Dominick Salvatore Schaums Outline of Microeconomics, 4th edition Schaums Outline Series 2006

CHAP. 11] RECENT AND ADVANCED TOPICS IN MARKET STRUCTURE 263
other firms can enter the industry and face exactly the same costs as existing firms) and exit is “entirely costless”
(i.e., if there are no sunk costs so that the firm can exit the industry without any loss of capital) in this case, the
market is said to be contestable. Actual competition is then less important than potential competition and the
firm or firms will charge a price that only covers average cost (and earn zero economic profit).
EXAMPLE 3 In Fig 11-1, D is the market demand curve and SAC and SMC are the short-run average and marginal cost
curves, respectively, of each of two identical firms in a contestable market. Each firm will sell 60 units of output at
P ¼ SAC ¼ SMC ¼ $6 (point E in the figure) and behave as a perfect competitor facing horizontal demand curve AEE 0
and earn zero economic profit. Any higher price invites “hit-and-run” entrants that would quickly eliminate all profits.
Fig. 11-1
11.4 PEAK-LOAD PRICING
The demand for some services, such as electricity, is higher during some periods (such as in the evening
and in the summer) than at other times. Electricity is also a nonstorable service (i.e., it must be generated when
needed). In order to satisfy peak demand, electrical power companies must bring into operation older and less
efficient equipment and thus incur higher costs during peak periods. According to peak-load pricing, consumer
welfare will be higher if power companies charge a price equal to short-run marginal cost, both during peak
periods when demand and marginal cost are higher and during off-peak periods when demand and marginal
cost are lower, rather than charging a constant price equal to the average cost for both periods combined.
EXAMPLE 4. Figure 11-2 shows that at the constant price of 4¢ kilowatt-hour, the public utility sells 4 million kilowatthours
(kWh) of electricity (point A 1 on D 1 ) during the off-peak period and 8 million kWh during the peak period (point A 2 on
D 2 ). But at A 1 , P . SMC, while at A 2 , P , SMC. With peak-load pricing, P ¼ SMC ¼ 3¢ (point E 1 ) in the off-peak period
and P ¼ SMC ¼ 5¢ (point E 2 ) in the peak period. The gain in consumer welfare is thus given by the sum of the two shaded
triangles.
Fig. 11-2