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Topic 5 Market structure, efficiency and failure Lecture 19

Topic 5 Market structure, efficiency and failure Lecture 19. In this lecture, we consider what factors influence whether there will be a large or a small number of firms in a market. We also consider the specific issues arising when there is a ‘natural monopoly’ in a market.

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Topic 5 Market structure, efficiency and failure Lecture 19

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  1. Topic 5 Market structure, efficiency and failure Lecture 19 In this lecture, we consider what factors influence whether there will be a large or a small number of firms in a market. We also consider the specific issues arising when there is a ‘natural monopoly’ in a market. Robin Naylor, Department of Economics, Warwick

  2. Topic 5 Market structure, efficiency and failure Lecture 19 Minimum Efficient Scale refers to the smallest quantity at which the LAC attains its minimum level. p LAC3 LAC1 LAC2 Firm 1 Firm 3 Firm 2 LAC1 D X1 X3 X X2 Robin Naylor, Department of Economics, Warwick

  3. Topic 5 Market structure, efficiency and failure Lecture 19 Suppose Firm 1 is producing X1. If there are no other firms in the market, what price can Firm 1 charge? Will it make a super-normal profit? p LAC1 LAC1 D X1 X Note that output at X1 is called Minimum Efficient Scale (MES). Robin Naylor, Department of Economics, Warwick

  4. Topic 5 Market structure, efficiency and failure Lecture 19 Suppose Firm 1 is producing X1. If there are no other firms in the market, what price can Firm 1 charge? Will it make a super-normal profit? p p1 LAC1 LAC1 D X1 X Note that output at X1 is called Minimum Efficient Scale (MES). Robin Naylor, Department of Economics, Warwick

  5. Topic 5 Lecture 19 Firm 1 is producing X1. Suppose now that Firm 2 enters the market and is identical to Firm 1 and produces the same amount, X1.What is total output? What price can be charged? Can each firm make a super-normal profit? p LAC1,2 LAC1,2 D X1 X1 X 2X1 Robin Naylor, Department of Economics, Warwick

  6. Topic 5 Lecture 19 Firm 1 is producing X1. Suppose now that Firm 2 enters the market and is identical to Firm 1 and produces the same amount, X1.What is total output? What price can be charged? Can each firm make a super-normal profit? p P1,2 LAC1,2 LAC1,2 D X1 X1 X 2X1 Robin Naylor, Department of Economics, Warwick

  7. Topic 5 Lecture 19 What if 3 identical firms are each producing X1? Can they each at least break even? p LAC1 D X1 X1 X1 X 3X1 Robin Naylor, Department of Economics, Warwick

  8. Topic 5 Lecture 19 p P1,2 P1,2,3 LAC1 D X1 X 3X1 Robin Naylor, Department of Economics, Warwick

  9. Topic 5 Lecture 19 How many (identical) firms in this market can each produce X1 and each break even? p LAC1 D X1 X Robin Naylor, Department of Economics, Warwick

  10. Topic 5 Lecture 19 How many (identical) firms in this market can each produce X1 and each break even? p LAC1 D X1 X1 X1 X 3X1 4X1 5X1 9X1 Robin Naylor, Department of Economics, Warwick

  11. Topic 5 Lecture 19 Suppose now that there is a reduction in market demand. How many firms (with identical costs as before), each producing X1, can at least break even? p LAC1 D D’ X1 X Robin Naylor, Department of Economics, Warwick

  12. Topic 5 Lecture 19 Suppose now that there is a reduction in market demand. How many firms (with identical costs as before), each producing X1, can at least break even? p LAC1 D D’ X1 X 6X1 Robin Naylor, Department of Economics, Warwick

  13. Topic 5 Lecture 19 What can you conclude about what determines the number of firms that we will find in a market? From this analysis, we see three crucial determinants . . . p LAC1 D X1 X Robin Naylor, Department of Economics, Warwick

  14. Topic 5 Lecture 19 We have seen the importance of: (i) the extent of demand. Now consider: (ii) MES (iii) Minimum LAC p LAC1’ LAC1 LAC1 D X1 X X1 ’ If MES is at X1’ instead of X1, how many firms can survive? Robin Naylor, Department of Economics, Warwick

  15. Topic 5 Lecture 19 We have seen the importance of: (i) the extent of demand. Now consider: (ii) MES (iii) Minimum LAC p LAC1’ LAC1 P1,2 LAC1 D X1 X X1 ’ 2X1 ’ If MES is at X1’ instead of X1, how many firms can survive? Robin Naylor, Department of Economics, Warwick

  16. Topic 5 Lecture 19 • We have seen the importance of: • the extent of demand. • MES • Now consider: • (iii) Minimum LAC LAC1 ’ p That is, what if the LAC curve shift upward, with no change in MES? LAC1 ’ LAC1 LAC1 D X1 X How many firms can survive? Robin Naylor, Department of Economics, Warwick

  17. Topic 5 Lecture 19 What if the LAC curve shift upward, with no change in MES? Whereas 9 firms could survive previously (see Slide 10), now only 5 can survive. LAC1 ’ p LAC1 ’ LAC1 LAC1 D X1 X 5X1 6X1 9X1 Robin Naylor, Department of Economics, Warwick

  18. Topic 5 Lecture 19 Consider the case in which only 1 firm can survive . . . . . . this is called: Natural Monopoly p LAC1 D X MES=X1 What will be the profit-maximising price and output of this Natural firm? Robin Naylor, Department of Economics, Warwick

  19. Topic 5 Lecture 19 What will be the profit-maximising price and output of this Natural Monopoly firm? Super-normal profit is given by area A=X*[pmon - LACmon] p LMC1 pmon LAC1 LACmon D X X1 X*mon MR X*: MR=MC Robin Naylor, Department of Economics, Warwick

  20. Topic 5 Lecture 19 What will be the Welfare Loss associated with this Natural Monopoly firm? Welfare Loss is given by the area between the LMC and Demand curves. p LMC1 pmon LAC1 LACmon D=MB X X1 X*mon X*soc MR Robin Naylor, Department of Economics, Warwick

  21. Topic 5 Lecture 19 Now read B&B 4th Ed., pp. 298-300, 469-474, 530-533. Robin Naylor, Department of Economics, Warwick

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