Firms are price takers because they have to sell at market price

Total, average and marginal revenue

Short-run profit maximization

Firms will produce when they can:

1)Earn profits

•Firms try to maximize profits. This is when TR>TC by the largest amount.

2)Incur a loss smaller than fixed costs

•Firms try to minimize losses. This is when TC>TR by the smallest amount.

•Firms seek to cover all variable costs and some of fixed costs (better than shutting down and losing all fixed costs)

•BUT, under the minimum AVC the firm will not operate as it is not covering the fixed cost (no supply)

Short-run profit maximization

•Firms can also maximize profits when the quantity produced causes marginal revenue (MR) to be equal to marginal cost (MC).

–At a smaller quantity, MR > MC, so more profit can be gained by increasing output

–At a larger quantity, MC > MR, so increasing output will decrease profits

–Therefore, MC is also equal to price in competitive markets.

Short-run profit maximization

How it works?

• In the long run, firms produce the level of output at which ATC is the lowest (highly efficient). The prices are lower and the quantities are greater than any other market structure.

2 Pure Monopoly

• Market Characteristics

– Only one firm in industry

– Product has no close substitutes

– Firm can strongly influence the price

1) Price maker: set price as high as possible

2) Price searcher: Set price that maximizes profits

– No market entry possible

• Natural Monopoly: economic and technical conditions allow only one efficient supplier because economies of scale are very high. Example: Electricity

• The monopoly firm’s demand curve is the entire industry’s demand curve.

• It is downward sloping showing that a higher quantity will be sold only if the price is lowered.

• This causes the MR to be decreasing as TR increases with a decreasing rate (because the price is decreasing as output increases)

Pure Monopoly: Revenue Maximization

Revenue is maximized at the unit elastic region of the demand curve where MR is equal to zero.

MR is below the demand curve

Pure Monopoly: Revenue Maximization

• In the elastic region of the D curve, decreasing price will increase TR because the quantity responds highly.

• In the inelastic region of the D curve, decreasing the price will decrease TR because the quantity responds slowly.

• However, monopolies care about profit maximization and not revenue maximization. This is where MC = MR

Pure Monopoly

• Notes:

– If the monopolistic firm decides to increase its price, it will sell a smaller quantity, lose revenues and lose some profits. This is why price searching is needed.

– If the monopolistic firm decreases price below AVC, it will lose & shutdown!

– A discriminating monopolist charges every customer a different price.

• Monopolistic industries produce fewer goods with higher prices than competitive industries.

• Because the price is higher than MC, resources are under allocated!

• Prices > MC causing inefficiency

– Efficiency in the society is achieved when the value paid by the firm (MC) is the same as the price paid by the consumer (P)

By : Mohammed Alkafas

coming soon