Understanding Monopoly and Competition

Economic Profit and Cost Calculations

Economic Profit: The measure of profit that subtracts total costs (including opportunity costs) from total revenue.
- Formula:
- Economic Profit = Total Revenue - Total Cost
Cost Components:
- Total Revenue: The total amount of money a firm receives from selling goods or services.
- Total Cost: The sum of fixed costs (costs that do not change with the level of output) and variable costs (costs that change with the level of output).
Average Variable Cost (AVC): A key concept that affects pricing and profit levels.
- Price can either be above or below average variable cost, affecting a firm's decision to stay in the market.
If the price is below AVC, the firm incurs a loss covering its fixed costs and the portion of variable costs it cannot cover.

Monopoly Power Definition: The ability of a single seller to influence the price of a good or service in a market.
- A monopolist is known as a price maker, as it can set prices above marginal cost.
Reasons for Monopoly Power:
- Control over key resources essential for production.
- Example: A water supplier controlling water in a city.
- Barriers to entry that prevent new firms from entering the market.
- Example: High costs associated with setting up utility lines.
Market Examples of Monopoly:
- Utility companies: Often have sole control over essential services due to government regulation.
- Pharmaceuticals: Patents grant monopoly power for a fixed duration, incentivizing innovation while preventing competition.
- Example: Patented drugs allowed sole production by the patent owner until expiration, after which generics can enter the market.

Definition of Perfect Competition: A market structure characterized by many firms producing identical goods with no barriers to entry or exit.
In a perfectly competitive market,
- Firms are price takers, unable to influence market prices due to their small size relative to the market.
- Demand for an individual firm’s product is perfectly elastic.
Long-run Dynamics:
- If firms earn profits, new firms enter, increasing supply and decreasing price until profits normalize to zero.
- Conversely, if firms incur losses, they exit the market, reducing supply and increasing price until remaining firms can make a normal profit.

As a monopolist sets the price, they face a downward-sloping demand curve; if they want to increase sales, they must lower prices.
Marginal Revenue (MR):
- The additional revenue gained from selling one more unit.
- In a monopoly, MR is always lower than the price because lowering the price affects all units sold.
Profit Maximization:
- Occurs where MR equals Marginal Cost (MC).
- At this point, the monopolist selects the price from the demand curve corresponding to the quantity produced.

Consumer Surplus: The difference between what consumers are willing to pay and what they actually pay. In monopolistic markets, consumer surplus tends to be lower than in competitive markets.
Post-Patent Expiration:
- Upon expiration of a product's patent, competition typically leads to a decrease in price and increase in supply, benefiting consumers through lower prices for generics.

Fixed Cost Definition: Costs that remain constant regardless of the level of production output. Examples include rent, salaries, and utilities.
When fixed costs increase, without changes in marginal costs, the profit equation will