1.

Firms in competitive market

- Many buyers and many sellers
- The goods offered for sale are largely the same.
- Firms can freely enter or exit the market.
⇨ Buyers and sellers are PRICE TAKER

● MR, MC bằng đạo hàm của TR hoặc TC theo Q

- A competitive firm can keep increasing its output without affecting the market price.
- So, each one-unit increase in Q causes revenue to rise by P, i.e., MR = P.
- MR = P is only true for firms in competitive markets.
- If MR > MC, then increase Q to raise profit. If MR < MC, then reduce Q to raise profit.
- MR = MC at the profit-maximizing Q.
- Shutdown: A short-run decision not to produce anything because of market conditions. Firms will
shut down if revenue falls by TR, costs fall by VC => P < AVC
+ Sunk cost: a cost that has already been committed and cannot be recovered
+ So, FC should not matter in the decision to shut down.
- Exit: A long-run decision to leave the market. Firms exit when P < ATC
- Enter (in the long-run): Firms will enter the market if P > ATC. If existing firms earn positive
economic profit, new firms enter the market, SR market supply curve shifts right, P falls, reducing
firms’ profits. Entry stops when firms’ economic profits have been driven to zero.
- If existing firms incur losses, some will exit the market, SR market supply curve shifts left, P rises,
reducing remaining firms’ losses. Exit stops when firms’ economic losses have been driven to zero.

2. MONOPOLY
- A monopoly is a firm that is the sole seller of a product without close substitutes.
- 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.
- The main cause of monopolies is barriers to entry – other firms cannot enter the market.
+ A single firm owns a key resource.
+ The govt gives a single firm the exclusive right to produce the good. (Patents, copyright laws,…)
+ Natural monopoly: a single firm can produce the entire market Q at lower ATC than could
several firms. Exp: 1000 homes need electricity. ATC is lower if one firm services all 1000 homes
than if two firms each service 500 homes.
- Increasing Q has two effects on revenue:
+ The output effect: More output is sold, which raises revenue
+ The price effect: The price falls, which lowers revenue
- To sell a larger Q, the monopolist must reduce the price on all the units it sells => MR<P
- A monopolist maximizes profit by producing the quantity where MR = MC. Once the monopolist
identifies this quantity, it sets the highest price consumers are willing to pay for that quantity.
x
 - Graph 2 shows that firm in a monopolistically
competitive market earning economic profits in
the short run.
- A competitive firm
+ takes P as given
+ has a supply curve that shows how its Q
depends on P
- A monopoly firm
+ is a “price-maker,” not a “price-taker”
+ Q does not depend on P; rather, Q and P are jointly determined by MC, MR, and the demand
curve => So there is no supply curve for monopoly.

- Public Policy Toward Monopolies

+ Increasing competition with antitrust laws
●Examples: Sherman Antitrust Act (1890), Clayton Act (1914)

●Antitrust laws ban certain anticompetitive practices, allow govt to break up monopolies
+ Regulation
Govt agencies set the monopolist’s price
For natural monopolies, MC < ATC at all Q,
so marginal cost pricing would result in losses.
If so, regulators might subsidize the monopolist or set P = ATC for zero economic profit.
+ Public ownership
Example: U.S. Postal Service
Problem: Public ownership is usually less efficient since no profit motive to minimize costs
+ Doing nothing
The foregoing policies all have drawbacks, so the best policy may be no policy.
- Price Discrimination: is the business practice of selling the same good at different prices to
different buyers. The characteristic used in price discrimination is willingness to pay (WTP): A firm
can increase profit by charging a higher price to buyers with higher WTP.
 - In the real world, perfect price discrimination is not possible:
- So, firms divide customers into groups based on some observable trait that is likely related to WTP,
such as age. Ex: movie ticket, airline prices, discount coupons, need-based financial aids,…
- 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 and the deadweight loss
- Marginal revenue is less than price, the monopoly price will be greater than marginal cost, leading
to a deadweight loss.

3. Monopolistic Competition
- Characteristics:
+ Many sellers
+ Product differentiation
+ Free entry and exit
- Examples: apartments, books, bottled water, clothing, fast food, night clubs,…
- 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 the 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.

- Why Monopolistic Competition Is Less Efficient than Perfect Competition

+ Excess capacity
▪ The monopolistic competitor operates on the downward-sloping part of its ATC curve,
produces less than the cost-minimizing output.
▪ Under perfect competition, firms produce the quantity that minimizes ATC.
+ Markup over marginal cost
▪ Under monopolistic competition, P > MC.

▪ Under perfect competition, P = MC.

- Number of firms in the market may not be optimal, due to external effects from the entry of new
firms:
+ The product-variety externality: surplus consumers get from the introduction of new products
+ The business-stealing externality: losses incurred by existing firms when new firms enter
market
- The inefficiencies of monopolistic competition are subtle and hard to measure. No easy way for
policymakers to improve the market outcome
- 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.
- Defenders of advertising believe:
+ It provides useful information to buyers.
 + Informed buyers can more easily find and exploit price differences.
+ Thus, advertising promotes competition and reduces market power.
- Results of a prominent study: Eyeglasses were more expensive in states that prohibited advertising
by eyeglass makers than in states that did not restrict such advertising.
- The theory of monopolistic competition describes many markets in the economy, yet offers little
guidance to policymakers looking to improve the market’s allocation of resources.
- A monopolistically competitive market has many firms, differentiated products, and free
entry.
- Each firm in a monopolistically competitive market has excess capacity – produces less than
the quantity that minimizes ATC. Each firm charges a price above marginal cost.
- Monopolistic competition does not have all of the desirable welfare properties of perfect
competition. There is a deadweight loss caused by the markup of price over marginal cost.
Also, the number of firms (and thus varieties) can be too large or too small. There is no clear way
for policymakers to improve the market outcome.

4. OLIGOPOLY
- Concentration ratio: the percentage of the market’s total output supplied by its four largest firms.
- The higher the concentration ratio, the less competition.
- Oligopoly: a market structure in which only a few sellers offer similar or identical products
- Collusion: an agreement among firms in a market about quantities to produce or prices to charge
- Cartel: a group of firms acting in unison, e.g., T-Mobile and Verizon in the outcome with collusion
- Nash equilibrium: a situation in which economic participants interacting with one another each
choose their best strategy given the strategies that all the others have chosen
- oligopoly Q is greater than monopoly Q but smaller than competitive Q.
- oligopoly P is greater than competitive P but less than monopoly P.
- Increasing output has two effects on a firm’s profits:
+ Output effect: If P > MC, selling more output raises profits.
+ Price effect: Raising production increases market quantity, which reduces market price and
reduces profit on all units sold.
- If output effect > price effect, the firm increases production.
- If price effect > output effect, the firm reduces production.
- Another benefit of international trade: Trade increases the number of firms competing, increases Q,
brings P closer to marginal cost
- Dominant strategy: a strategy that is best for a player in a game regardless of the strategies chosen
by the other players
- Oligopolists can maximize profits if they form a cartel and act like a monopolist.
- Yet, self-interest leads each oligopolist to a higher quantity and lower price than under the
monopoly outcome.
- The larger the number of firms, the closer will be the quantity and price to the levels that would
prevail under competition
- The prisoners’ dilemma shows that self-interest can prevent people from cooperating, even when
cooperation is in their mutual interest. The logic of the prisoners’ dilemma applies in many
situations.
- Policymakers use the antitrust laws to prevent oligopolies from engaging in anticompetitive
behavior such as price-fixing. But the application of these laws is sometimes controversial.
OTHER MATERIALS
The cost of production

▪ 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

▪ Accounting profit =total revenue minus total explicit costs

▪ Economic profit =total revenue minus total costs (including explicit and implicit costs)

▪ A production function shows the relationship between the quantity of inputs used to produce a
good, and the quantity of output of that good.

▪ The marginal product of any input is the increase in output arising from an additional unit of that
input, holding all other inputs constant.

▪ Marginal Cost (MC) is the increase in Total Cost from producing one more unit:

▪ Fixed costs (FC) – do not vary with the quantity of output produced. EX: cost of equipment, loan
payments, rent
 ▪ Variable costs (VC) – vary with

the quantity produced. EX: cost of materials

Economies of scale: ATC falls as Q increases.

Constant returns to scale: ATC stays the same as Q increases.
Diseconomies of scale: ATC rises as Q increases.

▪ Economies of scale occur when increasing production allows greater specialization:

workers are more efficient when focusing on a narrow task. More common when Q is low.

▪ Diseconomies of scale are due to coordination problems in large organizations.

E.g., management becomes stretched, can’t control costs. More common when Q is high.