Introduction to Economics

1. Introduction to Economics Microeconomics The US Economy

2. Market Power and Monopoly • Is monopoly a good thing or not? • How about Microsoft, is this firm good or bad for consumers?

3. Market Power & Market Structure • No market power: competition • many producers • firms are price takers • no excess profit • price to consumer = long run average cost • Market power: monopoly • one producer • monopolist is price setter • monopolist makes profits at expense of the consumer

4. The Brief for Competition • .... and against monopoly

5. Outline: Lecture Thirteen • Competitive Industries • agriculture • construction • Market Supply in the Short Run • The Optimal Plant Size • Market Supply in the Long Run

6. Competitive Markets • In the long run, resources will flow to a competitive market if firms are making excess profits • new firms will enter the industry • if returns to scale are constant, then price will be driven down to long run average total cost • if returns to scale first increase and then decrease, price will be driven down to minimum long run average cost • Consumers benefit from the efficient, lowest cost use of resources and the lowest price for the product • Excess Profits are driven to Zero

7. Competitive Industries: Agriculture source: Census of Agriculture, 1987

8. Competitive Industries sources: Census of Manufactures, 1987 Census of Construction Industries, 1987

9. Short Run • Plant Size of a firm is fixed

10. Short Run Market Supply: Two Firm Industry Market Supply MC, AVC MCII MCI AVCI AVCII QI + QII QI QII Quantity

11. Market Supply and Demand in the Short Run Supply Demand MC, Market Price pM QM Quantity

12. Short Run Market Supply: Two Firm Industry MC, AVC, ATC Market Supply MCII MCI ATCI ATCII AVCI PM AVCII Market Demand Quantity QI + QII QI QII In the short run, both firms are making excess profits. This may motivate them to find the lowest cost size for plant and equipment.

13. Short Run* World Supply: Copper * Existing Mines Fixed Source: Minerals Yearbook, 1985

14. Canada Peru US Chile Zaire Zambia

15. Long Run • What is the optimal plant size? • constant returns to scale • increasing, then decreasing returns • increasing returns to scale

16. Optimal Size of the Firm: Constant Returns to Scale MC, , ATC SMCII SMCI SATCII SATCI pM LATC, LMC Quantity If market price is above long run marginal cost, the firm will make the same excess profit per unit of output in a large plant as in a small plant. The firm may prefer larger to smaller. As long as firms are making excess profits, other firms will enter the industry, increasing supply, and driving price down to LMC.

17. Long Run Equilibrium Supply with the Free Entry of Firms: Constant Returns to Scale Short Run Supply Market Price Demand Supply after Entry of Profit Seeking Firms PM PM = LMC = LATC Long Run Supply Quantity

18. Optimal Size of the Firm: Constant Returns to Scale MC, , ATC SMCII SMCI SATCII SATCI LATC, LMC pM Quantity If market price is above long run marginal cost, the firm will make the same excess profit per unit of output in a large plant as in a small plant. The firm may prefer larger to smaller. As long as firms are making excess profits, other firms will enter the industry, increasing supply, and driving price down to LMC.

19. Optimal Size of Plant with Variable Returns to Scale LMC LATC Market Price LATC SMCIV SATCI SATCIV SATCII SMCIII SATCIII pM Quantity If market price is above long run average cost, then firms with efficient scale of plant, SATCIII ,will make an excess profit. In the long run other firms in the industry will move to this efficient size plant. As long as there are excess profits to be made, new firms will enter the industry, driving market price down to minimum long run average total cost, LATC.

20. Long Run Equilibrium Supply with the Free Entry of Firms: Variable Returns to Scale, Deceasing and then Increasing Short Run Supply Market Price Demand Supply after Entry of Profit Seeking Firms PM PM = LMC = Minimum LATC Long Run Supply Quantity

21. Optimal Size of Plant with Variable Returns to Scale LMC LATC Market Price LATC SMCIV SATCI SATCIV SATCII SMCIII SATCIII pM Quantity If market price is above long run average cost, then firms with efficient scale of plant, SATCIII ,will make an excess profit. In the long run other firms in the industry will move to this efficient size plant. As long as there are excess profits to be made, new firms will enter the industry, driving market price down to minimum long run average total cost, LATC.

22. Competitive Markets • In the long run, resources will flow to a competitive market if firms are making excess profits • new firms will enter the industry • if returns to scale are constant, then price will be driven down to long run average total cost • if returns to scale first increase and then decrease, price will be driven down to minimum long run average cost • Consumers benefit from the efficient, lowest cost use of resources and the lowest price for the product • Excess Profits are driven to Zero

23. Natural Monopoly • Increasing Returns to Scale • optimal size of the firm • larger is better • Constant Returns to Scale • optimal size of the firm: indeterminate • LAC = LMC = same at all outputs • Increasing then Decreasing Returns to Scale • optimal size of the firm: minimum LAC • minimum LAC where LAC = LMC

24. Optimal Size of Plant with Increasing Returns to Scale: Bigger is Better Price LATC SATCI SATCII LATC Quantity LMC

25. Market Power: Size in 1994 source: World Bank & Fortune 500

26. Market Power: Market Share

27. How does a monopolist use power to maximize profits? • marginal principle: increase output until marginal revenue = marginal cost

28. Monopoly Sales Price Market Demand A $10 B 0 0 Quantity Revenue $25,000 A B 0 Quantity

29. Increasing Returns to Scale and Long Run Total Costs $ Long Run Total Costs Quantity

30. Maximum Monopoly Profits: Marginal Revenue = Marginal Cost Revenue $ LTC R LTC Quantity $ Excess Profit Quantity 0

31. Monopoly Profits with Increasing Returns to Scale Price Market Demand Quantity MR

32. Monopoly Profits with Increasing Returns to Scale Price LATC Market Demand PM LATC Quantity LMC MR Q

33. Maximum Monopoly Profits: Marginal Revenue = Marginal Cost Revenue $ LTC R LTC Quantity $ Excess Profit Quantity 0

34. The Social Cost of Monopoly: Example, Constant Returns to Scale Competition Monopoly Market Demand Market Demand Consumer Surplus PM LATC = LMC LATC = LMC PM MR QCOMP QMONOP Under monopoly, consumers pay a higher price and consume less

35. The Social Cost of Monopoly: Example, Constant Returns to Scale Competition Monopoly Market Demand Market Demand Consumer Surplus Dead Weight Loss PM Profit LATC = LMC LATC = LMC PM MR QCOMP QMONOP Under monopoly, some consumer surplus is redistributed to the monopolist as profit, and some is lost to society

36. Social Policy • If returns to scale are constant • regulate • make the monopolist charge a price equal to marginal cost • obtain the competitive solution • If returns to scale are increasing • regulation is not so easy • can not set monopolist’s price equal to marginal cost: monopolist will suffer losses • because marginal cost is less than average cost • could socialize the industry and the government could subsidize the losses • could live with monopoly

37. Society How can we control it? Regulation, Franchises, Patents Higher Prices Less Goods Excess Profits MONOPOLY POWER Political Influence Strategic Planning Entrepreneurs How do we get it?

38. Strategic Planning: Brand Names source: USA Today , 1992

39. Advertising Cost of a Car source: Fortune

40. Strategic Action: Advertising source: Advertising Age

41. Classification of US Industry source: Survey of Current Business

42. competitive industries short run short run marginal cost optimal plant size long run long run marginal cost constant returns to scale free entry long run equilibrium variable returns to scale excess profits increasing returns to scale natural monopoly market share marginal revenue monopoly profit social cost of monopoly consumer surplus dead weight loss regulation of monopoly brand names strategic planning Summary-Vocabulary-Concepts