Microeconomics

• Publisher: QuickStudy Reference Guides
• Year: 2009
• ISBN:
  9781423212256
• Topic: Economía
• Subtopic: Teoría económica

With the economy currently in turmoil, understanding how businesses and consumers interact is more important than ever—for business owners and students of economics, alike. A handy, fluff-free resource tool, our 3-panel (6-page) guide simplifies the world of microeconomics through the use of definitions, formulas and full-color tables and charts.

MONOPOLY CHARACTERISTICS

• SINGLE SELLER (THE FIRM IS THE ENTIRE INDUSTRY)
• GOODS PRODUCED HAVE NO CLOSE SUBSTITUTES
• IMPERFECT INFORMATION
• PRICE MAKER OR PRICE SEARCHER: The downward-sloping demand curve facing the monopolist is also the market demand curve.
  1. Price must decline if the monopolist seeks to sell more. If the monopolist raises the price, the amount sold declines.
  2. The monopolist can choose the price or the amount sold, but not both.
• BECAUSE PRICE DECLINES AS OUTPUT IS EXPANDED, marginal revenue is less than price.
• AT Q WHERE MR = 0,
  1. Total revenue is maximized.
  2. Elasticity of demand curve is unitary elastic.
  
• BARRIERS TO ENTRY:
  1. Strong legal barriers, patents and licenses.
  2. Economies of scale keep out competition because the unit costs of a new entrant to the industry are much higher than the established monopolist who can charge lower prices.
  3. Control of an essential resource can prevent competitors from entering the market.

MONOPOLY PROFIT MAXIMIZATION

• PRODUCTION: The monopolist expands production to Q*, until the revenue from the last marginal unit (marginal revenue) equals the cost of producing it (marginal cost).
• PRICE: Once a level of production is selected, the demand curve gives the price (P*) that must be charged to persuade consumers to buy what is available.
• PROFIT: Production will continue in the short run as long as the price exceeds the average variable cost.
  1. If the price exceeds average variable cost (AVC) but is less than average total cost (ATC), the monopolist will produce at a loss.
  2. If the price exceeds average total cost, the monopolist will make a profit.
  3. In the long run, the monopolist can earn positive economic profits, but will shut down if it continues suffering losses.

MONOPOLY & EFFICIENCY

• THE MONOPOLIST IS NOT FORCED TO PRODUCE WHERE UNIT COSTS ARE LOWEST (LACK OF COMPETITION). Thus, productive efficiency may not be achieved.
• THE MONOPOLIST PRODUCES WHERE THE PRICE IS GREATER THAN THE MARGINAL COST. Hence, the consumer pays more for an extra unit of production than it costs society. Allocative efficiency is not achieved.
• MONOPOLISTS PRODUCE LESS AT A HIGHER PRICE THAN WOULD BE PRODUCED UNDER PERFECT COMPETITION. Monopoly profit reduces consumer welfare by charging consumers a higher price. A reduction in production even further reduces their welfare; a “deadweight” loss to society is created.

PRICE DISCRIMINATION CHARGING CONSUMERS DIFFERENT PRICES FOR THE SAME PRODUCT.

• REQUIREMENTS:
  1. Seller must be a monopolist or have considerable monopoly power.
  2. Sellers must be capable of dividing consumers into different classes, each class being charged a different price (market segmentation).
  3. Marginal costs of production for the different classes must be similar.
  4. Consumers charged a lower price must be incapable of reselling to consumers in the higher priced class.
• FOR EACH CLASS OF CONSUMERS, THE MONOPOLIST SHOULD ALLOCATE OUTPUT TO THE POINT WHERE the marginal revenues from selling to each class are equal to the marginal costs.
  1. Price discrimination reduces consumer surplus.
  2. Perfect price discrimination completely wipes out consumer surplus.

NATURAL MONOPOLY

• Definition: A natural monopoly arises because a single firm can supply the market and its long run average costs (LRAC) are still falling when the limits of market demand are reached. EX: Public Utilities.
  
• UNREGULATED NATURAL MONOPOLY will produce Q_U (where MR = LRMC) at P_U, making a profit.
  1. There is no incentive for the monopolist to lower price and lower costs because of lack of competition.
  2. The price will be raised to cover any cost increase.
  3. There is uncertainty about where the true cost and demand curves lie.
• SOCIALLY OPTIMAL OUTPUT (Q_O): D = LRMC. Here, allocative efficiency is achieved (output is produced up to the point where the cost of an extra unit equals the price consumers are willing to pay for the extra unit). At Q_O, the price P_O is less than LRAC and the monopolist realizes a loss. This requires a subsidy at least equal to the loss (which is most likely to occur if the government owns the firm).
• PRIVATELY OWNED NATURAL MONOPOLIES ARE USUALLY REGULATED. The regulation allows the monopolist to charge P_r and produce Q_r, where the price equals LRAC. This ensures a “fair” return to the monopolist (normal profits).
• PARTS OF A NATURAL MONOPOLY CAN BE OPENED TO COMPETITION. EX: A monopoly can be granted to the electric transmission system (wires, etc.) even if more than one company can produce the electricity to be generated.

MONOPOLISTIC COMPETITION

• CHARACTERISTICS:
  1. Large number of buyers and sellers
  2. Imperfect information; price maker
  3. Low barriers to entry
  4. Differentiated products (such as different brands or levels of service); costs are higher due to expenditures to differentiate products (such as advertising)
  5. Very elastic demand curve
  6. Short run behavior like a monopo...