Week 13: Profit Concepts and Market Structures in Economics

Accounting Profit

Total Revenue - Explicit Costs

Economic Profit

Total Revenue - Explicit - Implicit Costs

Profit Formula

Profit = Q × (P − ATC)

Positive Profit Condition

Profit is positive when P > ATC

Minimizing Losses in Perfect Competition

Operate when AVC < P < ATC: Recover some fixed costs

Shutdown Condition

Shut down when P < AVC: Loss per unit produced

Output Decision Rule

Produce where P = MC, only if P ≥ AVC

Short-Run Supply Curve

Individual firm: MC curve above minimum AVC; Market supply: Horizontal sum of all firms' supply curves above AVC

Monopolist Pricing

Monopolists set P > MR = MC; no direct relationship between price and quantity supplied ⇒ no supply curve

Long-Run Equilibrium in Perfect Competition

P = MC = min(AC); Economic profits attract entry → price falls; Economic losses cause exit → price rises; Result: zero economic profit

Long-Run Equilibrium in Monopolistic Competition

P > MC and P = ATC > min(AC); Inefficient due to excess capacity and product variety

Short-Run Definition

Fixed production capacity, fixed number of firms

Long-Run Definition

Capacity and number of firms can change

Demand-Side Strategies

Create customer lock-in (e.g., switching costs, brand loyalty, network effects)

Supply-Side Strategies

Develop cost advantages: Learning by doing, Mass production, R&D, Supplier relationships & input control

Regulatory Strategies

Use patents, licenses, regulations to block new entrants

Entry Deterrence

Signal threats credibly: Excess capacity, Flooding markets, Brand proliferation, Fierce reputation

Price Discrimination

Selling the same product at different prices to different customers

First-Degree Price Discrimination

Charge each customer their max willingness to pay; Extracts all consumer surplus (ideal but rare)

Second-Degree Price Discrimination

Quantity-based pricing (bulk discounts)

Third-Degree Price Discrimination

Price varies by identifiable customer segments (e.g., students, seniors)

Conditions for Price Discrimination

Market power, Ability to prevent resale, Ability to segment customers

Welfare Implications of First-Degree Price Discrimination

All surplus goes to producer; consumer surplus = 0

Welfare Implications of Second-Degree Price Discrimination

Transfer of surplus; producers benefit

Welfare Implications of Third-Degree Price Discrimination

Pareto improvement (adds new customers without harming existing ones)