1.AP MICROECONOMICS REVIEW: THEORY OF THE FIRM

2. Market Structure Continuum FOUR MARKET MODELS Pure Competition 3. Market Structure Continuum Pure Competition FOUR MARKET MODELS Imperfect Competition All Markets that are Not Purely Competitive 4. Market Structure Continuum Pure Competition FOUR MARKET MODELS Pure Monopoly 5. Market Structure Continuum Pure Competition Pure Monopoly FOUR MARKET MODELS Monopolistic Competition 6. Market Structure Continuum Pure Competition Pure Monopoly Monopolistic Competition FOUR MARKET MODELS Oligopoly 7. Market Structure Continuum Pure Competition Pure Monopoly Monopolistic Competition Oligopoly FOUR MARKET MODELS Pure Competition: Very Large Numbers Standardized Product Price Takers Free Entry and Exit 8. Market Structure Continuum Pure Competition Pure Monopoly Monopolistic Competition Oligopoly FOUR MARKET MODELS Pure Monopoly: Single Seller No Close Substitutes Price Maker Blocked Entry 9. Market Structure Continuum Pure Competition Pure Monopoly Monopolistic Competition Oligopoly FOUR MARKET MODELS Monopolistic Competition: Relatively Large Number of Sellers Differentiated Products Easy Entry and Exit 10. Market Structure Continuum Pure Competition Pure Monopoly Monopolistic Competition Oligopoly FOUR MARKET MODELS Oligopoly: A Few Large Producers Homogeneous or Differentiated Products Control Over Price, But Mutual Interdependence Strategic Behavior Entry Barriers 11. Economic Profit Implicit costs (including a normal profit) Explicit Costs Accounting costs (explicit costs only) Accounting Profit Economic(opportunity)Costs T O T A L R E V E N U E Profits to an Economist Profits to an Accountant ECONOMIC COSTS 12. SHORT-RUN COSTS GRAPHICALLY Quantity Costs(dollars) TC Total Cost Fixed Cost TVC Variable Cost TFC Combining TVC With TFC to get Total Cost 13. SHORT-RUN COSTS GRAPHICALLY Quantity Costs(dollars) AFC AVC ATC MC Plotting Average and Marginal Costs 14. PRODUCTIVITY AND COST CURVES Costs(dollars) Averageproductand marginalproduct Quantity of labor Quantity of output MP AP MC AVC 15. ECONOMIES AND DISECONOMIES OF SCALE UnitCosts Output long-run ATC Economies of scale 16. ECONOMIES AND DISECONOMIES OF SCALE UnitCosts Output long-run ATC Economies of scale Constant returns to scale 17. ECONOMIES AND DISECONOMIES OF SCALEUnitCosts Output long-run ATC Economies of scale Diseconomies of scale Constant returns to scale 18. SHORT-RUN PROFIT MAXIMIZATION Two Approaches... First: Total-Revenue -Total Cost Approach Three Characteristics of MR=MC Rule: The rule applies only if producing is preferred to shutting down Rule applies to all markets Rule can be restated P=MC Second: Marginal-Revenue -Marginal Cost Approach MR = MC Rule 19. $200 150 100 50 0 CostandRevenue 1 2 3 4 5 6 7 8 9 10 MC MR AVC ATC Economic Profit $131.00 $97.78 MARGINAL REVENUE-MARGINAL COST APPROACH Profit Maximization Position 20. $200 150 100 50 0 CostandRevenue 1 2 3 4 5 6 7 8 9 10 MC MR AVC ATC Economic Profit $131.00 $97.78 MARGINAL REVENUE-MARGINAL COST APPROACH MR = MC Optimum Solution Profit Maximization Position 21. $200 150 100 50 0 CostandRevenue 1 2 3 4 5 6 7 8 9 10 MC MR AVC ATC Economic Loss $81.00 $91.67 MARGINAL REVENUE-MARGINAL COST APPROACH Loss Minimization Position 22. $200 150 100 50 0 CostandRevenue 1 2 3 4 5 6 7 8 9 10 MC MR AVC ATC Economic Loss $81.00 $91.67 MARGINAL REVENUE-MARGINAL COST APPROACH Loss Minimization Position 23. $200 150 100 50 0 CostandRevenue 1 2 3 4 5 6 7 8 9 10 MC MR AVC ATC $71.00 MARGINAL REVENUE-MARGINAL COST APPROACH Short-Run Shut Down Point Minimum AVC is the Shut-Down Point 24. $200 150 100 50 0 CostandRevenue 1 2 3 4 5 6 7 8 9 10 MC MR AVC ATC Economic Loss $81.00 $91.67 MARGINAL REVENUE-MARGINAL COST APPROACH Loss Minimization Position 25. CostandRevenue,(dollars) MC MR1 MARGINAL REVENUE-MARGINAL COST APPROACH Quantity Supplied MR2 MR3 MR4 MR5 P1 P2 P3 P4 P5 Q2 Q3 Q4 Q5 Marginal Cost & Short-Run Supply Yields the Short-Run Supply Curve Supply No Production Below AVC 26. MARGINAL REVENUE-MARGINAL COST APPROACH Marginal Cost & Short-Run Supply AVC2 MC2 Higher Costs Move the Supply Curve to the Left CostandRevenue,(dollars) MC1 AVC1 Quantity Supplied S1 S2 27. MARGINAL REVENUE-MARGINAL COST APPROACH Marginal Cost & Short-Run Supply AVC2 MC2 Lower Costs Move the Supply Curve to the Right CostandRevenue,(dollars) MC1 AVC1 Quantity Supplied S1 S2 28. P Q S=MC AVC ATC 8 D P Q8000 D S= MCs IndustryFirm (price taker) Economic Profit $111$111 SHORT-RUN COMPETITIVE EQUILIBRIUM The Competitive Firm Takes its Price from the Industry Equilibrium 29. P Q S=MC AVC ATC 8 D P Q8000 D S= MCs IndustryFirm (price taker) Economic Profit $111$111 SHORT-RUN COMPETITIVE EQUILIBRIUM The Competitive Firm Takes its Price from the Industry Equilibrium How about the long-run? 30. Temporary profits and the reestablishment of long-run equilibrium S1 MC ATC P Q100 P Q100,000 IndustryFirm (price taker) $60 50 40 $60 50 40 PROFIT MAXIMIZATION IN THE LONG RUN MR D1 31. An increase in demand increases profits MR D1 MC ATC P Q100 P Q100,000 IndustryFirm (price taker) $60 50 40 $60 50 40 PROFIT MAXIMIZATION IN THE LONG RUN D2 Economic Profits S1 32. New competitors increase supply, and lower prices decrease economic profits. MR D1 MC ATC P Q100 P Q100,000 IndustryFirm (price taker) $60 50 40 $60 50 40 PROFIT MAXIMIZATION IN THE LONG RUN D2 Zero Economic Profits S1 S2 33. Decreases in demand, losses, and the reestablishment of long-run equilibrium S1 MC ATC P Q100 P Q100,000 IndustryFirm (price taker) $60 50 40 $60 50 40 PROFIT MAXIMIZATION IN THE LONG RUN D1 MR 34. A decrease in demand creates losses MR D1 MC ATC P Q100 P Q100,000 IndustryFirm (price taker) $60 50 40 $60 50 40 PROFIT MAXIMIZATION IN THE LONG RUN D2 Economic Losses S1 35. MR D1 MC ATC P Q100 P Q100,000 IndustryFirm (price taker) $60 50 40 $60 50 40 PROFIT MAXIMIZATION IN THE LONG RUN D2 Return to Zero Economic Profits S1 S3 Competitors with losses decrease supply prices return to zero economic profits. 36. P MR Q MC ATC Quantity Price Price = MC = Minimum ATC (normal profit) LONG-RUN EQUILIBRIUM FOR A COMPETITIVE FIRM 37. PURE COMPETITION AND EFFICIENCY Productive Efficiency Price = Minimum ATC Allocative Efficiency Price = MC Underallocation Price > MC Overallocation Price < MC 38. T MONOPOLY REVENUES & COSTS DollarsDollars $200 150 200 50 $750 500 250 MR Elastic 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 D Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 TR Q 39. MONOPOLY REVENUES & COSTS Q DollarsDollars $200 150 200 50 $750 500 250 TR MR D InelasticElastic 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 A Monopolist will always operate on the Elastic Portion of the Demand Curve Inelastic Portion MR is Negative 40. Profit Maximization Under Monopoly D MC ATC MR $94 $122 Profit MR = MC Profit Per Unit OUTPUT AND PRICE DETERMINATION Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price,costs,andrevenueRemember the MR=MC Rule? 41. Profit Maximization Under Monopoly D MC ATC MR $94 $122 Profit MR = MC Profit Per Unit OUTPUT AND PRICE DETERMINATION Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price,costs,andrevenue 42. Loss Minimization Under Monopoly D MC ATC MR A Pm Loss MR = MC Loss Per Unit OUTPUT AND PRICE DETERMINATION Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price,costs,andrevenue AVC Qm V Since Pm exceeds AVC, the firm will produce 43. Loss Minimization Under Monopoly D MC ATC MR A Pm Loss MR = MC Loss Per Unit OUTPUT AND PRICE DETERMINATION Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price,costs,andrevenue AVC Qm V What are the Economic Effects of Monopoly? 44. Q INEFFICIENCY OF PURE MONOPOLY P D MR S = MC Pc Pm QcQm At MR=MC A monopolist will sell less units at a higher price than in competition An industry in pure competition sells where supply and demand are equal 45. Q INEFFICIENCY OF PURE MONOPOLY P D MR S = MC Pc Pm QcQm At MR=MC A monopolist will sell less units at a higher price than in competition Monopoly pricing effectively creates an income transfer from buyers to the seller! 46. Q D MC ATC P Q1 PriceandCosts PRICE DISCRIMINATION Q2 A perfectly discriminating monopolist has MR=D, producing more product and more profit! MR=D 47. Q D MC ATC P Q1 PriceandCosts Economic profits with price discrimination PRICE DISCRIMINATION Q2 MR=D 48. Natural Monopolies Socially Optimum Price P = MC Fair-Return Price P = ATC Dilemma of Regulation REGULATED MONOPOLY Graphically 49. REGULATED MONOPOLY Q D MR MC ATC P PriceandCosts Monopoly Price MR = MC Qm Pm 50. REGULATED MONOPOLY Q D MR MC ATC P PriceandCosts Fair-Return Price Normal Profit Only Qf Pf 51. REGULATED MONOPOLY Q D MR MC ATC P PriceandCosts Socially-Optimum Price P = MC Qr Pr 52. REGULATED MONOPOLY Q D MR MC ATC PPriceandCosts MR = MC Fair-Return Price Socially-Optimum Price Qm Qf Qr Dilemma of Regulation Which Price? Pm Pf Pr 53. D MR P1 ATC PriceandCosts Q1 Short-Run Economic Profits Expect New Competitors PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Quantity A1 MC 54. D MR P1 ATC PriceandCosts Q1 Expect New Competitors PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Quantity A1 New competition drives down the price level leading to economic losses in the short run. MC Short-Run Economic Profits 55. D MR MC P2 ATC PriceandCosts Q2 Short-Run Economic Losses PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Quantity A2 56. Short-Run Economic Losses D MR MC P2 ATC PriceandCosts Q2 PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Quantity A2 With economic losses, firms will exit the market stability occurs when economic profits are zero. 57. D MR MC P3 = A3 ATC PriceandCosts Q3 PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Quantity Long-Run Equilibrium Normal Profit Only 58. MONOPOLISTIC COMPETITION AND EFFICIENCY Not Productively Efficient Minimum ATC Not Allocatively Efficient Price MC Excess Capacity Graphically 59. OLIGOPOLY BEHAVIOR A Game-Theory Overview High Low High Low UptownsPriceStrategy RareAirs Price Strategy BA DC $12 $15 $12 $6 $6 $8 $8$15 60. OLIGOPOLY BEHAVIOR A Game-Theory Overview High Low High Low UptownsPriceStrategy RareAirs Price Strategy BA DC $12 $15 $12 $6 $6 $8 $8$15 Greatest Combined Profit 61. OLIGOPOLY BEHAVIOR A Game-Theory Overview High Low High Low UptownsPriceStrategy RareAirs Price Strategy BA DC $12 $15 $12 $6 $6 $8 $8$15 Independent Actions Stimulate Response 62. OLIGOPOLY BEHAVIOR A Game-Theory Overview High Low High Low UptownsPriceStrategy RareAirs Price Strategy BA DC $12 $15 $12 $6 $6 $8 $8$15 Independent Actions Stimulate Response Gravitating to the Worst Case 63. OLIGOPOLY BEHAVIOR A Game-Theory Overview High Low High Low UptownsPriceStrategy RareAirs Price Strategy BA DC $12 $15 $12 $6 $6 $8 $8$15 Collusion Invites a Different Solution. 64. OLIGOPOLY BEHAVIOR A Game-Theory Overview High Low High Low UptownsPriceStrategy RareAirs Price Strategy BA DC $12 $15 $12 $6 $6 $8 $8$15 Collusion Invites a Different Solution. 65. OLIGOPOLY BEHAVIOR A Game-Theory Overview High Low High Low UptownsPriceStrategy RareAirs Price Strategy BA DC $12 $15 $12 $6 $6 $8 $8$15 But, the incentive to cheat is very real. Collusion Invites a Different Solution. 66. D1 MR1 Quantity The firms demand and marginal revenue curves KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price 67. MR2 D1 D2 MR1 Quantity KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price Rivals tend to follow a price cut 68. MR2 D1 D2 MR1 Quantity KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price Rivals tend to follow a price cut or ignore a price increase 69. MR2 D1 D2 MR1 Quantity Effectively creating a kinked demand curve KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price 70. D Quantity Effectively creating a kinked demand curve KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price 71. D MR1 Quantity Effectively creating a kinked demand curve KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price MC2 MC1 MR2 72. D Quantity Profit maximization MR = MC occurs at the kink. KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price MC2 MC1 MR2 MR1 73. D Quantity This behavior can set off a price war. KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price MC2 MC1 MR2 MR1 74. Colluding Oligopolists Will Split the Monopoly Profits. D MC ATC MR Economic Profit MR = MC Priceandcosts Q0 P0 A0 CARTELS AND OTHER COLLUSION