Ecomonics Lecture Notes by

Ahmed Fawzy
Eslesca 45D

Ahmedfawzy_80@hotmail.com


Dr Ahmed Ghonem











Microeconomics

Table of Content:
Supply and Demand Rules
Quantity Demanded and the Law of Demand
Quantity Supplied and the Law of Supply
Market Equilibrium
Shortage and Surplus
Elasticity
Price Elasticity of Demand
Revenue Calculations (How To increase revenue using Elasticity)
Factors Affecting Determinates of Elasticity
Price Elasticity of Supply
Income Elasticity
Cross Elasticity of Demand
Low Of Diminishing Marginal Utility
How Consumer will maximize this Total Utility at multiple products and Price limitation:
Using Graphical Representation (Budget Lines and Indefinite Curves)
Costs & Production
Total Cost , Fixed Cost , Variable Cost , Average Total Cost and Marginal Cost
Total Product (TP), Average Product (AP) , Marginal Product (MP)
Average Cost Curve and why the average total cost curve is U-Shaped?
Average/Total Cost Curves vs. the Marginal Cost ( Extra Graphs)
Law of Diminishing Marginal Returns
Using Graphical Representation (ISOQuant Curves and ISOCost Line )
Profit Maximization and Market Stature
Maximizing Profits
Marginal Revenue and Maximizing Revenue
Market Structures Summery
Summery Comparison
Market Structures in Details
Perfect Competition
Monopoly
Natural Monopoly or Atypical Monopoly
Typical Monopoly
Monopolistic Competition
Oligopoly










Micro Economics: is related to the economy of an economic unite.

Supply and Demand Rules:
Demand is from the point of view of the consumer
Supply is from the point of view of producer

Quantity Demanded and the Law of Demand

Quantity Demanded:
The Quantity demanded of a good or service is the amount that consumers plan to buy during a
given time period at a particular price.
The quantity demanded is not necessarily the same as the quantity actually bought.
Sometimes the quantity demanded exceeds the amount of goods available.
The quantity demanded is measured as an amount per unit of time.

A higher price reduces the quantity demanded for the following two reasons:

Substitution Effect: When price of a good rises, the switching possibility to a substitute good is
rises.
Income Effect: A higher price and unchanged income, people cannot afford to buy all things they
previously bought.

Demand Q
D
= (P, Y, P
C,
P
S
, T
)
; Where P: Price, Y: Income, T: Taxes,
P
C
Price of Compliance
,
P
S:
Price of Compliance


Assuming all other factors but price is constant < Ceteris paribus >

Then we will have Q
D
= (P)

Depended Independent


Q
D
= (P) @ Ceteris paribus Q
D
= a b P


Law of Demand:
There is a negative relationship between quantity demanded
and price of the product; at Ceteris paribus conditions (all
other factors are constant.)

So, the higher the price of a good, the smaller is the quantity
demanded; and the lower the price of a good, the greater is
the quantity demanded.

When we have Change in Quantity Demanded, we move
from one point to another on the curve.

Change in Demand is at the same prices but change in
other conditions, the curve slope will change


Q
D
= (P) @ Ceteris paribus Q
D
= a b P


Law of Demand:
There is a negative relationship between quantity
demanded and price of the product; at Ceteris paribus
conditions (all other factors are constant.)

So, the higher the price of a good, the smaller is the
quantity demanded; and the lower the price of a good, the
greater is the quantity demanded.

When we have Change in Quantity Demanded, we move
from one point to another on the curve.

Change in Demand is at the same prices but change in other
conditions, the curve moves up and down





Demand Curve:
A demand curve shows the relationship between the quantity demanded of a good and its price when all
other influences on consumers' planned purchases remain the same.

Assuming linearity: Q
D
= a - b P, b: illustrates the response on the quantity to the change in price.

Price Change Effect:

Change in Quantity demanded is the movement along the existing demand curve, caused by changing
the price of the product (Points on the blue curve)

Change in Demand is the shift of the entire demand curve, caused by change in any other factors that
affect the willingness or ability to buy other than the product price (e.g. curve move to D1 or D2)

Other Factor (Demand Shifters): Inflation, Substitute, Income Change, Expectation and
Forecasting)

What Happened to Demand (Not Quantity Demanded) if priced goes up or down ?
Nothing Change in Demand its self, or the demand Curve, only change Quantity Demand

When demand increases, the demand curve shifts rightward & quantity demanded at each point is greater

There are six main factors bring changes in demand:
The price of related goods, Expected future price,
Income, Expected future income and credit ,
Population, Preferences


For Normal Goods: (Qd 1/P)
If Price increased, Quantity demanded decreased. [-ve relationship]
Law of demand doesnt work with Both Inferior Goods and Luxuries Goods

For Luxuries Goods: (Qd P)
If Price increased, Quantity demanded increased. [+ve relationship]
(Example: expensive cars, every one who can afford them will try to buy them)

Inferior or low quality Goods: (1/Qd 1/P)
If Price decreased, Quantity demanded decreased. [+ve relationship]
If I have more money , I will but something more good
(Example: Cleopatra and Marlboro cigarettes, since when a price decreases , more money
will be available , to buy some better quality substitute , decreases the quantity
demanded on the low quality products)

Quantity Supplied and the Law of Supply

Quantity Supplied:

The quantity supplied of a good or service is the amount that producers plan to sell during a given
time period at a particular price.
The quantity supplied is not necessarily the same as the quantity actually sold. Sometimes the
quantity supplied is greater than the quantity demanded.
The quantity supplied is measured as an amount per unit of time.

Law of Supply:
The more of the good will be provided , the higher
its price , the less will be provided the lower its
prices at Ceteris paribus conditions
(from the supplier point of view , as the prices increase ,
supplier wont to provide more services to get more
profit)
Positive relationship between quantity supplied and
price holding Ceteris paribus

So, the higher the price of a good, the greater is the
quantity supplied; and the lower the price of a
good, the smaller is the quantity supplied.

Q
S
= ( P , T , P
i
) Q
S
= c + d P
Where P: Price, T: Technology, P
i
: Price of Inputs




Suplyer point of view





Supply Curve: A demand curve shows the relationship between the quantity supplied of a good and its
price when all other influences on producers' planned sales remain the same.

Assuming linearity: QS = c + d P, d: illustrates the response on the quantity to the change in price.

The supply curve can be interpreted as Minimum Supply Price curve that shows the lowest price at
which someone is willing to sell. This lowest price called Marginal Cost.

Price Change Effect

Change is Price, will cause movement along the existing Supply Curve, result Change in Quantity
Supplied (Or Change in Quantity Supply, is the change in quantity as the price change. Illustrated as the
movement along the supply curve (Points on the same curve)

Change in Supply is the shift of the entire supply curve, caused by change in any other factors that affect
the willingness or ability for a supplier to produce product other than the product price , the slope of
change in supply will shift rightward or leftward (e.g. curve S1 and S2)

Other Factor (Supply Shifters): (Profitability, Cost of Production, Cost of Labor , Cost of
Capital , Taxes , License , Audits , Worker Strikes , Natural Disasters , Better Technology,
Expectation )

What Happened to Supply if Priced goes up or down
Nothing Change in Supply its self, or the Supply Curve, only change Quantity Supplied

As the response to the change in price changes, the slope will change its angel (Curves D1, D2)

Change in Supply, when any other factor changes,
When supply increases, the supply curve shifts rightward & quantity supplied at each point is greater.

There are six main factors bring changes in supply:
The price of factors of production , The price of related goods produced
Expected future price , The number of suppliers
Technology , The state of nature


Market Equilibrium: Demand and supply determine market equilibrium, the equilibrium price (P*) and equilibrium
quantity (Q*) at the intersection of the demand curve and the supply curve.

The Equilibrium Price is the price at which the quantity demanded equals the quantity supplied.
The Equilibrium Quantity is the quantity bought and sold at the equilibrium price.

The price of a good will adjust until the quantity
demanded equals the quantity supplied.
QD = QS



So at the equilibrium price (P*) and
equilibrium quantity (Q*): QD = QS = Q*














The Equilibrium Price is the price at which the quantity demanded equals the quantity supplied.
The Equilibrium Quantity is the quantity bought and sold at the equilibrium price.

At equilibrium Q
D
= Q
S
&

If the price is too High (P1), the quantity supplied exceeds the quantity demanded. (Q
S
> Q
D
)
If the price is too Low (P2), the quantity demanded exceeds the quantity supplied. (Q
D
< Q
S
)
At Equilibrium Price (P3), the quantity demanded equals the quantity supplied. (Q
S
=Q
D
)

In case of Price Ceiling, the excess in demand results a Block Market. (e.g. Gas & solar prices)
In case of Price Flooring, the excess in supply results Over Production and Inflation (e.g. Milk
Prices in USA)
At the equilibrium price the market is Relaxing.





The four basic laws of supply and demand are
If Demand Increases (demand curve shifts to the right) and supply remains unchanged,
o a Shortage occurs, leading to a Higher Equilibrium price.

If Demand Decreases (demand curve shifts to the left) supply remains unchanged,
o a Surplus occurs, leading to a Lower Equilibrium price.

If demand remains unchanged and Supply Increases (supply curve shifts to the right),
o a Surplus occurs, leading to a Lower Equilibrium price.

If demand remains unchanged and Supply Decreases (supply curve shifts to the left),
o a Shortage occurs, leading to a Higher Equilibrium price.

Supplies Shortage and Surplus: (due to change in prices of the product, while we have same Supply
Capability and Demand Requests, a Quantity Gap is created)

At Shortage (Qd>Qs) when the quantity Supplied is less than quantity demanded
o (Under equilibrium), Force price up.

At Surplus (Qs>Qd) when the quantity Supplied is more than quantity Demanded
o (Over equilibrium), Force price to drop.

Value of Shortage or Surplus = |Qd-Ds| at the new price levels



Supply Shift
(When changing other Factors then price)

S1 is less than S0, Quantity Decreases,
Supply Decreases

prices Increases


Demand Shift
(When changing other Factors then price)

New Demand is Higher then Demand ,
Quantaty demanded increase

Price increase

The effects of all the possible changes in Demand and Supply









Elasticity ()
Elasticity is used to assess the change in consumer demand as a result of a change in the good's price.

Price Elasticity of Demand is the percentage change in quantity demanded divided by the percentage
change in the price.

Price elasticity of demand (PED or Ed) is a measure to the responsiveness, or elasticity, of the quantity
demanded of a good or service to a change in its price.

More precisely, it gives the percentage change in quantity demanded in response to a one percent change
in price (holding constant all the other determinants of demand, such as income)
Determining Demand

Elasticity Represent the quantity of the demand over the price change
Elasticity should be representing in absolute, as the result may be negative.
Low Elasticity ,

















Here are two types of calculation:
Point Elasticity: by using one of the two points Q1 or Q2 (Q2-Q1)/Q1 or (Q2-Q1)/Q2
Arc Elasticity: by using the average of the two points
(Used in case we have two points on the demand curve that are very far from each others , and
different in there price is high, so to get average we use Arc Calculations )


Factors Affecting Determinates of Elasticity

Necessity of the good:
As the necessity to a good increased, Elasticity is low (e.g. gasoline)
As the consumer has low necessity to the good, he has high Elasticity

Availability of substitutes:
As there is no substitute to a good, Elasticity is low (e.g. solar)
As there is a substitute to a good, Elasticity is high (consumer have alternatives to choose from)

Time Horizon (Long-run versus short-run elasticity)
At Short term Elasticity is low, but at Long term Elasticity is high,
Or as time horizon decreased, elasticity decreased)
(E.g. Arabs oil and USA now USA have low Elasticity for oil price change, but in long run USA will found substitutes
so there Elasticity will be very high )

Price of good (or Expenditure ) as the percentage of income
When the change in price represents a high percentage of income, elasticity is high.
When the change in price represents a low percentage of income, elasticity is low.

More factors affect the PED (Price elasticity of demand )

Buyers awareness of substitutes
Buyers justification of price change
Frequency of purchase
Usage in conjunction with assets previously bought
The product perceived quality, prestige, and/or exclusiveness
Magnitude of price change (Price indifference band) price is raised, the total revenue falls to zero


To increase revenue (Revenue Calculations) Revenue = P x Q P: Price, Q: Quantity

If Elasticity is Low (Absolute Value Less than one), the Price Increased,
Since people do not react or care much about price changes insensitive Reaction or Inelastic Demand

If Elasticity is High, (Absolute Value Greater than one), the Price Decreased.
Indicates relatively large quantity demanded reaction to relativity small price change, Demand is Elastic

If Case of Unite Elastic (Absolute Value Equal than one), this mean that size of quantity change is going
to be equal to the size of the price change, the changes exactly offset one another,
This mean that 10% increase in price is a 10% decrease in quantity demanded and there will be no
change in total revenue

In case of Low elasticity: Increasing Price by large amount will increase revenue by large amount.

In case of High elasticity: Decreasing price by small amount, Quantity Increased and revenue
increased by large amount. Or Increasing Quantity With the same price

If demand is elastic ( > 1): A 1% price cut increases the quantity sold by more than 1% and total
revenue increased.

If demand is inelastic ( < 1) : A 1% price cut increases the quantity sold by less than 1% and total
revenue decreased.

If demand is unit elastic ( = 1) : A 1% price increases the quantity sold by 1% and the total revenue
does not change.

If a price cut increases total revenue, demand is elastic.
If a price cut decreases total revenue, demand is inelastic
If a price cut leaves total revenue unchanged, demand is unit elastic.


The relationship between PED and Total Revenue: (extra notes from marketing lectures)

Perfect inelasticity, changes in the price do not
affect the quantity demanded for the good; raising
prices will cause total revenue to increase.

Inelastic, the percentage change in quantity
demanded is smaller than that in price. Hence,
when the price is raised, the total revenue rises,
and vice versa.
Unit elasticity, the percentage change in quantity
is equal to that in price, so a change in price will
not affect total revenue.
Elastic the percentage change in quantity
demanded is greater than that in price. Hence,
when the price is raised, the total revenue falls,
and vice versa.

Perfect elasticity, any increase in the price, no
matter how small, will cause demand for the good
to drop to zero. Hence, when the











Perfectly Inelastic Demand Goods: If Q
D
remains constant when the price changes, then is zero

Perfectly Elastic Goods: If Q
D
changes by a large percentage when a tiny price changes, then is
infinity

Unit Elastic Demand Goods: If the percentage change in QD equals the percentage change in Price, then
equals 1

Inelastic Demand: In general case, in which %QD is less than %P, then is between zero and 1

Elastic Demand: In general case, in which %QD exceeds %P, then is greater than 1



Elasticity is different from one point to another on the demand curve




Price Elasticity of Supply is the percentage change in quantity supplied divided by the percentage
change in the price.



Price Elasticity of supply is always positive.

From Supplier point of view , they always have option to pass and cascade the price increases to the
consumers



Income Elasticity is the percentage change in quantity demanded divided by the percentage change in
income.



In case of Basic goods, income elasticity is less than 1
No Big Change in demand for basic goods when income is changes

In case of Luxurious Goods, income elasticity is greater than 1
In case if income increases by X, the demand to buy Luxurious Goods is higher

In case of Inferior Goods, income elasticity is less than zero (negative)
In case if income increases by X, the demand to buy Inferior Goods is decreases

To increase revenue by elasticity in your firm:
Return to historical data, to know the effect of the price change in the consumer demand
Using surveys, and market researches, Note: surveys measures perception not reality
Use the competitor or other vendors data (Direct public reports, or indirect by head hunting)
Cross Elasticity of Demand is the relationship between the price and the demand of two products, and
what will happened in a product A , of the price of the product B is changed




Definition of Cross Elasticity of Demand is a measure of the responsiveness of the demand for a
good to a change in the price of a substitute or complement, other things remaining the same.

In case of Positive Cross Elasticity (Substitutes)
If price of product A increased the demand of product B increased
So the two products are Substitutes (e.g. Pepsi & Coca-Cola)

In case of Negative Cross Elasticity (Complements)
If price of product B increased the demand of product A decreased
So the two products are Complements e.g. Sugar & Tea

In case of Zero Cross Elasticity (Neutral)
If the price changes of product B does not affect the demand of product A
So the two products are Neutral. e.g. Chicken & ESLSCA



Low Of Diminishing Marginal Utility: if you give a consumer an identical successive unites of goods,
with each unite consumed more; it causes less and less happiness or satisfaction (Utility) less than the
previous one.
Or in other words
The more you consume of a good, the less Marginal Utility you get, and you reach the maximum Total
Utility when the marginal utility equal zero. (Marginal utility decreased as the consumption of a good
increased)

The Marginal Utility is the amount added to the total utility with the last unite you consume.
It assumes that customer have infinite supply, and using only one product.



Given
Unites to
a
Consumer
Unites
MU TU
Marginal
Utility
(Step)
Total
Utility
0 -- --
1 10 10
2 8 18
3 5 23
4 2 25
5 -3 22


Consumption should stop when customer stop adding more to his happiness, but instead start
losing his happiness (Utility)
Low can apply on everything but religions.
Assuming Singe Identical Product , and unlimited Resources in income or supply

To Reach maximum utility, consumption need to stop when marginal Utility equal Zero.

Utility: is the benefit or satisfaction that a person gets from the consumption of goods and services.

Total Utility: is the total benefit that a person gets from the consumption of all goods and services.

Marginal Utility: is the change in total utility that results from a one-unit increase in the quantity of good
consumed.

All the things that people enjoy and want more of have positive marginal utility.
Some objects and activities can generate negative marginal utility and lower total utility.

Marginal utility Decreased as the consumption of a good Increased this principle called diminishing
marginal utility.
Law of Diminishing Marginal Utility



How Consumer will maximize this Total Utility at multiple products and Price limitation:

Remember Marginal Utility is the step of addition added to the Total Utility.
To get maximum TU satisfaction, we need to get the mist added satisfaction per dollar spending
decision.
First Get the Marginal Utility (MU) per US Dollar.
Get the Products that have the highest MU /$
Equilibrium occurs when MU /$ spend in all products is equal , (assuming spending all income ,
and no savings ) , Equilibrium
Example
Assuming Income is spend on three products (Pizza , Cans , Cigarettes)
This is the MU Table per each product. (Notice that its values decrease over increase consumption
Assuming Prices for Eash Product is Pizza =12 $ , Can =8$ and Cigarettes = 4$ , and Total
Income is 100$ (need to be spend all to get maxim Utility)
Get the Marginal Utility per US Dollar



Start Selecting the piece of products that have highest (MU) per US Dollar , then the next highest
and so on , (in case two produces have the same MU/$ , chose any of them)
Get the product mix that have higher MU , until all the 100 $ is spend , and finally we will find
them capable to buy and Achieving Total Utility of








Using Graphical Representation (Budget Lines and Indefinite Curves)

Assuming Customer can chose products preferences (Choose his MU Table).
Preferences choices must be consonance.
We assuming that always have Positive MU , and Up scaled TU



When we have more than one product, we take piece for the first product
(The product that will generate higher MU/$), then take peace from the second, and so on.
In other word, we are cyclic over the products, to maximize Marginal Utility, and causes overall increase
in the Total Utility.

Assuming consumption of two products (A & B):
o at the beginning, MU
A
=MU
B

o After using Prod A, MU
A
<MU
B

o After using Prod B, MU
A
>MU
B


To reach Equilibrium (Maximum Total Utility that we can achieve using in income)

The increase in Marginal Utility causes decrease in Elasticity, and more willingness to spend.

Consumer re pattern there consumption in case of change on MU, in order to reach equilibrium.

According to the Low of Diminishing MU , Consumer shall stop when the consumed products are not
adding anything to his happiness , but start causing him lose happiness .

Or Marginal Utility when it reaches its Minimum acceptable level (Zero) , and any consumption after that
will causes MU to be negative , and reducing the Total Utility of the Consumer .






Utility of I4 is the highest , then I3 , then I2




Change in Price in Product on Y axis ,
While Fixied the one in the Y Axes

Indifferent Curves : They represent different
combinations of two producers A & B and there
quantities vs. The level of utility they generate

Each Curves They represent different
combination of product A & B that gave the same
level of utility ,

The higher level of the curves , the higher utility

Indifferent curves are never intersecting
Slope

Examples of indifferent curves, consumer can take meal in
GAD, MAC, or 4Season


Budget Lines : they are the budget limits that the
costumer can afford (assume no savings)

It marks the boundary between those combination
of goods and services that a consumer can afford
to buy and those that cannot afford.

Consumer can afford many different
combinations of goods and services, but they are
all limited by his income and the prices.
Slope =


Any point below Budget Line is Affordable, Any point b=Above Budget Line is Unaffordable

Budget line Shifting:
Due to Inflation, it will be shift downwards (left) with same slope
Due to Deflation , it will be shift Up words (right) with same slope
If change in price of one product A or B, or both of them, change in slope will happened.
o Assuming a consumer buys two products (A & B), budget line appears as a straight line (BL0)
o In case of increasing price of Product B, the budget line will change as shown in BL1
o In case of increasing price of Product A and decreasing price of prod B, budget line will
change as shown in BL2.

By applying the two graphs, the budget line will tangent with one of indifferent utility curves, the point of
tangency is called Tangency Level at which

The Tangency Line is the maximum Indifferent Curves that the consumer can afford

Any change in prices for a single product, or both of them, or inflation, will create New Equilibrium
point (point of tangency), causes new intersection with another Indifferent Curve

In case if not all income is used, we will have Intersection between Indifferent Curves and Budget Lines
Exaplels :



The Curve I2 , causes some savings , and not maximizing the
Costemern utility of the two products



Red Curve is after Price increasing


Price Decrease in Good X






Curve B , is higher Utility , but un affordable
Curve A , is the maximum utility that consumer can have (Tangency Level)
Curve C : Consumer have some savings , and not all income is spend on products

Costs & Production
Total Cost: is the cost of all the factors of production it uses.
Fixed Cost: Cost that will Not Change when production rates changes (ex : rent)
Variable Cost : Cost that will Change when production rates changes (ex : salaries ,
machines )


Total Cost = Fixed Cost + Variable Cost ( )

Average Total Cost ) ) : is the total cost per unit of output. ( )

Marginal Cost: is the increase in total cost that results from a one unit increase in output.

Or. It is the increase in total cost divided by the increase in output ( )


Total Product (TP): is the maximum output that a given quantity of labor can produce.

Average Product (AP): tells how productive workers are on average.
Where L: Labor, K: Capital

Marginal Product (MP) of one factor (Example Labor) is the increase in total product that results from
a one-unit increase in the quantity of this factor (labor employed), with all other inputs or factors of
production remaining the same level.









Average Cost Curve and why the average total cost curve is U-Shaped?
Average total cost is the sum of average fixed cost and
average variable cost, so the shape of the ATC curve combines
the shapes of the AFC and AVC curves.

The U-shape of the ATC curve arises from the influence of
two opposing forces:

1. Spreading total fixed cost over a larger output

2. Eventually diminishing returns


Initially, as Output Increases, average fixed cost and average variable cost decreases, so average total
cost decreases. So ATC curve slopes downward (Economies of Scale).

But as Output Increases Further and diminishing returns set in, average variable cost starts to increase.
With average fixed cost decreasing more quickly than average variable cost is increasing, the ATC curve
continues to slope downward.

Eventually, average variable cost starts to increase more quickly than average fixed cost decreases, so
average total cost start to increase. The ATC curve slopes upward. (Diseconomies of Scale)

Diminishing returns means that as output increases, ever-larger amount of labor are needed to produce an
additional unit of output.

Optimum Level or Minimum Efficient Scale (Constant Scale) is the range of output in which the total
cost is minimum.


Economies of Scale in Industry Level
Internal Factors: Increase sales opportunity, sharing resources , Strong Distribution

External Factor: The century infrastructure, and availability of low cost supporting functions and
the experts of the industry are located in a certain location, which reduce the cost when starting to
establish a new firm.
o e.g. Watches industry focused in Swedish. Arabic Movies industry focused in Egypt.
Avarage /Total Cost Curvs vs the Marginal Cost ( Extra Graphs)













Using the above rules , and the long run average cost curve economies of scale consept , a typical
example is that some major retalers or banks are investng in multiple stores in neer areas , better then one
big store on the area

Typicaly : When the organization is argeting a large number of sales or coustmers (higher quantaty) to
avoind reaching the diseconomy of scale , they establesh another bransh , and this they are using all
facotrs of production , causes the shift of the minimum effective scale point to a new point that generate
the targetet quantaty














Law of Diminishing Marginal Returns

Law of Diminishing Marginal Returns Definition: If we have number of factors for production , and we
increase on factor only , while fixing all other factors , the marginal productivity of the factor we
increase it is start decreasing .




As a firm uses more of a variable factor of production with a given quantity of the fixed factor of
production, the marginal product of the variable factor eventually diminishes.

Law of Diminishing Marginal Returns Occur when the marginal product of an additional worker is less
than the marginal product of the previous worker.

Arise from the fact that more and more workers are using the same capital and working in the same
space, if we increase one of the factors of production while holding all other factors, marginal
productivity of this factor decreases.

Producers are focus on two things when hiring new people Productivity and Price.

To reach Equilibrium or , Where W: Wages, I: Interest

, This indicates that the cost of Labors is less than the cost of Capital.
This will increase no of labors.

, This indicates that the productivity of Capital relevant to the cost is greater than
the productivity of labors relevant to their wages. Decrease the number of labor.

The producer prefer the Factor that have higher
ISOQuant Curves ( (Represents different combination of two factors of
production that produce same level of output productivity.

ISOCost Line ( ( Illustrates all the possible combinations of two factors that can
be used at given costs and for a given producers budget.




In case of increasing Wages & Interest, ISO cost slope will shift down.
In case of increasing Interest, ISO cost slope will change as shown in i1
In case of increasing Wages and decreasing Interest, ISO cost slope will change as shown in i2

By applying the two graphs, the ISO cost slope will tangent with one of ISO quant curves, the point of
tangency is called Tangency Level at which
The Tangency Level or the point of tangency is when I can maximize the productivity levels using all the
budget I have

Note: the Marginal Cost curve is the inverse of the Marginal Production curve


Profit Maximization and Market Stature

Do we need all this Diagrams?

Total product, Marginal product, Average product, Total cost. Total fixed cost. Total variable cost.
Average fixed cost, Average variable cost. Marginal cost , Thats a lot of graphs. !!



Truthfully, we dont need to keep carrying around all of these diagrams, as long as all of the information
from one can be found in another. Let me show you what I mean.





Let's compare our old average product/marginal product diagram with the average cost/marginal cost
diagram.



What do you notice? The range of increasing average product or increasing productivity is reflected in the
cost diagram by decreasing per-unit costs
The more productive your resources are, the cheaper it is to produce a unit of your product.

Now, what happens when there is a declining average product decreasing productivity?
This is reflected in the cost diagram by increasing per-unit costs; as your resources become less
productive, the more expensive it is per unit to produce your product.

In the end, because we can see all the productivity information reflected in the costs, we no longer need to
use the product curves.
This leaves us with the average cost diagram versus the total cost diagram.

Can I get all of the cost information from this graph?

OK, let's start with the obvious. It's a total cost diagram, so we should be able to find the total cost.

Say the company wants to know just how much it will cost overall to produce seven units (or 700 units, or
7000 units) of output. This one I can just read straight off the graph at seven units -- the total cost is $63.


Now suppose that youd like to know, out of that $63, how many dollars are going to overhead costs that
must be paid regardless of the output, and how many dollars go to pay for variable resources, like labor
or raw materials?




Fixed costs are the same, no matter how much output you produce, even if you produce no output at all.
But at no output, I don't need to pay for any of the variable resources,
Meaning that at Zero Output, all costs are Fixed Costs.

So in this case, my total fixed costs are $21.

This also tells me that to produce seven units of output, $21 of the $63 in total costs represent overhead or
fixed costs. Of course this must mean that the other $42 fees for variable resources, and labor and
materials.

Knowing the total cost of producing seven units of output is $63, this tells me that the cost of a single
unit, or average total cost, is $63 divided by seven, or $9. The fixed part of a single unit, or my average
fixed cost, is $21 divided by seven, or $3.

It follows that the variable part of the cost for single unit must be $6 -- either take the total variable cost of
$42 and divide it by the seven units that you are producing,
OR subtract the average fixed cost of $3 from the entire cost of a unit, $9.





This leaves only marginal cost.
Marginal cost is just the extra dollars I add to my
cost by producing one more unit of output.

In this case, because six units cost $60 and seven
units cost $63, the marginal cost of the seventh unit
is $3; it cost three dollars more to produce that
seventh unit.

It looks like I can get all the cost information from
this diagram.



Now, what about the average cost diagram
can I get total cost, total fixed cost, total
variable cost, and all the rest of them?

Let's take the easy ones first: I can read
straight from the diagram :

Average Total Cost ($9),
Average Variable Cost ($6),
Marginal Cost ($3)

Average a single unit costs $9, $6 of which
is variable, meaning the other $3 must be
the average fixed cost component.




If one unit costs $9, how much do
seven units cost? $9 per unit, times
seven units, is $63.

The variable piece per unit is $6,
so the variable cost of all seven
units must be $42.

Therefore, the remaining $21
represents fixed costs.


Conclusion: we can get ALL of the cost information from either of the diagrams.

Which one will we continue to use?, We're going to continue by using the average cost curves diagram.




There is good reason for using Average Cost Curves Diagrams

Our next step in looking at business decisions that are based on maximizing profit is to bring in
information about the product price, so that we can compare that to the cost.
Since goods are priced per unit, we need to be able to clearly see the cost per unit.

Let me show you: if I go back to the average cost diagram that we just looked at, but now
I put in a price tag, you should be able to tell me instantly if this producer is making money or losing
money.


Remembering that the average total cost,
or cost per unit, is $9

What happens if the product price is $10?

This producer makes a dollar in every unit
above and beyond the cost per unit,

so there is $7, total, of profit.



Now, what if price is $8?

The producer is not bringing in enough per unit
cover the cost;

in fact, the firm loses a dollar on each unit,

so there is a seven dollar loss.



Now will I know if the producer is reaching the objective of maximizing his or her profit?







Maximizing Profits

Profit: Total revenue minus total cost P=TR-TC
Total Revenue: Its just price times quantity, TR=TP*Q

How do I figure out how much output yields the maximum amount of profit?

Assuming price is always P* (let me say, for the moment, that P* is five dollars), if that's true, then for
output equals zero revenue is equal to $0. But if output equals one, revenue is $5. And at output of two,
revenue is $10, and so on.

That means that for Perfect Competition, Total Revenue is just a straight line, increasing at each unit
by the amount of the price.



But what about profit? Remember that Profit is the combined effect of Total Revenue and Total Cost.
This still doesn't show profit directly, but it does give us the information needed to figure out what profits
going to look like.

For example, at output levels. Q1 and Q2,
Whats the profit?
At both of these output levels, the total revenue
is exactly equal to the total cost, so the profit's
zero.

Area of Losses when Total Cost is higher than
Total Revenue

This leaves us with output levels from Q1 to Q2.
In this range, total revenue exceeds total cost, so
profits are earned




.

Now that we have an idea what profit looks like at different levels of output, what level
of output would you pick, if this were your business?
As a profit maximizer, you would want to pick the level that yields the highest profit.

In this diagram, that would be output level Q vs. the generated profit



Marginal Revenue is the additional revenue that will be generated by increasing product sales by 1 unit


Maximizing Revenue:
P () =TR-TC and TR=TP*Q

From Mathematical point of view, doing First Degree Differentiation then Equal Zero for the
Quantity/Profit Equation, , To know if the point is maximum or minimum, Second Degree
Differentiation





For maximum profit, the firm owner chooses the level of output at which marginal revenue equals
marginal cost.

Marginal revenue equals marginal cost is ALWAYS the profit maximizing rule.
Think about it this way: What if marginal revenue is NOT equal to marginal cost?

For example, what if marginal revenue is greater than marginal cost?

This means that more is being added to revenue than to cost, so profits are still rising you would want to
increase your output until marginal revenue equals marginal cost.



And what if marginal revenue is less than marginal cost? In this case, more is being added to cost than to
revenue, so profits are falling.

Notice this does not necessarily mean that profits are negative; just that profits have gone past the
maximum, and are now decreasing.

In this case, you would want to cut back on your output, until marginal revenue equals marginal cost.

In the end marginal revenue equals marginal cost is always the profit maximizing rule no matter
what the market structure.

Before Going into defiles in any of the Different Market Structures, our main rules are:

Average/Marginal cost curve do not change in any market stature




The Profit maximization Rule is the quantity in which the firm produces maximum Profit,
At marginal revenue equals marginal cost. (MR= MC)

MR Curve is different from one market stature to another

Market Structures Summery

Now, cost curves are always going to look the same, but other elements, like price, revenue, and
demand, will differ depending on the market structure that the business operates in.

Are there other lots of producers, or only a few? Is my product just like everyone else or is it unique?

The characteristics of a market will clue you in as to the type of market structure you're dealing with.
Really there is a continuum of market structures, lets take a look.



Perfect Competition, at one extreme, we have Perfect Competition.

Perfect Competition Characteristics

Large number of producers means that there are so many competitors that each one is too small to
affect the market.

Since nothing you do affects the market, no one really cares what you do, and you are free to make
decisions without worrying about how the competition will react.

Producing exactly the same thing or the product is identical -- or homogeneous, or non-
differentiated

Its easy for firms to come and go from the industry that is, there is free entry and exit.

Think about it. This industry has lots of producers. Why? Because it's easy to get in and set up shop.
In an industry like this -- lots of producers, all producing exactly that the same thing how much Market
Power (where market power is defined as the ability to control the price) does an individual firm
have? None.

You have no ability to drive the price, because
o Youre so small,
o Everyone else produces exactly what you do.

Monopoly

Now let's take a look at the opposite extreme of the market structure spectrum. Instead of a huge number
of producers, there's only one producer for the whole market, or a Monopoly (the prefix Mono meaning
one).

Monopolist Product Characteristics

The Monopolist product is unique; there really are no substitutes for this product.
In a monopolistic industry, entry by other firms it nearly impossible due to the extremely high barriers
to entry.

Given all of these characteristics -- only one producer, a unique product, and no one else can get into the
industry to compete with you
How much market power (ability to control price) does the monopoly producer have?

The monopolist has complete control over the price, within the boundaries of what consumers are
willing to pay.

Monopolistic Competition and Oligopoly

Are there other structures? Sure -- in fact, most real-world industries will fall somewhere in the middle
ground, not at the theoretical extremes of perfect competition or monopoly.
Two of these midrange structures are monopolistic competition and oligopoly.

Monopolistically Competitive structure is still competitive, so there are still a lot of producers; given
there are lots of producers,
We can assume that entry into the industry is easy
The products are not exactly the same, (Highly similar, yes; highly substitutable, yes; but not
identical.

Oligopoly (the prefix Oli means Few, so I'll have
Few large producers making up the market, each with a large amount of control, or market power.
There are some.
Barriers to entry, so it's hard, but not impossible, to get in.
The product in an oligopolistic market can be identical, like the members of OPEC who produce oil,
or differentiated, like car manufacturers

The key is that there are few enough producers that each one has a fairly large chunk of the market;
large enough that any individual producer can affect what happens in the market.

Because everyone's actions matter, the producers become mutually interdependent; whatever one does
affects everyone else.

This mutual interdependence actually makes the oligopoly the most complicated type of market structure
to operate in.






Summery Comparison


Market Structure Perfect
Competition

Monopolistic
Competition

Oligopoly

Monopoly

Number of Producers Huge 20 and Up 2 to 20 One
Barriers to Enter and Exit the
Market
Easy So Difficult
Homogeneity of Products Homogeneous Differentiated : Real and
Imaginary Differentiation
Dose Not Apply
Need For Advertising No Need Yes Yes No Need
Interdependent Between Film No No Yes
(Strong
Firms have
to keep eye
on each
other)
Not Apply
Summitry of Information
(Same information between
Buyer and Seller )
Yes High asymmetry












Market Structures in Details

Perfect Competition

How would you recognize a perfectly competitive industry if you ran across one?

In perfect competition,
There are a large number of sellers (there are a large number of buyers too). No individual is large
enough to affect the market.
The product is homogeneous, or identical, or non-differentiated. (No brand loyalty )
There's perfect information. It's actually not enough for products to be identical; everyone has to know
that the products are identical.
In a perfectly competitive industry, firm versus firm advertising is useless. All you'd be doing is
driving up your own costs, and then customers would just buy from a cheaper competitor. (However,
you may see industry-wide advertising; These kinds of campaigns raise demand for each firm's
product across the industry.)
Easy entry and exit. Because firms can enter and exit the industry at will, long-term profits would be
affected,

For the individual firm owner, the combined effect of these characteristics is that he/she has no power
to control price, or a Price Taker and will earn zero economic profit in the long run.

The price comes from? In a market with lots of buyers and sellers, the price is determined collectively by
the market supply and market demand. This, then, is the prevailing price for each firm.




What happens if the firm doesn't like this price?

If it tries to charge more than P*, all of the customers will go someplace else. So, the firm would be
forced back down to P*.
If it tries to charge less than P*, then all customers in the industry will come to this firm, This firm
cannot accommodate the entire industry demand -- costs would skyrocket, and the firm would be
forced back up to P* to get rid of some of the customers.

All of this means that the firm is a price taker, forced to accept P*, the market-determined equilibrium
price.


Note that this also means, because the firm charges P* regardless of the quantity demanded,
That P* represents the Firm's Demand, as well.

The Demand is in the Perfect Competition Perfectly Elastic Demand, where consumers are so
hypersensitive to price that price is

A perfectly competitive firm may not be able to choose its price,
But the firm owner will choose the level of output that will maximize his/her profits

You will always choose the level of output were marginal revenue equals marginal cost:

Let start with Marginal Revenue:

Marginal revenue is the additional revenue that you earn when you sell an additional unit of
output.

For a perfectly competitive firm, since all units are sold for the same price, each unit sold always
adds the same amount of revenue, P*.

For example, if price is $5, then the total revenue for zero units is $0, for one unit is $5, for two
units is $10, and so on. Selling one more unit generates five additional dollars of revenue each
time.

Therefore marginal revenue is equal to the equilibrium price. MR=P*

Note that this is only true for perfect competition.

Marginal cost:

Those cost curves in the same regardless of the structure were operating in.

This means that the marginal cost for the perfectly competitive firm is just marginal cost




Marginal Revenue and Marginal cost Curve for a Perfect Competition Market



Now all we need to do is select the level of output were marginal revenue equals marginal cost.

Now, because there are no average cost curves in this diagram yet, I can't actually show you how large or
small the profits are ; only that q* will be the best level of output for this particular producer, based on the
profit-maximizing rule.

Let's look at just one example of how to find profit using this model,


What if my perfectly competitive
producer is operating in an industry
where price is greater than the cost per
unit?

I can already tell that this producer will
be making profits, since there's more
coming in for each unit than there is
being paid out in cost, but let's see what
it looks like.

Notice that I positioned the average cost
curves below the price line.




Where is MR = MC? This gives me q*. At q*, what is the total revenue coming in?


Where is MR = MC? This gives me q*.
At q* what is the total revenue coming in?


Revenue is the price I can charge times the
number of units that I sell.

In this case, the green area.



At q*,
What's the total cost of producing this
output?

Its the cost per unit, ATC, times the
number of units I sell

In this case the red area.


The amount of revenue (in green) that
doesn't get chewed up by the costs (in red)
is profit.

In this case, Ive indicated profit by the blue
area.

In the short run, this producer earns positive
profits.


Why do we say in the short run?
Because those short run profits attract the sharks other outside firms see the profits and enter the industry
to set up shop.
This causes industry supply increase, driving the price downward.
In the end, the entry only stops when there are no more profits to attract the sharks; until price is equal to
average total cost, and the firms just break even.



In the long run, a perfectly competitive firm's profits are always equal to zero.
Different Examples of Profits or Losses Calculations (Comparative static analysis)


Abnormal Profit
Industry Selling Price is Higher than
Average Variable Cost , and Average Total Cost
Normal Profit
Industry Selling Price is Higher than
Average Variable Cost , and Just Equal to Average
Total Cost




Losses
Industry Selling Price is Higher
than average variable cost , but
less than average total cost
(Covering all the Variable Costs
and part of the total cost)

Losses
Industry Selling Price is Equal to
average variable cost , but less
than average total cost
(Just Covering the Variable
Costs)

Losses
Industry Selling Price is less than
both average variable cost ,
average total cost
(Cant Cover Average Variable
Costs or total costs )



Note: Sing the market as Perfect Competition may depend on the customer buying behavior or knolege on
the product ) , (






P*=d=MR
P*=d=MR
P*=d=MR
P*=d=MR
P*=d=MR
Monopoly

How will you know a monopoly if you see one?

Single seller, someone who sells a product for which there are no close substitutes,

There are significant barriers to entry, barriers that are so high, in fact, that no other producers can enter
the industry.

What kinds of barriers could there be that would keep competitors out?
Patents ( ) would keep others out, at least until the patent expired, or unless you sell the
right to use the idea to other people;
Sole ownership of a key resource would prevent competition.
Extremely high costs would keep many other producers out; in fact, in the case of extraordinarily high
fixed costs, you can get a situation where economies of scale kick in, and you're actually better off to
have only one producer (as power generation plants)

Natural Monopoly or Atypical Monopoly

In case of Extremely high costs to establish a business (like power generation plants ) So, if there's
just one company incurring all those upfront costs, that firm can spread the costs out over a large
quantity of production, and the cost per unit ends up being very low.

But if you break this company up, creating 10 smaller firms that would compete with each other,
each firm must repeat these initial costs, yet has only 1/10 of the customers, in this example. Cost
per unit ends up being very high.



In a case like this, with huge economies of scale, it's actually more efficient to have only one
producer, as a natural outcome of the cost structure. This would be a natural monopoly or
atypical monopoly

With a natural monopoly, the enormous fixed costs dominate, so that effectively, the average total
cost curves look like what we're accustomed to seeing in an average fixed cost curve; the more
you produce, the lower the cost per unit.

This type of monopoly (atypical monopoly) is the exception, though, and not the rule.

Typical Monopoly


First of all, because the monopoly is the only
seller of the product, anyone who wants to
buy the product must buy from the
monopoly.

This means that the demand faced by the
monopolist is the entire industry, or market,
demand.





What does marginal revenue look like?
I need to calculate total revenue before I can
calculate marginal revenue, which I do by
multiplying the price per unit times the
number of units. Then I can address marginal
revenue, or the amount of additional revenue I
generate by selling another unit.

Since I had NO revenue when my output was
zero, the marginal revenue of my first unit is
+$10,
The second unit adds $8 to revenue; the third
adds $6, and so on.




Notice that, unlike perfect competition, the
marginal revenue figures are less than the
prices. If I plot out the numbers for demand and
marginal revenue, you can see the contrast.

I use the price and quantity figures to plot
demand, and the marginal revenue and quantity
figures to plot the marginal revenue curve, so I
know that generally demand and marginal
revenue look like this.




To determine the monopolist's chosen output,
though,
I need to be able to find the output at which
marginal revenue equals marginal cost;

so I also need to add a marginal cost curve.
Because marginal cost looks the same, no matter
what the market structure is, (all I need to do is add
our usual J-shaped marginal cost curve to the
existing diagram.)

Now I can see the monopolist's profit-maximizing
output, Q*.



We don't know the monopolist's price yet.

To find it, you have to remember that this producer
can raise the price as high as the consumers are
willing to pay.

Since the demand reflects the buyers' willingness to
pay,

I go up to the demand curve to see what price I can
get for these Q* units of output.

Q* is the monopolist's profit-maximizing output.
P* is the price that can be charged for that output.



What's the monopolist's profit, this can be done by
adding the average cost curves

A Monopolist who is earning a positive profit. This
means that the price must be higher than the cost
per unit.

Remember that price times quantity yields your
total revenue (in green), Average total cost times
quantity gives your total cost (in red) , The
remaining area that I have here in blue is the firm's
profit.





What happens the monopoly's profit in the long run? I mean, if a competitive firm makes a profit in the
short run, then over time, other firms enter, and profits go to zero.

So what happens to the monopolists profit? Nothing happens. Remember the barriers to entry? Those
barriers keep competitors out, protecting the monopolist's profit.


Does the monopolist necessarily earn profit?

No; just because you're the only producer of something
doesn't guarantee you'll earn a profit.

If the cost per unit exceeds the price, you'll be losing
money just like any other business owner.

What'll happen in the long run? Any producer who's
losing money in the short run will get out in the long
run, taking his/her resources elsewhere.

Where does this leave industry?
If this producer leaves, there is no industry.



Why do so many people consider the monopolist to be the bad guy?
This is just a producer, trying to maximize profits like any other producer , Most people are opposed to a
monopoly because they prefer the alternative, competition.

If this were a competitive market, instead?

Remember that in a competitive market, the
market supply and the market demand determine
the price and quantity.

We know already that the monopoly faces the
industry, or market, demand;

Where's the industry supply? The marginal cost
curve, as long as we're above that minimum
average variable cost, is the monopoly supply.

And since the monopolist is the only supplier, it's
also the industry supply.


The intersection of industry supply and industry demand yield the price and quantity that we'd see
if this were perfectly competitive market.

Why do people consider the monopolist to be the bad guy?
Because the monopolist charges more, and provide less product.
The Once who don't like the monopolist are the consumers, who would
rather see the lower prices and greater quantities associated with a
competitive market


Monopolistic Competition

As the name of the structure suggests, it's
something a mash up of the characteristics of a
perfectly competitive market and those of a
monopoly market.



I t's Competitive, so, like perfect competition, there is large number of sellers a large enough number so
that no individual can affect the overall market , there's free entry and exit; firms find no substantial
barriers to entering or departing this market.

Moving the Direction of the Monopoly, the monopolistic competitors s product is differentiated; this
product differentiation gives the monopolistically competitive firm a small amount of control over the
price it can charge.

Not a lot of control, because the products are still highly similar, but a little control.

Differentiation may be Real or Artificial, where there are physical differences in the products. It is
possible in this market structure to have artificial differentiation, where two products are physically
identical, but through marketing (say, attractive packaging, or celebrity endorsements), consumers are
convinced that the products are different.

In a monopolistically competitive market, perfect information does not exist, and consumers can be
fooled into believing that products are different by the use of advertising and marketing.

In the end, as long as consumers perceive the products to be different, then the products are different; it
doesn't matter whether the difference is real or artificial.

What does the market look like?

The demand facing each producer will be a
small fraction of the overall market demand.
And the demand will be elastic.

The monopolistically competitive firm's
demand will be downward-sloping, if fairly
flat, showing that the firm has a small amount
of control over its price.



From here, you can treat the graph much as
you treated the monopoly graph. With a
downward-sloping demand, the firm's
marginal revenue will lie below its demand
curve.


To find the profit-maximizing output and
price for the firm,

we need to add the marginal cost curve,
determine where marginal revenue equals
marginal cost to get the optimal output, q*,



And then use the demand line to determine
how much the firm owner can get the buyers
to pay for those q*units.


Like a monopolist, a monopolistically
competitive firm could make money, lose
money, or break even in the short run;





But like perfect competition, the picture will change
long run the firm will end up just breaking even over
time.

Why? Because not only does the firm have very little
market power, remember also the assumption of free
entry and exit
If a monopolistically competitive firm is making a
profit in the short run, then other firms will see that
profit, and they will enter the industry.

This will draw away some customers from the existing
firm, lowering demand, and eventually the existing firm
will just break even.

If profits still exist, new firms continue to enter until
there are no more profits to be had.




What if the firm is losing money in the short run?

In the long run, then, some firms will leave; their
customers will have to shift other sellers,

So that the remaining firms will see their demand
curves increase until such point as they can break even.

At that point, exit from the industry stops.

So in the long run, like the perfectly competitive firm,
the profits are driven to zero.




There is an important difference

The perfectly competitive firm in the long run always ends up operating at the most efficient point, that is,
the lowest per unit cost on the long-run average total cost curve.

Whereas the monopolistically competitive firm always operates just shy of peak efficiency, operating at a
slightly higher cost, and producing fewer units.




To wrap up, let's do a quick recap of this market structure as compared to perfect competition and
monopoly.
There are a large number of firms, more like perfect competition; with respect to the product
produced, it's not identical across firms, as with perfect competition, but neither is it unique.
The products are differentiated, but highly similar and therefore highly substitutable.
Entry and exit are easy, which affects the ability to sustain profits.
All types of firms use the MR=MC rule to maximize profit, and any firm could make money, lose
money, or break even in the short run. But in the long run, only a firm with barriers to entry to protect
its profits can sustain those profits.
What about price and output? The result will be somewhere between the two extreme structures --
producing more than a monopoly but less than perfectly competitive market; charging less than
monopoly but more than perfectly competitive market.
Oligopoly

We've reached our final, and our most complex, market structure: Oligopoly.

In an oligopoly, you would find only a small number of sellers, that is, few enough so that any
individual seller can affect the market, and the firm's actions will have an impact on all the other
sellers.
The product can be either the same, like oil, or differentiated, like automobiles,
There are fairly high barriers to entry.

What will prices and output look like? What is the potential for profit?

The oligopoly market structure will result in a higher price than either competitive market, although not
so high as a monopoly, and will be able to maintain some profit, if it exists, into the long run because of
the barriers to entry.

Why the oligopoly most complex, market structure?
Well that's because the actions of any one firm will have an impact on all of the other players in the
market, This mutual interdependence among firms means that each firm keeps an eye on everyone else,
trying not only to anticipate moves but also to have their own reaction plan in place.

The oligopolistic firm's Demand:

This demand (kinked Shape) is effectively composed of two
different demand curves, because the game-playing
behavior,
If you will, of the firms in this industry will change
depending on whether the firm
is implementing a price increase, or a price decrease.


When the oligopolistic firm goes to increase its price:
The rivals will not follow; they will let that one firm
increase its price, and then they will gain the customers
as buyers are driven away by the initiating firm's higher
prices.
What this means for the firm is that, if it raises its price,
and no other producer follows suit, Then the initiating
firm will see a large decrease in quantity demanded.

i.e., the demand is more elastic when the firm attempts to
increase its price.
Well, what if the firm lowers its price? The rivals are aware
that they could lose substantial market share if they do not
follow along and lower their prices as well,

What happens if everyone lowers prices? The firm that
initiated the price decrease would see very little change in
quantity demanded because, for the most part, customers
stay where they are; that is, the demand faced by the
firm is inelastic when there is a price decrease.

If the firm raises price, no rivals follow, it loses a lot of customers, and the demand is elastic;
If it lowers its price, everyone follows, and not much is gained by that firm in terms of sales, or
you have inelastic demand.

This will also result in a very unusual marginal
revenue curve.

Think about the marginal revenue that would be
associated with the more elastic price increase
scenario.

Then, consider the marginal revenue that would be
associated with the more inelastic price decrease
demand.




To find the profit-maximizing output and price for the firm,
All you need is the output where marginal revenue equals marginal
cost. Marginal cost looks the same regardless of the market structure,

So you just add it to the oligopolistic firm's demand diagram.

You can find Q*, the output where marginal revenue equals marginal
cost, and then use the demand curve to determine the highest price the
firm can get the consumers to pay for those Q* units.



In the short run, the firm could make money, lose money, or break even depending on the position of the average cost curves.


If the firm makes money in the short run, the barriers to entry help to protect these profits, even in the
long run.
Remember, in an oligopoly market structure it is difficult, but not impossible; to enter the market, so there
may be some loss of profit to new rivals over time.

If the firm loses money in the short run, it will exit the industry in the long run, leaving behind more
customers for the rival firms.

So, in the end, how does the oligopoly compare to the other market structures?

The oligopolistic firm can maintain profit into the long run, but the profits earned aren't quite as high as
the monopoly could earn.

Collusion happens when the firms of an oligopoly get together and attempt to act like a single large firm
a monopoly in order to boost their profits.