Microeconomics - Schemi

Profit Maximization and Long-Run Equilibrium

P=MR=MC

Economic profit = R - wL - rKπ

Zero economic profit: A firm is earning a normal return on its investment, it is doing as well as it could by investing its money elsewhere. If your economic rent is negative, go out of business. Enter the business when you can earn a positive long-run profit. Exit the business when it faces the prospect of a long-run loss.

Long-run competitive equilibrium: All firms in an industry are maximizing profit, no firm has an incentive to enter or exit, and price is such that quantity supplied equals quantity demanded. This occurs when:

• All firms maximize profit
• No incentive to entry or exit, resulting in zero economic profit
• P and Q are in the long-run equilibrium

Economic rent: Amount the firms are willing to pay for an input less the minimum amount necessary to obtain it. Er = WTP - Pmin

INDUSTRY LONG RUN SUPPLY CURVE:

Constant-cost industry: Industry whose long-run supply curve is horizontal.

Increasing-cost industry: Industry...

whose long-run supply curve is upwardsloping: increasing-cost industry: industry whose long-run supply curve is downwardsloping Taxation effect: shift of the curve, percentage change of ∆Q ∆P, resulting in a percentage change in Q PMC=MC1+tS=S1+t: COMPETITIVE MARKETS Welfare effect: gains and losses to consumers and producers Price control= price FLOOR and price CEILING ∆ in CS: some consumers are worse off and others are better off ∆ in PS: some producers will stay in the market with smaller gains and others will go out of business Deadweight loss: net loss of total surplus Economic efficiency: Maximization of aggregate consumer and producer surplus Market failure: situation in which an unregulated competitive market is inefficient because prices fail to provide proper signals to consumers and producers Externality: Action taken by either a producer or a consumer which affects other producers or consumers but is not accounted for by the market price Two important instances inwhich market failure can occur: 1. Externalities: can be positive or negative 2. Lack of Information: lemons principle PRICE CEILING: minimum price, create deadweight loss ∆PS=-A-C ∆CS= A-B ∆SURPLACE=-B-C PRICE FLOOR: maximum price, keeping in count the cost of production and deadweight loss ∆PS=A-C-D ∆CS= -A-B ∆SURPLACE=-B-C-D price support: Price set by government above free-market level and maintained by governmental purchases of excess supply PRICE SUPPORT: government cost ∆PS= A+B+D ∆CS= -A-B GOV. COST= (Q2-Q1)*Ps WELFARE EFFECT=∆CS+∆PS-GOV COST= D-(Q2-Q1)*Ps PRODUCTION QUOTAS ∆PS= A-C+(GOV PAYMENTS=A+B+D) ∆CS= -A-B ∆WELAFRE=-B-C IMPORT QUOTAS ∆PS= A ∆CS= -A-B-C ∆WELAFRE= -B-C IMPORTS QUOTAS + TARIFFS: government revenue (∆PS+∆CS+GOV) ∆PS= A ∆CS= -A-B-C-D GOV TARIFF= D ∆WELAFRE= -B-C SPECIFIC TAX: Pd-Ps=t ∆PS= -C-D ∆CS= -A-B ∆WELAFRE= -B-C In case of tax on prod: shift of S, in case of tax on consumer: shift

1. of DPASS-THROUGH FUNCTIONEs=P-S FUNCTION Es-Ed( ) ( )∆Q P*Esd= ∆P QSUBSIDYà negative tax
2. The benefits can be shared equally or not
3. Using the P-S function:
• If Ed/Es is smallerà benefit to buyers
• If Ed/Es is largerà benefit to sellers
4. Conditions for tax and subsidy:
1. quantity sold and buyer price lie in the demand curve
2. quantity sold and seller price lie on the supply curve
3. quantity demanded equal to quantity supplied
4. difference between the price the buyer pays and the price sellers receivemust be equal to the tax t=
5. MARKET POWER
• Monopoly: market that has only one seller, but many buyers
• Monopsony: market with many sellers, but only one buyer
• market power: Ability of a seller or buyer to affect the price of a good.
6. PROFIT MAXIMIZATION
1. Q*: max π Q( ) ( )-C ( )=Rπ Q Q Q∆π ∆ R ∆C= - =0∆ Q ∆ Q ∆QMR-MC=0∨MR=MCmarginal revenue: Change in revenue resulting from a

one-unit increase in output optimal choice: MR = MC MR < MC: decrease output MR > MC: increase output MR = MC: no incentive to change

∆ TR = MR = ∆Q ∆Q Incremental revenue from an incremental unit of quantity Producing 1 extra unit and selling it for P: 1*P

Firm downward sloping demand curve: produce 1 extra unit = drop in price = -revenue per unit Markup: minus inverse of the elasticity of demand MCP = (∆ P * Q) / ∆ R = MR = ∆Q / ∆Q

New price is the solution of the equation: if MC = 0, impossible to use the equation The monopoly charges a price that depends inversely from the elasticity of demand Never produce a quantity in the inelastic portion of the demand Where the demand curve is elastic, we are assured that |Ed| > 1, and thus the markup is greater than 1, so P > MC: nearest is P to MC More competitive market graph ∆ TC < O = TR - TC If MR < 0:

àQ TR TC↓ ↑ ↓ π ↑∆QShift in demandMonopolistic marketà no one to one relation between P and Qà no S curveMonopolistic output depends onà MC and shape od DShift in D cause changes in P and QEffect of a taxMR=MC+ tFirms MC and AC are affected by the taxà the monopolistic firm will increase Pas, or more, of tMultiplant firm( )−C ( )=P∗QT −Cπ 1 Q1 2 Q2A firm can produce in more plants à if MC is equalà produce same quantityà il MC is higher than the otherà produce less inthat plantincrease output until incremental profit is 0( )∆ P∗QT ∆ C 1−∆ Q1 ∆Q 1MR-MC1=0/MR-MC2=0MR=MC1=MC2Monopoly powerLerner index of monopoly power: Measure of monopoly power calculated asexcess of price over marginal cost as a fraction of priceà depends on market demand, number of firms in the market and interactionamong firmsàIn perfect competitive market P=MC SO

L=0−1P−MC =L= P Ed0<=L<=1D very elasticà small mark upD less elasticàhigher markup

Entry barriers: circumstances that prevent or greatly impede a potential competitor’s entry into the market or ability to compete in the market:

• Legal barriers: government regulation or intellectual properties like patents or copyrights
• Economic barriers: large economies of scale, tech superiority, capital requirements or control over imports of inputs or network externalities (like preferences or standards)
• Deliberate actions (collusion, lobbying, government authorities and force)

Interaction of firms

The elasticity of demand sets a lower limit on the magnitude of elasticity for each firmà E of demand limits the monopoly power of individual producer

Firms can:

• Compete aggressivelyà loss of monopoly power
• Colludeà more monopoly power

So monopoly power has to be thought of in a dynamic context

Social cost of monopoly power rent-seeking: Spending money

In socially unproductive efforts to acquire, maintain, or exercise monopoly (lobbying activities, avoiding antitrust scrutiny, etc.), society incurs a net loss of inefficiency known as deadweight loss. In a competitive market, the point of optimal production (P-opt.) for a monopolist is different from the optimal point in a competitive market. The government is in charge of regulating the monopoly through various means such as price regulation and antitrust laws. Price regulation involves the government imposing a price ceiling to reduce deadweight loss. If the price (P) is above the equilibrium point in a competitive market, there will be deadweight loss. On the other hand, if the price is lower than the equilibrium point in a competitive market, there will be a shortage. If the price is lower than the average cost (AC), the firm will go out of business. This is dangerous because if a natural monopoly decides to go out of business, there will be no goods available. To avoid deadweight loss, the government can impose a price equal to the marginal cost (P=MC). However, this will only be effective if the total cost (TC) is less than or equal to the average variable cost (AV) multiplied by the quantity (Q). It is also important to consider other variables that can make the monopoly go out of business. A natural monopoly refers to a firm that can produce the entire output of the market at a cost lower than what it would be if there were several firms. This is often due to large fixed costs.cost: Total cost divided by the quantity of output producedaverage variable cost: Variable cost divided by the quantity of output producedaverage fixed cost: Fixed cost divided by the quantity of output producedmarginal cost: Additional cost of producing one more unit of outputaverage revenue: Total revenue divided by the quantity of output soldmarginal revenue: Additional revenue from selling one more unit of outputprice discrimination: Practice of charging different prices to different customers for the same productperfect competition: Market structure characterized by a large number of buyers and sellers, homogeneous products, perfect information, and free entry and exitmonopoly: Market structure characterized by a single seller, no close substitutes, and significant barriers to entrymonopolistic competition: Market structure characterized by a large number of sellers, differentiated products, and relatively easy entry and exitoligopoly: Market structure characterized by a small number of sellers, interdependence among firms, and barriers to entry and exitmarket power: Ability of a firm to influence the price or quantity of a good or service in the marketprice elasticity of demand: Measure of the responsiveness of quantity demanded to a change in priceincome elasticity of demand: Measure of the responsiveness of quantity demanded to a change in incomecross-price elasticity of demand: Measure of the responsiveness of quantity demanded of one good to a change in the price of another goodperfectly elastic demand: Demand for a good or service that is infinitely responsive to a change in priceperfectly inelastic demand: Demand for a good or service that is completely unresponsive to a change in price

expenditure: Price paid per unit of a good

competitive buyers and sellers

Net benefità Marginal expenditure above average expenditure−TEQ: max NB=TV=MEMV ( )Q∗∆ PME=P+ ∆Q

Chose Q and P that prevailà both lower than competitive market

Mark downà P<MV−PMVm= P−P −1MV =P Es

Markdown depend inversely from the elasticity of supply

monopoly and monopsony

Monopolyà AR=D, S=X

Monopolyà P>MCàmarkup= depend on PE of market or firm demand

Monopsonyà MV=D, S=AX

MonopsonyàP<MVàmarkdown= depend from PE of supply

Sources of monopoly power:

Elasticity of market supply: supply has high elasticityàsmall monopsony powero if supply has low elasticityà high monopsony poweroNumber of buyers Interaction among buyers: competition among buyersSocial cost of monopoly powerbilateral monopoly: M