Chapter 12

General Equilibrium & the Efficient of Perfect Competition

Partial equilibrium analysis: the process of examining the equilibrium conditions in individual markets & for households & firms separately General equilibrium: the condition that exists when all markets in an economy are in simultaneous equilibrium Efficiency: the condition in which the economy is producing what people want at least possible cost Market Adjustment to Changes in Demand *Causes demand to shift* 1. Tastes & preferences 2. Expectation 3. Change in income 4. Prices of substitutes & complementary goods 5. Variable goods

Allocative Efficiency & Competitive Equilibrium Pareto Efficiency A condition in which no change is possible that will make some members of society better off without making some other members of society worse off Revisiting Consumer & Producer Products

The Efficiency of Perfect Competition All societies answer these basic questions in the design of their economic systems: 1. What gets produced? 2. How is it produced? 3. Who gets what is produced? Efficiency uses these three questions & their answers to prove informally that perfect competition is efficient Under perfect competition o Resources are allocated among firms efficiently o Final products are distributed among households efficiently o System produces the things that people want

Efficient Allocations of Resources Among Firms Firms face the same price (input price) in the factor market The assumptions that factor markets are competitive and open, that all firms pay the same prices for input, & that all firms maximize profits lead to the conclusion that the allocation of resources among firms is efficient Efficient Distribution of Outputs Among Households Everybody can buy what they want Free & open markets are essential to this result Producing What People Want: The Efficient Mix of Output P=MC o P=willingness to pay o MC=opportunity cost of resources needed to produce output Lets say we have good X o Px > MCx Society gains value by producing more of good X o Px < MCx Society gains value by producing less of good X o Society will produce the efficient mix of output if all firms equate price and marginal cost

The Sources of Market Failure Market failure: occurs when resources are misallocated, or allocated inefficiently. The result is waste or lost value Four important sources of market failure 1. imperfect market structure, or noncompetitive behavior 2. the existence of public goods 3. the presence of external costs & benefits 4. imperfect information Imperfect Markets P does not = MC (does not have to hold) EQUALS: o Market power o Firms will not be price takers o Efficient mix of output is not guaranteed We have limited number of firms Public Goods Goods & services that bestow collective benefits on members of society No one can be excluded from enjoying their benefits Examples o National defense (classic) o Police protection o Homeland security

o Preservation of wilderness lands o Public health Externalities A cost or benefit imposed or bestowed on an individual or a group that is outside, or external to, the transaction Examples o Air or water pollution (classic) o Noise o Congestion o Your house painted a color that neighbors think is ugly Imperfect Information The absence of full knowledge concerning product characteristics, available prices, & so on

Chapter 13

Monopoly and Antitrust Policy

Imperfectly competitive industry: an industry in which individual firms have some control over the price of their output Market power: an imperfectly competitive firms ability to raise price w/o losing all of the quantity demanded for its product Forms of Imperfect Competition & Market Boundaries Monopoly: a market structure in which one firm makes up the entire market Oligopoly: an industry in which there is a small number of firms Pure monopoly: an industry with a single firm that produces a product for which there are no close substitutes and in which significant barriers to entry prevent other firms from entering the industry to compete for profits Barriers to Entry Barriers to entry: factors that prevent new firms from entering & competing in imperfectly competitive industries 1. Legal 2. Natural 3. Technological The Key Difference Between a Monopolist & a Perfect Competitor 1. A monopolistic firms MR is not its price a. MR is always below its price b. MR changes as output changes & is not equal to the price 2. A monopolistic firms output decision can affect price 3. There is no competition in monopolistic markets, so monopolists see to it that monopolists, not consumers, benefit Table 13.1 Marginal Revenue Facing a Monopolist
(1) Quantity (2) Price (3) Total Revenue (4) Marginal Revenue

0 1 2 3 4 5 6 7 8 9 10

$11 10 9 8 7 6 5 4 3 2 1

0 $10 18 24 28 30 30 28 24 18 10

$10 8 6 4 2 0 -2 -4 -6 -8

Why MR is always below its price? We assume that the monopolist must sell all its product at a single price (no price discrimination) To raise output & sell it, the firm must lower the price it changes

Marginal Revenue and Total Revenue A monopolys marginal revenue curve bisects the quantity axis between the origin & the point where the demand curve hits the quantity axis. A monopolys MR curve shows the change in total revenue that results as a firm moves along the segment of the demand curve that lies exactly above it

The Monopolists Profit-Maximizing Price & Output

Perfect Competition & Monopoly Compared In a perfectly competitive industry in the long run, price will be equal to long-run average cost. The market supply curve is the sum of all the short-run marginal cost curves of the firms in the industry. Here we assume the firms are using a technology that exhibits constant returns to scale: LRAC is flat. Big firms enjoy no cost advantages.

Comparison of Monopoly & Perfectly Competitive Outcomes for a Firm w/ Constant Returns to Scale In the newly organized monopoly, the marginal cost curve is the same as the supply that represented the behavior of all the independent firms when the industry was organized competitively. Quantity produced by the monopoly will be less than the perfectly competitive level of output, & the monopoly price will be higher than the price under perfect competition. o Under monopoly, P = Pm = $4 and Q = Qm = 2,500 o Under perfect competition, P = Pc = $3 and Q = Qc = 4,000

Ownership of a Scarce Factor of Production Diamond (natural) o The ownership of a scarce factor of production is a barrier to entry

Economies of Scale Natural monopoly: an industry that realizes such large economies of scale in producing that single-firm production of that good or service is most efficient The most efficient production will be close to the demand curve

Price Discrimination
Price discrimination: charging different prices to different buyers Perfect price discrimination: occurs when a firm charges the maximum amount that buyers are willing to pay for each unit

With perfect price discrimination, there is no DWL, but also no consumer surplus Monopolist will actually produce the efficient quantity of output (Qc) Demand curve becomes same as marginal revenue o When a firm can charge the max that anyone is willing to pay for each unit, that price is marginal revenue

Examples of Price Discrimination 1. Movie discount for senior citizens, students, & children 2. Airline discounts for Saturday night stay overs 3. Airline tickets for different classes (economic, business, etc) 4. LSU football ticket discounts for students Remedies for Monopoly: Anti-trust Policy Major Antitrust Legislation The Sherman Act of 1890 1911 there are 2 companies sued by violating the Sherman Act o Standard oil %91 o American Tobacco %75- %90 GUILTY o Why guilty? Because both of them used tough tactics to prevent competition Summary Monopolist are unjust because they restrict freedom to enter business Monopolist transfer income from deserving consumers to underserving monopolists Monopolist output is lower & price is higher than in competitive markets Because monopolies reduce output & charge P > MC, monopolies create a welfare loss for society A price discriminating monopolist earns more profit than a normal monopolist by charging different prices In a natural monopoly the competitive outcome where P=MC results in losses