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Current time:0:00Total duration:3:41

Marginal revenue and marginal cost in imperfect competition

AP.MICRO:
PRD‑3 (EU)
,
PRD‑3.B (LO)
,
PRD‑3.B.1 (EK)
,
PRD‑3.B.3 (EK)

Video transcript

in this video we're going to think about marginal revenue and marginal cost for a firm in an imperfectly competitive market but before we do that I just want to be able to review and compare to what we already know about a firm in a perfectly competitive market so right over here we're analyzing the firm's economics this shows the marginal cost as a function of quantity and we've talked about this before oftentimes it will trend down initially as you have better specialisation and some efficiencies and then it might start trending up as they're just coordination cost or other costs that make the marginal cost go up and we have talked about this notion that in a perfectly competitive market the firm is a price taker there's going to be some market price let's call this P sub M some price in the market for the good that they are producing there's many producers who are producing this good and they're undifferentiated and there's no barriers to entry and so they just have to be price takers there no matter how many units they produce they're just going to be able to get that same market price so firm in a competitive market that market price defines their marginal revenue curve their marginal revenue curve will essentially just be a horizontal line like this and we've already studied this in previous videos and we talked about that here if this firm was trying to maximize his profit and if it was rational it would produce the quantity where marginal cost is equal to marginal revenue so it would produce this quantity right over here but now let's think about how things are a bit different for a firm an imperfectly competitive market in a previous video we talked about how an imperfectly competitive market there's some differentiation amongst the various players who are competing and so they their market price is a function of quantity if they just produce a bunch of their product the price that again the market is likely to go down so they will have their own firm specific demand curve maybe it looks something like this so that is their demand curve and we also saw in that video that that demand curve essentially the price that they could get at any quantity that that's not going to be the same as a marginal revenue curve if the demand curve is downward sloping like that the marginal revenue curve is likely to be even more downward-sloping so it's going to be look something like this that would be the marginal revenue curve now in this situation what would it be rational for the firm to do well once again it would want to produce the quantity where the marginal cost is equal to the marginal revenue so they would want to produce this quantity right over here but you see something interesting here if they produce at this quantity notice the price that they can get in the market is much higher than that the price that they get in the market is higher than the marginal cost and the marginal revenue at that point and because we see a situation where price is greater than your marginal cost versus in a perfectly competitive market where you see that price is equal to marginal cost that that is the optimal quantity but because you have this gap that people are willing to pay more than that marginal cost but you still aren't going to be able to produce any more because it doesn't make sense from a marginal revenue point of view this gap the difference between the price and the marginal cost at this rational quantity for this firm and an imperfectly competitive market to produce economists would refer to this as an inefficiency inefficiency folks are willing to pay more than that marginal cost but you still have no motivation to produce more because if you produce more even though the price is higher than the marginal cost your marginal revenue is going to be below the marginal cost and so you would be taking a hit in aggregate on those extra units