Copyright ©2014 Pearson Education, Inc. All rights reserved..docx

Copyright ©2014 Pearson Education, Inc. All rights reserved.
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ECO 2220, Principles of Microeconomics - Section 1C
Class Presentation for
April 5 & 7, 2016
Chapter #27
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Total Revenue $14.792 billion (2013)
Total Assets $15.474 billion (2013)
Total Equity $3.607 billion (2013)
Number of Employees 30,200 (2013)
Will Keith Kellogg
April 7, 1860 – October 6, 1951
Battle Creek, Michigan
Founded February 16, 1906, Battle Creek Michigan
The company was founded as the outgrowth of his work with his
brother John Harvey Kellogg at the Battle Creek Sanitarium
following practices based on the Seventh-day Adventist Church.

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Looking Forward:April 5, 2016 – Journal #9 due.April 7, 2016 –
Test #3
Chapters # 24, 25, 26, & 27
April 12, 2016 – Journal #10 due.
April 19, 2016 – Project Paper Due
April 28, 2016 – Test #4
Chapters # 29, 30, & 32
Prepared By Brock Williams
Chapter 27
Oligopoly and Strategic Behavior
In an oligopoly, defined as a market with just a few firms, each
firm has an incentive to act strategically, anticipating the
possible actions and reactions of its fellow oligopolists.
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Learning Objectives
Explain why a price-fixing cartel is difficult to maintain.
Explain the effects of a low-price guarantee on the price.
Describe the prisoners' dilemma.
Explain the behavior of an insecure monopolist.
Explain two advertisers dilemmas.
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► 3:02 www.youtube.com/watch?v=UoFqV1lxA7Q
Opening Strategy Chess
Originated in India during the Gupta Empire [320 – 550 CE].
Chess
A Game of Strategy
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● oligopoly
A market served by a few firms.
● game theory
The study of decision making in strategic situations.
Oligopoly and Strategic Behavior
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● concentration ratio
The percentage of the market output produced by the largest
firms.
An alternative measure of market concentration is the
Herfindahl-Hirschman Index (HHI). It is calculated by squaring
the market share of each firm in the market and then summing
the resulting numbers.
An oligopoly—a market with just a few firms—occurs for three
reasons:
1 Government barriers to entry.
2 Economies of scale in production.
3 Advertising campaigns.
WHAT IS AN OLIGOPOLY?
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Generally considered the most complex of the four market
structures;
Great deal of mutual interdependence;
Actions of one will affect the others;
Power to fix prices and output.
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WHAT IS AN OLIGOPOLY? (cont.)
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Source: Baleryandsnacks.com
America’s Top 10 Best Selling Brands : 2014RankBrand$
SalesManufacture1Honey Nut Cheerios$ 510,260,672General
Mills2Frosted Flakes$ 434,359,552Kellogg’s3Honey Bunches of
Oats$ 386, 719,872Post4Cheerios$ 339,127,424General
Mills’5Cinnamon Toast Crunch$ 313,750,720General
Mills’6Frosted Mini Wheats$ 269,797,824Kellogg’s7Lucky
Charms$ 260, 945,312General Mills’8Fruit Loops$
251,377,232Kellogg’s9Raisin Bran$
184,225,400Kellogg’s10Rice Krispies$ 146,600,208Kellogg’s

*
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TYPES OF COMPETITIONKIND OF COMPETITION# OF
PRODUCERS & DEGREE OF PRODUCT
DIFFERTIATIONPART OF ECONOMY WHERE
PREVELENTDEGREE OF CONTROL OVER PRICEMETHODS
OF MARKETINGPerfect CompetitionMany producers; identical
productsA few agricultural industriesNoneMarket exchange or
auctionImperfect CompetitionMany differentiated sellersMany
producers; many real or fancied difference in
productToothpaste, retail trade; conglomeratesOligopolyFew
producers: little or no difference in productSteel, aluminum-
SomeAdvertising and quality rivalry; administered pricesFew
producers; some differentiation of productsAutos,
machineryComplete monopolySingle producer; unique product
without close substitutesA few utilitiesConsiderablePromotional
and ”institutional” public-relations advertising
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Perfect Competition, Monopoly and Monopolistic
CompetitionPerfect CompetitionMonopolyMonopolistic
CompetitionThere are many sellers.A single firm sells a

product.Many firms (small economies of scale)There are many
buyers.There are many buyers.
There are many buyers.
The product is homogeneous.The product has no close
substitutes.A differentiated products. (offer different
performance level or appearance)There are no barriers to market
entry.There are many barriers to market entry.No artificial
barriers to entry. (no patents or regulations)Both buyers and
sellers are price takers.The seller has market power to affect
price.Products are close substitutes – (there is intense
competition between firms for consumers)
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Econ 2220 November 13 & 18, 2013
Perfect Competition / Monopoly / Monopolistic Competition /
OligopolyPerfect CompetitionMonopolyMonopolistic
CompetitionOligopolyThere are many sellers.A single firm sells
a product.Many firms (small economies of scale)Few Firms
There are many buyers.There are many buyers.There are many
buyers.There are many buyers.The product is homogeneous.The
product has no close substitutes.A differentiated products.
(offer different performance level or appearance)Firms have

high degree of concentration in a particular market.There are no
barriers to market entry.There are many barriers to market
entry.No artificial barriers to entry. (no patents or
regulations)High barriers to entry.
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WHAT IS AN OLIGOPOLY? (cont.)
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● duopoly
A market with two firms.
● cartel
A group of firms that act in unison, coordinating their price and
quantity decisions.

27.1 CARTEL PRICING AND THE
DUOPOLISTS’ DILEMMA
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Examples of Duopoly:
Air Bus and Boeing – airlines;
BNSF Railway and Union Pacific Railroad;
Northfolk Southern Railway and CSX Transportation (eastern
US)
Apple and Microsoft
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● price-fixing
An arrangement in which firms conspire to fix prices.
A Cartel Picks the Monopoly Quantity and Price
The monopoly outcome is shown by point a, where marginal
revenue equals marginal cost.
The monopoly quantity is 60 passengers and the price is $400.

If the firms form a cartel, the price is $400 and each firm has 30
passengers (half the monopoly quantity).
The profit per passenger is $300 (equal to the $400 price minus
the $100 average cost), so the profit per firm is $9,000.
profit = (price − average cost) × quantity per firm
DUOPOLISTS’ DILEMMA (cont.)
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FIGURE 27.2
Competing Duopolists Pick a Lower Price
(A) The typical firm maximizes profit at point a, where
marginal revenue equals marginal cost. The firm has 40
passengers.
(B) At the market level, the duopoly outcome is shown by point
d, with a price of $300 and 80 passengers. The cartel outcome,
shown by point c, has a higher price and a smaller total
quantity.

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Game Tree for the Price-Fixing Game
The equilibrium path of the game is square A to square C to
rectangle 4: Each firm picks the low price and earns a profit of
$8,000.
The duopolists’ dilemma is that each firm would make more
profit if both picked the high price, but both firms pick the low
price.
● game tree
A graphical representation of the consequences of different
actions in a strategic setting.
Price-Fixing and the Game Tree
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Price-Fixing and the Game Tree

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Equilibrium of the Price-Fixing Game
● dominant strategy
An action that is the best choice for a player, no matter what the
other player does.
● duopolists’ dilemma
A situation in which both firms in a market would be better off
if both chose the high price, but each chooses the low price.
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Nash Equilibrium
● Nash equilibrium
An outcome of a game in which each player is doing the best he
or she can, given the action of the other players.

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John Forbes Nash, Jr.
June 13, 1928 - May 23, 2015 (aged 86)
An Americanmathematician with fundamental contributions in
game theory, differential geometry, and partial differential
equations.
Nash's work has provided insight into the factors that govern
chance and decision making inside complex systems in daily
life.
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At the beginning of the 19th Century, high overland
transportation costs protected salt producers from competition
with one another, generating local salt monopolies. Over the
course of the 19th Century, decreases in overland transportation
costs increased competition between salt producers and
decreased prices.
In response to the increased competition, salt producers in a
particular state colluded by forming a salt pool, enterprises that
set a uniform price and distributed the salt of all participating
producers. Some pools established output quotas or paid firms
not to produce salt for a year, a practice known as “dead-
renting” a salt furnace.
Every pool arrangement broke down, usually within a year or
two of its formation. In some cases, individual firms cheated on
the cartel by selling salt outside the cartel. In other cases the
artificially high price caused new firms to enter the market and
underprice the salt pool.

FAILURE OF THE SALT CARTEL
APPLYING THE CONCEPTS #1: Why do cartels sometimes
fail to keep price high?
A P P L I C A T I O N
1
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Low-Price Guarantees
● low-price guarantee
A promise to match a lower price of a competitor.
27.2 OVERCOMING THE
DUOPOLISTS’ DILEMMA
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Low-Price Guarantees FIGURE 27.4
Low-Price Guarantees Increase Prices
When both firms have a low-price guarantee, it is impossible for
one firm to underprice the other. The only possible outcomes
are a pair of high prices (rectangle 1) or a pair of low prices

(rectangles 2 or 4).
The equilibrium path of the game is square A to square B to
rectangle 1. Each firm picks the high price and earns a profit of
$9,000.
27.2 OVERCOMING THE
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Repeated Pricing Games with Retaliation for Underpricing
● grim-trigger strategy
A strategy where a firm responds to underpricing by choosing a
price so low that each firm makes zero economic profit.
● tit-for-tat
A strategy where one firm chooses whatever price the other firm
chose in the preceding period.
Repetition makes price-fixing more likely because firms can
punish a firm that cheats on a price-fixing agreement, whether
it’s formal or informal:
1 A duopoly pricing strategy.
Choosing the lower price for life.
2 A grim-trigger strategy.
3 A tit-for-tat strategy.
27.2 OVERCOMING THE

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Repeated Pricing Games with Retaliation for Underpricing
FIGURE 27.5
A Tit-for-Tat Pricing Strategy
Under tit-for-tat retaliation, the first firm (Jill, the square)
chooses whatever price the second firm (Jack, the circle) chose
the preceding month.
27.2 OVERCOMING THE
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Price-Fixing and the LawUnder the Sherman Antitrust Act of
1890 and subsequent legislation, explicit price-fixing is illegal.
It is illegal for firms to discuss pricing strategies or methods of
punishing a firm that underprices other firms.
27.2 OVERCOMING THE
The purpose of the [Sherman] Act is not to protect businesses

from the working of the market; it is to protect the public from
the failure of the market. The law directs itself not against
conduct which is competitive, even severely so, but against
conduct which unfairly tends to destroy competition itself.
U.S. Supreme Court in Spectrum Sports, Inc. v. McQuillan 506
U.S. 447 (1993):
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Price Leadership
● price leadership
A system under which one firm in an oligopoly takes the lead in
setting prices.
The problem with an implicit pricing agreement is that it relies
on indirect signals that are often garbled and misinterpreted.
When one firm suddenly drops its price, the other firm could
interpret the price cut in one of two ways:
• A change in market conditions.
• Underpricing.
27.2 OVERCOMING THE

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In two successive months (November and December), a Florida
tire retailer listed prices for 35 types of tires in newspaper
advertisements. In November the average price was $45, and in
December the average price was $55.
The December advertisement was different in another way: it
included a low-price guarantee under which the retailer agreed
to match any lower advertised price (and also pay the customer
some percentage of the price gap). In fact, for each of the 35
types of tires, the December price was the same or higher than
the November price. In this case, a low-price guarantee
generated higher prices.
Is the relationship between low-price guarantees and prices
apparent or real? A careful study of the retail tire market
suggests that prices are generally higher in markets where firms
offer low-price guarantees. On average, the presence of a low-
price guarantee increases prices by a modest $4 per tire, or
about 10 percent of the price.
LOW-PRICE GUARANTEE INCREASES TIRE PRICES
APPLYING THE CONCEPTS #2: Do low price guarantees
generate higher or lower prices?
2
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● payoff matrix

A matrix or table that shows, for each possible outcome of a
game, the consequences for each player.
27.3 SIMULTANEOUS DECISION MAKING AND THE
PAYOFF MATRIX
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Simultaneous Price-Fixing Game
Payoff Matrix for the Price-Fixing Game
Jill’s profit is in red, and Jack’s profit is in blue.
If both firms pick the high price, each firm earns a profit of
$9,000. Both firms will pick the low price, and each firm will
earn a profit of only $8,000.
PAYOFF MATRIX (cont.)
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The Prisoners’ Dilemma
Payoff Matrix for the Prisoners’ Dilemma

The prisoners’ dilemma is that each prisoner would be better off
if neither confessed, but both people confess.
The Nash equilibrium is shown in the southeast corner of the
matrix. Each person gets five years of prison time.
PAYOFF MATRIX (cont.)
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An economics professor discovered three students cheating on
the final.
Speaking to them individually, he gave each student two options
▪ If the student confessed, he or she would receive a zero on
the exam, but suffer no other consequences.
▪ If they did not confess, he or she would go before the
Office of Student Judicial Affairs, and any confessions by the
other two students would be used as evidence.
Is this a prisoner’s dilemma?
What is the likely outcome?
CHEATING ON THE FINAL EXAM: THE CHEATERS’
DILEMMA
APPLYING THE CONCEPTS #3: When does cooperation break
down?
3

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FIGURE 27.8
Deterring Entry with Limit Pricing
Point c shows a secure monopoly, point d shows a duopoly, and
point z shows the zero-profit outcome.
The minimum entry quantity is 20 passengers, so the entry-
deterring quantity is 100 (equal to 120 – 20), as shown by point
e.
The limit price is $200.
27.4 THE INSECURE MONOPOLIST AND ENTRY
DETERRENCE
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Entry Deterrence and Limit Pricing
The quantity required to prevent the entry of the second firm is
computed as follows:
deterring quantity = zero profit quantity − minimum entry
quantity
DETERRENCE (cont.)

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Game Tree for the Entry-Deterrence Game
The path of the game is square A to square C to rectangle 4.
Mona commits to the entry-deterring quantity of 100, so Doug
stays out of the market.
Mona’s profit of $10,000 is less than the monopoly profit but
more than the duopoly profit of $8,000.
DETERRENCE (cont.)
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● limit pricing
The strategy of reducing the price to deter entry.
● limit price
The price that is just low enough to deter entry.

DETERRENCE (cont.)
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Examples: Aluminum and Campus Bookstores
● contestable market
A market with low entry and exit costs.
Entry Deterrence and Contestable Markets
When Is the Passive Approach Better?Entry deterrence is not
the best strategy for all insecure monopolists.
Sharing a duopoly can be more profitable than increasing output
and cutting the price to keep the other firm out.Alcoa
maintained a relatively low price and large quantity between
1893 and 1940 to deter entrance of other firms.
If your campus bookstore suddenly feels insecure about its
monopoly position, it could cut its prices to prevent online
booksellers from capturing too many of its customers.
DETERRENCE (cont.)
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Microsoft has a virtual monopoly in the market for personal-
computer operating systems and business software. But there is
a constant threat that another firm will launch competing
products, so Microsoft engages in limit pricing to deter entry

into its key markets. A recent study computes some of the
numbers behind the insecure monopoly.
The pure monopoly price for a software bundle of the Windows
operating system and the Office Suite of business tools is about
$354, but the actual price (the limit price) is about $143. The
estimated cost for a second firm to develop, maintain, and
market an alternative software bundle is about $38 billion, and
Microsoft’s actual price is just low enough to make such an
investment unprofitable.
The pure monopoly profit would be about $191 billion, while
the profit under Microsoft’s limit pricing is about $153 billion.
Although the profit under the entry-deterrence strategy is less
than the pure monopoly profit, it is greater than the profit
Microsoft would earn if it allowed a second firm to enter the
market ($148 billion). In other words, entry deterrence is the
best strategy.
MICROSOFT AS AN INSECURE MONOPOLIST
APPLYING THE CONCEPTS #4: How does a monopolist
respond to the threat of entry?
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FIGURE 27.10
Game Tree for the Advertisers’ Dilemma
Adeline moves first, choosing to advertise or not. Vern’s best
response is to advertise no matter what Adeline does.

Knowing this, Adeline realizes that the only possible outcomes
are shown by rectangles 1 and 3.
From Adeline’s perspective, rectangle 1 ($6 million) is better
than rectangle 3 ($5 million), so her best response is to
advertise. Both Adeline and Vern advertise, and each earns a
profit of $6 million.
27.5 THE ADVERTISERS’ DILEMMA
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Milk is advertised by the National Fluid Milk Producers, and
industry group. The milk producers pool their resources and
fund the campaign with a tax. Why?The is a standardized good,
so advertising by one producer increases demand for all
producers.
▪ The Got Milk campaign increases demand about 6 percent.
▪ If a single firm advertised, it would incur all the expense,
but only a
fraction of the benefit.
▪ The solution is to share costs and benefits.
GOT MILK?
APPLYING THE CONCEPTS #5: What is the rationale for
generic advertising?
5

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cartel
concentration ratio
contestable market
dominant strategy
duopolists’ dilemma
duopoly
game theory
game tree
grim-trigger strategy
kinked demand curve model
low-price guarantee
limit price
limit pricing
Nash equilibrium
oligopoly
payoff matrix
price-fixing
price leadership
tit-for-tat
K E Y T E R M S
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Econ 2220 November 13 & 18, 2013
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March 31, & April 5, 2016
Chapter #26
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“A few fly bites cannot stop a spirited horse.”
Mark Twain
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Looking Forward:March 29, 2016 – Journal #8 due.April 5,
2016 – Journal #9 due.April 7, 2016 – Test #3
Chapters # 24, 25, 26, & 27
April 28, 2016 – Test #4

Chapters # 29, 30, & 32
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Ray Kroc was the first businessman to apply the principles of
mass production in a service industry.
Raymond Albert Kroc
October 5, 1902 – January 14, 1984
The quality of a leader is reflected in the standards they set for
themselves.
Chapter 26
Market Entry and Monopolistic Competition
In the recession that started in 2008, some industries
actually experienced increases in demand that caused market
entry—new firms entered the markets.
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Learning Objectives
Describe and explain the effects of market entry.
List the conditions for equilibrium in monopolistic competition.
Contrast monopolistic competition and perfect competition.
Explain the role of advertising in monopolistic competition.

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Real Life Example-
Proposal for Steak Escape Development
November 2009
Location CSU / WU Wilberforce, Ohio
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● monopolistic competition
A market served by many firms that sell slightly different
products.
The term monopolistic competition actually conveys the two
key features of the market:
• Each firm in the market produces a good that is slightly
different from the goods of other firms, so each firm has a
narrowly defined monopoly.
• The products sold by different firms in the market are
close substitutes for one another, so there is intense competition
between firms for consumers.
Market Entry and Monopolistic Competition
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M A R G I N A L P R I N C I P L E
Increase the level of an activity as long as its marginal benefit

exceeds its marginal cost. Choose the level at which the
marginal benefit equals the marginal cost.
26.1 THE EFFECTS OF MARKET ENTRY
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Market Entry Decreases Price and Squeezes Profit
(A) A monopolist maximizes profit at point a, where marginal
revenue equals marginal cost. The firm sells 300 toothbrushes at
a price of $2.00 (point b) and an average cost of $0.90 (point c).
The profit of $330 is shown by the shaded rectangle.
(B) The entry of a second firm shifts the firm-specific demand
curve for the original firm to the left. The firm produces only
200 toothbrushes (point d) at a lower price ($1.80, shown by
point e) and a higher average cost ($1.00, shown by point f).
The firm’s profit, shown by the shaded rectangle, shrinks to
$160.
26.1 THE EFFECTS OF MARKET ENTRY (cont.)
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Entry Squeezes Profits from Three Sides
Entry shrinks the firm’s profit rectangle because it is squeezed
from three directions. The top of the rectangle drops because
the price decreases. The bottom of the rectangle rises because
the average cost increases. The right side of the rectangle moves
to the left because the quantity decreases.

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Entry Squeezes Profits from Three Sides
Entry shrinks the firm’s profit rectangle because it is squeezed
from three directions. The top of the rectangle drops because
the price decreases. The bottom of the rectangle rises because
the average cost increases. The right side of the rectangle moves
to the left because the quantity decreases.
Examples of Entry: Stereo Stores, Trucking, and Tires
Empirical studies of other markets provide ample evidence that
entry decreases market prices and firms’ profits. In other words,
consumers pay less for goods and services, and firms earn lower
profits.
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Consider the market for television signals provided to
residential consumers. How will an existing cable-TV provider
respond to the entry of a firm that provides TV signals via
satellite?
In most cases, the entry of a satellite firm causes the cable firm
to improve the quality of service and decrease its price, so
consumer surplus increases. In some cases, the cable company
improves the quality of service and increases price.
Because the service improvement is typically large relative to
the price hike, consumer surplus increases in this case too. On
average, the entry of a satellite firm increases the monthly
consumer surplus per consumer from $3.96 to $5.22, an increase
of 32 percent.
SATELLITE VS. CABLE
APPLYING THE CONCEPTS #1: How does market entry affect
prices?

1
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Under a market structure called monopolistic competition, firms
will continue to enter the market until economic profit is zero.
Here are the features of monopolistic competition:
• Many firms. (Small economies of scale small firs can
produce at about the average cost of large firms)
• A differentiated product. (A process used to distinguish
their products from those of its competitors)
• No artificial barriers to entry. (No patients or regulations
that could prevent firms from entering the market)
● product differentiation
The process used by firms to distinguish their products from the
products of competing firms.
26.2 MONOPOLISTIC COMPETITION
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Perfect Competition, Monopoly and the Affordable Care
ActPerfect CompetitionMonopolyAffordable Care ActThere are
many sellers.A single firm sells a product.Open to all private
health insurance providers (HIP) in AmericaThere are many
All citizens who do not currently have health insurance must
join exchangesThe product is homogeneous.The product has no
close substitutes.Act establishes minimum standards for
policiesThere are no barriers to market entry.There are many
barriers to market entry.Large barriers for market entry –
economies of scaleBoth buyers and sellers are price takers.The
seller has market power to affect price.Act establishes market
prices for participating HIP’s

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Perfect Competition, Monopoly and Monopolistic
CompetitionPerfect CompetitionMonopolyMonopolistic
CompetitionThere are many sellers.A single firm sells a
product.Many firms (small economies of scale)There are many
There are many buyers.
The product is homogeneous.The product has no close
substitutes.A differentiated products. (offer different
performance level or appearance)There are no barriers to market
entry.There are many barriers to market entry.No artificial
barriers to entry. (no patents or regulations)Both buyers and
price.Products are close substitutes – (there is intense
competition between firms for consumers)

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When Entry Stops: Long-Run EquilibriumFIGURE 26.2
Long-Run Equilibrium with Monopolistic Competition
Under monopolistic competition, firms continue to enter the
market until economic profit is zero.
Entry shifts the firm specific demand curve to the left.
The typical firm maximizes profit at point a, where marginal
revenue equals marginal cost.
At a quantity of 80 toothbrushes, price equals average cost
(shown by point b), so economic profit is zero.
26.2 MONOPOLISTIC COMPETITION (cont.)
Page 571
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Differentiation by Location
Long-Run Equilibrium with Spatial Competition
Book stores and other retailers differentiate their products by
selling them at different locations.
The typical book store chooses the quantity of books at which
its marginal revenue equals its marginal cost (point a).

Economic profit is zero because the price equals average cost
(point b).
26.2 MONOPOLISTIC COMPETITION (cont.)
Page 572
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OPENING A DUNKIN’ DONUTS SHOP
APPLYING THE CONCEPTS #2: Are monopolistically
competitive firms profitable?One way to get into a
monopolistically competitive market is to get a franchise for a
nationally advertised product.
Table 26.1 shows the franchise fees and royalty rates for several
franchising opportunities. The fees indicate how much
entrepreneurs are willing to pay for the right to sell a brand-
name product.
2
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Average Cost and VarietyThere are some trade-offs associated
with monopolistic competition. Although the average cost of
production is higher than the minimum, there is also more
product variety.Restaurant MealsShoes and clothing
When firms sell the same product at different locations, the
larger the number of firms, the higher the average cost of
production. But when firms are numerous, consumers travel
shorter distances to get the product. Therefore, higher

production costs are at least partly offset by lower travel costs.
26.3 TRADE-OFFS WITH ENTRY AND
MONOPOLISTIC COMPETITION
Examples: Miller Lane environment
Page 574
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Monopolistic Competition versus Perfect Competition FIGURE
26.4
Monopolistic Competition versus Perfect Competition
(A) In a perfectly competitive market, the firm-specific demand
curve is horizontal at the market price, and marginal revenue
equals price.
In equilibrium, price = marginal cost = average cost.
The equilibrium occurs at the minimum of the average-cost
curve.
MONOPOLISTIC COMPETITION (cont.)
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Monopolistic Competition versus Perfect Competition FIGURE
26.4 (cont’d.)
Monopolistic Competition versus Perfect Competition

(B) In a monopolistically competitive market, the firm- specific
demand curve is negatively sloped and marginal revenue is less
than price.
In equilibrium, marginal revenue equals marginal cost (point b)
and price equals average cost (point c).
MONOPOLISTIC COMPETITION (cont.)
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HAPPY HOUR PRICING
APPLYING THE CONCEPTS #3: How does monopolistic
competition compare to perfect competition?Consider the
phenomenon of “happy hour.” Many bars and restaurants near
workplaces face an increase in demand for food and drink
around 5:00 p.m., and many cut their prices for an hour or two.
According to the model of perfect competition, an increase in
demand will lead to higher, not lower prices. What explains the
happy-hour combination of higher demand and lower prices?
Bars are subject to monopolistic competition. Each bar has a
local monopoly within its neighborhood, but faces competition
from other bars outside its neighborhood. For an individual
consumer, the higher the demand for food and drink, the greater
the incentive to consider alternatives to the nearest bar. If you
expect to purchase large quantities of bar food and drink, the
savings achieved by finding a lower price at an alternative bar
will be relatively large. In other words, when individual demand
increases, each bar faces a more elastic demand for its products.
In a market subject to monopolistic competition, the bar’s
rational response to more elastic demand (more sensitive
consumers) is to decrease its price. In graphical terms, the

demand curve facing each bar becomes flatter, and the demand
curve will be tangent to the average-cost curve at a larger
quantity and a lower price and average cost.
3
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PICTURE OF MAN VS. PICTURE OF WOMAN
APPLYING THE CONCEPTS #4: How does advertising affect
consumer choices?A South African consumer lender decided to
use a mass mailing of 53,000 loan offers to test the sensitivity
of consumers to variations in interest rates and other features of
loan offers. The interest rates in the offer letters ranged from
3.75% to 11.75% per month.
As expected, the uptake rate (the number of consumers who
accepted a particular loan offer) was higher for offer letters
with low interest rates. The elasticity of the uptake rate with
respect to the interest rate was -0.34: a 10% decrease in the
interest rate (from say an interest rate of 7.0% to 6.3%)
increased the uptake rate by 3.4%. More surprising was
the finding that the uptake rate among men was much higher
when the offer letter included a picture of a woman rather than
a picture of a man. Replacing a male model with a female
model was equivalent to cutting the interest rate by 25 percent,
for example, from 7.0 percent to 5.25 percent. In contrast, the
uptake rate for women consumers was unaffected by the gender
of the model.
4

26-*
An advertisement that doesn’t provide any product information
may actually help consumers make decisions.
26.4 ADVERTISING FOR PRODUCT
DIFFERENTIATION
26-*
monopolistic competition
product differentiation
K E Y T E R M S
26-*
Econ 2220 November 4 & 6, 2013
“A few fly bites cannot stop a spirited horse.”
Mark Twain
25-*

March 29 & 31, 2016
Chapter #25
25-*
“Courage doesn't always roar, sometimes it's the quiet voice at
the end of the day whispering 'I will try again tomorrow”
Mary Anne Radmacher
25-*
Looking Forward:March 29, 2016 – Journal #8 due.April 5,
2016 – Journal #9 due.April 7, 2016 – Test #3
Chapters # 24, 25, 26, & 27
April 28, 2016 – Test #4
Chapters # 29, 30, & 32
25-*
1st Kroger Store 1883

Bernard Henry “Barney” Kroger Sr.
18860 – 1938
Founder & Owner
Kroger Stores
2,625 Locations;
343,000 Employees;
Revenue $108.5 Billion (2014)
Total Assets $24.652 Billion (2013)
Total Equity $4.207 Billion (2013)
Chapter 25
Monopoly and Price Discrimination
On college campuses across the country, beverage companies
like Coca Cola and Pepsi pay cash in exchange for monopoly
power--exclusive rights to sell beverages on campus.
25-*
Learning Objectives
Describe and explain a monopolist's output decision
Explain why a monopoly is socially inefficient
Identify the tradeoffs associated with a patent
Describe the practice of price discrimination

25-*
● monopoly
A market in which a single firm sells a product that does not
have any close substitutes. (definition)
● market power
The ability of a firm to affect the price of its product.
(characteristic)
● barrier to entry
Something that prevents firms from entering a profitable
market. (condition/characteristic)
25-*
● patent
The exclusive right to sell a new good for some period of time.
(tool –barrier to entry)
● network externalities
The value of a product to a consumer increases with the number
of other consumers who use it. (condition/characteristic)
● natural monopoly
A market in which the economies of scale in production are so
large that only a single large firm can earn a profit. (Cable TV
service; electricity transmissions; water systems & other
utilities)

25-*
Here are the five features of a perfectly competitive market:
1 There are many sellers.
2 There are many buyers.
3 The product is homogeneous.
4 There are no barriers to market entry.
5 Both buyers and sellers are price takers.
Perfect Competition
Recall from Chapter 24 -
25-*

25-*
YouTube Video – ACA (2013)
https://www.youtube.com/watch?v=vju70I6qSKk
http://obamacarefacts.com/howdoes-obamacare-work/
Obomacare Website Facts
25-*
Perfect Competition and the Affordable Care ActPerfect
CompetitionAffordable Care ActThere are many sellers.Open to
all private health insurance providers (HIP) in AmericaThere
are many buyers.All citizens who do not currently have health
insurance (employers or other means) must join exchangesThe
product is homogeneous.Act establishes minimum standards for
policiesThere are no barriers to market entry.Large barriers for
market entry – economies of scaleBoth buyers and sellers are
price takers.Act establishes market prices for participating
HIP’s

25-*
Perfect Competition, Monopoly and the Affordable Care
ActPerfect CompetitionMonopolyAffordable Care ActThere are
many sellers.A single firm sells a product.Open to all private
health insurance providers (HIP) in AmericaThere are many
All citizens who do not currently have health insurance
(employers or other means) must join exchangesThe product is
homogeneous.The product has no close substitutes.Act
establishes minimum standards for policiesThere are no barriers
to market entry.There are many barriers to market entry.Large
barriers for market entry – economies of scaleBoth buyers and
price.Act establishes market prices for participating HIP’s
25-*
A monopoly is inefficient from society’s perspective because it
produces too little output.

25-*
Total Revenue and Marginal RevenueFIGURE 25.1
The Demand Curve and the Marginal-Revenue Curve
Marginal revenue equals the price for the first unit sold, but is
less than the price for additional units sold. To sell an
additional unit, the firm cuts the price and receives less revenue
on the units that could have been sold at the higher price.
The marginal revenue is positive for the first four units, and
negative for larger quantities.
25.1 THE MONOPOLIST’S OUTPUT DECISION
25-*
A Formula for Marginal Revenue
marginal revenue
= new price + (slope of demand curve × old quantity)The first
part of the formula is the good news, the money received for the
extra unit sold.
The second part is the bad news from selling one more unit, the
revenue lost by cutting the price for the original customers.
(chap 22)
The revenue change equals the price change required to sell one
more unit—the slope of the demand curve, which is a negative
number—times the number of original customers who get a
price cut.
25.1 THE MONOPOLIST’S OUTPUT DECISION (cont.)

25-*
Using the Marginal Principle
A monopolist can use the marginal principle to decide how
much output to produce.
25-*
FIGURE 25.2
The Monopolist Picks a Quantity and a Price
To maximize profit, the monopolist picks point a, where
marginal revenue equals marginal cost.
The monopolist produces 900 doses per hour at a price of $15
(point b).
The average cost is $8 (point c), so the profit per dose is $7
(equal to the $15 price minus the $8 average cost) and the total
profit is $6,300 (equal to $7 per dose times 900 doses).
The profit is shown by the shaded rectangle.

25-*
The three-step process explaining how a monopolist picks a
quantity and how to compute the monopoly profit is as follows:
1 Find the quantity that satisfies the marginal principle, that
is, the quantity at which marginal revenue equals marginal cost.
2 Using the demand curve, find the price associated with the
monopolist’s chosen quantity.
3 Compute the monopolist’s profit. The profit per unit sold
equals the price minus the average cost, and the total profit
equals the profit per unit times the number of units sold.
25-*
We expect the owner of a major-league baseball team to choose
the quantity (the number of fans at the game) at which MR =
MC. The marginal cost of an additional fan is close to zero, so
the profit-maximization rule simplifies to MR = 0. And yet for
the typical team, it appears that MR is actually negative: adding
fans by selling more tickets actually decreases total revenue
from tickets. What explains this puzzling behavior?
We can illustrate the puzzle with a simple example. Suppose
that with a ticket price of $24, the team sells 20,000 tickets. If
the slope of the demand curve is -0.002, marginal revenue is -
$16: MR = $24 - 0.002 x 20,000 = -$16. In this case, cutting
the price to sell one more ticket generates good news ($24
collected from the new fan) that is less than the bad news (the
$40 lost on the 20,000 fans who would have paid the higher
price). The marginal revenue is negative, so the team could
increase its total revenue from tickets by increasing the price
and decreasing the quantity of tickets sold. Why don’t MLB
teams increase their ticket prices?
The solution to this puzzle is concessions. Suppose the average

MLB fan spends $20 per game on merchandise that costs the
owner about $4 to provide. In this case, each ticket sold
generates an additional $16 in net concession revenue to the
owner, just enough to offset the $16 revenue loss on ticket
sales. Once we expand the definition of marginal revenue to
include the net revenue from concessions, the owner’s choice is
consistent with the profit-maximization. What appears to be too
low a price could be just about right.
MARGINAL REVENUE FROM A BASEBALL FAN
APPLYING THE CONCEPTS #1: How does a monopolist
maximize profit?
1
25-*
Deadweight Loss from Monopoly FIGURE 25.3
Monopoly versus Perfect Competition: Its Effect on Price and
Quantity
(A) The monopolist picks the quantity at which the long-run
marginal cost equals marginal revenue—200 does per hour, as
shown by point a. As shown by point b on the demand curve,
the price required to sell this quantity is $18 per dose.
(B) The long-run supply curve of a perfectly competitive,
constant-cost industry intersects the demand curve at point c.
The equilibrium price is $8, and the equilibrium quantity is 400
doses.
25.2 THE SOCIAL COST OF MONOPOLY
Example

25-*
Deadweight Loss from Monopoly FIGURE 25.4
The Deadweight Loss from a Monopoly
A switch from perfect competition to monopoly increases the
price from $8 to $18 and decreases the quantity sold from 400
to 200 doses.
Consumer surplus decreases by an amount shown by the areas B
and D, while profit increases by the amount shown by rectangle
B. The net loss to society is shown by triangle D, the
deadweight loss from monopoly.
The formula for the area of a rectangle is
area of rectangle = base × height
The formula for the area of a triangle is
area of triangle = 1/2 × base × height
● deadweight loss from monopoly
A measure of the inefficiency from monopoly; equal to the
decrease in the market surplus.
25.2 THE SOCIAL COST OF MONOPOLY (cont.)
25-*
Rent Seeking: Using Resources to Get Monopoly Power
● rent seeking
The process of using public policy to gain economic profit.

Given the social costs of monopoly, the government uses a
number of policies to intervene in markets dominated by a
single firm or likely to become a monopoly.
Monopoly and Public Policy
25.2 THE SOCIAL COST OF MONOPOLY (cont.)
25-*
A developer interested in building a casino in Creswell, Oregon,
placed a curious announcement in the local newspaper. If local
voters approved the casino, the developer promised to give
citizens a total of $2 million per year.
With an adult population of about 1,600, each adult in Creswell
would receive a cash payment of $1,250 per year. Why did the
developers propose this deal?
This is an example of rent seeking: The casino developer was
seeking the profits that would come from having a monopoly in
the casino market, and was willing to pay at least $2 million to
get it.
A CASINO MONOPOLY IN CRESWELL OREGON?
APPLYING THE CONCEPTS #2: What is the value of a
monopoly?
2
25-*
Incentives for Innovation (page #555)
Let’s use the arthritis drug to show why a patent encourages
innovation. Suppose a firm called Flexjoint hasn’t yet
developed the drug but believes the potential benefits and costs

of doing so are as follows:The economic cost of research and
development will be $14 million, including all the opportunity
costs of the project.The estimated annual economic profit from
a monopoly will be $2 million (in today’s dollars).Flexjoint’s
competitors will need three years to develop and produce their
own versions of the drug, so if Flexjoint isn’t protected by a
patent, its monopoly will last only three years.
Based on these numbers, Flexjoint won’t develop the drug
unless the firm receives a patent that lasts at least 7 years.
That’s the length of time the firm needs to recover the research
and development costs of $14 million ($2 million per year times
7 years). If there is no patent and the firm loses its monopoly in
3 years, it will earn a profit of $6 million, which is less than the
cost of research and development. In comparison, with a 20-
year patent the firm will earn $40 million, which is more than
enough to recover its $14 million cost.
25.3 PATENTS AND MONOPOLY POWER
25-*
It is sensible for a government to grant a patent for a product
that would otherwise not be developed, but it is not sensible for
other products. Unfortunately, no one knows in advance whether
a particular product would be developed without a patent, so the
government can’t be selective in granting patents. In some
cases, patents lead to new products, while in other cases they
merely prolong monopoly power.
Trade-Offs from Patents
25.3 PATENTS AND MONOPOLY POWER (cont.)
25-*
When the patent for a brand-name drug expires, other firms

introduce generic versions of the drug. The generics are
virtually identical to the original branded drug, but they sell at a
much lower price. The producers of branded drugs have an
incentive to delay the introduction of generic drugs and
sometimes use illegal means to do so.In recent years, the
Federal Trade Commission (FTC) has investigated allegations
that the makers of branded drugs made deals with generic
suppliers to keep generics off the market.Alleged practices
included cash payments and exclusive licenses for new versions
of the branded drug.In 2003, the FTC ruled that two drug
makers had entered into an illegal agreement when Schering-
Plough paid Upsher-Smith Laboratories $60 million to delay the
introduction of a low-price alternative to its prescription drug
K- Dur 20, which is used to treat people with low
potassium.Another tactic is to claim that generics are not as
good as the branded drug. Because generic versions are
virtually identical to the branded drugs, such claims are not
based on science.
BRIBING THE MAKERS OF GENERIC DRUGS
APPLYING THE CONCEPTS #3: What happens when a patent
expires and a monopoly ends?
3
25-*
● price discrimination
The practice of selling a good at different prices to different
consumers.
Although price discrimination is widespread, it is not always
possible. A firm has an opportunity for price discrimination if

three conditions are met:
1 Market power. (control over its price; neg sloped demand
curve.)
2 Different consumer groups. (must be willing to pay; prices
measured by elasticity of demand)
3 Resale is not possible.
25.4 PRICE DISCRIMINATION
Examples: Discounts on airline tickets; Coupons for groceries &
restaurants; manufactures rebates, etc.
25-*
Senior Discounts in Restaurants FIGURE 25.5
The Marginal Principle and Price Discrimination
To engage in price discrimination, the firm divides potential
customers into two groups and applies the marginal principle
twice—once for each group.
Using the marginal principle, the profit-maximizing prices are
$3 for seniors (point b) and $6 for nonseniors (point d ).
25.4 PRICE DISCRIMINATION (cont.)
25-*
Price Discrimination and the Elasticity of DemandWe can use
the concept of price elasticity of demand to explain why price
discrimination increases the restaurant’s profit. From the
chapter on elasticity [20], we know that when demand is elastic
(Ed > 1), there is a negative relationship between price and total
revenue: When the price decreases, total revenue (price times

quantity sold) increases because the percentage increase in the
quantity demanded exceeds the percentage decrease in price.
25-*
Examples: Movie Admission versus Popcorn, and Hardback
versus Paperback BooksWhy do senior citizens pay less than
everyone else for admission to a movie, but the same as
everyone else for popcorn? As we’ve seen, a senior discount is
not an act of generosity by a firm, but an act of profit
maximization. Senior citizens are typically willing to pay less
than other citizens for movies, so a theater divides its
consumers into two groups—seniors and others—and offers a
discount to seniors. This price discrimination in favor of senior
citizens increases the theater’s profit.Why are hardback books
so much more expensive than paperback books? Most books are
published in two forms—hardback and paperback. Although the
cost of producing a hardback book is only about 20 percent
higher than producing a paperback, the hardback price is
typically three times the paperback price. Booksellers use
hardbacks and paperbacks to distinguish between two types of
consumers: those who are willing to pay a lot and those who are
willing to pay a little. The pricing of hardback and paperback
books is another example of price discrimination, under which
consumers with less elastic demand pay a higher price.
25-*
That $4 bucket of popcorn you get in the movie theater costs
less than $0.10 to produce. What explains the 4,000 percent
markup?

Moviegoers vary in their willingness to pay for seeing a movie,
and a movie theater has an incentive to identify the high
demanders and charge them more, while keeping the price low
for the low demanders. A reliable predictor of the willingness
to pay for a movie is the consumption of movie popcorn: The
people who buy a lot of popcorn are the consumers who are
willing to pay the most for a movie experience. So a convenient
way for the theater to charge more to the consumers who are
willing to pay more is to jack up the price of popcorn. As a
result, the low demanders simply pay the admission price, while
the high demanders pay the admission price plus the jacked-up
price of a bucket of popcorn.
We can illustrate with a simple example. Suppose a low
demander is willing to pay $11 for a movie, while a high
demander is willing to pay $15 for a movie and popcorn. If the
theater charges $10 for admission and $4 for popcorn, each
consumer will get a consumer surplus of $1 (equal to $11 – $10
for the low demander and $15 – $14 for the high demander), so
both consumers will see the movie. If instead the theater
charged $12 for admission and $0.10 for popcorn, the high
demander will see the movie, but the low demander won’t.
WHY DOES MOVIE POPCORN COST SO MUCH?
APPLYING THE CONCEPTS #4: When do firms have an
opportunity to charge different prices to different consumers?
4
*
25-*

barrier to entry
deadweight loss from monopoly
market power
monopoly
natural monopoly
network externalities
patent
price discrimination
rent seeking
K E Y T E R M S
25-*
“Courage doesn't always roar, sometimes it's the quiet voice at
the end of the day whispering 'I will try again tomorrow”
Mary Anne Radmacher
24-*
March 22, & 24, 2016
Chapter #24

24-*
Econ 2220
24-*
Charles E. Merril
1885 – 1956
In 1915 he and Edmond C. Lynch (1885 – 1938) created Merril
Lynch Investing
If the planters carry politics into the fields they will find it bad
business.
24-*
Looking Forward:March 17, 2016 – Test #2
Chapters # 20, 21, 22, & 23March 22, 2016 – Journal #7
due.March 24, 2016 - Project Paper Outline Due.March 29,
2016 – Journal #8 due.April 5, 2016 – Journal #9 due.April 7,
2016 – Test #2
Chapters # 24, 25, 26, & 27
Chapter 24

Perfect Competition
In the award-winning 2004 movie Sideways, the main character
raved about pinot noir wine. This review increased the demand
for pinot noir wine grown in the Willamette Valley in Oregon.
24-*
Learning Objectives
Distinguish between four market structures
Explain the short-run output rule and the break-even price
Explain the shut-down rule
Explain why the short-run supply curve is positively sloped
Explain why the long-run industry supply curve may be
positively sloped
Describe the short-run and long-run effects of changes in
demand for an increasing-cost industry
Describe the short-run and long-run effects of changes in
demand for a constant-cost industry
24-*
perfectly competitive market
A market with many sellers and
buyers of a homogeneous product
and no barriers to entry. price taker
A buyer or seller that takes the market price as given.
Perfect Competition

24-*
Here are the five features of a perfectly competitive market:
1 There are many sellers.
2 There are many buyers.
3 The product is homogeneous.
4 There are no barriers to market entry.
5 Both buyers and sellers are price takers.
Perfect Competition
24-*
Perfect Competition and the Affordable Care ActPerfect
CompetitionAffordable Care ActThere are many sellers.Open to
all private health insurance providers (HIP) in AmericaThere
are many buyers.All citizens who do not have health insurance
(employers or other means) must join exchangesThe product is
homogeneous.Act establishes minimum standards for policies
for all customersThere are no barriers to market entry.Large
barriers for market entry – economies of scaleBoth buyers and
sellers are price takers.Act helps to establish market prices for
participating HIP’s

24-*
24.1 PREVIEW OF THE FOUR
MARKET STRUCTURES
Perfect Competition: There are many sellers & buyers;
homogeneous product; no barriers to entry; price takers are
buyers & sellers.
Monopoly: A single firm serves the entire market. A monopoly
occurs when the barriers to market entry are very large.
Monopolistic competition: There are no barriers to entering the
market, so there are many firms, and each firm sells a slightly
different product.
Oligopoly: The market consist of just a few firms because
economies of scale or government policies limit the number of
firms.
24-*
Monopoly versus Perfect Competition
In Panel A, the demand curve facing a monopolist is the market
demand curve.
In Panel B, a perfectly competitive firm takes the market price
as given, so the firm-specific demand curve is horizontal. The
firm can sell all it wants at the market price, but would sell
nothing if it charged a higher price.

MARKET STRUCTURES (cont.)
24-*
MARKET STRUCTURES (cont.)
24-*
The Total Approach: Computing Total Revenue and Total Cost
24.2 THE FIRM’S SHORT-RUN OUTPUT DECISION
24-*
The Total Approach: Computing Total Revenue and Total Cost
► FIGURE 24.2
Using the Total Approach to Choose an Output Level
Economic profit is shown by the vertical distance between the
total-revenue curve and the total-cost curve.
To maximize profit, the firm chooses the quantity of output that
generates the largest vertical difference between the two curves.
24.2 THE FIRM’S SHORT-RUN OUTPUT DECISION (cont.)
24-*

24-*
The Marginal Approach marginal revenue
The change in total revenue from
selling one more unit of output.
marginal revenue = price
To maximize profit, produce the quantity where price =
marginal cost
24-*
The Marginal Approach
The Marginal Approach to Picking an Output Level
A perfectly competitive firm takes the market price as given, so
the marginal benefit, or marginal revenue, equals the price.
Using the marginal principle, the typical firm will maximize
profit at point a, where the $12 market price equals the marginal
cost.

Economic profit equals the difference between the price and the
average cost ($4.125 = $12 – $7.875) times the quantity
produced (eight shirts per minute), or $33 per minute.
24-*
Profit
24-*
Economic Profit and the Break-Even Price
economic profit = (price − average cost) × quantity produced
break-even price
The price at which economic profit is
zero; price equals average total cost.
24-*
THE BREAK-EVEN PRICE FOR SWITCHGRASS, A
FEEDSTOCK FOR BIOFUEL
APPLYING THE CONCEPTS #2: What is the break-even
price?

To illustrate the notions of break-even price, let’s look at these
prices for the typical farmer.
Comparing switchgrass to alfalfa:The implicit rent on land to
grow alfalfa $120 per acre.If the switchgrass yield is 3 tons per
acre, the opportunity cost is $40 per ton.If the explicit cost of a
ton of switchgrass is $36The breakeven price is $76 = $36 +
$40To get some farmers to grow switchgrass instead of alfalfa
the price must be at least $56 per ton and to get the most fertile
land switched the price must be $95 per ton, or $76 on average.
2
24-*
24.3 THE FIRM’S SHUT-DOWN DECISION
Two approaches:
Revenue; Price
24-*
Total Revenue, Variable Cost, and the Shut-Down Decision
operate if total revenue > variable cost
shut down if total revenue < variable cost
24.3 THE FIRM’S SHUT-DOWN DECISION

24-*
Total Revenue, Variable Cost, and the Shut-Down Decision
► FIGURE 24.4
The Shut-Down Decision and the Shut-Down Price
When the price is $4, marginal revenue equals marginal cost at
four shirts (point a).
At this quantity, average cost is $7.50, so the firm loses $3.50
on each shirt, for a total loss of $14.
Total revenue is $16 and the variable cost is only $13, so the
firm is better off operating at a loss rather than shutting down
and losing its fixed cost of $17.
The shutdown price, shown by the minimum point of the AVC
curve, is $3.00.
24.3 THE FIRM’S SHUT-DOWN DECISION (cont.)
*
24-*
operate if total revenue > variable cost
shut down if total revenue < variable cost

*
24-*
The Shut-Down Price
operate if price > average variable cost
shut down if price < average variable cost shut-down price
The price at which the firm is
indifferent between operating and
shutting down; equal to the minimum
average variable cost.
24-*
Fixed Costs and Sunk Costs sunk cost
A cost that a firm has already paid – or -
committed to pay, so it cannot be
recovered.
24-*
STRADDLING THE ZINK COST CURVE
APPLYING THE CONCEPTS #3: What is the shut down

price?Zinc is a vital input to the production of steel. Because
the cost of mining zinc varies from one mine to another, the
shutdown price varies too. The world price of zinc decreased
from roughly $2,300 per ton in 2010-2011 to $1,900 in early
2012.
The lower price was below the shutdown prices of Alcoa’s
mines in Italy and Spain: at a price of $1,900, the total revenue
from the mines was less than the variable cost of operating the
mines.
The shutdown of Alcoa’s mines decreased mining output by
531,000 tons. Although mines with lower production costs
continued mining at a price of $1,900, many mines have
shutdown prices in the range $1,500 to $1,900, and will shut
down if the price continues to drop.
3
24-*
The Firm’s Short-Run Supply Curve short-run supply curve
A curve showing the relationship
between the market price of a
product and the quantity of output
supplied by a firm in the short run.
24.4 SHORT-RUN SUPPLY CURVES
24-*
The Firm’s Short-Run Supply Curve

Short-Run Supply Curves
24.4 SHORT-RUN SUPPLY CURVES (cont.)
In Panel A, the firm’s short-run supply curve is the part of the
marginal-cost curve above the shut-down price.
In Panel B, there are 100 firms in the market, so the market
supply at a given price is 100 times the quantity supplied by the
typical firm. At a price of $7, each firm supplies 6 shirts per
minute (point b), so the market supply is 600 shirts per minute
(point f)
24-*
The Short-Run Market Supply Curve short-run market supply
curve
between market price and the
quantity supplied in the short run.
24-*
Market Equilibrium
Market Equilibrium
In Panel A, the market demand curve intersects the short-run
market supply curve at a price of $7.
In Panel B, given the market price of $7, the typical firm
satisfies the marginal principle at point b, producing six shirts
per minute. The $7 price equals the average cost at the
equilibrium quantity, so economic profit is zero, and no other
firms will enter the market.

24-*
long-run market supply curve
between the market price and
quantity supplied in the long run. increasing-cost industry
An industry in which the average cost of production increases
as the total output of the industry increases; the long-run
supply curve is positively sloped.
24.5 THE LONG-RUN SUPPLY CURVE FOR AN
INCREASING-COST INDUSTRY
24-*
Production Cost and Industry Size
INCREASING-COST INDUSTRY (cont.)
[page 532 – 534]
24-*
Drawing the Long-Run Market Supply Curve
Long-Run Market Supply Curve
The long-run market supply curve shows the relationship
between the price and quantity supplied in the long run, when
firms can enter or leave the industry.
At each point on the supply curve, the market price equals the

long-run average cost of production. Because this is an
increasing-cost industry, the long-run market supply curve is
positively sloped.
INCREASING-COST INDUSTRY (cont.)
24-*
The Short-Run Response to an Increase in Demand
Short-Run Effects of an Increase in Demand
An increase in demand for shirts increases the market price to
$12, causing the typical firm to produce eight shirts instead of
six.
Price exceeds the average total cost at the eight-shirt quantity,
so economic profit is positive. Firms will enter the profitable
market.
24.6 SHORT-RUN AND LONG-RUN EFFECTS
OF CHANGES IN DEMAND
24-*
The Long-Run Response to an Increase in Demand
Short-Run and Long-Run Effects of an Increase in Demand
The short-run supply curve is steeper than the long-run supply
curve because of diminishing returns in the short run.
In the short run, an increase in demand increases the price from
$7 (point a) to $12 (point b).

In the long run, firms can enter the industry and build more
production facilities, so the price eventually drops to $10 (point
c).
The large upward jump in price after the increase in demand is
followed by a downward slide to the new long-run equilibrium
price.
24.6 SHORT-RUN AND LONG-RUN EFFECTS
OF CHANGES IN DEMAND (cont.)
24-*
constant-cost industry
An industry in which the average cost
of production is constant; the long-run supply curve is
horizontal.
24.7 LONG-RUN SUPPLY FOR A
CONSTANT-COST INDUSTRY
24-*
Long-Run Supply Curve for a Constant-Cost Industry
Long-Run Supply Curve for a Constant-Cost Industry
In a constant-cost industry, input prices do not change as the
industry grows.
Therefore, the average production cost is constant and the long-
run supply curve is horizontal.

For the candle industry, the cost per candle is constant at $0.05,
so the supply curve is horizontal at $0.05 per candle.
CONSTANT-COST INDUSTRY (cont.)
*
24-*
Hurricane Andrew and the Price of Ice
► FIGURE 24.11
Hurricane Andrew and the Price of Ice
A hurricane increases the demand for ice, shifting the demand
curve to the right.
In the short run, the supply curve is relatively steep, so the
price rises by a large amount—from $1 to $5.
In the long run, firms enter the industry, pulling the price back
down.
Because ice production is a constant-cost industry, the supply is
horizontal, and the large upward jump in price is followed by a
downward slide back to the original price.
CONSTANT-COST INDUSTRY (cont.)
24-*

break-even price
constant-cost industry
firm-specific demand curve
increasing-cost industry
long-run market supply curve
marginal revenue
perfectly competitive market
price taker
short-run market supply curve
short-run supply curve
shut-down price
sunk cost
K E Y T E R M S
24-*
Econ 2220

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