BENEFIT-COST ANALYSIS: An analytical technique that compares the benefit generated by an activity with its opportunity cost of production. The rule is that if benefits exceed costs, then the activity is efficient and should be undertaken. In some cases the end result of benefit-cost analysis is net benefits, which is benefits minus cost. A positive value means the activity is efficient. In other cases the end result of benefit-cost analysis is a benefit-cost ratio, which is benefits divided by costs. A ratio greater than 1.0 is thus the indication of an efficient activity.
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MONOPOLY, FACTOR MARKET ANALYSIS:
The analysis of a factor market characterized by monopoly indicates that the single seller maximizes profit by equating marginal revenue to marginal cost. This results in a higher price and smaller quantity than achieved with perfect competition. As such, it does not achieve an efficient allocation of resources. Monopoly is combined with monopsony to form a bilateral monopoly market structure. Monopoly is a market characterized by a single firm selling a unique product with few if any close substitutes. Competition is commonly prevented by barriers to entry into the market. These characteristics mean monopoly is a price maker with complete market control. Monopoly is most commonly analyzed in terms of output or product markets in which business firms are the producers and household consumers are the buyers. However, monopoly also can be used to analyze resource or factor markets.
When monopoly is applied to a factor market, the only difference is that the good sold is the services of a factor of production rather than a traditional consumption good. However, the inefficiency found with monopoly rings just as strong with factor markets as with product markets. Monopoly is the poster child for inefficiency, whether it controls a product market or a factor market. The price charged by a monopoly is higher and the quantity exchanged is less than would be had by perfect competition.
Monopoly Cost and RevenueAn example that can illustrate a monopoly factor market is provided by the United Tree Choppers Union. This hypothetical labor union controls the supply-side of the factor market for the tree chopping labor services. If any of the thousands of prospective employers want to hire tree chopping labor services, they must go through the United Tree Choppers Union.
As such, the United Tree Choppers Union is a monopoly seller and a price maker when it comes to selling tree chopping labor services. The Choppers Union can set the quantity of labor services, then charge the price that employers are willing and able to pay.
This diagram displays the market for labor services supplied by the Choppers Union. The vertical axis measures the factor price (wage rate) and the horizontal axis measures the quantity of labor services (number of workers). The key for any monopoly seller like the Choppers Union, is that the demand curve it faces for selling labor is THE market demand curve for the factor.
|Tree Chopping Employment
- Demand: To identify the labor demand curve facing the Choppers Union, click the [Demand]. The resulting curve, labeled D, is negatively sloped, indicating that potential employers are willing to pay a lower wage to increase the quantity hired. More to the point, if the Choppers Union wants to sell more labor services, it must accept a lower wage. This demand curve is also the average revenue curve for the Choppers Union.
- Marginal Revenue: Because the Choppers Union charges a lower wage (average revenue) to sell more labor, marginal revenue is less than average revenue at each level of employment. Marginal revenue is the key bit of information the Choppers Union needs to sell the profit maximizing number of workers. To identify the marginal revenue curve, click the [Marginal Revenue] button. The revealed curve, labeled MR, is also negatively sloped and lies below the demand (average revenue) curve.
- Marginal Cost: The other half of the Choppers Union's profit-maximizing decision is marginal cost. Marginal cost indicates the change in total cost resulting from the employment of one additional worker. A click of the [Marginal Cost] button reveals the Choppers Union's marginal cost curve, labeled MC. This curve is positively-sloped because marginal cost is based on marginal product which declines with extra employment due to of the law of diminishing marginal returns.
Profit Maximizing EmploymentAll of the information needed to identify the quantity of workers that would maximize the Choppers Union's profit (that is, the total income of the union members) is in hand. The profit-maximizing employment is the quantity that equates marginal revenue and marginal cost, which is the intersection of the MR and MC curves. Click the [Profit Max] button to highlight this quantity. The profit-maximizing quantity of employment is 30,000 workers.
Why is this profit maximization?
Once the Choppers Union identifies the profit-maximizing level of labor services to sell, the final step is to determine how much to charge for each worker. This information is found on the market demand curve (D). According to the market demand, a wage of $15 is sufficient for prospective employers to hire 30,000 workers. Because the Choppers Union is a monopoly, it needs to charge no less than this wage.
- Should the Choppers Union sell the services of fewer than 30,000 workers, then marginal revenue is greater than marginal cost. An extra worker generates more revenue for the union than it adds to cost. This increases the Choppers Union's profit. The Choppers Union should sell more labor services if marginal revenue exceeds marginal cost.
- Should the Choppers Union sell the services of more than 30,000 workers, then marginal revenue is less than marginal cost. An extra worker contributes less to revenue for the union than it adds to cost. This decreases the Choppers Union's profit. The Choppers Union should sell fewer labor services if marginal revenue is less than marginal cost.
- Should the Choppers Union sell the services of exactly 30,000 workers, then marginal revenue is equal to marginal cost. An extra worker contributes as much to revenue as to cost. This keeps the Choppers Union's profit constant. The Choppers Union should not change the quantity of labor services sold if marginal revenue is equal to marginal factor.
(In)EfficiencyAs a profit-maximizing monopoly with market control, the United Tree Choppers Union does not achieve an efficient allocation of resources. This results because marginal cost is not equal to the factor price. While the Choppers Union charges a factor price of $15 per hour, marginal cost is $7.50 per hour.
This difference between factor price and marginal cost is a prime indicator of inefficiency. Factor price is the value of the good produced. Marginal cost is the opportunity cost of production, the value of goods not produced. If the two are equal, then the value of the good produced is equal to the value of goods not produced. Society cannot generate more overall satisfaction by producing more or less of the good.
However, for a monopoly like the United Tree Choppers Union, marginal cost is less than factor price. In this case the value of the good produced is greater than the value of goods not produced. Society can generate more overall satisfaction by producing more of the good.
Because profit maximization means marginal revenue is equal to marginal cost, and because marginal revenue is less than factor price, marginal cost is also less than factor price for monopoly. A profit-maximizing monopoly does not, will not, cannot, efficiently allocate resources.
MONOPOLY, FACTOR MARKET ANALYSIS, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: March 4, 2024].
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