Microeconomics Study Notes: Public Goods, Production & Cost, Perfect Competition, and Monopoly

Public Choices, Public Goods, and Common Resources

Types of Goods: Rivalry and Excludability

Goods can be classified based on whether consumption by one person reduces availability for others (rivalry) and whether people can be prevented from using them (excludability).

• Private Goods: Rival and excludable (e.g., a sandwich).

• Club Goods: Non-rival and excludable (e.g., subscription TV).

• Common Resources: Rival and non-excludable (e.g., fish in the ocean).

• Public Goods: Non-rival and non-excludable (e.g., national defense).

Market Failure and Public Goods

• Public goods are underprovided by private markets due to the free rider problem—individuals benefit without paying, making exclusion difficult.

• Efficient provision of a public good occurs where marginal social benefit (MSB) equals marginal social cost (MSC).

• To find the market demand for a public good, individual marginal benefit curves are added vertically.

Common Resources and the Tragedy of the Commons

• Common resources tend to be overused because individuals do not consider the external cost imposed on others.

• Tragedy of the Commons: Overuse or depletion of a common resource due to rivalry and non-excludability (e.g., overfishing).

Production and Cost

Types of Costs

• Explicit Costs: Out-of-pocket payments by the firm (e.g., wages, rent).

• Implicit Costs: Opportunity costs of using resources owned by the firm (e.g., owner's time, capital).

• Accounting Cost = Explicit Cost

• Economic Cost = Explicit Cost + Implicit Cost

Profit Concepts

• Accounting Profit = Total Revenue − Accounting Cost

• Economic Profit = Total Revenue − Economic Cost

Short Run vs. Long Run

• Short Run: At least one input is fixed.

• Long Run: All inputs are variable.

Product Measures

• Total Product (TP): Total output produced.

• Marginal Product (MP): Additional output from one more unit of the variable input.

• Average Product (AP): Total product divided by the quantity of the variable input.

Diminishing Marginal Product

• As more units of a variable input are added to fixed inputs, marginal product eventually falls (Law of Diminishing Returns).

• MP intersects AP at the maximum point of AP.

Cost Measures and Formulas

• Total Cost (TC) = Total Fixed Cost (TFC) + Total Variable Cost (TVC)

• Average Fixed Cost (AFC) = TFC / Q

• Average Variable Cost (AVC) = TVC / Q

• Average Total Cost (ATC) = TC / Q = AFC + AVC

• Marginal Cost (MC): The increase in total cost from producing one more unit of output.

$TC = TFC + TVC$

$AFC = \frac{TFC}{Q}$

$AVC = \frac{TVC}{Q}$

$ATC = \frac{TC}{Q} = AFC + AVC$

$MC = \frac{\Delta TC}{\Delta Q}$

• MC intersects AVC and ATC at their minimum points.

Long-Run Average Cost

• Reflects economies of scale at lower output levels (cost per unit falls as output increases).

• Reflects diseconomies of scale at higher output levels (cost per unit rises as output increases).

Perfect Competition

Market Structure and Firm Behavior

• Many firms produce a homogeneous product.

• Free entry and exit in the market.

• Perfect information—all buyers and sellers know prices and technology.

• Firms are price takers: The market determines price; individual firms cannot influence it.

Revenue and Profit Maximization

• For a perfectly competitive firm: Demand = Average Revenue (AR) = Marginal Revenue (MR) = Price (P).

• The firm chooses output where MR = MC. Since P = MR, the profit-maximizing rule is P = MC.

$P = MR = MC$

• Economic Profit = (P − ATC) × Q

$\text{Economic Profit} = (P - ATC) \times Q$

Short-Run Outcomes

• Firms may earn profits, zero economic profit, or losses.

• Break-even Point: $P = ATC$ (economic profit is zero).

• Shutdown Condition: In the short run, the firm produces if $P \geq AVC$ and shuts down if $P < AVC$.

• If $AVC < P < ATC$, the firm operates at a loss but covers variable cost and part of fixed cost.

Long-Run Adjustment

• Free entry and exit drive economic profit to zero in the long run; surviving firms earn zero economic profit.

Monopoly

Characteristics of Monopoly

• Single firm produces a good or service with no close substitutes.

• Significant barriers to entry prevent competition.

Demand and Marginal Revenue

• A monopolist faces a downward-sloping demand curve; marginal revenue (MR) lies below demand.

• For a linear demand curve, MR has the same price intercept as demand but is steeper.

Profit Maximization

• The monopolist chooses output where MR = MC, then charges the price on the demand curve at that quantity.

• Compared to perfect competition, monopoly produces a lower quantity and charges a higher price.

Price Discrimination

• Charging different prices to different consumers for the same good, not based on cost differences.

• Increases profit if the firm can separate markets and prevent resale.

Natural Monopoly and Regulation

• Natural Monopoly: One firm can supply the entire market at lower cost than multiple firms due to persistent economies of scale.

• Regulated Marginal Cost Pricing: Regulator sets $P = MC$ (allocatively efficient, but may require subsidy if $MC < ATC$).

• Average Cost Pricing: Regulator sets $P = ATC$ (firm covers all costs, earns zero economic profit, but price is above MC).

• Two-Part Tariff: Consumers pay a fixed fee plus a per-unit price, helping cover fixed costs while keeping per-unit price near MC.

Profit and Loss in Monopoly

• Economic Profit = (P* − ATC*) × Q*

$\text{Economic Profit} = (P^* - ATC^*) \times Q^*$

• Graphically, profit is the rectangle with height $(P^* - ATC^*)$ and width $Q^*$.

• A monopoly can make profits or losses in the short run.

• Shutdown Condition: In the short run, the monopolist operates if $P \geq AVC$ and shuts down if $P < AVC$.

• If losses persist in the long run, the monopolist cannot remain in business indefinitely.

• Because monopoly price exceeds marginal cost, monopoly creates deadweight loss relative to perfect competition.

Comparison Table: Types of Goods

Type of Good	Rival?	Excludable?	Example
Private Good	Yes	Yes	Ice cream cone
Club Good	No	Yes	Subscription TV
Common Resource	Yes	No	Fish in the ocean
Public Good	No	No	National defense

Example: Tragedy of the Commons

• Overfishing in international waters: Each fisher has an incentive to catch as much as possible, leading to depletion of the fish stock.

Example: Monopoly Regulation

• Electric utilities are often natural monopolies. Regulators may set prices at average cost to ensure the firm covers costs but does not earn excess profit.

Additional info: Academic context and examples have been added to clarify definitions and applications.