M​i​c​h​a​e​l​ ​S​c​h​m​i​d​ ​2​0​1​8 

Index 

1.1 Competitive markets: Demand and supply 

Markets 
Demand 
Supply 
Market equilibrium 
The role of the price mechanism 
Market efficiency 
1.2 Elasticity 
Price elasticity of demand (PED) 
Cross price elasticity of demand (XED) 
Income elasticity of demand (YED) 
Price elasticity of supply (PES) 
1.3 Government intervention 
Indirect taxes 
Subsidies 
Price controls 
1.4 Market failure 
Negative externalities of production 
Negative externalities of consumption 
Positive externalities of production 
Positive externality of consumption 
Public goods 
Common access resources 
Asymmetric information 
Abuse of monopoly power 
1.5 Theory of the firm and market structures 
Production and costs 
Goals of firms 
Perfect competition 
Monopoly 
Monopolistic competition 
Oligopoly 
Price discrimination 
1.1 Competitive markets: Demand and supply 

Markets 
● A place where goods and services are traded for currency (doesn’t have to be money) 
○ Examples:  Formal  markets  (supermarket,  corner  store,  etc.),  online  markets  (eBay,  Amazon, 
etc.), informal markets (craigslist, swap-meets, drug dealers) 

Demand 
● The  law  of  demand:  at  lower  prices  consumers  are  more  willing  and  able  to  purchase  goods  and 
services ceteris paribus 
● The market demand is an aggregate of all individual consumers’ demand 
● Demand curve slopes downwards 

○  
● Demand curve shifts due to the following non-price determinants of demand 
○ Change in income 
■ For normal goods demand will shift rightwards as one is able to and willing to buy more 
● Examples: restaurant meals  
■ For inferior goods demand will shift leftwards as one can now afford normal goods 
● Examples: knock-off/no-name products, non-organic foods 
○ Preferences 
■ If  something  leads  to  consumer  tastes  changing  positively  or  negatively  the  demand 
curve will shift right or left respectively 
● Examples:  Advertising  (increases  demand),  government  regulations/advertising 
(decreases demand[e.g. cigarettes])  
○ Prices of related goods 
■ For  substitutes,  demand  of  good  A  will  decrease  if  price  of good B decreases and vice 
versa 
● Examples:  if  the  price  of  Coca-Cola  increases  the  demand for Pepsi will rise (as 
it is now cheaper) 
■ For complements, demand of good A will decrease for a rise in price of good B and vice 
versa 
 ● Examples:  if  the  price  of  hot  dog  sausages  goes  up  the  demand  for  hot  dog 
buns  will  fall  as  it  is  more  expensive  to  cook  hot  dogs  (both  are  necessary  to 
make hot dogs) 
○ Demographic changes 
■ Change  in  population  means  that  more  people  will be able to buy the product and thus 
the demand goes up and vice versa 
● Examples:  Mass  immigration  (increases  population  and  demand)  or  mass 
emigration (decreases population and demand) 
● Movements along the demand curve only occur due to a change in price 
● Linear  demand  function  is  in  the  form  Q​D​=A-BP  where  P is price, A is the ‘price intercept’ (price where 
demand is 0), and B is the slope. SLOPE IS ​NOT​ PED 

Supply 
● The  law  of  supply  is  as  price  increases  producers  are  more  willing  and  able  to  produce  goods  and 
services ceteris paribus 
● The market supply is an aggregate of all individuals producers’ supply 
● Supply curve slopes upwards as a reflection of the law of supply 

○  
● The supply curve shifts due to the following non-price determinants of supply 
○ Costs of factors of production 
■ If  the  costs  of  the  factors  of  productions  (Capital,  Entrepreneurship,  Land,  Labour)  rise 
then  the  producers  is  less  able  and  willing  to  produce  at  any  price  level  shifting  the 
supply curve left 
● Examples: Price of oil gets more expensive 
○ Technology 
■ If the level of technology increases production will be more efficient 
● Examples: using computers helps everything to be more efficient.  
○ Price of related goods 
■ Joint supply if demand decreases for one then supply will fall for both.  
● Example:  a  cow  farmer  can  produce  milk  or  leather,  if  the  amount  of  leather 
demanded decreases the amount of milk supplied shifts left. 
■ Competitive  supply  (e.g.  producing  corn  for  food  or  for  gas)  is  when  a  firm  picks  to 
produce something that has more demand, shifting the supply of the other good left.  
 ● Example:  a  corn  farmer  can  produce  either  corn  as  food  or  as  gas  for  cars.  If 
suddenly  there  is  a  rise  in  demand  for  gas  then  the  supply  of  food  corn  will 
decreases. 
○ Expectations of future prices/demands 
■ If  prices  are  supposed  to  rise in a month then a firm may store the goods and decrease 
supply in order to increase it later when the price has risen, shifting supply left. 
● Examples: Stock market (buy low, sell high) 
○ Indirect taxes and subsidies 
■ A  tax will shift supply left as it increases input prices, a subsidy will shift supply right as it 
decreases the input prices. 
● Examples:  Tax  on  cigarettes  to  decrease  consumption  will  make  supply  shift 
left. Subsidy on education will shift the supply right. 
● Movements along the supply curve occur due to changes in price by the consumer. Shifts occur for the 
above reasons.  
● The  linear  supply  function  is  Q​S​=C+DP  where P is price, C is the price intercept (the supply when price 
is 0) and D is the slope. 
○ SLOPE IS ​NOT​ PES 

Market equilibrium 
● Equilibrium is the point where supply and demand meet.  
● It  is  assumed  that  we  will  always  reach  equilibrium  point,  it  is  self  righting  so  that  if  supply  shifts  right 
price will fall in order to reach the new, lower, equilibrium point. 
● If  there  is  a  surplus  in  supply,  supply  will  shift  right  using  non-price  determinants  in  order  to  create 
equilibrium. Alternatively demand could also be shifted right through non-price determinants. 

○  
● To calculate the equilibrium point solve Q​S​=Q​D 

The role of the price mechanism 

● Factors of production are scarce and are allocated according to price 
● The  price  that  consumers  are  willing  to  pay  signals  the  consumer  the  demand  for  the  product  and 
where to allocate scarce resources  
● A higher price would provide incentives to firms to produce more, since there is a larger profit 
Market efficiency 
● Surpluses 
○ Consumer  surplus  (green)  exists  when  the  consumer  is  paying  less  than  he  would  be  willing 
and able to and thus he feels as though he has more money. 
○ Producer  surplus  (red)  exists  when  the  producer  is  receiving  more  revenue  than  he  would  be 
willing and able to produce at 

○  
● Allocative  efficiency  is  at  market  equilibrium  as  here  consumer  and producer surplus are maximised. A 
pareto optimality is achieved, no one can become better off without someone being worse off 

1.2 Elasticity 

Price elasticity of demand (PED) 

● PED is the responsiveness of consumers in demand after a change in price. 
D2−D1
percentage change in quantity demanded
● PED  can  be  calculated  through  P ED = percentage change in price = D1
P 2−P 1   to  calculate  any  variable 
P1

one needs 4 out of 5 value (QD​1​, QD​2​, P​1​, P​2​, PED).  

● PED is always negative (due to law of demand) but we use the absolute 
● The higher the PED the more elastic 
● Determinants of PED (SPLAT): 
○ Substitutes 
■ If there are substitutes demand will be elastic 
● Example:  Pepsi  and  Coca-Cola,  if  Pepsi’s  price  rises  one  can  just  buy 
Coca-Cola instead so demand will remain elastic 
○ Proportion of income 
■ If the price is high, demand will be elastic as consumers will wait and shop around 
● Example: New phone vs. salt 
○ Luxury or necessity 
■ Luxuries  are  elastic  as  they  are  not  necessary to have whilst necessities will be inelastic 
as one needs them 
● Example: new TV is elastic whilst water is inelastic 
○ Addictivity 
 ■ If a good is addictive it will tend to be inelastic to demand 
● Example: cigarettes are addictive so demand is inelastic 
○ Time period 
■ Takes time to find alternatives 
● Example: takes time to quit smoking 
● On  a  demand  curve  the  PED  is  elastic  at  the  top  section (as demand here is low and price is high and 
therefore  a  change  in  price  will  lead  to  a  more  than  proportional  change  in  demand  [e.g.  if  price 
changes  from  10  to  9  and  quantity  changes  from  1  to  2  that  is  a  decrease  of  10%  in  change  but  an 
increase of 100% in price]). The opposite is true for the inelastic section. 
● Applications involve: 
○ Firms making decisions on price changes (increase price on inelastic goods for more profit) 
○ Government analysing what to tax 
○ PED  for  primary  goods  is  low  as  it  is  a  need  (e.g.  fruit  and  veg)  whilst  for  manufactured 
products it is higher as they are wants. 

Cross price elasticity of demand (XED) 

● XED is the responsiveness of good x’s demand after a change in good y’s price. 
D2−D1
percentage change in quantity demanded f or good X
● Calculate X ED = percentage change in price f or good Y = D1
P 2−P 1  
P1

● If  a  good  is  a  substitute  it  will  have  a  positive  XED  as  a  rise  in  price  of  good  y  will  result  in  a  rise  in 
demand  for  good  x  (double  positive  =  positive  value)  or  if  the  price  of  good  y  falls  there will be a fall in 
demand for good x (double negative = positive value) 
● Complementary  goods  have  a  negative  XED  as  a  rise  in  price  of  good  y  will  result  in  a  decrease  of 
demand  for  good  x  (positive  and  negative  =  negative  value). If the price of good y falls then demand of 
good x will rise (negative and positive = negative value) 
● The higher the absolute value of XED, the closer the products are related. 
● Application  is  for  firms  to  identify  if  there  goods  are  substitutes or complements to other products and 
to what extent. 

Income elasticity of demand (YED)  

● YED measures the change in demand of a good due to the change in income 
D2−D1
percentage change in quantity demanded
● Calculate Y ED = percentage change in income = D1
Y 2−Y 1  
Y1

● Normal  goods  have  a  positive  value  of  YED  as  if  income  increases  the  quantity  demanded  will  also 
increase (double positive = positive value) 
● Inferior  goods  will  have  a  negative  value  of  YED  as  when  income  increases  demand  will  decrease 
(positive and negative = negative value) 
● Higher  values  of  YED  (greater  than  1)  are  luxuries.  They  will  decrease  in  demand  due  to  even  a  slight 
fluctuation of income 
● Lower  values  of  YED  (less  than  -1)  are  necessities.  They  will  remain  unaffected  by  changes  in  income 
as one needs them 
 ● Application  is  that  for  primary  products  (fruit  and  veg)  the  YED  is  low  whilst  for  manufactured  goods 
(TV,  Phones)  the  YED  is  high.  For  services  (chauffeur,  servant)  it  is  even  higher  as  these  are  very  high 
luxuries. 

Price elasticity of supply (PES) 

● PES measures the change in supply of a good due to the change in price 
S2−S1
percentage change in quantity supplided
● Calculate P ES = percentage change in price = S1
P 2−P 1  
P1

● Determinants of PES 
○ Time 
■ In  the  market  period  (immediately  after  the  change)  price  is  very  inelastic,  in  the  short 
term  it  becomes  more  elastic,  and  in  the  long  term  it  is  very  elastic.  The  more  time  a 
producer  has  the  more  he  is  able  to  change  his  factors  of  production  in  order  to  cater 
the change in price. 
○ Mobility of FOP 
■ If  the  factors  of  production  are  easily  expandable  or  removable  then  the  PES  will  be 
elastic. 
○ Unused capacity 
■ If one has extra machines available one can easily expand quickly making PES elastic 
○ Ability to store 
■ If one can store inventory it is easy to increase supply quickly making PES elastic 
● Applications  are  that  the  PES  of  primary  commodities  are  low  as  they  are easily storable, expandable, 
and  movable,  whereas  manufactured  products  are  inelastic  to  PES  as  production  can  not  be  easily 
downsized. 

1.3 Government intervention 

Indirect taxes 
● Specific and ad valorem taxes are placed on goods and services by the government 
● A  specific  tax  is  a  specific  amount  of  money  added  per  unit  (e.g.  1 dollar a day hotel tourist fee) whilst 
an ad valorem tax is a percentage based tax (e.g. 19% VAT in Germany). 
● When  drawn,  a  specific  tax  is  a  rightwards  shift  of  the  demand  curve  parallel  to  the  original  one, 
whereas a percentage tax is also a rightwards shift yet has a different slope. 
 ○ Specific Tax 

○ Ad Valorem Tax 
● Consequences of implementing a tax: 
○ Government: 
■ Revenue is earned through taxes 
○ Consumers 
■ Increase price level 
■ Change consumption patterns 
■ Discourage spending 
○ Producers 
■ Increase production costs 
■ Lower efficiency 

●  
○ Red is the amount of the tax paid by the consumer 
○ Blue is the amount paid by the producer 
○ Yellow is the deadweight loss or cost to society 
○ Red + Blue is the government revenue 
● The  amount  of  the  tax  paid  by  the  consumer  and  producer  depends  on  the  PED.  At  more  inelastic 
PEDs the consumer pays more and at elastic PEDs producers pay more of the tax. 
 ● A  specific  tax  changes  the  price  intercept  of  the  supply  curve.  Say  that  a  2  dollar  tax  was  applied  to 
Q​S​=C+DP. The new curve would be Q​S​=C+D(P-2) 
● An  ad  valorem  tax  changes  the  slope  of  the  supply  curve.  Say  that  a  20%  tax  was  applied  to 
Q​S​=C+DP. The new curve would be Q​S​=C+D(P-0.2P) 

Subsidies 
● A subsidy is a specific amount given to the producer by the government per unit. 
● Government provides subsidies for: 
○ Lower cost of necessities 
■ E.g. Milk, fruit, salt 
○ Promote merit goods 
■ E.g. education 
○ Protectionism internationally 

●  
● Consequences: 
○ Consumers 
■ Paying lower price 
○ Producers 
■ Reduces cost of production 
■ Could cause inefficiency 
■ Inefficient allocation of resources 
○ Government 
■ Government spending 
● Opportunity cost 

●  
○ Red is the gain in producer surplus 
○ Blue is the gain in consumer surplus 
○ Yellow is the deadweight loss due to inefficient allocation of resources  
 ○ Red+Blue+Yellow is the total cost of the subsidy for the government 
● For  the  equation  one  adds  the  value  of  the  subsidy  to  the  price.  Say  there  was  a  $2  subsidy  on  the 
equation Q​S​=C+DP. The new equation will be Q​S​=C+D(P+2) 

Price controls 
● Price ceilings (max prices) are implemented by the government to control rent and food prices.  

●  
● At  P​C  firms  are  producing  below  equilibrium  which  causes  there  to  be  an  excess  of  demand  (Q​D  is
​  

demanded  but  only  Q​S  is

​   supplied).  There  is  a shortage, inefficient resource allocation, welfare impacts 

(deadweight loss equal to the yellow section) 

● Non-price rationing systems might have to be used (food stamps) 
● If  shortages  persist  there  might  be  a  parallel  underground  market  selling  at  higher  (often  extortionist 
prices) 
○ Example  Venezuela  Corn  Flour  is  regulated  and  massively  sold  in underground markets due to 
shortages for very high prices. 
● Price  floors  (minimum  prices)  are  implemented  to  support  firms  (agricultural  products  and  minimum 
wages) 

●  
● There  is  a  surplus  of supply as at the higher price, firms are willing to supply more yet due to the higher 
price consumers are willing to purchase and demand less. Therefore there is extra supply (Q​s​-Q​D​) 
● Surpluses might have to be bought up by the government  
○ E.g. German government buying up milk surpluses after implementing a price floor   
● Inefficient  resource  allocation  is  present  as  the  orange  section  in  the above diagram is the deadweight 
loss. 
1.4 Market failure 
● A  market  failure  is  a  failure  of  the  market  to  achieve  allocative  efficiency,  resulting  in  the  over  or under 
allocation of resources. 
● Externalities  are  spillover  costs  or  benefits  to  a  third  party  due  to  the  consumption  or  production  of  a 
good or service. This can be measured using: 
○ MPB  Marginal  Private  Benefit:  the  additional  benefit  gained  by  producing  or  consuming  a 
product to the producer or consumer 
○ MSB  Marginal  Social  Benefit:  the  additional  benefit  gained  by  society  by  producing  or 
consuming a product 
○ MPC  Marginal  Private  Cost:  the  additional  cost  incurred  by  producing or consuming a product 
to the producer or consumer 
○ MSC  Marginal  Social  Cost: the additional cost incurred to society by producing or consuming a 
product 

Negative externalities of production 

○  
○ A  firm  producing  something  that  causes  pollution  (e.g. nuclear power) affects other people and 
thus  the  marginal  social  cost  is  higher  than  the  marginal  private  cost  the  consumer  has.  The 
consumer  is  happy  to  pollute  as  it  saves  him  money,  he  doesn’t  have  to  pay  to  clean  the 
pollution  properly.  Yet  society  is  not happy as it is making the drinking water poisonous making 
their costs higher. 
○ Welfare is lost through this as shown in the red deadweight loss. 
○ This  can  be  solved  through  a  cap  and  trade  or  permit  scheme  where  one  pays  for  how much 
carbon dioxide or other pollution they exert (this increases costs for consumer shifting MPC left) 
○ This would however make the price of power go up. 
Negative externalities of consumption 

○  
○ Consumers  using  cigarettes  create  second  hand  smoke  which  society  doesn’t  like.  The 
benefits  for  the  private  consumer  (enjoying  the  cigarette)  are  higher  than  the  ones  for  society 
(there are little benefits to others). Thus MPB>MSB. 
○ Welfare is lost through this as shown in the red deadweight loss 
○ This can be solved through an indirect tax on cigarettes which will shift MPB towards the left. 
○ This would make the price of cigarettes go up and affects the addicted. 

Positive externalities of production 

○  
○ Producers  of  tree  farms  incur  a  high  cost  in  their  production  yet  due  to  the  spillover  benefit  of 
trees  acting  as  carbon  sinks  which  produce  oxygen  from  carbon  dioxide.  This  makes the cost 
to society lower.  
○ As there are not enough tree farms a deadweight loss occurs as highlighted above in red 
○ This can be solved by subsidies to shift MPC further left. 
○ The  government  has  an  opportunity  cost  when  picking  this  subsidy.  They  could  spend  this 
money on something better. 
Positive externality of consumption 

○  
○ For  education  the  benefit  to  oneself  is  high  as it increases ones positions etc. yet the benefit to 
society  is  even  higher  (more  educated  people  =  safer  society  =  higher  paying jobs = pay more 
taxes = better society). Thus MSB>MPB.  
○ Yet this is under provided causing there to be the red deadweight loss. 
○ This  can  be  fixed  by  direct  provision  of  education (public schools for free), advertisement (push 
demand  for  schools  [doesn’t  work  in  this  example  but whatever]), legislation (force school for x 
years). 
○ The  government  must  spend  money  to  provide  this  and  they  could  spend  the  money  on 
something better maybe. 

Public goods 
● Public goods are non rivalrous and non excludable. 
○ Example: street lights, everyone can use them and you can stop people from using them 
● Free riders are those who use the street lights without paying taxes for example.  
○ Due to these people there is a lack of provision of public goods. 
○ The  government  must  therefore  provide  public  goods  which  others  will  not,  which  increases 
taxes and takes money from other government projects. 

Common access resources 

● Common access resources are resources (FOPs) that are available to everyone. 
○ Example: Fish pond 
● Sustainability is the ability to maintain resources for the future generations 
○ Example:  only  fish  a  few  fish  so  that  they  can  continue  to  reproduce  and  there  will  be  fish  for 
the next generations 
● As  one  does  not  need  to  pay  for  goods  and  services  here  some  may  overuse  these  goods  and 
services 
○ Example: overfishing 
○ Example:  continued  use  of  fossil  fuels  will  result  in  there  not  being  any  more  left  for  future 
generations. This is a negative externality of production. 
 ● Solutions  to  this  include  carbon  taxes,  cap  and  trade  schemes,  privatisation,  and  funding  for  clean 
technologies. 
● As  no  one  owns  common  access  resources  the  government  may  be  limited  in  response.  For 
international  common  access  resources  such  as  the  ocean  there  must  be  effective  international 
cooperation. 

Asymmetric information 
● Asymmetric information is when one party knows more than another in a transaction 
○ If the seller knows more than the consumer, the consumer might be overcharged 
■ Example:  when  buying  a  used  car  the  seller  might  hide  that  something doesn't work in 
order for you to remain interested and sell the car for more than it is worth 
● Solutions: 
○ Regulations 
○ Licenses 
○ Provision of information by the government 
○ If  the  consumer  knows  more  than  the  seller,  the  producer  might  be  charging  to  little  and  not 
able to cover his costs 
■ Example:  Lie  about  a  condition  you  have  to  your  health  insurance  to  get  a  cheaper 
premium 
● Solutions: 
○ Mandatory medical checks before 
○ Direct provision of health care 
○ Regulations and laws 

Abuse of monopoly power 

● Abuse  of  monopoly  power:  if  a  monopoly  charges  more  than  would  be  fair  and  charges  extortionist 
prices then this is a market failure as it is not allocatively efficient and creates a welfare loss 
○ Example: pharma firms charging 1000 dollars for medications they have patents on 
● Solutions:  
○ Nationalisation 
○ Legislation 
○ Regulation 
○ Trade liberalisation 
○ Revoking patents or copyrights 

1.5 Theory of the firm and market structures  

Production and costs 

● Short run: at least one factor of production remains fixed 
 ○ Labour can’t be changed quickly due to labour laws for example 
● Long run: all factors of production can be changed 
● The total product is the output or amount of products a firm produces 
○ Marginal product is the extra product created from an extra input (amount of labour) 
■ To the right of maximum marginal product diminishing marginal returns occurs. 
○ Average product is the total product divided by the input (amount of labour) 
● Law of diminishing returns are the points at which the benefits gained are less than the extra input 
○ Example:  extra  workers  might  just  get  in  the  way  after  a  while  because  you  don’t  need  20 
people to work a machine, it will just 
● Economic costs are explicit and implicit costs 
○ Explicit costs are the costs for the factors that one must pay 
■ Example: labour costs, rent, input costs 
○ Implicit costs are opportunity costs 
■ Example: opportunity cost of not producing something else 
● Costs 
○ Average costs are the costs per unit of input 
○ Total costs are all the costs combined (fixed cost + variable cost) 
○ Marginal costs are the costs per additional unit of input 
● Revenue is the total amount of money the firm receives before costs are deducted 
○ Total revenue is the price multiplied by the units of output 
○ Average revenue is the total revenue divided by the quantity of output 
○ Marginal revenue is the extra revenue per extra unit of output 
● Profit is the amount of revenue minus the costs 
○ Total profit is the total revenue minus the total costs 
○ Average profit is the total profit divided by the total output 
○ Marginal profit is the amount of profit gained by producing one extra unit of output 
● At 0 economic profit all costs are covered and firms will continue to produce. 
○ Above  economic  profit  is  supernormal  profit.  Firms  can  use  this  extra  money  to  do  extra 
research and development 
○ Below economic profit is loss where costs are greater than revenue. 

Goals of firms 
● Profit maximisation 
○ Occurs when the difference between TR and TC is maximised or where MR=MC 
● Alternative goals of firms include 
○ Revenue maximisation 
■ MR=0 
○ Growth maximisation 
■ Put expanding operations first in order to have a bigger market share  
■ Economies of scale 
● By increasing in size AC lowers until a certain point 
● Diminishing returns after a certain point due to communication issues etc. 
○ Satisficing 
 ■Instead  of  maximising  a  behavior  the  firms pick a satisficing point where they are happy 
to produce 
○ Corporate social responsibility 
■ Producing at an environmentally sustainable point 

Perfect competition 
● Assumptions 
○ Large number of small firms 
○ Homogenous products 
○ Freedom of entry and exit 
○ Perfect information 
○ Perfect resource mobility 
● Revenue curves 
○ D=AR=MR=P 
■ This is as all the firms are price takers 
○ The  market  price  is  determined  by  a  normal  demand  supply  diagram  and  the  equilibrium  is 
equal to D=AR=MR=P 
● Profit maximisation in the short run 
○ In  the  short  run  it  is  possible  to  make  abnormal  profit,  normal  profit,  or  negative  profit  where 
MC=MR  
● Profit maximisation in the long run 
○ In  the  long  run  firms  making  negative  profit  will  adjust  or  leave  increasing  revenue  (less firms = 
more customers per firm = more revenue). 
○ In  the  long  run,  if  firms  are  making  abnormal  profits  more  firms will join lowering revenue (more 
firms = less customers per firm = less revenue). 
○ Thus in the long run only zero economic profit is possible 
● Shut  down  price  is  when  one  produces  below  AVC.  This  price  loss  is  greater  than  AFC  making  it 
impossible to continue production. 
● Allocative efficiency 
○ Allocative  efficiency  is  achieved  as  price  is  equal  to  MC  and  therefore  the  consumer  is  paying 
the lowest possible price 
○ If  you  are  producing  above this point, consumers will go to the competition forcing you to leave 
or lower price 
○ If you are producing below this point, other firms will follow or leave 
● Productive efficiency  
○ Productive  efficiency  is  producing  at  lowest  ATC  as  at  this  point  costs  are  minimised  and 
therefore price also is. 
○ In the long run a firm produce at minimum ATC 
○ In  the  short  run one can earn supernormal profits or losses and thus not producing at minimum 
ATC. 

Monopoly 
● Assumptions of the model 
○ Single large dominant firm in the market 
○ No close substitutes 
○ Significant barriers to entry 
■ Patents, copyright, trademark, etc. 
● Revenue curves 
 ○  
○ D=AR following the law of demand 
○ Always  produce  at  the  elastic  section  as  this  is  where  MR  is  positive  and  therefore every extra 
product has earned positive revenue. 
○ MR is twice as steep is AR/D 
● Profit maximisation 
○ Quantity is where MC=MR but price is the AR at this quantity. 
○ Firms  can  earn  supernormal  profits  in  the  long  run  as  they  are  the  only  ones  able  to  produce 
the good due to the high barriers to entry 
● Revenue maximisation  
○ Where MR=0 
○ After  this  point  we  are  producing  negative  MR  meaning  that  the  firm  is  losing  revenue  for  the 
extra good produced 
● Natural monopoly 
○ Monopolies that exist due to their scale (large economy of scale, small firms can’t compete) and 
barriers 
■ Example:  telecommunication  or  train  networks,  not  every  firm  can  set  up  their  own 
cabling and railing. 
○ Natural monopoly looks the same as a monopoly just that it is less steep. 
● Monopoly and efficiency 
○ At profit maximising point there is an allocative inefficiency (and welfare loss as shown above). 
○ Despite  such  inefficiencies  monopolies  are  still  desirable  as  the  supernormal  profit  (achievable 
for  perfect  competition)  can  be  used  for  research  and  development  and  innovation,  and 
increasing economies of scale.  
● Policies to regulate monopoly power 
○ Legislation 
■ Controlling patents 
■ Nationalisation 

Monopolistic competition 
● Assumptions of the model 
○ Large number of firms 
○ Differentiated products (different brands for example; Nike vs Adidas)  
○ No barriers to entry and exit 
● Revenue curves 
○ Product  differentiation  leads  to  a small degree of monopoly power and therefore to a negatively 
sloping demand curve for the product 
● Profit maximisation 
○ Possibility to make loss or profit in the short run 
 ○ In the long run due to the absence of barriers firms will make normal profit 
● Non price competition 
○ Instead of price competition firms will take part in non-price competition such as: 
■ Advertisement 
■ Innovations 
■ Product differentiation 
● Monopolistic competition and efficiency 
○ Neither  allocative  efficiency  nor  productive  efficiency  are  achieved  by  monopolistically 
competitive firms 
○ Not producing at lowest ATC or where MC=MR 

○  

Oligopoly 
● Assumptions of the model 
○ Small number of large firms 
○ Differentiated or homogeneous product 
○ High barriers to entry 
○ Interdependence on other firms creates the dilemma whether to compete or to collude 
○ Concentration  ratios  may  be  used  to  identify  if  it  is  a  oligopoly.  (The  x biggest firms control y% 
of the market). 
● Game theory 
○ Prisoner's  dilemma  shows  us the outcomes of firms, if they both cheat, both lose, if one cheats 
they win and the other loses, if both don’t cheat they both have prices. 

○  
● Collusion 
○ Is  when  two  or more companies in an oligopoly work together to create a monopoly power and 
change prices. 
○ This is illegal and is also called a cartel 
 ○ Goal  of  cartels  is  to  limit  competition  between  member  firms  and  to  maximise joint profits as a 
collective monopoly. 
○ Members in a cartel have an even higher incentive to cheat 
○ Cartels  are  difficult to maintain due to them being illegal mostly and even if they are legal (OPEC 
for Oil is legal) they might still be rivaled by other firms (OPEC is rivaled by the US or Russia).  
● Informal/tacit collusion 
○ Price leadership by a leading firm which others follow 
○ Legal 
● Non-collusive oligopoly 
○ Firms in a non-collusive oligopoly are interdependent on one another.  
○ Price rigidities exist as seen in the kinked demand curve 

○  
■ Firms  start  at  E.  The  upper  section  is  elastic  as  if  a  firm  goes  here  by  increasing  price 
consumers will go to the other firms producing at E 
■ The  lower  part  is  inelastic  as  if  one  firm  moves,  others  will  follow  making  the  benefits 
very small to go here. This is why most will stay at E 
○ To  solve  this  price  rigidity  non-price  competition  is  common  as  price  wars  are  not  good  for 
profits most of the time. 

Price discrimination 
● Conditions for price discrimination to occur 
○ Different consumer groups that are easily groupable and have different price elasticities of 
demand for the product. Must be groupable otherwise a senior could buy some senior 
discounted tickets and sell them to younger people. 
■ Age 
■ Gender 
○ Firm possesses some market power 
● For example train tickets can be made more expensive in peak times (for business travelers) as one 
needs to travel here making the demand for them elastic whereas for off peak time travelers the 
demand is elastic (they will wait if need be). Thus one can show price discrimination as follows. 
○  
■ Market one shows the inelastic demand for peak tickets 
■ Market two shows the elastic demand for off-peak tickets 
■ Combining the MRs in the third diagram shows us the best point to be producing to 
maximise profits (MR=MC) which can be used for the other two markets as well.