26
0
6
31
ATC
Marginal Marginal
revenue cost
Profit
-50 -
1
-
Monopoly
60
50
40
30
20
10
0
0
1
2
Demand
3
4
ATC
5
MR
6
7
MC
Profit maximization: MR=MC at output=4 units and price=35 (look at Demand curve). Thus,
Monopoly reduces output and charges higher price.
d. Define market efficiency as the summation of consumer surplus and producer surplus. An
efficient market maximizes that combined surplus
From the example above, monopoly produces 4 units w/ price $35 while perfectly competitive
firm produces more than 4 units (around 5.5) w/ less than $35 (show intersection of Demand
curve and MC curve).
OR from last week recitations notes as shown below:
We need to draw AC curve to the figure below, which lies below orange line, and
intersection of AC and Demand curve gives LR equilibrium for the perfectly
competitive firm. It produces more than a monopoly (i.e. more than 4.5) but with a
lower price than monopoly price.
1. Is the perfect competition efficient in this sense? why?
A market is efficient when the marginal cost to the consumer is just equal to the marginal cost
of the producer. This is a characteristic of perfect competition. From the figure below if we
assume that monopoly market are divided into large number of perf. Compt. Markets. Then in
the SR perf. Comp. firm produces more than 4.5 units with a lower price i.e. less than 6
(intersection of MC and Demand). In the long run, LR competitive output where AC intersects
Demand curve (P=AR=AC), output is larger than monopoly and price is lower.
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2. Why is the monopoly market outcome less efficient? Since it produces deadweight loss as you
can show from the figure below.
12
10
8
6
4
2
0
1
2
3
4
5
6
7
8
9
10
Redmarginal cost (imagine that it is the sum of MC curves of all perf. Comp. firms)
Green demand (AR)
Orangemarginal revenue
3. profits in SR and LR
Example 2: Perfect Competition
1) (DVD movie seller or Greek yogurt shop etc) + no economic rent
When a factor of production has qualities that make it uniquely well suited to production, then it earns
rent.
Economic rent: the portion of the earnings of a factor of production that exceeds the minimum
necessary to induce that factor to be supplied.
Market price=$16 (P=MR=AR=$16). Then profit=$16*7000-99000=13000 in the SR. This positive
profit creates tendency for others to enter into the industry and so in the LR (no economic rent in this
case) economic profit is zero i.e. produce at the min. of ATC=$13.83=P and so economic profit=0.
Quantity
0
1000
2000
3000
4000
5000
6000
7000
8000
Total
cost
50000
55000
58000
59000
64000
70000
83000
99000
122000
ATC
55
29
19.67
16
14
13.83
14.14
15.25
Marginal
cost
5
3
1
5
6
13
16
23
you can draw MC, ATC and show equilibrium in SR and in LR.
2) Economic rent: SR profits followed by reduced but still positive economic profit in the LR
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No need to give a numerical example; we can assume that the above cost structure is true for a case
where there is economic profit such as Randy Smith or Starbucks.
3) Other examples: basketball players, football players etc
Any other examples that you can think of…
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