ee more readings 2014
TRANSCRIPT
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Example- Application ofBEA
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Example- Application of BEA(Contd.)
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TAX and Economic
Analysis
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Basic Tax Equations -ndividual
!ross ncome ! " salaries # $a%es # interest and
dividends # ot&er income
Taxa'le ncomeT " ! personal exemptions
standard or itemied deductions
TaxT " (taxa'le income)(applica'le tax
rate)
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Before-Tax and After-Tax Cas& *lo$
+C* " cas& in,o$s cas& out,o$s Cas& *lo$ 'efore Tax (C*BT)
C*BT " %ross income expenses initialinvestment # salva%e value
" ! E # Cas& *lo$ After Tax (C*AT)
C*AT " C*BT taxes
Add /epreciation
C*AT " ! E # (! E /)(Te) An evaluation format
ee Ta'le 01 2 and Example 01.2 for acomputational format
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E3ect on Taxes of /i3erent/epreciation 4et&ods and 5ecovery
eriods
Criteria used to compare di3erent depreciationmet&ods compute ---
6'7ective 4inimie t&e 8 of future taxespaid o$in% to a %iven depreciation met&od T&e total taxes paid are equal for all depreciation models
T&e 8 of taxes paid is less for accelerated depreciation
met&ods &orter depreciation periods result in lo$er 8 of future
taxes paid over lon%er time periods
n
tax
t=1
PW = (taxes in year t)(P/F,i,t)
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/epreciation 5ecapture and Capital
!ains (9osses) for Corporations
Capital %ain (C!) C! " sellin% price :rst cost C! "
/epreciation 5ecapture (/5) /5 " sellin% priceyear t 'ook valuetime of sale /5 B;t
Capital 9oss (C9)
C9 " 'ook value sellin% price C9 " B;t-
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/5 ummary - 6utcomes
Zero, $0
Book ValueBV
t
First Cost
P
0
of suc& income tax? provided t&at t&e totalincome exceeds 5s. 0 crore. (4ar%inal 5elief in urc&ar%e? ifapplica'le)
At t&e rate of 0@ of suc& income tax? provided t&at t&e totalincome exceeds 5s. 0@ crores.
"u'atio! Cess 2 of t&e total of ncome Tax and urc&ar%e.
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I!"ia(Contd.)I!'ome Ta% Sla3s 4 Rates for #ssessme!t 5ear 6021
Com)a! other tha! a Domesti' Com)a!
I!'ome Ta%
F >@ of on so muc& of t&e total income as consist of (a) royalties receivedfrom !overnment or an ndian concern in pursuance of an a%reement made'y it $it& t&e !overnment or t&e ndian concern after t&e 20st day of 4arc&?0GH0 'ut 'efore t&e 0st day of April? 0G1HI or (') fees for renderin% tec&nicalservices received from !overnment or an ndian concern in pursuance of ana%reement made 'y it $it& t&e !overnment or t&e ndian concern after t&e
of suc& income tax? provided t&at t&e total income exceeds5s. 0@ crores.
"u'atio! Cess 2 of t&e total of ncome Tax and urc&ar%e.
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I!"ia(Contd.)I!'ome Ta% Sla3s 4 Rates for #ssessme!t 5ear 6021
;ar+i!al Relief = 8&en an assesseeKs taxa'le income exceeds5s. 0 crore? &e is lia'le to pay urc&ar%e at prescri'ed rates
mentioned a'ove on ncome Tax paya'le 'y &im. Lo$ever? t&eamount of ncome Tax and urc&ar%e s&all not increase t&eamount of income tax paya'le on a taxa'le income of 5s. 0crore 'y more t&an t&e amount of increase in taxa'le income.
%am)le
n case of an individual assesseee (M H@ years) &avin% taxa'leincome of 5s. 0?@@?@0?@@@D-
0. ncome Tax 5s.
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I!"ia(Contd.)Value #""e" Ta% 7V#T8=;alue Added Tax (;AT) $as introduced as tax reform to overcome t&e pro'lems
associated $it& prevalent sales tax structure. T&e sales tax structure is
associated $it& t&e pro'lems of dou'le taxation and multiplicity of taxesresultin% in cascadin% tax 'urden. *or instance? in t&e sales tax structure? 'eforea commodity is produced? inputs are :rst taxed? and t&en after t&e commodity is
produced $it& input tax load? output is taxed a%ain. T&is causes an unfair dou'le
taxation $it& cascadin% e3ects. ;AT also a'olis&es multiplicity of taxes liketurnover tax? surc&ar%e on sales tax? additional surc&ar%e? etc.
;alue Added Tax (;AT) is a multi-point system of taxation. Tax is levied on value
addition at eac& sta%e of transaction in t&e productionD distri'ution c&ain. T&eterm Kvalue additionK implies t&e increase in value of %oods and services at eac&
sta%e of production or transfer of %oods and services. ;AT is a tax on t&e :nalconsumption of %oods or services and is ultimately 'orne 'y t&e consumer. ;AT
allo$s Knput tax credit (TC)K for tax paid at earlier sta%e? $&ic& can 'eappropriated a%ainst t&e ;AT lia'ility on su'sequent sale.
T&e desi%n of ;AT $it& input tax credit is 'ased on documentation of tax invoice?cas& memo or 'ill. Every re%istered dealer? &avin% turnover of sales a'ovespeci:ed amount? needs to issue to t&e purc&aser serially num'ered tax invoice
$it& t&e prescri'ed particulars. *or identi:cationD re%istration of dealers under
;AT? t&e Tax ayerKs denti:cation +um'er (T+) is used. T+ consists of 00 di%itnumerals t&rou%&out t&e country. ts :rst t$o c&aracters represent t&e tateCode and t&e set-up of t&e next nine c&aracters can vary in di3erent tates.
I "i l
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I!"ia %am)le
D i i
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De)re'iatio! $@,:/0
738 BV@> 60,000 60,00070.60 0.@6
0.608" $2,-10
Eote alva%e value " U>?@@@ is not used 'y4AC5 and B;H" @
;#CRS Re'o*er Perio"
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;#CRS Re'o*er Perio"Re'o*er )erio" 7!8 is function ofproperty class
T(o sstems for determinin% recovery period=
eral "e)re'iatio! sstem 7GDS8 fastest (riteo& allo(e"
alter!ati*e "e)re'iatio! sstem 7#DS8 lo!+er re'o*er
uses SLIRS )u3li'atio! /1 %ives n values for an asset. *or example= ;#CRS! *alue
#sset "es'ri)tio! GDS #DS ra!+e
pecial manufacturin% devices? race&orses? tractors @@ 2
Computers? oil drillin% equipment? autos? trucks? 'uses 21 .2
6Vce furniture? railroad car? )ro)ert !ot i! a!other 'lass -0 2
+onresidential real property (not land itself) @/0
Qnit-of-roduction (Q6)
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/epreciation/epreciation 'ased on usage of equipment? not
time
/epreciation for year t o'tained 'y relation
/t" (B )
Example= A ne$ mixer is expected to process J million yd2ofconcrete over0@-year life time. /etermine depreciation for year 0 $&en
J@@?@@@ yd2 is processed. Cost of mixer $as U01>?@@@ $it& no
salva%e expected.
olution= /0" (01>?@@@ @) " U01?>@@
a'tual usa+e for eart
e%)e'te" total lifetimeusa+e
/00,000/,000,000
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%am)le Cost a!" Per'e!ta+e
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) +De)letio!A mine purc&ased for U2.> million &as a total expectedyield of one million ounces of silver. /etermine t&edepletion c&ar%e in year J $&en 2@@?@@@ ounces aremined and sold for U2@ per ounce usin% (a) cost depletion?and (') percenta%e depletion. (c) 8&ic& is lar%er for yearJP
Solutio! 9et depletion amounts equal C/AJand /AJ
or? C/J" 2?>@@?@@@D 0?@@@?@@@ " U2.>@ per ounce
CD#/" 2.>@(2@@?@@@) " $,020,000
738 ercenta%e depletion rate for silver mines is @.0>
PD#/" (@.0>)(2@@?@@@)(2@) " $,@20,000
)er'e!ta+e "e)letio! amount? provided it is W >@ of T
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4arket tructures and
Competition
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8LAT A C64ETT;E
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8LAT A C64ETT;E4A5RETP
As a result of its c&aracteristics? t&eperfectly competitive market &as t&efollo$in% outcomes=
T&e actions of any sin%le 'uyer or sellerin t&e market &ave a ne%li%i'le impacton t&e market price.
Eac& 'uyer and seller takes t&e marketprice as %iven.
8LAT A C64ETT;E
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8LAT A C64ETT;E4A5RETP
A competitive market &as many'uyers and sellers tradin% identicalproducts so t&at eac& 'uyer and
seller is a price taker. Buyers and sellers must accept t&e price
determined 'y t&e market.
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T&e 5evenue of a Competitive *irm
Average revenue tells us &o$ muc&revenue a :rm receives for t&etypical unit sold.
Avera%e revenue is total revenuedivided 'y t&e quantity sold.
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T&e 5evenue of a Competitive *irm
n perfect competition?avera%erevenue equals t&e price of t&e %ood.
1 - e r a % e R e - e n ' e = T o t a ! r e - e n ' e
; ' a n t i t y
P r i c e ; ' a n t i t y
; ' a n t i t y
P r i c e
=
=
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T&e 5evenue of a Competitive *irm
Marginal revenue is t&e c&an%e intotal revenue from an additional unitsold.
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T&e 5evenue of a Competitive *irm
*or competitive :rms? mar%inalrevenue equals t&e price of t&e %ood.
Ta'le 0 Total? Avera%e? and 4ar%inal 5evenuefor a Competitive *irm
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for a Competitive *irm
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56*T 4AX4YAT6+ A+/ TLE
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56*T 4AX4YAT6+ A+/ TLEC64ETT;E *54 Q9 CQ5;E
T&e %oal of a competitive :rm is tomaximie pro:t.
T&is means t&at t&e :rm $ill $ant to
produce t&e quantity t&at maximiest&e dierence !et"een total revenueand total cost.
Ta'le < ro:t 4aximiation= A +umericalExample
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Example
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*i%ure 0 ro:t 4aximiation for a Competitive *irm
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Quantity+
Costs
and
Revenue
MC
ATC
AVC
MC1
Q1
MC
Q
The firm ma,imies
profit b( producingthe uantit( at whichmarginal cost eualsmarginal re/enue.
Q*A0
P MR1 MR P AR MR
56*T 4AX4YAT6+ A+/ TLE
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56*T 4AX4YAT6+ A+/ TLEC64ETT;E *54 Q9 CQ5;E
ro:t maximiation occurs at t&equantity $&ere marginal revenueequals marginal cost.
56*T 4AX4YAT6+ A+/ TLE
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56*T 4AX4YAT6+ A+/ TLEC64ETT;E *54 Q9 CQ5;E
Jhe!MR > MC in'reaseQ
Jhe!MR < MC de'reaseQ
Jhe!MR = MC ProHt isma%imi9e".
*i%ure < 4ar%inal Cost as t&e Competitive *irmsupply Curve
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pp y
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Quantity+
Price
MC
ATC
AVC
P1
Q1
P
Q
This section of thefirm2s MCcur/e isalso the firm2s suppl(cur/e.
T&e *irms &ort-5un /ecision to &ut
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T&e *irm s &ort 5un /ecision to &ut/o$n
A s#utdo"nrefers to a s&ort-rundecision not to produce anyt&in%durin% a speci:c period of time
'ecause of current marketconditions.
$%itrefers to a lon%-run decision to
leave t&e market.
T&e *irms &ort-5un /ecision to &ut
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T&e *irm s &ort 5un /ecision to &ut/o$n
T&e :rm considers its sunk costs$&en decidin% to exit? 'ut i%norest&em $&en decidin% $&et&er to s&ut
do$n. &unk costs are costs t&at &ave already
'een committed and cannot 'erecovered.
T&e *irms &ort-5un /ecision to &ut
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T&e *irm s &ort 5un /ecision to &ut/o$n
T&e :rm s&uts do$n if t&e revenue it%ets from producin% is less t&an t&evaria'le cost of production.
&ut do$n ifTR ' C &ut do$n ifTRQ ' CQ
&ut do$n ifP ' AC
*i%ure 2 T&e Competitive *irms &ort 5un upplyCurve
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MC
Quantity
ATC
AVC
+
Costs
Firmshuts
down if
P3AVC
Firm2s short-runsuppl( cur/e
4f P5AVC,firm willcontinue to producein the short run.
4f P5ATC6 the firmwill continue toproduce at a profit.
T&e *irms &ort-5un /ecision to &ut
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T&e *irm s &ort 5un /ecision to &ut/o$n
T&e portion of t&e mar%inal-costcurve t&at lies a'ove avera%evaria'le cost is t&e competitive :rms
s#ort*run supply curve.
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T&e *irms 9on%-5un /ecision to Exit or
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T&e *irm s 9on% 5un /ecision to Exit orEnter a 4arket
A :rm $ill enter t&e industry if suc&an action $ould 'e pro:ta'le. Enter ifTR + TC
Enter ifTRQ + TCQ Enter ifP + ATC
*i%ure J T&e Competitive *irms 9on%-5un upplyCurve
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MC = long-run S
Firme,its if
P 3ATC
Quantity
ATC
+
Costs
Firm2s long-runsuppl( cur/e
Firmenters ifP 5ATC
TLE Q9 CQ5;E + A
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C64ETT;E 4A5RET
T&e competitive :rms lon%-runsupply curve is t&e portion of itsmar%inal-cost curve t&at lies a'ove
avera%e total cost.
*i%ure J T&e Competitive *irms 9on%-5un upplyCurve
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MC
Quantity
ATC
+
Costs
Firm2s long-runsuppl( cur/e
TLE Q9 CQ5;E + A
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C64ETT;E 4A5RET
&ort-5un upply CurveT&e portion of its mar%inal cost curve
t&at lies a'ove avera%e varia'le cost.
9on%-5un upply CurveT&e mar%inal cost curve a'ove t&e
minimum point of its avera%e total costcurve.
*i%ure > ro:t as t&e Area 'et$een rice andAvera%e Total Cost
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(a) A ir! "ith Pro#its
Quantity+
Price
P AR MR
ATCMC
P
ATC
Q
7profit-ma,imiing uantit(8
"rofit
*i%ure > ro:t as t&e Area 'et$een rice andAvera%e Total Cost
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($) A ir! "ith %osses
Quantity+
Price
ATCMC
7loss-minimiing uantit(8
P AR MRP
ATC
Q
Loss
TLE Q9 CQ5;E + A
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C64ETT;E 4A5RET
4arket supply equals t&e sum of t&equantities supplied 'y t&e individual:rms in t&e market.
T&e &ort 5un= 4arket upply $it& a
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pp y*ixed +um'er of *irms
*or any %iven price? eac& :rmsupplies a quantity of output so t&atits mar%inal cost equals price.
T&e market supply curve re,ects t&eindividual :rms mar%inal costcurves.
*i%ure H 4arket upply $it& a *ixed +um'er of *irms
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(a) &ndividua' ir! Supp'y
Quantity (#ir!)+
Price
MC
1.++
1++
9.++
++
($) aret Supp'y
Quantity (!aret)+
Price
Suppl(
1.++
1++6+++
9.++
++6+++
T&e 9on% 5un= 4arket upply $it&
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% pp yEntry and Exit
*irms $ill enter or exit t&e marketuntil pro:t is driven to ero.
n t&e lon% run? price equals t&e
minimum of avera%e total cost. T&e lon%-run market supply curve is
&oriontal at t&is price.
*i%ure 1 4arket upply $it& Entry and Exit
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(a) ir!*s +ero-Pro#it Condition
Quantity (#ir!)+
Price
($) aret Supp'y
Quantity (!aret)
Price
+
P minimumATC
Suppl(
MC
ATC
T&e 9on% 5un= 4arket upply $it&
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Entry and Exit
At t&e end of t&e process of entryand exit? :rms t&at remain must 'emakin% ero economic pro:t.
T&e process of entry and exit endsonly $&en price and avera%e totalcost are driven to equality.
9on%-run equili'rium must &ave :rmsoperatin% at t&eir eVcient scale.
8&y /o Competitive *irms tay in
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Business f T&ey 4ake Yero ro:tP
ro:t equals total revenue minustotal cost.
Total cost includes all t&e opportunity
costs of t&e :rm. n t&e ero-pro:t equili'rium? t&e
:rms revenue compensates t&e
o$ners for t&e time and money t&eyexpend to keep t&e 'usiness %oin%.
A &ift in /emand in t&e &ort 5un and
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9on% 5un
An increase in demand raises priceand quantity in t&e s&ort run.
*irms earn pro:ts 'ecause price no$
exceeds avera%e total cost.
*i%ure An ncrease in /emand in t&e &ort 5unand 9on% 5un
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ir!
(a) &nitia' Condition
Quantity (#ir!)+
Price
aret
Quantity (!aret)
Price
+
D$emand6 1
SShort-run suppl(6 1
P1
ATC
Long-runsuppl(
P1
1Q
A
MC
*i%ure An ncrease in /emand in t&e &ort 5unand 9on% 5un
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aretir!
($) Short-Run Response
Quantity (#ir!)+
Price
MC ATC"rofit
P1
Quantity (!aret)
Long-runsuppl(
Price
+
D1
D
P1
S1
P
Q1
A
Q
P %
*i%ure An ncrease in /emand in t&e &ort 5unand 9on% 5un
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P1
ir!
(c) %ong-Run Response
Quantity (#ir!)+
Price
MC ATC
aret
Quantity (!aret)
Price
+
P1
P
Q1 Q
Long-runsuppl(
%
D1
D
S1
A
S
Q#
8&y t&e 9on%-5un upply Curve 4i%&t
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lope Qp$ard
ome resources used in productionmay 'e availa'le only in limitedquantities.
*irms may &ave di3erent costs.
8&y t&e 9on%-5un upply Curve 4i%&t
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lope Qp$ard
4ar%inal *irmT&e marginal ,rmis t&e :rm t&at $ould
exit t&e market if t&e price $ere any
lo$er.
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4onopoly
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8&ile a competitive :rm is apricetaker? a monopoly :rm is apricemaker.
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A :rm is considered a monopolyif . . . it is t&e sole seller of its product.
its product does not &ave closesu'stitutes.
8L 46+669E A5E
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8L 46+669E A5E
T&e fundamental cause of monopolyis !arriers to entry.
8L 46+669E A5E
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8L 46+669E A5E
Barriers to entry &ave t&ree sources= 6$ners&ip of a key resource.
T&e %overnment %ives a sin%le :rm t&e
exclusive ri%&t to produce some %ood. Costs of production make a sin%le
producer more eVcient t&an a lar%enum'er of producers.
4onopoly 5esources
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4onopoly 5esources
Alt&ou%& exclusive o$ners&ip of akey resource is a potential source ofmonopoly? in practice monopolies
rarely arise for t&is reason.
!overnment-Created 4onopolies
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!overnment Created 4onopolies
!overnments may restrict entry 'y%ivin% a sin%le :rm t&e exclusiveri%&t to sell a particular %ood in
certain markets.
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+atural 4onopolies
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+atural 4onopolies
An industry is a natural monopoly$&en a sin%le :rm can supply a %oodor service to an entire market at a
smaller cost t&an could t$o or more:rms.
+atural 4onopolies
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a u a o opo es
A natural monopolyarises $&ent&ere are economies of scale overt&e relevant ran%e of output.
*i%ure 0 Economies of cale as a Cause of 4onopoly
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Quantity o# ,utput
A/erage
total
cost
+
Cost
L68 46+669E 4ARE 56/QCT6+A+/ 5C+! /EC6+
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A+/ 5C+! /EC6+
4onopoly versus Competition 4onopoly
s t&e sole producer
*aces a do$n$ard-slopin% demand curve
s a price maker
5educes price to increase sales
Competitive *irm s one of many producers
*aces a &oriontal demand curve
s a price taker
ells as muc& or as little at same price
*i%ure < /emand Curves for Competitive and4onopoly *irms
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Quantity o# ,utput
$emand
(a) A Co!petitive ir!*s e!and Curve ($) A onopo'ist*s e!and Curve
+
Price
Quantity o# ,utput+
Price
$emand
A 4onopolys 5evenue
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p y
Total 5evenueP Q = TR
Avera%e 5evenue
TRQ = AR = P
4ar%inal 5evenue
TRQ = MR
Ta'le 0 A 4onopolys Total? Avera%e?and 4ar%inal 5evenue
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A 4onopolys 5evenue
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p y
A 4onopolys 4ar%inal 5evenue A monopolists mar%inal revenue is
al$ays less t#ant&e price of its %ood.
T&e demand curve is do$n$ard slopin%. 8&en a monopoly drops t&e price to sell onemore unit? t&e revenue received frompreviously sold units also decreases.
A 4onopolys 5evenue
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p y
A 4onopolys 4ar%inal 5evenue 8&en a monopoly increases t&e amount
it sells? it &as t$o e3ects on total
revenue (P
Q).T&e output e3ectSmore output is sold? so Qis &i%&er.
T&e price e3ectSprice falls? so Pis lo$er.
*i%ure 2 /emand and 4ar%inal-5evenue Curves fora 4onopoly
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Quantity o# Water
Price
9111+
;
?
&
#
1
+1
#
&
$emand
7a/erage
re/enue8
*arginal
re/enue
1 # & ? > = An Advertisin% !ame
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Copyright2001 South"esternho!son %earning
ar'$oro* s ecision
Advertise
Advertise
*arlboro gets 9#billion profit
amel gets 9#billion profit
amel gets 9?billion profit
*arlboro gets 9billion profit
amel gets 9
billion profit
*arlboro gets 9?billion profit
amel gets 9&
billion profit
*arlboro gets 9&billion profit
on*t Advertise
on*t
Advertise
Ca!e'*s
ecision
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8&y eople ometimes Cooperate
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*irms t&at care a'out future pro:ts$ill cooperate in repeated %amesrat&er t&an c&eatin% in a sin%le %ame
to ac&ieve a one-time %ain.
*i%ure 1 \ack and \ill 6li%opoly !ame
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:ac*s ecision
Se'' 40
;a''ons
Se'' 40 ;a''ons
Gac) gets
916>++ profit
Gill gets916>++ profit
Gill gets96+++ profit
Gac) gets
916?++ profit
Gill gets
916?++ profit
Gac) gets
96+++ profit
Gill gets
916
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Cooperation amon% oli%opolists isundesira'le from t&e standpoint ofsociety as a $&ole 'ecause it leads
toproduction t#at is too lo"andprices t#at are too #ig#.
5estraint of Trade and t&e Antitrust9a$s
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Antitrust la$s make it ille%al torestrain trade or attempt tomonopolie a market.
&erman Antitrust Act of 0G@ Clayton Act of 0G0J
Controversies over Antitrust olicy
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Antitrust policies sometimes may notallo$ 'usiness practices t&at &avepotentially positive e3ects=
5esale price maintenance redatory pricin%
Tyin%
Controversies over Antitrust olicy
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5esale rice 4aintenance (or fair trade) occurs $&en suppliers (like $&olesalers) requireretailers to c&ar%e a speci:c amount
redatory ricin%
occurs $&en a lar%e :rm 'e%ins to cut t&e priceof its product(s) $it& t&e intent of drivin% itscompetitor(s) out of t&e market
Tyin%
$&en a :rm o3ers t$o (or more) of its productsto%et&er at a sin%le price? rat&er t&an separately
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4onopolistic Competition
4onopolistic Competition
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mperfect competition refers to t&osemarket structures t&at fall 'et$eenperfect competition and puremonopoly.
T&e *our Types of 4arket tructure
.u!$er o# ir!s/
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Tap water able T
*onopol(7hapter 1?8
Do/els *o/ies
*onopolisticompetition7hapter 1=8
Tennis balls rude oil
Eligopol(7hapter 1>8
"erfect
heat *il)
ompetition7hapter 1&8
ype o# Products/
4denticalproducts$ifferentiatedproductsEnefirm Fewfirms
*an(firms
4onopolistic Competition
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Types of mperfectly Competitive4arkets Monopolistic Competition
4any :rms sellin% products t&at are similar'ut not identical.
6li%opoly 6nly a fe$ sellers? eac& o3erin% a similar or
identical product to t&e ot&ers.
4onopolistic Competition
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4arkets t&at &ave some features ofcompetition and some features ofmonopoly.
4onopolistic Competition
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Attri'utes of 4onopolisticCompetition 4any sellers
roduct di3erentiation *ree entry and exit
4onopolistic Competition
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4any ellersT&ere are many :rms competin% for t&e
same %roup of customers. roduct examples include 'ooks? C/s?
movies? computer %ames? restaurants? pianolessons? cookies? furniture? etc.
4onopolistic Competition
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roduct /i3erentiation Eac& :rm produces a product t&at is at
least slig#tly dierentfrom t&ose ofot&er :rms.
5at&er t&an 'ein% a price taker? eac&:rm faces a do"n"ard*sloping demandcurve.
4onopolistic Competition
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*ree Entry or Exit *irms can enter or exit t&e market
$it&out restriction.
T&e num'er of :rms in t&e marketad7usts until economic pro:ts areero.
C64ETT6+ 8TL
/**E5E+TATE/ 56/QCT
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T&e 4onopolistically Competitive*irm in t&e &ort 5un &ort-run economic pro:ts encoura%e
ne$ :rms to enter t#e market. T&is= ncreases t&e num'er of products o3ered.
5educes demand faced 'y :rms already int&e market.
ncum'ent :rms demand curves s&ift to t&eleft.
/emand for t&e incum'ent :rms productsfall? and t&eir pro:ts decline.
*i%ure 0 4onopolistic Competition in t&e &ort 5un
(a) ir! aes Pro#it
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Quantity+
Price
"rofit-ma,imiing
uantit(
"rice
$emand
MR
ATC
A/eragetotal cost
"rofit
MC
C64ETT6+ 8TL
/**E5E+TATE/ 56/QCT
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T&e 4onopolistically Competitive*irm in t&e &ort 5un &ort-run economic losses encoura%e
:rms to e%it t#e market. T&is= /ecreases t&e num'er of products o3ered.
ncreases demand faced 'y t&e remainin%:rms.
&ifts t&e remainin% :rms demand curvesto t&e ri%&t.
ncreases t&e remainin% :rms pro:ts.
*i%ure 0 4onopolistic Competitors in t&e &ort 5un
($) ir! aes %osses
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$emand
Quantity+
Price
"rice
Loss-minimiing
uantit(
A/eragetotal cost
MR
LossesATC
MC
T&e 9on%-5un Equili'rium
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*irms $ill enter and exit until t&e:rms are makin% exactly eroeconomic pro:ts.
*i%ure < A 4onopolistic Competitor in t&e 9on% 5un
Price
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Quantity+
$emandMR
ATCMC
"rofit-ma,imiing
uantit(
PATC
9on%-5un Equili'rium
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T$o C&aracteristics As in a monopoly? price exceeds
mar%inal cost. ro:t maximiation requires mar%inal
revenue to equal mar%inal cost.T&e do$n$ard-slopin% demand curve makes
mar%inal revenue less t&an price.
As in a competitive market? price equalsavera%e total cost.
*ree entry and exit drive economic pro:t toero.
4onopolistic versus erfectCompetition
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T&ere are t$o note$ort&y di3erences'et$een monopolistic and perfectcompetitionSexcess capacity andmarkup.
4onopolistic versus erfectCompetition
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Excess CapacityT&ere is no excess capacity in perfectcompetition in t&e lon% run.
*ree entry results in competitive :rms
producin% at t&e point $&ere avera%e totalcost is minimied? $&ic& is t&e eVcient scaleof t&e :rm.
T&ere is excess capacity in monopolisticcompetition in t&e lon% run.
n monopolistic competition? output is lesst&an t&e eVcient scale of perfect competition.
*i%ure 2 4onopolistic versus erfect Competition
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Quantity+
Price
$emand
(a) onopo'istica''y Co!petitive ir!
Quantity+
Price
P MC P MR7demand
cur/e8
($) Per#ect'y Co!petitive ir!
MCATC
MCATC
MR
@fficientscale
P
Cuantit(produced Cuantit( produced @fficient scale
4onopolistic versus erfectCompetition
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4arkup 6ver 4ar%inal Cost *or a competitive :rm? price equals
mar%inal cost.
*or a monopolistically competitive :rm?price exceeds mar%inal cost.
Because price exceeds mar%inal cost? anextra unit sold at t&e posted price
means more pro:t for t&emonopolistically competitive :rm.
*i%ure 2 4onopolistic versus erfect Competition
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Quantity+
Price
$emand
(a) onopo'istica''y Co!petitive ir!
Quantity+
Price
P MC P MR7demand
cur/e8
($) Per#ect'y Co!petitive ir!
*ar)up
MCATC
MCATC
MR
*arginalcost
P
Cuantit(produced Cuantit( produced
*i%ure 2 4onopolistic versus erfect Competition
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Price
$emand
(a) onopo'istica''y Co!petitive ir!
Price
P MC P MR7demand
cur/e8
($) Per#ect'y Co!petitive ir!
*ar)up
MCATC
MCATC
MR
*arginalcost
P