Professional Documents
Culture Documents
February 9, 2022
Definition of market
Market is a group of buyers and sellers of a particular good or service
→ the firm takes the market price of the product as given, choosing its
output on the assumption that the price will be unaffected by the output
choice.
Microeconomics February 9, 2022 10 / 92
Profit maximization (Theory of profit - chapter 5)
∆π
= ∆TR/∆Q − ∆TC /∆Q = 0 (2)
∆Q | {z } | {z }
MR MC
How much output should a firm produce over the short run, when its
plant size is fixed (capital = constant, labour is changeable)?
A firm can use information about revenue and cost to make a
profit-maximizing output decision.
Output Rule:
If a firm is producing any output, it should produce at the level at which
marginal revenue equals marginal cost.
A supply curve for a firm tells us how much output it will produce at
every possible price
Competitive firms will increase output to the point: P = MC
→ The firm’s supply curve is the portion of the MC curve for which MC >
AVC.
In the short-run:
Profit is the area ABCD
In the long-run:
The firm maximizes its profit by choosing the output at which price equals
long-run marginal cost LMC.
The firm increases its profit from ABCD to EFGD by increasing its output
in the long run.
Economic profit
π = TR − (wL + rK ) (3)
| {z }
=TC
2. No firm has an incentive either to enter or exit the industry because all
firms are earning zero economic profit.
3. The price of the product is such that the quantity supplied by the
industry is equal to the quantity demanded by consumers.
In (a) we see that firms earn positive profits because long-run average cost
reaches a minimum of $30 (at q2).
Positive profit encourages entry of new firms and causes a shift to the
right in the supply curve to S2, as shown in (b).
The long-run supply curve for a constant-cost industry is, a horizontal line
at a price that is equal to the long-run minimum average cost of
production.
The term “increasing cost” refers to the upward shift in the firms’ long-run
average cost curves, not to the positive slope of the cost curve itself.
The industry supply curve can be downward sloping. In this case, the
unexpected increase in demand causes industry output to expand as
before. But as the industry grows larger, it can take advantage of its size
to obtain some of its inputs more cheaply.
Consumer surplus
is the area above the market price and up to the demand curve; this is the
total benefit or value that consumers receive beyond what they pay for the
good.
Producer surplus
is the area above the supply curve up to the market price; this is the
benefit that lower-cost producers enjoy by selling at the market price.
Consumer A would pay $10 for a good whose market price is $5 and
therefore enjoys a benefit of $5. Consumer B enjoys a benefit of $2, and
Consumer C, who values the good at exactly the market price, enjoys no
benefit. Consumer surplus, which measures the total benefit to all
consumers, is the yellow-shaded area between the demand curve and the
market price.
(A − B) + (−A − C ) = −B − C (4)
b. In the long run, how many units will this firm produce and what price
will it sell each unit for in this market?
c. What is the total market Qm produced in this market in the long run?
Microeconomics February 9, 2022 40 / 92
Solutions
a. What is the average total cost for the representative firm?
b. In the long run (MC = ATC), how many units will this firm produce
and what price will it sell each unit for in this market (P= MC)?
100/q + 5 + q = 5 + 2q −→ q = 10 (6)
1 What is monopoly?
2 Sources of monopoly power
3 Demand and marginal revenue for a monopolist?
4 Monopolist’s output decision (price, quantity and profit)
5 Is there any supply curve for a monopolist?
6 Measuring market power
7 Price discrimination
A monopoly
is a market that has only one seller but many buyers.
Market power
is an ability of a seller or buyer to affect the price of a good.
P = a − bQ (7)
TR = Q.P = aQ − bQ 2 (8)
AR = TR/Q = a − bQ (9)
∆π
= ∆TR/∆Q − ∆TC /∆Q = 0 (11)
∆Q | {z } | {z }
MR MC
Q* maximizes profit
is the output level at which MR = MC.
∆TR ∆(PQ)
MR = = (12)
∆Q ∆Q
∆P Q ∆P
MR = P + Q = P + Ph ih i (13)
∆Q P ∆Q
Q ∆P
MR = P + P h ih i (14)
P ∆Q
| {z }
1/Ed
1
MR = P + P = MC (15)
Ed
P − MC 1
=− (16)
P Ed
In (a), the demand curve D1 shifts to new demand curve D2. But the new
marginal revenue curve MR2 intersects marginal cost at the same point as
the old marginal revenue curve MR1. The profit-maximizing output
therefore remains the same, although price falls from P1 to P2.
In (b), the new marginal revenue curve MR2 intersects marginal cost at a
higher output level Q2. But because demand is now more elastic, price
remains the same.
Monopoly power
is the ability to set price above marginal cost and that the amount by
which price exceeds marginal cost depends inversely on the elasticity of
demand facing the firm.
The less elastic the demand curve is, the more monopoly power a firm has.
The ultimate determinant of monopoly power is therefore the firm’s
elasticity of demand.
The Lerner index always has a value between zero and one. For a perfectly
competitive firm, P = MC, so that L = 0. The larger is L, the greater is
the degree of monopoly power.
Microeconomics February 9, 2022 60 / 92
Price markup
Ed is the elasticity of demand for the firm, not the elasticity of market
demand.
(The next slide) If the firm’s demand is elastic, as in (a), the markup is
small and the firm has little monopoly power. The opposite is true if
demand is relatively inelastic, as in (b).
Recall in Equation 18: the less elastic its demand curve, the more
monopoly power a firm has.
Three factors determine a firm’s elasticity of demand:
1 The elasticity of market demand. Because the firm’s own demand will
be at least as elastic as market demand, the elasticity of market
demand limits the potential for monopoly power.
2 The number of firms in the market. If there are many firms, it is
unlikely that any one firm will be able to affect price significantly.
3 The interaction among firms. Even if only two or three firms are in
the market, each firm will be unable to profitably raise price very
much if the rivalry among them is aggressive, with each firm trying to
capture as much of the market as it can.
Figure (a) shows a monopolist that charges the same price to all
customers. Total surplus in this market equals the sum of profit (producer
surplus) and consumer surplus.
Despite knowing that oil waste had been dumped at the source, the
supplier – Vinaconex Water Supply Joint Stock Company (Viwasupco) –
continued to pump water into family homes. At a press conference, the
company’s CEO even said: “Viwasupco was the biggest victim in this
case.”
The case has raised questions about who is responsible for checking water
quality and ensuring it is safe for use, and whether the participation of the
private sector in delivering public goods is as necessary and efficient as
expected.
Microeconomics February 9, 2022 71 / 92
Shinkansen Japanese High-speed rail
1 Many sellers: There are many firms competing for the same group of
customers.
2 Product differentiation: Each firm produces a product that is at least
slightly different from those of other firms. Thus, rather than being a
price taker, each firm faces a downward-sloping demand curve.
3 Free entry and exit: Firms can enter or exit the market without
restriction. Thus, the number of firms in the market adjusts until
economic profits are driven to zero.
4 It is a hybrid of monopoly and competition.
Similarly, if firms are making losses, old firms exit, and the demand curves
of the remaining firms shift to the right. Because of these shifts in
demand, a monopolistically competitive firm eventually finds itself in the
longrun equilibrium shown here.
In this long-run equilibrium: P = ATC and the firm earns zero profit.
Two differences:
1 The perfectly competitive firm produces at the efficient scale, where
average total cost is minimized. By contrast, the monopolistically
competitive firm produces at less than the efficient scale.
2 Price equals marginal cost under perfect competition, but price is
above marginal cost under monopolistic competition.
a. How does N, the number of firms in the market, affect each firm’s
demand curve? Why?
Demand: Q = 100/N – P, when there is an increase in N, the demand
decreases and the demand curve shifts inward.
b. How many units does each firm produce? (The answers to this and the
next two questions depend on N.)
Calculate MR using demand curve by calculating TR, then first
differentiating TR subject to Q −→ we need to rearrange demand curve
so that Q = 100/N – P −→ P = 100/N - Q −→ TR = PxQ =
100Q/N − Q 2 −→ TR 0 (Q) = 100/N − 2Q
Maximizing profit: MR = MC −→ 100/N − 2Q = 2Q −→ Q = 25/N
c. What price does each firm charge?
Q = 100/N – P = 25/N −→ P = 75/N
Microeconomics February 9, 2022 87 / 92
Exercise 2
Oligopoly:
A market structure in which only a few sellers offer similar or identical
products
Strategy
Because oligopolistic markets have only a small number of firms, each firm
must act strategically. Each firm knows that its profit depends not only on
how much it produces but also on how much the other firms produce. In
making its production decision, each firm in an oligopoly should consider
how its decision might affect the production decisions of all the other firms.
Game theory
the study of how people behave in strategic situations.
Collusion
An agreement among firms in a market about quantities to produce or
prices to charge.
Cartel
A group of firms acting in unison.
Example: OPEC. What is OPEC? Please try to look in youtube.
Website of OPEC: https://www.opec.org/opecw eb/en/
Nash equilibrium:
a situation in which economic actors interacting with one another each
choose their best strategy given the strategies that all the other actors
have chosen