Topic 2 - Part 2 SIMPLE PRICING - ECON

At the end of Topic 2 - Part 2, you will be able to:

Determine a firm’s profit-maximizing output.
Describe the four main types of market structure.
Graphically identify the competitive equilibrium and derive short-run supply curve characteristics of perfect competition.
Contrast the short-run and long-run competitive equilibria and supply curves.
Show how a monopoly chooses an output level to maximize its profit.
Calculate the extent of a monopoly’s market power.
Describe how monopoly causes a market failure.
List the causes of monopoly.

Revenue (R): R = price (p) × quantity (q).
Cost (C): C = opportunity costs; the value of the best alternative use of inputs.
Profit (π): π = R - C,
- If π < 0, the firm incurs a loss.

Calculate profits over time by considering the present value of future profits, discounted using the interest rate.

Output Decision: Determine the output level (q) that maximizes profit or minimizes loss.
Shutdown Decision: Evaluate if it's more profitable to produce or to shut down entirely.

Shutdown Rule 1: Shut down if losses can be reduced.
Shutdown Rule 2: Shut down if revenue falls below avoidable costs (e.g., variable costs). In the short run, fixed costs are avoidable in the long run.

Firm behavior depends on market structure:
- Ease of entry and exit.
- Ability to differentiate products.

Type of Structure Price Setting Price Level Entry Conditions Firms Long-run Profit Strategy Products Example
Perfect Competition	Price taker	Low	Free entry	Many	0	None	Homogeneous products	Apple farmers
Monopoly	Price setter	Very high	No entry	1	> 0	Yes (no rivals)	Single product	Patented drug manufacturers
Oligopoly	Price setter	High	Limited entry	Few	> 0	Yes	May be differentiated	Automobile producers
Monopolistic Competition	Price setter	High	Free entry	Many	0	Yes	Differentiated products	Plumbers in a small town

Large number of buyers and sellers: No individual can influence the market price.
Identical products: Products are homogeneous.
Full information: Buyers have complete knowledge of prices.
Negligible transaction costs: Very low costs associated with buying and selling.
Free entry and exit: Firms can freely enter or leave the market in the long run.

Firms maximize profit by producing where MR = MC.
If a firm incurs losses but can cover variable costs, it should continue operating short-term.

All costs become variable; firms achieve zero economic profit.
Decision-making focuses on minimizing losses and maximizing profit by choosing the production level where long-run marginal cost equals marginal revenue.

Marginal Revenue (MR): Change in revenue from selling one additional unit.
Demand Curve Influence: MR curve lies below the demand curve for monopolies.
Profit Maximization Condition: MR = MC determines the optimal output level.

Market power allows monopolies to set prices above marginal costs, affecting market price.
Factors influencing a monopoly's market power include demand elasticity and cost structure.

Monopolies create deadweight loss due to less output compared to perfectly competitive markets, leading to consumer and producer surplus losses.
Market power results in inefficient allocation of resources.

Text: Managerial Economics and Strategy, Perloff and Brander, 3rd Edition, Pearson.