ENTREPRENEUR

1
ENTREPRENEUR

• A person who comes up with an idea for a business
  and coordinates the production and sale of goods
  and services
• The entrepreneur builds the production facility,
  buys raw materials and hires workers.
• An entrepreneur takes risks, committing time and
  money to a business without any guarantee that
  the business will be profitable.

2
NATURAL MONOPOLY

• The entry of a second firm would make the market
  price less than the average cost of production,
  so a single firm will serve the entire market.
• A single firm is profitable, but a pair of firms
  would lose money.
• Classic examples are public utilities (sewerage,
  water, and electricity generation) and
  transportation services (railroad freight and
  mass transit).

3
Dollars per 1,000 Kilowatt Hours
Long-Run Average Cost
m
8.20
c
6.20
n
Long-Run Marginal Cost
4.60
Marginal Revenue
Monopolists demand (Market demand)
3
Billions of Kilowatt Hours
4
THE MARGINAL PRINCIPLE

• The marginal principle is satisfied at point
  n, with 3 billion kilowatt hours (kwh) of
  electricity.
• The price associated with this quantity is
  8.20 (shown at point m) and the average cost is
  6.20 (shown at point c).
• The profit per unit of electricity is 2.00.
• The price exceeds the average cost, so the
  electric company will earn a profit.

5
WHAT IF A SECOND FIRM ENTERED THE MARKET ?

• Entry of a second firm would shift the demand
  curve for the first firm to the left, from D1 to
  D2
• At each price, the first firm will sell a smaller
  quantity of electricity, because it now shares
  the market with another firm.
• In general, the larger the number of firms, the
  lower the demand curve facing the typical firm in
  a two-firm market.

6
Dollars per 1,000 Kilowatt Hours
Long-Run Average Cost
D1
D2
m
8.20
c
6.20
Firms Demand Curve with two firms
Monopolists demand (Market demand)
3
Billions of Kilowatt Hours
7
WILL A SECOND FIRM ENTER A NATURAL MONOPOLY ?

• The demand curve for a typical firm in a two-firm
  market lies entirely below the long-run
  average-cost curve.
• There is no quantity at which the price exceeds
  the average cost of production.
• No matter what price is charged, the firm will
  lose money.
• A SECOND FIRM WILL NOT ENTER THE MARKET!

8
Dollars per 1,000 Kilowatt Hours
Long-Run Average Cost
D1
D2
m
8.20
c
6.20
Firms Demand Curve with two firms
Monopolists demand (Market demand)
3
1.5
Billions of Kilowatt Hours
9
PRICE CONTROLS FOR A NATURAL MONOPOLY

• When a monopoly is inevitable, the government
  often sets a maximum price for the monopolist.
• Local governments regulate utilities and firms
  that provide water, electricity, and local
  telephone service.
• State governments use public utility commissions
  (PUCs) to regulate the electric-power industry.

10
AVERAGE-COST PRICING POLICY

• The government picks the price at which the
  demand curve intersects the average-cost curve.

11
Dollars per 1,000 Kilowatt Hours
m
Unregulated Monopoly
8.20
Regulated Monopoly
r
6.00
Average Cost w / regulation
5.20
Original Average Cost
i
Monopolists demand (Market demand)
3
5
Billions of Kilowatt Hours
12
Effect of Regulatory Pricing On Firms Production
Costs

• Under average-cost pricing, a change in the
  firms production cost will not affect the firms
  profit because the government will adjust the
  regulated price to keep the price equal to the
  average cost.
• Because there is no reward for cutting its costs
  and no penalty for higher costs, the firm has
  little incentive to control its cost.
• Costs will increase, pulling up regulated price.

13
MONOPOLISTIC COMPETITION

• MANY FIRMS,
• DIFFERENTIATED PRODUCT,
• SLIGHT CONTROL OVER PRICE,
• NO ARTIFICIAL BARRIERS TO ENTRY

14
MONOPOLISTIC COMPETITION

• Many Firms
• Relatively small economies of scale small
  firms can produce at about same average cost as
  large firms market can support many firms.
• Differentiated Product
• Firms sell slightly different products
  differentiation with respect to physical
  characteristics, location, services, and aura or
  image associated with good.

15
MONOPOLISTIC COMPETITION

• Slight control over price
• When a firm increases its price, some of its
  customers will switch to other firms that sell
  slightly different products.
• No artificial barriers to entry
• In a market subject to monopolistic
  competition, each firm has a monopoly in selling
  its own differentiated product, but competes with
  other firms selling similar products.

16
HOW FIRMS DIFFERENTIATE THEIR PRODUCT

• Physical Characteristics
• Different size, color, shape, texture, or taste
• Examples athletic shoes, toothpaste, dress
  shirts, appliances, and pens
• Location
• Differentiated by where products are sold
• Examples gas stations, music stores, grocery
  stores, movie theaters, and ice-cream parlors

17
HOW FIRMS DIFFERENTIATE THEIR PRODUCTS

• Services
• Helpful sales people versus self-service, home
  delivery, free technical assistance
• Aura or Image
• Use of advertising to make products stand out
  from group of virtually identical products,
• Examples aspirin, designer jeans, and motor oil

18
SHORT-RUN EQUILIBRIUM WITH MONOPOLISTIC
COMPETITION A SINGLE MUSIC STORE
m
19
Dollars per CD
Monopolists demand (market demand)
n
8
Long-run average cost or long-run marginal cost
Marginal Revenue
300
640
CDs Sold Per Hour
19
SHORT-RUN EQUILIBRIUM

• The marginal principle is satisfied at point n
  (MR MC).
• Monopolist sells 640 CDs per hour.
• Price of CD is 19 (point m), average cost is 8
  (point c).
• Monopolists profit per CD is 11.

20
SHORT-RUN EQUILIBRIUM WITH MONOPOLISTIC
COMPETITION ENTER A SECOND STORE
D1
D2
Dollars per CD
m
19
e
18
Monopolists demand (market demand)
f
8
Long-run average cost or long-run marginal cost
Firms Demand Curve with two Firms
New Marginal Revenue
440
640
CDs Sold Per Hour
21
ENTER A SECOND STORE

• Entry of a second firm shifts the demand curve
  facing the typical firm left from D1 to D2.
• The marginal principle is satisfied at point f
  (MC new MR).
• Each firm will produce 440 CDs per hour at a
  price of 18 (point e) and an average cost of 8
  (point f).
• Price of CDs decreases.
• Profit per CD decreases from 11 (19 -8) to 10
  (18 -8).

22
LONG-RUN EQUILIBRIUM WITH MONOPOLISTIC
COMPETITION MUSIC STORES
Dollars per CD
h
14
Long-run average cost Long-run marginal cost
e
8
Marginal Revenue
Demand Curve for Typical Store
70
CDs Sold Per Hour
23
LONG-RUN EQUILIBRIUM WITH MONOPOLISTIC COMPETITION

• With no artificial barriers to entry, firms will
  continue to enter market until each music store
  makes zero economic profit.
• As firms enter market, demand curve shifts left.
• Typical firm satisfies marginal principle at
  point g and sells 70 CDs per hour.
• Price is 14 (point h) and average cost is 14 --
  zero economic profit.

24
LONG-RUN EQUILIBRIUM WITH MONOPOLISTIC COMPETITION

• As the number of firms increases, the profit per
  CD decreases for two reasons
• Lower Price -
• The stores compete for customers by cutting
  prices.
• Higher Average Cost -
• As more firms enter market, eventually move
  upward along negatively-sloped portion of
  average-cost curve to higher average cost (fewer
  CDs sold per store).

25
TRADEOFFS WITH MONOPOLISTIC COMPETITION

• Good News Lower Price -
• Competition decreases the price of a product.
• Good News Lower Travel Cost -
• With larger number of competitors, the shorter
  the distance each customer must travel to the
  nearest store.
• Bad News Higher Average Cost -
• As output per store decreases, the average
  cost of a typical store increases.