Robin Naylor, Department of Economics, Warwick 1 In this lecture, we consider what factors influence...
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Transcript of Robin Naylor, Department of Economics, Warwick 1 In this lecture, we consider what factors influence...
Robin Naylor, Department of Economics, Warwick
1
In this lecture, we consider what factors influence whether there will be a large or a small number of firms in a market.
We also consider the specific issues arising when there is a ‘natural monopoly’ in a market.
Topic 5 Market structure, efficiency and failureLecture 19
Robin Naylor, Department of Economics, Warwick
2
Topic 5 Market structure, efficiency and failureLecture 19
X
p
D
X1
Minimum Efficient Scale refers to the smallest quantity at which the LAC attains its minimum level.
LAC1
LAC1 LAC2
X2
Firm 1Firm 2
LAC3
Firm 3
X3
Robin Naylor, Department of Economics, Warwick
3
Topic 5 Market structure, efficiency and failureLecture 19
X
p
D
X1
LAC1
Suppose Firm 1 is producing X1. If there are no other firms in the market, what price can Firm 1 charge? Will it make a super-normal profit?
LAC1
Note that output at X1 is called Minimum Efficient Scale (MES).
Robin Naylor, Department of Economics, Warwick
4
Topic 5 Market structure, efficiency and failureLecture 19
X
p
D
X1
LAC1
Suppose Firm 1 is producing X1. If there are no other firms in the market, what price can Firm 1 charge? Will it make a super-normal profit?
LAC1
Note that output at X1 is called Minimum Efficient Scale (MES).
p1
Robin Naylor, Department of Economics, Warwick
5
Topic 5 Lecture 19
X
p
DX1
LAC1,2
Firm 1 is producing X1.
Suppose now that Firm 2 enters the market and is identical to Firm 1 and produces the same amount, X1. What is total output?
What price can be charged?
Can each firm make a super-normal profit?
X1
2X1
LAC1,2
Robin Naylor, Department of Economics, Warwick
6
Topic 5 Lecture 19
X
p
DX1
LAC1,2
Firm 1 is producing X1.
Suppose now that Firm 2 enters the market and is identical to Firm 1 and produces the same amount, X1. What is total output?
What price can be charged?
Can each firm make a super-normal profit?
X1
2X1
LAC1,2
P1,2
Robin Naylor, Department of Economics, Warwick
7
Topic 5 Lecture 19
X
p
D
3X1
LAC1
What if 3 identical firms are each producing X1?
Can they each at least break even?
X1X1 X1
Robin Naylor, Department of Economics, Warwick
9
Topic 5 Lecture 19
X
p
D
LAC1
How many (identical) firms in this market can each produce X1 and each break even?
X1
Robin Naylor, Department of Economics, Warwick
10
Topic 5 Lecture 19
X
p
D
LAC1
How many (identical) firms in this market can each produce X1 and each break even?
X1X1 X1
3X14X1
5X1 9X1
Robin Naylor, Department of Economics, Warwick
11
Topic 5 Lecture 19
X
p
D
LAC1
Suppose now that there is a reduction in market demand.
How many firms (with identical costs as before), each producing X1, can at least break even?
X1D’
Robin Naylor, Department of Economics, Warwick
12
Topic 5 Lecture 19
X
p
D
LAC1
Suppose now that there is a reduction in market demand.
How many firms (with identical costs as before), each producing X1, can at least break even?
X1D’
6X1
Robin Naylor, Department of Economics, Warwick
13
Topic 5 Lecture 19
X
p
D
LAC1
What can you conclude about what determines the number of firms that we will find in a market?
From this analysis, we see three crucial determinants . . .
X1
Robin Naylor, Department of Economics, Warwick
14
Topic 5 Lecture 19
X
p
D
LAC1
We have seen the importance of:
(i) the extent of demand.
Now consider:
(ii) MES
(iii) Minimum LAC
X1
LAC1’
X1 ’
LAC1
If MES is at X1’ instead of X1, how many firms can survive?
Robin Naylor, Department of Economics, Warwick
15
Topic 5 Lecture 19
X
p
D
LAC1
We have seen the importance of:
(i) the extent of demand.
Now consider:
(ii) MES
(iii) Minimum LAC
X1
LAC1’
X1 ’
LAC1
If MES is at X1’ instead of X1, how many firms can survive?
2X1 ’
P1,2
Robin Naylor, Department of Economics, Warwick
16
Topic 5 Lecture 19
X
p
D
LAC1
We have seen the importance of:
(i)the extent of demand.
(ii)MES
Now consider:
(iii) Minimum LAC
X1
LAC1
LAC1 ’
LAC1 ’ That is, what if the LAC curve shift upward, with no change in MES?
How many firms can survive?
Robin Naylor, Department of Economics, Warwick
17
Topic 5 Lecture 19
X
p
D
LAC1
What if the LAC curve shift upward, with no change in MES?
Whereas 9 firms could survive previously (see Slide 10), now only 5 can survive.
X1
LAC1
LAC1 ’
LAC1 ’
5X1 6X1
9X1
Robin Naylor, Department of Economics, Warwick
18
Topic 5 Lecture 19
X
p
D
LAC1
Consider the case in which only 1 firm can survive . . .
. . . this is called:
Natural Monopoly
MES=X1
What will be the profit-maximising price and output of this Natural firm?
Robin Naylor, Department of Economics, Warwick
19
Topic 5 Lecture 19
X
p
D
LAC1
What will be the profit-maximising price and output of this Natural Monopoly firm?
X1
LMC1
MR
X*mon
pmon
LACmon
X*: MR=MC
Super-normal profit is given by area A=X*[pmon - LACmon]
Robin Naylor, Department of Economics, Warwick
20
Topic 5 Lecture 19
X
p
D=MB
LAC1
What will be the Welfare Loss associated with this Natural Monopoly firm?
X1
LMC1
MR
X*mon
pmon
LACmon
X*soc
Welfare Loss is given by the area between the LMC and Demand curves.