Chapter 6 The Two Extremes Perfect Competition and

Chapter 6 The Two Extremes: Perfect Competition and Pure Monopoly

Did You Know That. . . • In common speech, competition simply means “rivalry? ” • Under extreme perfectly competitive situations, individual buyers and sellers cannot affect the market price? • Economic profits that perfectly competitive firms may earn for a time ultimately disappear as other firms enter the industry? Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -2

Characteristics of a Perfectly Competitive Market Structure • Perfect Competition § A market structure in which the decisions of individual buyers and sellers have no effect on market price Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -3

Characteristics of a Perfectly Competitive Market Structure (cont'd) • Perfectly Competitive Firm § A firm that is such a small part of the total industry that it cannot affect the price of the product or service that it sells Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -4

Characteristics of a Perfectly Competitive Market Structure (cont'd) • Price Taker § A competitive firm that must take the price of its product as given because the firm cannot influence its price Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -5

Characteristics of a Perfectly Competitive Market Structure (cont'd) • Why a perfect competitor is a price taker 1. Large number of buyers and sellers 2. Homogenous products are perfect substitutes 3. Buyers and sellers have equal access to information 4. No barriers to entry or exit Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -6

The Demand Curve of the Perfect Competitor • Question § If the perfectly competitive firm is a price taker, who or what sets the price? Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -7

Figure 24 -1 The Demand Curve for a Producer of Flash Memory Pen Drives, Panel (a) Neither an individual buyer nor seller can influence the price The interaction of market supply and demand yields an equilibrium price of $5 Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -8

The Demand Curve of the Perfect Competitor (cont'd) • The perfectly competitive firm is a price taker, selling a homogenous commodity with perfect substitutes. § Will sell all units for $5 § Will not be able to sell at a higher price § Will face a perfectly elastic demand curve at the going market price Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -9

Figure 24 -1 The Demand Curve for a Producer of Flash Memory Pen Drives Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -10

How Much Should the Perfect Competitor Produce? • Perfect competitor accepts price as given § Firm raises price, it sells nothing § Firm lowers its price, it earns less revenues than it otherwise would • Perfect competitor has to decide how much to produce § Firm uses profit-maximization model Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -11

How Much Should the Perfect Competitor Produce? (cont'd) • The model assumes that firms attempt to maximize their total profits. § The positive difference between total revenues and total costs • The model also assumes firms seek to minimize losses. § When total revenues may be less than total costs Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -12

How Much Should the Perfect Competitor Produce? (cont'd) • Total Revenues § The price per unit times the total quantity sold § The same as total receipts from the sale of output Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -13

How Much Should the Perfect Competitor Produce? (cont'd) Profit p = Total revenue (TR) – Total cost (TC) TR = P x Q TC = TFC + TVC P determined by the market in perfect competition Q determined by the producer to maximize profit Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -14

Figure 24 -2 Profit Maximization, Panel (a) Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -15

Figure 24 -2 Profit Maximization, Panel (b) Total Output/ Sales/ Total day Costs Market Price Total Revenue Total Profit 0 $10 $5 $0 $10 1 15 5 5 10 2 18 5 10 8 3 20 5 15 5 4 21 5 20 1 5 23 5 25 2 6 26 5 30 4 7 30 5 35 5 8 35 5 40 5 9 41 5 45 4 10 48 5 50 2 11 56 5 55 1 Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -16

How Much Should the Perfect Competitor Produce? (cont'd) • Profit-Maximizing Rate of Production § The rate of production that maximizes total profits, or the difference between total revenues and total costs § Also, the rate of production at which marginal revenue equals marginal cost Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -17

Figure 24 -2 Profit Maximization, Panel (c) Total Output/ Sales/ Market day Price 0 $5 1 5 2 5 3 5 4 5 5 5 6 5 7 5 8 5 9 5 10 5 11 5 Marginal Cost Marginal Revenue $5 $5 3 5 2 5 1 5 2 5 3 5 4 5 5 5 6 5 7 5 8 5 Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -18

Using Marginal Analysis to Determine the Profit-Maximizing Rate of Production • Marginal Revenue § The change in total revenues divided by the change in output • Marginal Cost § The change in total cost divided by the change in output Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -19

Using Marginal Analysis to Determine the Profit-Maximizing Rate of Production (cont'd) • Profit maximization occurs at the rate of output at which marginal revenue equals marginal cost. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -20

Short-Run Profits • To find out what our competitive individual flash memory producer is making in terms of profits in the short run, we have to determine the excess of price above average total cost. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -21

Short-Run Profits (cont'd) • From Figure 24 -2 previously, if we have production and sales of seven flash drives, TR = $35, TC = $30, and profit = $5. • Now we take info from column 6 in panel (a) and add it to panel (c) to get Figure 24 -3. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -22

Figure 24 -3 Measuring Total Profits • Profits are maximized where MR = MC • This occurs at Q = 7. 5 units Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -23

Short-Run Profits (cont'd) • Graphical depiction of maximum profits § The height of the rectangular box represents profits per unit. § The length represents the amount of units produced. § When we multiply these two quantities, we get total economic profits. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -24

Figure 24 -4 Minimization of Short-Run Losses • Losses are minimized where MR = MC • This occurs at Q = 5. 5 units Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -25

Short-Run Profits (cont'd) • Short-run average profits are determined by comparing ATC with P = MR = AR at the profit-maximizing Q. • In the short run, the perfectly competitive firm can make either economic profits or economic losses. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -26

The Short-Run Shutdown Price • What do you think? § Would you continue to produce if you were incurring a loss? Ø In the short run? Ø In the long run? Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -27

The Short-Run Shutdown Price (cont'd) • As long as the loss from staying in business is less than the loss from shutting down, the firm will continue to produce. • A firm goes out of business when the owners sell its assets; a firm temporarily shuts down when it stops producing, but is still in business. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -28

The Short-Run Shutdown Price (cont'd) • As long as the price per unit sold exceeds the average variable cost per unit produced, the earnings of the firm’s owners will be higher if it continues to produce in the short run than if it shuts down. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -29

The Short-Run Shutdown Price (cont'd) • Short-Run Break-Even Price § The price at which a firm’s total revenues equal its total costs § At the break-even price, the firm is just making a normal rate of return on its capital investment (it’s covering its explicit and implicit costs). • Short-Run Shutdown Price § The price that just covers average variable costs § It occurs just below the intersection of the marginal cost curve and the average variable cost curve. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -30

Figure 24 -5 Short-Run Shutdown and Break-Even Prices Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -31

The Meaning of Zero Economic Profits • Question § Why produce if you are not making a profit? • Answer § Distinguish between economic profits and accounting profits. § Remember when economic profits are zero a firm can still have positive accounting profits. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -32

The Supply Curve for a Perfectly Competitive Industry • Question § What does the short-run supply curve for the individual firm look like? • Answer § The firm’s short-run supply curve is its marginal cost curve at and above the point of intersection with the average variable cost curve. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -33

Figure 24 -6 The Individual Firm’s Short-Run Supply Curve • Given the price, the quantity is determined where MC = MR • Short-run supply = MC above minimum AVC Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -34

The Supply Curve for a Perfectly Competitive Industry (cont'd) • The Industry Supply Curve § The locus of points showing the minimum prices at which given quantities will be forthcoming § Also called the market supply curve Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -35

Figure 24 -7 Deriving the Industry Supply Curve Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -36

The Supply Curve for a Perfectly Competitive Industry (cont'd) • Factors that influence the industry supply curve (determinants of supply) § Firm’s productivity § Factor costs Ø Wages, prices of raw materials § Taxes and subsidies § Number of sellers Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -37

Price Determination Under Perfect Competition • Question § How is the market, or “going, ” price established in a competitive market? • Answer § This price is established by the interaction of all the suppliers (firms) and all the demanders. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -38

Price Determination Under Perfect Competition (cont'd) • The competitive price is determined by the intersection of the market demand curve and the market supply curve. § The market supply curve is equal to the horizontal summation of the supply curves of the individual firms. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -39

Figure 24 -8 Industry Demand Supply Curves and the Individual Firm Demand Curve, Panel (a) Pe is the price the firm must take Pe and Qe determined by the interaction of the industry S and market D Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -40

Figure 24 -8 Industry Demand Supply Curves and the Individual Firm Demand Curve, Panel (b) • Given Pe, firm produces qe where MC = MR § If AC = AC 1, break-even • If AC = AC 2, losses • If AC = AC 3, economic profit Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -41

The Long-Run Industry Situation: Exit and Entry • Profits and losses act as signals for resources to enter an industry or to leave an industry. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -42

The Long-Run Industry Situation: Exit and Entry (cont'd) • Signals § Compact ways of conveying to economic decision makers information needed to make decisions § An effective signal not only conveys information but also provides the incentive to react appropriately. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -43

The Long-Run Industry Situation: Exit and Entry (cont'd) • Exit and entry of firms § Economic profits Ø Signal resources to enter the market § Economic losses Ø Signal resources to exit the market Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -44

The Long-Run Industry Situation: Exit and Entry (cont'd) • Allocation of capital and market signals § Price system allocates capital according to the relative expected rates of return on alternative investments. § Investors and other suppliers of resources respond to market signals about their highest-valued opportunities. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -45

The Long-Run Industry Situation: Exit and Entry (cont'd) • Tendency toward equilibrium (note that firms are adjusting all of the time) § At break-even, resources will not enter or exit the market. § In competitive long-run equilibrium, firms will make zero economic profits. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -46

The Long-Run Industry Situation: Exit and Entry (cont'd) • Long-Run Industry Supply Curve § A market supply curve showing the relationship between prices and quantities after firms have been allowed time to enter or exit from an industry, depending on whethere have been positive or negative economic profits Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -47

The Long-Run Industry Situation: Exit and Entry (cont'd) • Constant-Cost Industry § An industry whose total output can be increased without an increase in long-run per-unit costs § Its long-run supply curve is horizontal. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -48

Figure 24 -9 Constant-Cost, Increasing-Cost, and Decreasing-Cost Industries, Panel (a) Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -49

The Long-Run Industry Situation: Exit and Entry (cont'd) • Increasing-Cost Industry § An industry in which an increase in industry output is accompanied by an increase in long-run per unit costs § Its long-run industry supply curve slopes upward. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -50

Figure 24 -9 Constant-Cost, Increasing-Cost, and Decreasing-Cost Industries, Panel (b) Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -51

The Long-Run Industry Situation: Exit and Entry (cont'd) • Decreasing-Cost Industry § An industry in which an increase in industry output leads to a reduction in long-run perunit costs § Its long-run industry supply curve slopes downward. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -52

Figure 24 -9 Constant-Cost, Increasing-Cost, and Decreasing-Cost Industries, Panel (c) Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -53

Long-Run Equilibrium • In the long run, the firm can change the scale of its plant, adjusting its plant size in such a way that it has no further incentive to change; it will do so until profits are maximized. • In the long run, a competitive firm produces where price, marginal revenue, marginal cost, short-run minimum average cost, and longrun minimum average cost are equal. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -54

Figure 24 -11 Long-Run Firm Competitive Equilibrium Copyright © 2008 Pearson Addison Wesley. All rights reserved. 24 -55

Did You Know That. . . • A monopoly can arise whenever sellers are given exclusive rights to distribute a good? • A law intended to “help New York wineries” creates a situation called monopoly? Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -56

Definition of a Monopolist • Monopolist § A single supplier of a good or service for which there is no close substitute § The monopolist therefore constitutes the entire industry. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -57

Barriers to Entry • Question § How does a firm obtain monopoly power? • Answers § Barriers to entry that allow the firm to make long-run economic profits § Barriers to entry are restrictions on who can start as well as stay in business. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -58

Barriers to Entry (cont'd) • Barriers to entry include § Ownership of resources without close substitutes § Economies of scale § Legal or governmental restrictions Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -59

Barriers to Entry (cont'd) • Ownership of resources without close substitutes § The Aluminum Company of America (ALCOA) at one time owned most of of the world’s bauxite. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -60

Barriers to Entry (cont'd) • Economies of scale § Low unit costs and prices drive out rivals. § The largest firm can produce at the lowest average total cost. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -61

Barriers to Entry (cont'd) • Natural Monopoly § A monopoly that arises from the peculiar production characteristics in an industry § It usually arises when there are large economies of scale § One firm can produce at a lower average cost than can be achieved by multiple firms Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -62

Figure 25 -1 The Cost Curves That Might Lead to a Natural Monopoly Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -63

Barriers to Entry (cont'd) • Legal or governmental restrictions § Licenses, franchises, and certificates of convenience § Examples include Ø Electrical Ø Radio utilities and television broadcasting Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -64

International Policy Example: Malaysia’s Drug-Labeling Monopoly • Sellers of drugs and medical products are required to affix holographic labels providing information on usage. • To obtain these labels, sellers have only one choice. They must buy the labels from a company called Mediharta. • This company is the only label manufacturer that Malaysia’s Registrar of Companies has approved to produce holographic labels. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -65

Barriers to Entry (cont'd) • Legal or governmental restrictions § Patents Ø Intellectual property § Tariffs Ø Taxes on imported goods § Regulation Ø Safety and quality Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -66

Barriers to Entry (cont'd) • Cartels § An association of producers in an industry that agree to set common prices and output quotas to prevent competition Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -67

The Demand Curve a Monopolist Faces • The monopolist faces the industry demand curve because the monopolist is the entire industry. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -68

The Demand Curve a Monopolist Faces (cont'd) • Recall that under perfect competition § Firm faces perfectly elastic demand curve, it is a price taker § The forces of supply and demand establish the price per unit § Marginal revenue, average revenue, and price are all the same Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -69

The Demand Curve a Monopolist Faces (cont'd) • Perfect competition versus monopoly § The perfect competitor doesn’t have to worry about lowering price to sell more. § In a purely competitive situation, the firm accounts for a small part of the market. Ø It can sell its entire output, whatever that may be, at the same price. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -70

The Demand Curve a Monopolist Faces (cont'd) • Perfect competition versus monopoly § The more the monopolist wants to sell, the lower the price it has to charge on the last unit sold. § To sell the last unit, the monopolist has to lower the price because it is facing a downward sloping demand curve. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -71

Figure 25 -2 Demand Curves for the Perfect Competitor and the Monopolist Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -72

The Demand Curve a Monopolist Faces (cont'd) Monopoly Perfect Competition Single seller Many sellers Faces entire industry demand Faces perfectly elastic demand Must lower price to sell more Must produce more to sell more Not all units sold for same price (MR < P) All units sold for same price (P = MR) Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -73

Figure 25 -3 Marginal Revenue: Always Less Than Price Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -74

Elasticity and Monopoly • The monopolist faces a downwardsloping demand curve, and cannot charge any price. § A common misconception • Thus, depending on the price charged a different quantity will be demanded. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -75

Elasticity and Monopoly (cont'd) • Question § If a monopoly raises price, what will happen to quantity demanded? • Hint § Remember how consumers respond to a change in price. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -76

Elasticity and Monopoly (cont'd) • Recall § Monopolist is a single seller of a well-defined good or service with no close substitute. Ø Think of some imperfect substitutes. § The demand curve slopes downward because individuals compare marginal satisfaction to cost. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -77

Elasticity and Monopoly (cont'd) • After all, consumers have limited incomes and unlimited wants. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -78

Cost and Monopoly Profit Maximization • We assume profit maximization is the goal of the pure monopolist, just as it is for the prefect competitor. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -79

Cost and Monopoly Profit Maximization (cont'd) • Perfect competitor has only to decide on the profit-maximizing output rate because price is given. § The perfect competitor is a price taker. • For the pure monopolist, we must seek a profit-maximizing price output combination. § The monopolist is a price searcher. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -80

Cost and Monopoly Profit Maximization (cont'd) • Price Searcher § A firm that must determine the price-output combination that maximizes profit because it faces a downward-sloping demand curve Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -81

Cost and Monopoly Profit Maximization (cont'd) • We can determine the profit-maximizing price-output combination with either of two equivalent approaches. § By looking at total revenues and total costs or by looking at marginal revenues and marginal costs Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -82

Cost and Monopoly Profit Maximization (cont'd) • Total revenues-total costs approach § Maximize the positive difference between total revenues and total costs • Marginal revenue-marginal cost approach § Profit maximization will also occur where marginal revenue equals marginal cost. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -83

Cost and Monopoly Profit Maximization (cont'd) • Question § Why produce where marginal revenue equals marginal cost? • Answer § This is where the greatest positive difference between total revenue and total cost occurs. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -84

Today’s Agenda • Questions from last time? • Complete Chapter 25 § Monopoly • Chapter 26 § Monopolistic Competition Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -85

Figure 25 -4 Monopoly Costs, Revenues, and Profits, Panel (a) Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -86

Figure 25 -4 Monopoly Costs, Revenues, and Profits, Panels (b) and (c) Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -87

Cost and Monopoly Profit Maximization (cont'd) • Producing past where MR = MC § Incremental cost exceeds incremental revenue • Producing less than where MR = MC § Monopolist not maximizing profits here either Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -88

Figure 25 -5 Maximizing Profits Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -89

Calculating Monopoly Profit • Monopoly profit is given by the shaded area, which is equal to total revenues (P Q) minus total costs (ATC Q). Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -90

Figure 25 -6 Monopoly Profit Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -91

Calculating Monopoly Profit (cont'd) • No guarantee of profit § The term monopoly conjures up the notion of a greedy firm ripping off the public. Ø If ATC is everywhere above AR, or demand q No price-output combination allows the monopolist to cover costs Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -92

Figure 25 -7 Monopolies: Not Always Profitable Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -93

On Making Higher Profits: Price Discrimination • Price Discrimination § Selling a given product at more than one price, with the difference being unrelated to differences in cost Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -94

On Making Higher Profits: Price Discrimination (cont'd) • Price Differentiation § Establishing different prices for similar products to reflect differences in marginal cost in providing those commodities to different groups of buyers Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -95

On Making Higher Profits: Price Discrimination (cont'd) • Necessary conditions for price discrimination 1. The firm must face a downward-sloping demand curve. 2. The firm must be able to readily (and cheaply) identify buyers or groups of buyers with predictably different elasticities of demand. 3. The firm must be able to prevent resale of the product or service. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -96

Example: Why Students Pay Different Prices to Attend College • Out-of-pocket tuition rates for any two college students can differ by considerable amounts. • The reason is that colleges offer students diverse financial aid packages depending on their “financial need. ” • The college determines prices that families are most likely to pay, so that it can engage in price discrimination. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -97

Figure 25 -8 Toward Perfect Price Discrimination in College Tuition Rates Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -98

The Social Cost of Monopolies • Comparing monopoly with perfect competition § Let’s assume a monopolist comes in and buys up every single perfect competitor. § Notice the monopolist produces a smaller quantity and sells at a higher price. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -99

The Social Cost of Monopolies (cont'd) • Comparing monopoly with perfect competition § Monopolists raise the price and restrict production compared to a perfectly competitive situation. § Consumers pay a price that exceeds the marginal cost of production and resources are misallocated in such a situation. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -100

Figure 25 -9 The Effects of Monopolizing an Industry Copyright © 2008 Pearson Addison Wesley. All rights reserved. 25 -101

Key Terms and Concepts • barriers to entry • patent • economies of scale • perfect competition • government monopoly • price setter • marginal revenue • pure monopoly • market structure • technological monopoly • natural monopolies Copyright © 2005 Pearson Addison-Wesley. All rights reserved. • price taker 6 -102