Intro.
to Economics
6. Week
Firm Behavior and The Organization of Industry: Monopoly
Key Questions-The Cost of Production
• What is a production function? What is marginal product? How are they related?
• What are the various costs, and how are they related to each other and to output?
• How are costs different in the short run vs. the long run?
• What are “economies of scale”?
• The economy is made up of thousands of firms that produce the goods and ser-
vices you enjoy every day.
• For many firms, the division of total costs between fixed and variable costs de- pends on
the time horizon.
• Cost of production is all the costs that a company incurs when offering a service
or manufacturing a product.
• The cost of production is an important factor for businesses to consider when
assessing their financial health.
Total Revenue, Total Cost, Profit
§ We assume that the firm’s goal is to maximize profit.
Profit = Total revenue – Total cost
the amount a firm receives from the market value of the
the sale of its output inputs a firm uses in
production
§ Total revenue is the total receipts a seller can obtain from selling
goods or services to buyers.
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Costs: Explicit vs. Implicit
§ Explicit costs require an outlay of money,
e.g., paying wages to workers.
§ Implicit costs do not require a cash outlay,
e.g., the opportunity cost of the owner’s time.
§ Remember one of the principle:
↓ The cost of something is what you give up to get it.
§ This is true whether the costs are implicit or explicit. Both matter for
firms’ decisions.
↓
An implicit cost is a cost that exists without the exchange of cash and is
not recorded for accounting purposes.
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General Evaluation about the Cost of Production
§ Costs are critically important to many business decisions, including
production, pricing, and hiring.
§ Implicit costs do not involve a cash outlay yet are just as important as
explicit costs to firms’ decisions.
§ Remember one of the principle:
The cost of something is what you give up to get it.
§ This is true whether the costs are implicit or explicit. Both matter for
firms’ decisions.
§ Production costs typically include supplies and raw materials that are
consumed during production, along with labor expenses.
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Key Questions-Monopoly
§ Why do monopolies arise?
§ How do monopolies affect society’s well-being?
§ What can the government do about monopolies?
§ What is price discrimination?
§ A monopoly is a market structure where a single seller or producer assumes a
dominant position in an industry or a sector.
§ Monopolies are discouraged in free-market economies as they stifle competition and
limit substitutes for consumers.
§ A monopoly is a business that is characterized by a lack of competition within a market
and unavailable substitutes for its product.
A Key Introduction for Monopoly
§ A monopoly is a firm that is the sole seller of a product without close
substitutes.
§ The key difference:
A monopoly firm has market power, the ability to influence the market
price of the product it sells.
§ A competitive firm has no market power.
§ Monopoly and competition, basic factors in the structure of
economic markets.
§ In economics, monopoly and competition signify certain complex
relations among firms in an industry.
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Price Discrimination
§ Discrimination: treating people differently based on some characteristic,
e.g. race or gender.
§ Price discrimination: selling the same good at different prices to
different buyers.
§ In the real world, perfect price discrimination is not possible:
§ No firm knows every buyer’s willingness to pay.
§ Buyers do not announce it to sellers.
§ In a perfect business world, companies would be able to eliminate all
consumer surplus through first-degree price discrimination.
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Examples of Price Discrimination
§ Movie tickets
Discounts for seniors, students, and people who can attend during
weekday afternoons. They are all more likely to have lower willingness to
pay than people who pay full price on Friday night.
§ Airline prices
Discounts for Saturday-night stayovers help distinguish business travelers,
who usually have higher willingness to pay, from more price-sensitive
leisure travelers.
§ Discount coupons
People who have time to clip and organize coupons are more likely to have
lower income and lower willingness to pay than others.
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As a General about Monopoly
§ In the real world, pure monopoly is rare.
§ Yet, many firms have market power, due to:
§ selling a unique variety of a product
§ having a large market share and few significant competitors
§ In many such cases, most of the results from this chapter apply, including:
§ markup of price over marginal cost
§ deadweight loss
Policymakers may respond by regulating monopolies, using antitrust laws to
promote competition, or by taking over the monopoly and running it. Due to
problems with each of these options, the best option may be to take no action.
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Key Questions-Monopolistic Competition
§ What market structures lie between perfect competition and monopoly, and what are
their characteristics?
§ How do monopolistically competitive firms choose price and quantity? Do they earn
economic profit?
§ In what ways does monopolistic competition affect society’s welfare?
§ What are the social costs and benefits of advertising?
§ Monopolistic competition occurs when an industry has many companies that offer
similar competing products.
§ Monopolistic competition is a condition of a market structure and is on the
continuum alongside perfect competition, monopoly, and oligopoly.
Between Monopoly and Competition
Two extremes
§ Perfect competition: many firms, identical products
§ Monopoly: one firm
In between these extremes: imperfect competition
§ Oligopoly: only a few sellers offer similar or identical products.
§ Monopolistic competition: many firms sell similar but not identical products.
➥Short run: Under monopolistic competition, firm behavior is very similar to monopoly.
➥Long run: In monopolistic competition, entry and exit drive economic profit to zero.
§ If profits in the short run: New firms enter market, taking some demand away from
existing firms, prices and profits fall.
§ If losses in the short run:Some firms exit the market, remaining firms enjoy higher demand
and prices.
Advertising
§ In monopolistically competitive industries, product differentiation and markup
pricing
lead naturally to the use of advertising.
§ In general, the more differentiated the products,
the more advertising firms buy.
§ Economists disagree about the social value of advertising.
§ Critics of advertising believe:
§ Society is wasting the resources it devotes to advertising.
§ Firms advertise to manipulate people’s tastes.
§ Advertising impedes competition – it creates the perception that products are more
differentiated than they really are, allowing higher markups.