Download chapter 12 - Oregon State University

ENTREPRENEUR
• A person who comes up with an idea for a
business and coordinates the production
and sale of goods and services:
• The entrepreneur builds the production
facility, buys raw materials and hires
workers.
• An entrepreneur takes risks, committing
time and money to a business without any
guarantee that the business will be
profitable.
NATURAL MONOPOLY
• The entry of a second firm would make the
market price less than the average cost of
production, so a single firm will serve the
entire market.
• A single firm is profitable, but a pair of firms
would lose money.
• Classic examples are public utilities
(sewerage, water, and electricity generation)
and transportation services (railroad freight
and mass transit).
Dollars per
1,000
Kilowatt
Hours
Long-Run
Average Cost
m
8.20
c
6.20
n
4.60
Long-Run
Marginal Cost
Marginal
Revenue
3
Monopolist’s demand
(Market demand)
Billions of Kilowatt Hours
THE MARGINAL PRINCIPLE
The marginal principle is satisfied at point
n, with 3 billion kilowatt hours (kwh) of
electricity.
The price associated with this quantity is
$8.20 (shown at point m) and the average
cost is $6.20 (shown at point c).
The profit per unit of electricity is $2.00.
The price exceeds the average cost, so the
electric company will earn a profit.
WHAT IF A SECOND FIRM
ENTERED THE MARKET ?
• Entry of a second firm would shift the
demand curve for the first firm to the left,
from D1 to D2:
• At each price, the first firm will sell a
smaller quantity of electricity, because it
now shares the market with another firm.
• In general, the larger the number of firms,
the lower the demand curve facing the
typical firm in a two-firm market.
Dollars per
Long-Run
Average Cost
1,000
Kilowatt
D1
Hours
D2
m
8.20
c
6.20
Firm’s Demand
Curve with two
firms
Monopolist’s demand
(Market demand)
3
Billions of Kilowatt Hours
WILL A SECOND FIRM ENTER A
NATURAL MONOPOLY ?
• The demand curve for a typical firm in a
two-firm market lies entirely below the longrun average-cost curve.
• There is no quantity at which the price
exceeds the average cost of production.
• No matter what price is charged, the firm
will lose money.
A SECOND FIRM WILL NOT ENTER THE
MARKET!
Dollars per
Long-Run
Average Cost
1,000
Kilowatt
D1
Hours
D2
m
8.20
c
6.20
Firm’s Demand
Curve with two
firms
1.5
Monopolist’s demand
(Market demand)
3
Billions of Kilowatt Hours
PRICE CONTROLS FOR A
NATURAL MONOPOLY
• When a monopoly is inevitable, the
government often sets a maximum price for
the monopolist.
• Local governments regulate utilities and
firms that provide water, electricity, and
local telephone service.
• State governments use public utility
commissions (PUCs) to regulate the
electric-power industry.
AVERAGE-COST PRICING
POLICY
• The government picks the price
at which the demand curve
intersects the average-cost
curve.
Dollars per
1,000
Kilowatt
Hours
m Unregulated Monopoly
8.20
Regulated Monopoly
r
Average Cost w / regulation
6.00
5.20
i
Original Average Cost
Monopolist’s demand
(Market demand)
3
5
Billions of Kilowatt Hours
Effect of Regulatory Pricing On
Firm’s Production Costs
• Under average-cost pricing, a change in the
firm’s production cost will not affect the
firm’s profit because the government will
adjust the regulated price to keep the price
equal to the average cost.
• Because there is no reward for cutting its
costs and no penalty for higher costs, the
firm has little incentive to control its cost.
• Costs will increase, pulling up regulated
price.
MONOPOLISTIC COMPETITION
• MANY FIRMS,
• DIFFERENTIATED PRODUCT,
• SLIGHT CONTROL OVER
PRICE,
• NO ARTIFICIAL BARRIERS TO
ENTRY
MONOPOLISTIC COMPETITION
• Many Firms:
Relatively small economies of scale; small
firms can produce at about same average
cost as large firms; market can support
many firms.
• Differentiated Product:
Firms sell slightly different products;
differentiation with respect to physical
characteristics, location, services, and aura
or image associated with good.
MONOPOLISTIC COMPETITION
• Slight control over price:
When a firm increases its price, some of its
customers will switch to other firms that
sell slightly different products.
• No artificial barriers to entry
In a market subject to monopolistic
competition, each firm has a monopoly in
selling its own differentiated product, but
competes with other firms selling similar
products.
HOW FIRMS DIFFERENTIATE
THEIR PRODUCT
• Physical Characteristics:
Different size, color, shape, texture, or taste;
Examples: athletic shoes, toothpaste, dress
shirts, appliances, and pens;
• Location:
Differentiated by where products are sold;
Examples: gas stations, music stores,
grocery stores, movie theaters, and icecream parlors;
HOW FIRMS DIFFERENTIATE
THEIR PRODUCTS
• Services:
Helpful sales people versus self-service,
home delivery, free technical assistance;
• Aura or Image:
Use of advertising to make products stand
out from group of virtually identical
products,
Examples: aspirin, designer jeans, and motor
oil
SHORT-RUN EQUILIBRIUM WITH MONOPOLISTIC
COMPETITION: A SINGLE MUSIC STORE
19
Dollars
per
CD
8
m
n
Monopolist’s demand
(market demand)
Long-run average cost
or long-run marginal cost
Marginal Revenue
300
640
CDs Sold Per Hour
SHORT-RUN EQUILIBRIUM
• The marginal principle is satisfied at point n
(MR =MC).
• Monopolist sells 640 CDs per hour.
• Price of CD is $19 (point m), average cost is
$8 (point c).
• Monopolist’s profit per CD is $11.
SHORT-RUN EQUILIBRIUM WITH MONOPOLISTIC
COMPETITION: ENTER A SECOND STORE
D1
D2
Dollars
m
19
per
e
CD 18
Monopolist’s demand
(market demand)
f
8
Firm’s Demand Long-run average cost
Curve with two or long-run marginal cost
Firms
New Marginal Revenue
440 640
CDs Sold Per Hour
ENTER A SECOND STORE
• Entry of a second firm shifts the demand
curve facing the typical firm left from D1 to
D2.
• The marginal principle is satisfied at point f
(MC = new MR).
• Each firm will produce 440 CDs per hour at
a price of $18 (point e) and an average cost
of $8 (point f).
• Price of CDs decreases.
• Profit per CD decreases from $11 ($19 -$8)
to $10 ($18 -$8).
LONG-RUN EQUILIBRIUM WITH MONOPOLISTIC
COMPETITION: MUSIC STORES
Dollars
per
CD
h
14
8
Long-run average cost
Long-run marginal cost
e
Marginal
Revenue
Demand Curve for Typical Store
70
CDs Sold Per Hour
LONG-RUN EQUILIBRIUM WITH
MONOPOLISTIC COMPETITION
• With no artificial barriers to entry, firms will
continue to enter market until each music
store makes zero economic profit.
• As firms enter market, demand curve shifts
left.
• Typical firm satisfies marginal principle at
point g and sells 70 CDs per hour.
• Price is $14 (point h) and average cost is
$14 -- zero economic profit.
LONG-RUN EQUILIBRIUM WITH
MONOPOLISTIC COMPETITION
As the number of firms increases, the profit per CD
decreases for two reasons:
• Lower Price The stores compete for customers by cutting
prices.
• Higher Average Cost As more firms enter market, eventually move
upward along negatively-sloped portion of
average-cost curve to higher average cost (fewer
CDs sold per store).
TRADEOFFS WITH
MONOPOLISTIC COMPETITION
• Good News: Lower Price Competition decreases the price of a product.
• Good News: Lower Travel Cost With larger number of competitors, the shorter
the distance each customer must travel to the
nearest store.
• Bad News: Higher Average Cost As output per store decreases, the average cost
of a typical store increases.