Microeconomics Chapter 9
Perfectly competitive market> a market with many sellers and buyers of a homogeneous product and no
barriers to entry
Price taker> a buyer or seller that takes the market price as given
9.1 Preview of the Four Market Structures
The market demand curve shows the relationship between the price and the quantity that suppliers can
sell in the market, assuming all firms charge the same price. In contrast, the firm-specific demand curve
shows the relationship between the price charged by a specific firm and the quantity that firm can sell. In a
monopoly, a single firm serves the entire market, so the firm-specific demand curve is the same as the
market demand curve. Most markets lie between the extremes of monopoly and perfect competition.
Monopoly. A single firm that serves the entire market. A monopoly occurs when the barriers to market
entry are very large. This can result from very large economies of scale (local phone service, cable TV) or a
government policy that limits the number of firms (drugs covered by patents).
Monopolistic competition. There are no barriers to entering the market, so there are many firms, and
each firm sells a slightly different product (coffee shops, local grocery store).
Oligopoly. The market consists of just a few firms because economies of scale or government policies limit
the number of firms (cars, computer chips, airline travel).
Characteristic Perfect Monopolistic Oligopoly Monopoly
Competition Competition
Number of firms Many Many Few One
Type of product Homogeneous Differentiated Homogeneous or Unique
differentiated
Entry conditions No barriers No barriers Large barriers Large barriers
9.2 The Firm’s Short-Run Output Decision
A firm’s objective is to maximize economic profit, which equals total revenue minus economic cost. Recall
that economic cost includes all the opportunity costs of production (explicit and implicit).
Total Approach: One way for a firm to decide how much to produce is to compute the economic profit at
different quantities and then pick the quantity that generates the highest profit. When profit reaches its
highest level with two different quantities, we assume the firm produces the larger quantity.
Marginal Approach: The other way for a firm to decide how much output to produce relies on the marginal
principle. Recall marginal principle: increase the level of an activity as long as its marginal benefit exceeds
its marginal cost. Choose the level at which the marginal benefit equals the marginal cost.
Marginal revenue> the change in total revenue from selling one more unit of output
A perfectly competitive firm takes the market price as given, so the marginal revenue is simply the price
(MR = P). The marginal principle tells us that the firm will maximize its profit by choosing the quantity at
which price equals marginal cost. To maximize profit, produce the quantity where P = MC.
One way to compute a firm’s total economic profit is to multiply the average profit per unit produced by
the quantity produced. Economic profit = (price – average cost) x quantity produced
Break-even price> the price at which economic profit is zero (price = average total cost)
Remember that zero economic profit means that the firm making just enough money to cover all its costs,
including the opportunity costs of the entrepreneur.
9.3 The Firm’s Shut-Down Decision
When a firm is losing money, should it continue to operate or shut down?
This is a short-run decision. The decision-making rule is:
operate if total revenue > variable cost
shut down if total revenue < variable cost
There is a shortcut for determining whether it’s sensible to continue to operate:
operate if price > average variable cost
shut down if price < average variable cost
, Shut-down price> the price at which the firm is indifferent between operating and shutting down; equal
to the minimum average variable cost
Long-run market supply curve> a curve showing the relationship between the market price and
quantity supplied in the long run
Increasing-cost industry> an industry in which the average cost of production increases as the total
output the industry increases (the long-run supply curve is positively sloped)
Constant-cost industry> an industry in which the average cost of production is constant (the long-run
supply curve is horizontal)
Microeconomics Chapter 10
Monopoly> a market in which a single firm sells a product that does not have any close substitutes. In
contrast with a perfectly competitive firm, a monopolist controls the price of its product, so he is a price
maker and has market power (the ability of a firm to affect the price of its product). A monopoly occurs
when a barrier to entry prevents a second firm from entering a profitable market. Among the possible
barriers are patents, network externalities, government licensing, the ownership or control of a key
resource, and large economies of scale in production.
Patent> the exclusive right to sell a new good for some period of time
Network externalities> the value of a product to a consumer increases with the number of other
consumers who use it
Natural monopoly> a market in which the economies of scale in production are so large that only a single
large firm can earn a profit. The market can support only one profitable firm, because if a second firm
entered the market, both firms would lose money (cable TV services, electricity transmission, water
systems).
10.1 The Monopolist’ Output Decision
Also a monopolist must decide how much output to produce, given its objective of maximizing its profit.
He can use the marginal principle for this decision.
Marginal revenue = new price + (slope of demand curve x old quantity)
Two way to compute a firm’s profit:
Profit = total revenue – total cost
Profit = profit per dose x quantity of doses
10.2 The Social Cost of Monopoly
Why should we as a society be concerned about monopoly? A monopolist uses its market power to charge
a relatively high price. If this is it, a monopolist would simply gain at the expenses of consumers. But, it
goes further. Monopoly is inefficient because it generates less output than a perfectly competitive market.
Deadweight loss from monopoly> a measure of the inefficiency from monopoly; equal to the decrease in
the market surplus
Rent seeking> the process of using public policy to gain economic profit
Rent seeking is inefficient because it uses resources that could be used in other ways.
Given the social costs of monopoly, the government uses a number of policies to intervene in markets
dominated by a single firm or likely to become a monopoly. In the case of natural monopoly, the
government can intervene by regulating the price the natural monopolist charges. In other markets, the
government uses antitrust policies to break monopolies into smaller companies and prevent corporate
mergers that would lead to others. These policies are designed to promote competition, leading to lower
prices and more production.
10.3 Patents and Monopoly Power
One source of monopoly power is a government patent that gives a firm the exclusive right to produce a
product for 20 years. A patent encourages innovation because the innovators know they will earn
Perfectly competitive market> a market with many sellers and buyers of a homogeneous product and no
barriers to entry
Price taker> a buyer or seller that takes the market price as given
9.1 Preview of the Four Market Structures
The market demand curve shows the relationship between the price and the quantity that suppliers can
sell in the market, assuming all firms charge the same price. In contrast, the firm-specific demand curve
shows the relationship between the price charged by a specific firm and the quantity that firm can sell. In a
monopoly, a single firm serves the entire market, so the firm-specific demand curve is the same as the
market demand curve. Most markets lie between the extremes of monopoly and perfect competition.
Monopoly. A single firm that serves the entire market. A monopoly occurs when the barriers to market
entry are very large. This can result from very large economies of scale (local phone service, cable TV) or a
government policy that limits the number of firms (drugs covered by patents).
Monopolistic competition. There are no barriers to entering the market, so there are many firms, and
each firm sells a slightly different product (coffee shops, local grocery store).
Oligopoly. The market consists of just a few firms because economies of scale or government policies limit
the number of firms (cars, computer chips, airline travel).
Characteristic Perfect Monopolistic Oligopoly Monopoly
Competition Competition
Number of firms Many Many Few One
Type of product Homogeneous Differentiated Homogeneous or Unique
differentiated
Entry conditions No barriers No barriers Large barriers Large barriers
9.2 The Firm’s Short-Run Output Decision
A firm’s objective is to maximize economic profit, which equals total revenue minus economic cost. Recall
that economic cost includes all the opportunity costs of production (explicit and implicit).
Total Approach: One way for a firm to decide how much to produce is to compute the economic profit at
different quantities and then pick the quantity that generates the highest profit. When profit reaches its
highest level with two different quantities, we assume the firm produces the larger quantity.
Marginal Approach: The other way for a firm to decide how much output to produce relies on the marginal
principle. Recall marginal principle: increase the level of an activity as long as its marginal benefit exceeds
its marginal cost. Choose the level at which the marginal benefit equals the marginal cost.
Marginal revenue> the change in total revenue from selling one more unit of output
A perfectly competitive firm takes the market price as given, so the marginal revenue is simply the price
(MR = P). The marginal principle tells us that the firm will maximize its profit by choosing the quantity at
which price equals marginal cost. To maximize profit, produce the quantity where P = MC.
One way to compute a firm’s total economic profit is to multiply the average profit per unit produced by
the quantity produced. Economic profit = (price – average cost) x quantity produced
Break-even price> the price at which economic profit is zero (price = average total cost)
Remember that zero economic profit means that the firm making just enough money to cover all its costs,
including the opportunity costs of the entrepreneur.
9.3 The Firm’s Shut-Down Decision
When a firm is losing money, should it continue to operate or shut down?
This is a short-run decision. The decision-making rule is:
operate if total revenue > variable cost
shut down if total revenue < variable cost
There is a shortcut for determining whether it’s sensible to continue to operate:
operate if price > average variable cost
shut down if price < average variable cost
, Shut-down price> the price at which the firm is indifferent between operating and shutting down; equal
to the minimum average variable cost
Long-run market supply curve> a curve showing the relationship between the market price and
quantity supplied in the long run
Increasing-cost industry> an industry in which the average cost of production increases as the total
output the industry increases (the long-run supply curve is positively sloped)
Constant-cost industry> an industry in which the average cost of production is constant (the long-run
supply curve is horizontal)
Microeconomics Chapter 10
Monopoly> a market in which a single firm sells a product that does not have any close substitutes. In
contrast with a perfectly competitive firm, a monopolist controls the price of its product, so he is a price
maker and has market power (the ability of a firm to affect the price of its product). A monopoly occurs
when a barrier to entry prevents a second firm from entering a profitable market. Among the possible
barriers are patents, network externalities, government licensing, the ownership or control of a key
resource, and large economies of scale in production.
Patent> the exclusive right to sell a new good for some period of time
Network externalities> the value of a product to a consumer increases with the number of other
consumers who use it
Natural monopoly> a market in which the economies of scale in production are so large that only a single
large firm can earn a profit. The market can support only one profitable firm, because if a second firm
entered the market, both firms would lose money (cable TV services, electricity transmission, water
systems).
10.1 The Monopolist’ Output Decision
Also a monopolist must decide how much output to produce, given its objective of maximizing its profit.
He can use the marginal principle for this decision.
Marginal revenue = new price + (slope of demand curve x old quantity)
Two way to compute a firm’s profit:
Profit = total revenue – total cost
Profit = profit per dose x quantity of doses
10.2 The Social Cost of Monopoly
Why should we as a society be concerned about monopoly? A monopolist uses its market power to charge
a relatively high price. If this is it, a monopolist would simply gain at the expenses of consumers. But, it
goes further. Monopoly is inefficient because it generates less output than a perfectly competitive market.
Deadweight loss from monopoly> a measure of the inefficiency from monopoly; equal to the decrease in
the market surplus
Rent seeking> the process of using public policy to gain economic profit
Rent seeking is inefficient because it uses resources that could be used in other ways.
Given the social costs of monopoly, the government uses a number of policies to intervene in markets
dominated by a single firm or likely to become a monopoly. In the case of natural monopoly, the
government can intervene by regulating the price the natural monopolist charges. In other markets, the
government uses antitrust policies to break monopolies into smaller companies and prevent corporate
mergers that would lead to others. These policies are designed to promote competition, leading to lower
prices and more production.
10.3 Patents and Monopoly Power
One source of monopoly power is a government patent that gives a firm the exclusive right to produce a
product for 20 years. A patent encourages innovation because the innovators know they will earn
