Download Part II: Micro-Economics (the Market): II

Part II:
II-1:
Micro-Economics (the Market):
Perfect Competition (Chap 8):
The demand for the individual firm’s product is infinitely elastic.
i.e., the market price = AR= MR
The firm’s profit maximizing output: MR = MC:
 The firm’s supply curve is its MC above its minimum average variable cost
(AVC) curve. If MR is greater than the AVC, a portion of the fixed cost is
also covered.
 At equilibrium, the economic profit is zero (i.e., MR = minimum ATC).
A permanent decrease in demand:
 a shift of the market demand curve to the left, not a movement along the
demand curve;
 the price would fall, increasing losses (P < minimum ATC) for the firms;
 as firms exit the market, the market S shifts to the left in the short run,
 the market price goes up,
 the remaining firm’s output goes up.
Plant size and long-run average cost depend on:
 Whether it is a decreasing or increasing cost industry,
 Long run changes in D and S
Efficiency of Perfect competition:
 For the individual firm: at equilibrium, P (=MR) is the minimum total
average cost;
 The market: consumer surplus and producer surplus are fully realized without
any dead weight loss.
II-2:
Monopoly (Chap 9):
Natural monopoly:
 if economies of scale prevails over the entire long-run-average-cost curve,
 if average cost is still falling when the entire market demand is satisfied.
A single price monopoly:
Profit maximizing output:
Q* where MR = MC (given the scale of the production)
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The market demand curve is the AR curve;
The MR curve lies below the AR curve (the market demand curve),
Profit = Price (AR) – Average Total Cost
If the regulator sets the price equal to the monopolist’s long-run average
cost, then the monopolist’s economic profit will be zero.
 The demand is elastic because at Q*, MR (=MC) >0,
Revenue maximizing output:
Output where the price elasticity of the demand is 1 (MR=0).
Inefficiency of monopoly compared with perfect competition:
 A smaller output and a higher price compared to perfect competition.
 Consumer surplus available under perfect completion is substantially
reduced by the monopoly’ profit and a deadweight loss: under perfect
competition (the consumer surplus and producer surplus) vs. monopoly
(consumer surplus, producer surplus, monopoly’s profit, deadweight)
With a competitive price for the monopoly rent (economic profit):
 Buy the monopoly paying a price until the economic profit becomes zero,
 The cost of maintaining monopoly (barrier to entry)would push up the
ATC
Price discrimination by monopoly:
How to increase the monopolist’s profit?
 The profit maximizing output is where MR =MC;
 when the monopolist charges different price to different customers, the
market demand curve becomes the monopolist’s marginal revenue curve;
 The consumer surplus is replaced with the monopolist’s additional profit.
II-3:
Monopolistic Competition & Oligopoly (Chap 10):
Monopolistic competition:
product differentiation
A declining demand curve (i.e., not a flat demand curve):
output @ MR = MC,
profit/ loss = P – ATC
Advertising:
shifts up the ATC;
makes demand more elastic (a flatter MR)
As output increases, the price falls, the markup shrinks.
In the long run, economic profit = 0, when output @ MR = MC
Excess capacity (Q < Q @ minimum ATC),
markup (price > MC)
Oligopoly:
barriers to entry by new firms
Natural oligopoly:
the efficient scale of production & economies of scale.
The kinked demand curve:
price hikes are not matched, but price cuts are
A broken MR curve, the MCs pass through the break.
A shift in MC within the break won’t change the price or quantity.
Collusion (i.e., communicating) among oligopolists,
Can make monopoly’s profits if they don’t cheat;
One firm cheats (Q up, ATC down), the complier incurs a loss;
If both cheat, then back toward the competitive equilibrium P and Q.
e.g., the OPEC
The game theory:
taking into account the expected behavior of others
The prisoners’ dilemma:
rules (no communication),
payoffs : Neither confesses 2 years;
Only one confesses 1, one denies 10 years;
Both confess 5 years;
stategies,
outcome,
The Nash equilibrium:
Strategy:
Outcome:
what’s my best option, supposing the other’s action?
Neither firm earns an economic profit,
because both firms cheat on the agreement:
Sub-optimal outcome,
II-4:
Efficiency and Competitive Market (Chapters 3, 17):
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Market price as a means of resources allocation
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Demand curve and consumer surplus (marginal social benefit)
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Supply curve and producer surplus (marginal social cost)
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“The invisible hand” maximizes the consumer and producer surpluses.
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Obstacles to efficiency: deadweight loss from under- and over- production
II-4:
Market Interference (Chapters 3, 16):
Interference of market demand and supply:
Obstacles to efficiency:
deadweight loss from under- and over- production
The supply of housing:
after earthquake (a shift of the supply to the left);
long run adjustment (a shift of the supply to the right)
Taxes:
A tax on sellers (S shifts to the left) & a tax on buyers (D shifts to the left):
inelastic demand, P goes up (buyers pay the tax),
elastic demand, P does not change (sellers pay the tax)
inelastic supply, P does not change (sellers pay the tax),
elastic supply, P goes up (buyers pay the tax)
changes in consumer & producer surpluses,
deadweight loss,
tax revenue
Subsidies:
Production subsidies: shift Supply curve to the right,
Q increases, P falls
Fiat:
Rent ceiling:
Housing shortage,
black market rent
(consumer & producer surpluses, deadweight loss, loss from search)
Minimum wage:
Unemployment
(firms’ & workers’ surpluses, deadweight loss, loss from search)
Production quota:
Q falls to the quota, P rises
Illegal goods:
both D, S shift to the left because of the penalty for breaking the law.
Public goods: everyone can consume it.
The free-rider problem: enjoying public goods without paying for your share
of the cost.
II-5:
Markets for Factors of Production (Chapters 13, 14):
Labor:
The demand for labor:
The demand for a factor of production is a derived demand.
Marginal Revenue Product (MRP) of labor, MRP = MP* MR
Profit maximizing demand for labor:
Profit maximizing quantity @ MR = MC becomes
MRP = Wage
diminishing marginal product
= > diminishing marginal revenue product
The supply of labor:
each person’s supply curve bends backward.
Income effect dominated the opportunity cost of leisure
The labor union shifts the supply curve to left (P up, Q down)
Monopsony:
Demand is the MRP of labor,
Supply is the AC;
derive MC from the S (AC),
Profit maximization rule:
quantity where MR =MC becomes MRP =Wage
Q & P lower than the competitive equilibrium
Minimum wage law in Monopsony:
P at the minimum wage,
Set P such that Q is greater than under no minimum wage
Capital:
The demand for and supply of financial capital:
the subject of Corporate Finance
 The Marginal Revenue Product (MRP) of capital (i.e., expected cash flow),
 The price of capital: interest rate (risk free interest rate + risk premium),
 Incur outflow now in exchange for uncertain cash inflow in the future,
 Discount the expected cash flow using an appropriate discount rate corresponds to
the uncertainty of the cash-flow,
 The NPV rule of investment decision,
Land:
The stock supply of land is perfectly inelastic:
As compared to the supply of a non-renewable resource that is perfectly elastic
Because the suppliers will decide whether to sell it or to keep;
The supply of a non-renewable resource is perfect elastic at a price that
equals the present value of the expected price next period,
Management:
 Separation of ownership and management of the firm’s resources,
 The board of directors represent the owners’ interests,
 The agency problem
between owners and managers, owners and directors
Economic rent earned by the owner of a factor of production;
 Economic rent = supplier’ surplus (the area above the supply curve);
 The area below the supply curve is the opportunity cost.
If the supply curve is horizontal (perfectly elastic), zero economic rent
and 100 % opportunity cost.