Download Price and Output in Monopolistic Competition

Chapter 11
PRICE AND OUTPUT IN MONOPOLY,
MONOPOLISTIC COMPETITION, AND
PERFECT COMPETITION
© 2013 Cengage Learning
Gottheil — Principles of Economics, 7e
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Economic Principles
Price, output and economic profit
under conditions of monopoly
Price, output and economic profit
for the firm in monopolistic
competition
Normal profit
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Gottheil — Principles of Economics, 7e
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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
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Economic Principles
The Schumpeterian illustration of
low price and high efficiency
under conditions of monopoly
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Monopoly Price and Output
Monopolists are distinguished from
other types of entrepreneurs by their
market position—not by their
motivation, morality, strategy or
objective.
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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.
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EXHIBIT 1
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MARKET DEMAND FOR ICE
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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.
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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.
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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.
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Price and Output Under Monopoly
Recall the MR = MC Rule:
• Expand production if MR > MC.
• Profit is maximized when MR = MC.
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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.
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Price and Output Under Monopoly
Economic profit
• A firm’s total revenue minus its total explicit and
implicit costs.
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EXHIBIT 2
COST AND REVENUE SCHEDULES FOR THE
NICK RUDD ICE COMPANY
Note: Figures are rounded to the nearest dollar.
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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
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Exhibit 2: Cost and Revenue
Schedule for the Nick Rudd
Ice Company
2. Since the company is a pricemaker, should it charge the
highest price possible?
• No. The highest price possible does not
necessarily generate the most profit.
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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.
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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.
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Maximum Profit, but Less than
Maximum Efficiency
• 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.
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EXHIBIT 3
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PRICE AND OUTPUT DETERMINATION
IN MONOPOLY
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Exhibit 3: Price and Output
Determination in Monopoly
What is the total profit for the profitmaximizing firm in Exhibit 4?
• The profit-maximizing firm produces where
MR = MC. This point is at a quantity of 300 in
Exhibit 4.
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Exhibit 3: Price and Output
Determination in Monopoly
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.
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Exhibit 3: Price and Output
Determination in Monopoly
What is the total profit for the profit
maximizing firm in Exhibit 4?
• Total profit = $(150 – 52) × 300 = $29,400
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Price and Output in
Monopolistic Competition
• 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.
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EXHIBIT 4
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RUDD’S DEMAND CURVE AS NEW FIRMS
ENTER THE MARKET
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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
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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
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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
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EXHIBIT 5
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RUDD’S PRICE AND OUTPUT IN A MONOPOLISTICALLY COMPETITIVE MARKET
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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.
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Price and Output in
Monopolistic Competition
• 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.
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EXHIBIT 6
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RUDD’S LONG-RUN EQUILIBRIUM PRICE AND
OUTPUT IN MONOPOLISTIC COMPETITION
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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.
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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.
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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
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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.
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Price and Output in
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.
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Price and Output in
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.
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Price and Output in Perfect
Competition
• There is no product differentiation
in a perfectly competitive market.
• Firms in perfect competition are
typically modest in size.
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EXHIBIT 7A
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THE COMPETITIVE FIRM’S COST
STRUCTURE
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EXHIBIT 7B
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THE COMPETITIVE FIRM’S COST
STRUCTURE
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Exhibit 7: The Competitive
Firm’s Cost Structure
How does ATC change as the firm
changes output from 4.5 to 6.0 in
Exhibit 7?
• 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.
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Price and Output in Perfect
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.
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Price and Output in Perfect
Competition
For firms in perfect competition, price
always equals marginal revenue
(P = MR).
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EXHIBIT 8A
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DEMAND AND SUPPLY FOR ICE IN A
PERFECTLY COMPETITIVE MARKET
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EXHIBIT 8B
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DEMAND AND SUPPLY FOR ICE IN A
PERFECTLY COMPETITIVE MARKET
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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.
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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.
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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.
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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.
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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.
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EXHIBIT 9A
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THE PERFECTLY COMPETITIVE FIRM IN THE
SHORT RUN
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EXHIBIT 9B
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THE PERFECTLY COMPETITIVE FIRM IN THE
SHORT RUN
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Exhibit 9: The Perfectly Competitive
Firm in the Short-Run
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.
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Exhibit 9: The Perfectly Competitive
Firm in the Short-Run
2. What is the economic profit received
by the firm in Exhibit 9?
• Economic profit = $(78 – 51) × 5.5 = $148.50
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EXHIBIT 10 EFFECTS OF A SHIFT IN MARKET SUPPLY
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Exhibit 10: Effects of a Shift
in Market Supply
1. How does the equilibrium price
change as the supply curve shifts
from S to S to S in Exhibit 10?
1
2
3
• The short-run equilibrium price changes from
$78 at S1 to $60 at S2 and to $47 at S3.
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Exhibit 10: Effects of a Shift
in 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.
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Long-Run Equilibrium Price and
Output for the Firm in Perfect
Competition
The long-run equilibrium position of
firms in perfect competition is
identified by P = MR = MC = ATC.
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EXHIBIT 11
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THE MARKET AND FIRM IN LONG-RUN
EQUILIBRIUM
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Exhibit 11: The Market and Firm
in 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.
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EXHIBIT 12 ANATOMY OF THE FIRM’S LONG-RUN
SUPPLY CURVE
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Exhibit 12: Anatomy of the
Firm’s Long-Run Supply Curve
Where does the supply curve begin
for the firm in Exhibit 12?
• 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.
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Long-Run Equilibrium Price
and Output for the Firm in
Perfect Competition
The market supply curve is the
aggregation of the long-run MC
curves of the firms in the market.
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EXHIBIT 13 ANATOMY OF THE MARKET SUPPLY CURVE
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Exhibit 13: Anatomy of the
Market Supply Curve
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
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EXHIBIT 14 THE INNOVATOR FIRM IN PERFECT
COMPETITION
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Exhibit 14: The Innovator Firm
in Perfect Competition
Complete this sentence: Innovation
results in _____ economic profit in
the long-run.
i. Higher
ii. The same
iii. Lower
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Exhibit 14: The Innovator Firm
in Perfect Competition
Complete this sentence: Innovation
results in _____ economic profit in
the long-run.
i. Higher
ii. The same
iii. Lower
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Exhibit 14: The Innovator Firm
in 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
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EXHIBIT 15 CONSTANT AND INCREASING RETURNS
TO SCALE
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Exhibit 15: Constant and
Increasing Returns to Scale
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.
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The Schumpeter Hypothesis
• 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.
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The Schumpeter Hypothesis
• Monopoly profits permit these firms to
experiment with new technologies that
ultimately lead to more efficient
production.
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The Schumpeter Hypothesis
• 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.
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EXHIBIT 16 MONOPOLY AND PERFECT
COMPETITION: SCHUMPETER’S VIEW
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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.
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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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