Introduction to Economics

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Llad Phillips 1 Introduction to Economics Microeconomics Microeconomics The US Economy The US Economy

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Introduction to Economics. Microeconomics The US Economy. Market Power and Monopoly. Is monopoly a good thing or not? How about Microsoft, is this firm good or bad for consumers?. Market Power & Market Structure. No market power: competition many producers firms are price takers - PowerPoint PPT Presentation

Transcript of Introduction to Economics

Page 1: Introduction to Economics

Llad Phillips 1

Introduction to EconomicsIntroduction to Economics

MicroeconomicsMicroeconomics

The US EconomyThe US Economy

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Market Power and MonopolyMarket Power and Monopoly

Is monopoly a good thing or not?Is monopoly a good thing or not? How about Microsoft, is this firm good or How about Microsoft, is this firm good or

bad for consumers?bad for consumers?

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Market Power & Market StructureMarket Power & Market Structure No market power: competitionNo market power: competition

many producersmany producers firms are price takersfirms are price takers no excess profitno excess profit price to consumer = long run average costprice to consumer = long run average cost

Market power: monopolyMarket power: monopoly one producerone producer monopolist is price settermonopolist is price setter monopolist makes profits at expense of the monopolist makes profits at expense of the

consumerconsumer

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The Brief for CompetitionThe Brief for Competition

.... and against monopoly.... and against monopoly

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Outline: Lecture ThirteenOutline: Lecture Thirteen

Competitive IndustriesCompetitive Industries agricultureagriculture constructionconstruction

Market Supply in the Short RunMarket Supply in the Short Run The Optimal Plant SizeThe Optimal Plant Size Market Supply in the Long RunMarket Supply in the Long Run

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Competitive MarketsCompetitive Markets In the long run, resources will flow to a In the long run, resources will flow to a

competitive market if firms are making competitive market if firms are making excess profitsexcess profits new firms will enter the industrynew firms will enter the industry

if returns to scale are constant, then price will be if returns to scale are constant, then price will be driven down to long run average total costdriven down to long run average total cost

if returns to scale first increase and then decrease, if returns to scale first increase and then decrease, price will be driven down to minimum long run price will be driven down to minimum long run average costaverage cost

Consumers benefit from the efficient, Consumers benefit from the efficient, lowest cost use of resources and the lowest lowest cost use of resources and the lowest price for the productprice for the product

Excess Profits are driven to ZeroExcess Profits are driven to Zero

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Competitive Industries: AgricultureCompetitive Industries: AgricultureProduct # of Firms Producingcattle 1176346corn 789326soybeans 441899wheat 352237dairy products 162555tobacco 136682peanuts 18905rice 12013

source: Census of Agriculture, 1987

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Competitive IndustriesCompetitive IndustriesProduct # of Firms Producingcontract construction 1951509apparel 22872millwork, plywood 7930household furniture 5606book publishers 2856computer/office Equip 2134knitted textiles 2130iron/steel foundry Pdt 1231footwear 479petroleum refining 331

sources: Census of Manufactures, 1987 Census of Construction Industries, 1987

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Short RunShort Run

Plant Size of a firm is fixedPlant Size of a firm is fixed

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AVCI

MCI

AVCII

MCII

QI QIIQI + QII

MarketSupply

Quantity

MC, AVC

Short Run Market Supply: Two Firm Industry

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Market Supply and Demand in the Short Run

Demand SupplyMC,MarketPrice

Quantity

pM

QM

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AVCI

MCI

AVCII

MCII

QI QIIQI + QII

MarketSupply

Quantity

MC, AVC,ATC

Short Run Market Supply: Two Firm Industry

PM MarketDemand

In the short run, both firms are making excess profits. This maymotivate them to find the lowest cost size for plant and equipment.

ATCI ATCII

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Short Run* World Supply: CopperShort Run* World Supply: CopperCountry Marginal Cost Metric Tons, 000Zaire 0.49 $ per # 560.0Zambia 0.54 $ per # 363.0Chile 0.58 $ per # 1356.4US 0.68 $ per # 1007.3Peru 0.79 $ per # 397.2Canada 0.88 $ per # 724.4

* Existing Mines Fixed

Source: Minerals Yearbook, 1985

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Short Run Supply of World Copper, 1985 .

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

0 1000 2000 3000 4000 5000

Production, Thousands of Metric Tons .

Marginal Cost, $ per # .

Zaire

Zambia

ChileUS

Peru

Canada

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Long RunLong Run

What is the optimal plant size?What is the optimal plant size? constant returns to scaleconstant returns to scale increasing, then decreasing returnsincreasing, then decreasing returns increasing returns to scaleincreasing returns to scale

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SMCISMCII

Quantity

MC, ,ATC

Optimal Size of the Firm: Constant Returns to Scale

If market price is above long run marginal cost, the firm willmake the same excess profit per unit of output in a large plant as in a small plant. The firm may prefer larger to smaller. As long as firms are making excess profits, other firms will enter the industry,increasing supply, and driving price down to LMC.

SATCISATCII

LATC, LMC

pM

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Demand

Long Run Equilibrium Supply with the Free Entry of Firms:Constant Returns to Scale

PM

Market Price

Short Run Supply

PM = LMC =LATC

Supply afterEntry of ProfitSeeking Firms

Quantity

Long Run Supply

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SMCISMCII

Quantity

MC, ,ATC

Optimal Size of the Firm: Constant Returns to Scale

If market price is above long run marginal cost, the firm willmake the same excess profit per unit of output in a large plant as in a small plant. The firm may prefer larger to smaller. As long as firms are making excess profits, other firms will enter the industry,increasing supply, and driving price down to LMC.

SATCISATCII

LATC, LMCpM

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LATC

Optimal Size of Plant with Variable Returns to Scale

SATCI

SATCIII

SATCIV

SATCII

SMCIV

LMC

If market price is above long run average cost, then firms withefficient scale of plant, SATCIII ,will make an excess profit. In the long run other firms in the industry will move to this efficient size plant. As long as there are excess profits to be made, new firms will enter the industry, driving market price down to minimum long run average total cost, LATC.

MarketPrice

Quantity

pM

LATC

SMCIII

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Demand

Long Run Equilibrium Supply with the Free Entry of Firms:Variable Returns to Scale, Deceasing and then Increasing

PM

Market Price

Short Run Supply

PM = LMC =MinimumLATC

Supply afterEntry of ProfitSeeking Firms

Quantity

Long Run Supply

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LATC

Optimal Size of Plant with Variable Returns to Scale

SATCI

SATCIII

SATCIV

SATCII

SMCIV

LMC

If market price is above long run average cost, then firms withefficient scale of plant, SATCIII ,will make an excess profit. In the long run other firms in the industry will move to this efficient size plant. As long as there are excess profits to be made, new firms will enter the industry, driving market price down to minimum long run average total cost, LATC.

MarketPrice

QuantitypM

LATC

SMCIII

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Competitive MarketsCompetitive Markets In the long run, resources will flow to a In the long run, resources will flow to a

competitive market if firms are making competitive market if firms are making excess profitsexcess profits new firms will enter the industrynew firms will enter the industry

if returns to scale are constant, then price will be if returns to scale are constant, then price will be driven down to long run average total costdriven down to long run average total cost

if returns to scale first increase and then decrease, if returns to scale first increase and then decrease, price will be driven down to minimum long run price will be driven down to minimum long run average costaverage cost

Consumers benefit from the efficient, Consumers benefit from the efficient, lowest cost use of resources and the lowest lowest cost use of resources and the lowest price for the productprice for the product

Excess Profits are driven to ZeroExcess Profits are driven to Zero

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Natural MonopolyNatural Monopoly Increasing Returns to ScaleIncreasing Returns to Scale

optimal size of the firmoptimal size of the firm larger is betterlarger is better

Constant Returns to ScaleConstant Returns to Scale optimal size of the firm: indeterminateoptimal size of the firm: indeterminate

LAC = LMC = same at all outputsLAC = LMC = same at all outputs

Increasing then Decreasing Returns to ScaleIncreasing then Decreasing Returns to Scale optimal size of the firm: minimum LACoptimal size of the firm: minimum LAC

minimum LAC where LAC = LMCminimum LAC where LAC = LMC

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Optimal Size of Plant with Increasing Returns to Scale: Bigger is Better

SATCI

SATCII

Price

Quantity

LATC

LATC

LMC

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Market Power: Size in 1994Market Power: Size in 1994Country Corporation GDP, $B Sales, $BSweden 169

GM 155Taiwan 150

Ford 129Norway 105

Exxon 101Toyota 95

Hong Kong 91Wal-Mart 83ATT 75

source: World Bank & Fortune 500

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Market Power: Market ShareMarket Power: Market ShareProduct Firms Mkt Shrinst. breakfast Carnation, Pillsbury 100/3tennis balls Gen Corp, Pepsico 100/4disp. diapers P&G, Kimberly 99/4breakfast cereal Kellogg, Gen Mills 98/4video gameplayer

Nintendo, Sega 98/2

cameras, film Kodak, Polaroid 98/4car rental Hertz, Avis 95/4credit cards VISA, MasterCard 92/3beer Anheuser-Busch 90/4detergent P&G, Lever Bros 86/3records & tapes Time-Warner, Sony 77/4

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How does a monopolist use power to maximize profits?How does a monopolist use power to maximize profits?

marginal principle: increase output until marginal principle: increase output until marginal revenue = marginal costmarginal revenue = marginal cost

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Monopoly Sales

Price Market Demand

Quantity

00

Quantity

Price Quantity Revenue Marginal Revenue 10 0 09 1000 9000 90008 2000 18000 90007 3000 21000 30006 4000 24000 30005 5000 25000 10004 6000 24000 -10003 7000 21000 -30002 8000 18000 -30001 9000 9000 -90000 10000 0 -9000

Revenue

$25,000

$10

0

A

B

A B

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Long Run Total Costs

Increasing Returns to Scale and Long Run Total Costs

$

Quantity

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LTC

$LTCR

Quantity

Revenue

Maximum Monopoly Profits: Marginal Revenue = Marginal Cost

$Excess Profit

0 Quantity

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Monopoly Profits with Increasing Returns to Scale

Price

Quantity

Market Demand

MR

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Monopoly Profits with Increasing Returns to Scale

Price

Quantity

LATC

LATC

LMC

Market Demand

MR

Q

PM

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LTC

$LTCR

Quantity

Revenue

Maximum Monopoly Profits: Marginal Revenue = Marginal Cost

$Excess Profit

0 Quantity

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The Social Cost of Monopoly: Example, Constant Returns to Scale

LATC = LMC

Market Demand

Competition Monopoly

Market Demand

LATC = LMCPM

Consumer Surplus

MR

QCOMP QMONOP

PM

Under monopoly, consumers pay a higher price and consume less

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The Social Cost of Monopoly: Example, Constant Returns to Scale

LATC = LMC

Market Demand

Competition Monopoly

Market Demand

LATC = LMCPM

Consumer Surplus

MR

QCOMP QMONOP

PM

Under monopoly, some consumer surplus is redistributed to the monopolist as profit, and some is lost to society

Profit

Dead Weight Loss

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Social PolicySocial Policy If returns to scale are constantIf returns to scale are constant

regulateregulate make the monopolist charge a price equal to make the monopolist charge a price equal to

marginal costmarginal cost• obtain the competitive solutionobtain the competitive solution

If returns to scale are increasingIf returns to scale are increasing regulation is not so easyregulation is not so easy

can not set monopolist’s price equal to marginal can not set monopolist’s price equal to marginal cost: monopolist will suffer lossescost: monopolist will suffer losses

• because marginal cost is less than average costbecause marginal cost is less than average cost

could socialize the industry and the government could socialize the industry and the government could subsidize the lossescould subsidize the losses

could live with monopolycould live with monopoly

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MONOPOLY POWER

Society

How can we control it?

Regulation,Franchises,Patents

Higher PricesLess GoodsExcess Profits

Entrepreneurs

How do we get it?

PoliticalInfluence

Strategic Planning

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Strategic Planning: Brand NamesStrategic Planning: Brand NamesBrand Company Value, $BMarlboro Philip Morris 31Coca-Cola Coca-Cola 24Budweiser Anheuser-Busch 10Pepsi-Cola PepsiCo 10Nescafe Nestle 9Kellogg Kellogg 8Winstons RJR Nabisco 6Pampers Procter & Gamble 6Camels RJR Nabisco 4Campbell Campbell Soup 4

source: USA Today , 1992

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Advertising Cost of a CarAdvertising Cost of a Car

company $ per sale TV, $M, ‘91Mercedes 620 49Nissan 435 267Toyota 381 403GM 198 978Chrysler 198 335Ford 123 408

source: Fortune

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Strategic Action: AdvertisingStrategic Action: AdvertisingCompany Advertising, ‘94: $BProctor & Gamble 2.7Philip Morris 2.4General Motors 1.9Ford Motor Co. 1.2Sears, Roebuck 1.1AT&T 1.1PepsiCo 1.1Chrysler 1.0Disney 0.9Johnson & Johnson 0.9

source: Advertising Age

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Classification of US IndustryClassification of US IndustrySector % Pvt Domestic OutputAg, Forestry & Fishg 1.9Mining 0.9Construction 5.3Manufacturing 21.0Transport, Commun 8.6Wholesale Trade 6.8Retail Trade 10.2Finance, Insur, Real 18.6Services: Pers & Bus 26.8Total 100.0

source: Survey of Current Business

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Summary-Vocabulary-ConceptsSummary-Vocabulary-Concepts competitive industriescompetitive industries short runshort run short run marginal costshort run marginal cost optimal plant sizeoptimal plant size long runlong run long run marginal costlong run marginal cost constant returns to scaleconstant returns to scale free entryfree entry long run equilibriumlong run equilibrium variable returns to scalevariable returns to scale excess profits excess profits

increasing returns to scaleincreasing returns to scale natural monopolynatural monopoly market sharemarket share marginal revenuemarginal revenue monopoly profitmonopoly profit social cost of monopolysocial cost of monopoly consumer surplusconsumer surplus dead weight lossdead weight loss regulation of monopolyregulation of monopoly brand namesbrand names strategic planningstrategic planning