ENTREPRENEUR A person who comes up with an idea for a business and coordinates the production and sale of goods and services:A person who comes up with

ENTREPRENEURENTREPRENEUR• A person who comes up with an idea for a A person who comes up with an idea for a

business and coordinates the production and business and coordinates the production and sale of goods and services:sale of goods and services:

• The entrepreneur builds the production The entrepreneur builds the production facility, buys raw materials and hires workers.facility, buys raw materials and hires workers.

• An entrepreneur takes risks, committing time An entrepreneur takes risks, committing time and money to a business without any and money to a business without any guarantee that the business will be profitable.guarantee that the business will be profitable.

• The entry of a second firm would make the The entry of a second firm would make the market price less than the average cost of market price less than the average cost of production, so a single firm will serve the entire production, so a single firm will serve the entire market.market.

• A single firm is profitable, but a pair of firms A single firm is profitable, but a pair of firms would lose money.would lose money.

• Classic examples are public utilities (sewerage, Classic examples are public utilities (sewerage, water, and electricity generation) and water, and electricity generation) and transportation services (railroad freight and mass transportation services (railroad freight and mass transit).transit).

NATURAL MONOPOLYNATURAL MONOPOLY

8.20

6.206.20

4.604.60

33

mm

cc

nn

Long-Run Long-Run Average CostAverage Cost

Long-Run Long-Run Marginal CostMarginal Cost

Monopolist’s demandMonopolist’s demand(Market demand) (Market demand)

Marginal Marginal RevenueRevenue

Billions of Kilowatt HoursBillions of Kilowatt Hours

Dollars perDollars per1,000 1,000

KilowattKilowattHoursHours

THE MARGINAL PRINCIPLETHE MARGINAL PRINCIPLE

The marginal principle is satisfied at point The marginal principle is satisfied at point n, with 3 billion kilowatt hours (kwh) of n, with 3 billion kilowatt hours (kwh) of electricity.electricity.

The price associated with this quantity is The price associated with this quantity is $8.20 (shown at point m) and the average $8.20 (shown at point m) and the average cost is $6.20 (shown at point c).cost is $6.20 (shown at point c).

The profit per unit of electricity is $2.00.The profit per unit of electricity is $2.00.

The price exceeds the average cost, so the The price exceeds the average cost, so the electric company will earn a profit.electric company will earn a profit.

WHAT IF A SECOND FIRM WHAT IF A SECOND FIRM ENTERED THE MARKET ?ENTERED THE MARKET ?

• Entry of a second firm would shift the demand Entry of a second firm would shift the demand curve for the first firm to the left, from Dcurve for the first firm to the left, from D11 to D to D22::

• At each price, the first firm will sell a smaller At each price, the first firm will sell a smaller quantity of electricity, because it now shares quantity of electricity, because it now shares the market with another firm.the market with another firm.

• In general, the larger the number of firms, the In general, the larger the number of firms, the lower the demand curve facing the typical firm lower the demand curve facing the typical firm in a two-firm market.in a two-firm market.

8.20

6.206.20

33

mm

cc






Firm’s Demand Firm’s Demand Curve with two Curve with two

firmsfirms

DD11

DD22

WILL A SECOND FIRM ENTER A WILL A SECOND FIRM ENTER A NATURAL MONOPOLY ?NATURAL MONOPOLY ?

• The demand curve for a typical firm in a The demand curve for a typical firm in a two-firm market lies entirely below the long-two-firm market lies entirely below the long-run run average-average-cost curve.cost curve.

• There is no quantity at which the price There is no quantity at which the price exceeds the average cost of production.exceeds the average cost of production.

• No matter what price is charged, the firm No matter what price is charged, the firm will lose money.will lose money.

A SECOND FIRM WILL NOT ENTER THE A SECOND FIRM WILL NOT ENTER THE MARKET!MARKET!

8.20

6.206.20

33

mm

cc






Firm’s Demand Firm’s Demand Curve with two Curve with two

firmsfirms

DD11

DD22

1.51.5

PRICE CONTROLS FOR A PRICE CONTROLS FOR A NATURAL MONOPOLYNATURAL MONOPOLY

• When a monopoly is inevitable, the When a monopoly is inevitable, the government often sets a maximum price for government often sets a maximum price for the monopolist.the monopolist.

• Local governments regulate utilities and Local governments regulate utilities and firms that provide water, electricity, and firms that provide water, electricity, and local telephone service.local telephone service.

• State governments use public utility State governments use public utility commissions (PUCs) to regulate the commissions (PUCs) to regulate the electric-power industry.electric-power industry.

AVERAGE-COST PRICING AVERAGE-COST PRICING POLICYPOLICY

• The government picks the price The government picks the price at which the demand curve at which the demand curve intersects the average-cost intersects the average-cost curve.curve.

8.20

33

mm





Unregulated MonopolyUnregulated Monopoly

5.205.20ii Original Average CostOriginal Average Cost

Average Cost w / regulationAverage Cost w / regulation6.006.00

55

rrRegulated MonopolyRegulated Monopoly

Effect of Regulatory Pricing On Effect of Regulatory Pricing On Firm’s Production CostsFirm’s Production Costs

• Under average-cost pricing, a change in the Under average-cost pricing, a change in the firm’s production cost will not affect the firm’s firm’s production cost will not affect the firm’s profit because the government will adjust the profit because the government will adjust the regulated price to keep the price equal to the regulated price to keep the price equal to the average cost. average cost.

• Because there is no reward for cutting its Because there is no reward for cutting its costs and no penalty for higher costs, the firm costs and no penalty for higher costs, the firm has little incentive to control its cost.has little incentive to control its cost.

• Costs will increase, pulling up regulated price.Costs will increase, pulling up regulated price.

MONOPOLISTIC COMPETITIONMONOPOLISTIC COMPETITION

• MANY FIRMS,MANY FIRMS,

• DIFFERENTIATED PRODUCT,DIFFERENTIATED PRODUCT,

• SLIGHT CONTROL OVER SLIGHT CONTROL OVER PRICE,PRICE,

• NO ARTIFICIAL BARRIERS TO NO ARTIFICIAL BARRIERS TO ENTRYENTRY

MONOPOLISTIC COMPETITIONMONOPOLISTIC COMPETITION• Many Firms:Many Firms:

Relatively small economies of scale; small Relatively small economies of scale; small firms can produce at about same average firms can produce at about same average cost as large firms; market can support cost as large firms; market can support many firms.many firms.

• Differentiated Product:Differentiated Product:

Firms sell slightly different products; Firms sell slightly different products; differentiation with respect to physical differentiation with respect to physical characteristics, location, services, and aura characteristics, location, services, and aura or image associated with good.or image associated with good.

MONOPOLISTIC COMPETITIONMONOPOLISTIC COMPETITION• Slight control over price:Slight control over price:

When a firm increases its price, When a firm increases its price, somesome of its of its customers will switch to other firms that sell customers will switch to other firms that sell slightly different products.slightly different products.

• No artificial barriers to entryNo artificial barriers to entry

In a market subject to monopolistic competition, In a market subject to monopolistic competition, each firm has a monopoly in selling its own each firm has a monopoly in selling its own differentiated product, but competes with other differentiated product, but competes with other firms selling similar products.firms selling similar products.

HOW FIRMS DIFFERENTIATE HOW FIRMS DIFFERENTIATE THEIR PRODUCTTHEIR PRODUCT

• Physical Characteristics:Physical Characteristics:

Different size, color, shape, texture, or taste;Different size, color, shape, texture, or taste;

Examples: athletic shoes, toothpaste, dress Examples: athletic shoes, toothpaste, dress shirts, appliances, and pens;shirts, appliances, and pens;

• Location:Location:

Differentiated by where products are sold;Differentiated by where products are sold;

Examples: gas stations, music stores, grocery Examples: gas stations, music stores, grocery stores, movie theaters, and ice-cream parlors; stores, movie theaters, and ice-cream parlors;

HOW FIRMS DIFFERENTIATE HOW FIRMS DIFFERENTIATE THEIR PRODUCTSTHEIR PRODUCTS

• Services:Services:

Helpful sales people versus self-service, home Helpful sales people versus self-service, home delivery, free technical assistance;delivery, free technical assistance;

• Aura or Image:Aura or Image:

Use of advertising to make products stand out Use of advertising to make products stand out from group of virtually identical products,from group of virtually identical products,

Examples: aspirin, designer jeans, and motor Examples: aspirin, designer jeans, and motor oiloil

1919

88

300300 640640

mm

nnMonopolist’s demandMonopolist’s demand

(market demand)(market demand)

Long-run average costLong-run average costor long-run marginal costor long-run marginal cost

Marginal RevenueMarginal Revenue

DollarsDollarsperperCDCD

CDs Sold Per HourCDs Sold Per Hour

SHORT-RUN EQUILIBRIUM WITH MONOPOLISTIC SHORT-RUN EQUILIBRIUM WITH MONOPOLISTIC COMPETITION: A SINGLE MUSIC STORECOMPETITION: A SINGLE MUSIC STORE

SHORT-RUN EQUILIBRIUMSHORT-RUN EQUILIBRIUM

• The marginal principle is satisfied at point n The marginal principle is satisfied at point n (MR =MC).(MR =MC).

• Monopolist sells 640 CDs per hour.Monopolist sells 640 CDs per hour.

• Price of CD is $19 (point m), average cost is Price of CD is $19 (point m), average cost is $8 (point c).$8 (point c).

• Monopolist’s profit per CD is $11.Monopolist’s profit per CD is $11.

1919

88

440440 640640

mm

Monopolist’s demandMonopolist’s demand(market demand)(market demand)

Long-run average costLong-run average costor long-run marginal costor long-run marginal cost

New Marginal RevenueNew Marginal Revenue



SHORT-RUN EQUILIBRIUM WITH MONOPOLISTIC SHORT-RUN EQUILIBRIUM WITH MONOPOLISTIC COMPETITION: ENTER A SECOND STORECOMPETITION: ENTER A SECOND STORE

1818 ee

ff

DD11DD22

Firm’s DemandFirm’s DemandCurve with twoCurve with two

FirmsFirms

ENTER A SECOND STOREENTER A SECOND STORE• Entry of a second firm shifts the demand curve Entry of a second firm shifts the demand curve

facing the typical firm left from Dfacing the typical firm left from D11 to D to D22..

• The marginal principle is satisfied at point f (MC = The marginal principle is satisfied at point f (MC = new MR).new MR).

• Each firm will produce 440 CDs per hour at a price Each firm will produce 440 CDs per hour at a price of $18 (point e) and an average cost of $8 (point f).of $18 (point e) and an average cost of $8 (point f).

• Price of CDs decreases.Price of CDs decreases.• Profit per CD decreases from $11 ($19 -$8) to $10 Profit per CD decreases from $11 ($19 -$8) to $10

($18 -$8).($18 -$8).

88Long-run average costLong-run average costLong-run marginal costLong-run marginal cost



LONG-RUN EQUILIBRIUM WITH MONOPOLISTIC LONG-RUN EQUILIBRIUM WITH MONOPOLISTIC COMPETITION: MUSIC STORESCOMPETITION: MUSIC STORES

1414

7070

hh

ee

Demand Curve for Typical StoreDemand Curve for Typical Store

MarginalMarginalRevenueRevenue

LONG-RUN EQUILIBRIUM WITH LONG-RUN EQUILIBRIUM WITH MONOPOLISTIC COMPETITIONMONOPOLISTIC COMPETITION• With no artificial barriers to entry, firms will With no artificial barriers to entry, firms will

continue to enter market until each music continue to enter market until each music store makes zero economic profit.store makes zero economic profit.

• As firms enter market, demand curve shifts As firms enter market, demand curve shifts left.left.

• Typical firm satisfies marginal principle at Typical firm satisfies marginal principle at point g and sells 70 CDs per hour.point g and sells 70 CDs per hour.

• Price is $14 (point h) and average cost is Price is $14 (point h) and average cost is $14 -- $14 -- zero economic profitzero economic profit..

As the number of firms increases, the profit per CD As the number of firms increases, the profit per CD decreases for two reasons:decreases for two reasons:

• Lower Price -Lower Price -

The stores compete for customers by cutting The stores compete for customers by cutting prices.prices.

• Higher Average Cost -Higher Average Cost -

As more firms enter market, eventually move As more firms enter market, eventually move upward along negatively-sloped portion of upward along negatively-sloped portion of average-cost curve to higher average cost (fewer average-cost curve to higher average cost (fewer CDs sold per store).CDs sold per store).

LONG-RUN EQUILIBRIUM WITH LONG-RUN EQUILIBRIUM WITH MONOPOLISTIC COMPETITIONMONOPOLISTIC COMPETITION

TRADEOFFS WITH TRADEOFFS WITH MONOPOLISTIC COMPETITIONMONOPOLISTIC COMPETITION

• Good NewsGood News: Lower Price -: Lower Price -

Competition decreases the price of a product.Competition decreases the price of a product.• Good NewsGood News: Lower Travel Cost -: Lower Travel Cost -

With larger number of competitors, the shorter the With larger number of competitors, the shorter the distance each customer must travel to the nearest distance each customer must travel to the nearest store.store.

• Bad NewsBad News: Higher Average Cost -: Higher Average Cost -

As output per store decreases, the average cost of As output per store decreases, the average cost of a typical store increases.a typical store increases.

Documents

ENTREPRENEUR A person who comes up with an idea for a business and coordinates the production and sale of goods and services:A person who comes up with