Econ210 Lecture 7 Slides

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Econ210 Lecture 7 Slides

  1. 1. Introductory Microeconomics<br />Monopoly, or<br />Price Searching<br />
  2. 2. Monopoly<br />Goals of Course:<br />1. Understand how free exchange solves scarcity problem.<br />2. Understand ways in which free exchange fails to solve scarcity problem.<br />Monopoly is market failure.<br />
  3. 3. Competition vs Monopoly<br />The important difference between monopoly and perfect competition<br />The demand curve facing the firm.<br />CompetitionMonopoly<br />P<br />P<br />Firm Demand<br />Firm Demand<br />Q<br />Q<br />
  4. 4. Perfect Competition<br />Supply in competitive markets: the supply curve tells you how much quantity will be supplied at a given price.<br />1. Implication: firms see price, decide how much to produce.<br />2. But aren&apos;t prices set by firms, and not just given to them?<br />P<br />Supply<br />Peq<br />Q<br />Qfirm<br />
  5. 5. Competitive Markets<br />Firms in competitive markets have little to say about the price. <br />They don&apos;t set the price, they accept it; it is given by the market.<br />Perfect competition, characteristics:<br />i. lots of firms<br />ii. identical products (perfect substitutes)<br />iii. no one firm dominates the market, produces a significant portion of output.<br />
  6. 6. Competitive Markets<br />Examples <br />Commodities<br />financial markets <br />PCs<br />certain airline routes (NY to LA)<br />
  7. 7. Competition vs Monopoly<br />Demand faced by a single firm in a competitive market: perfectly elastic demand<br />if he tries to sell at a price higher than the market price, he sells zero.<br />If he sets a lower price, he is not maximizing profits.<br />He is a price taker.<br />Firm<br />Market<br />P<br />P<br />Market Supply<br />PMKT<br />PMKT<br />Firm Demand<br />Market Demand<br />Q<br />Q<br />
  8. 8. Competitive Markets<br /><ul><li>Consequences of Price Taking</li></ul>P<br />Firm Supply Decision<br />PMKT<br />D<br />Q<br />
  9. 9. Competitive Markets<br /><ul><li>Consequences of Price Taking
  10. 10. The decision to produce one more:
  11. 11. MB = P </li></ul>P<br />Firm Supply Decision<br />PMKT<br />D<br />Q<br />Q+1<br />Q<br />
  12. 12. Competitive Markets<br /><ul><li>Consequences of Price Taking
  13. 13. The decision to produce one more:
  14. 14. MB = P
  15. 15. Ex. Say P=100</li></ul>P<br />Firm Supply Decision<br />100<br />D<br />Q<br />
  16. 16. Competitive Markets<br /><ul><li>Consequences of Price Taking
  17. 17. The decision to produce one more:
  18. 18. MB = P
  19. 19. Ex. Say P=100
  20. 20. Q=10, R=1000</li></ul>P<br />Firm Supply Decision<br />100<br />D<br />R=1000<br />Q<br />10<br />
  21. 21. Competitive Markets<br /><ul><li>Consequences of Price Taking
  22. 22. The decision to produce one more:
  23. 23. MB = P
  24. 24. Ex. Say P=100
  25. 25. Q=10, R=1000
  26. 26. Q=11, R=1100</li></ul>P<br />Firm Supply Decision<br />100<br />D<br />R = 1100<br />Q<br />11<br />10<br />
  27. 27. Competitive Markets<br /><ul><li>Consequences of Price Taking
  28. 28. The decision to produce one more:
  29. 29. MB = P
  30. 30. Ex. Say P=100
  31. 31. Q=10, R=1000
  32. 32. Q=11, R=1100
  33. 33. MB=P=100</li></ul>P<br />Firm Supply Decision<br />MB = 100<br />100<br />D,MB<br />Q<br />11<br />10<br />
  34. 34. Competitive Markets<br /><ul><li>Marginal Analysis
  35. 35. Produce every unit for which
  36. 36. Stop when MB=MC
  37. 37. MB=P=MC
  38. 38. Supply curve is MC curve</li></ul>P<br />Firm Supply Decision<br />MC=S<br />PMKT<br />D,MB<br />Q<br />QS<br />MB=MC<br />
  39. 39. Competitive Markets<br />Consequence of Price Taking behavior<br />P=MC for each firm<br />P=MC for market <br />P=Marginal value to consumers<br />Optimal solution to scarcity problem:<br />Each unit for which MB&gt;MC is produced<br />P<br />Supply=MC<br />PMKT<br />Demand=MB<br />Q<br />QMKT<br />
  40. 40. Definitions<br />Fact: Coca-Cola’s share of the Italian Soft-drink market = 80%<br />Q: Is Coca-Cola a Monopoly in Italy?<br />A) Yes B) No<br />
  41. 41. Definitions<br />Fact: Coca-Cola’s share of the Italian Soft-drink market = 80%<br />
  42. 42. Definitions<br />Fact: Coca-Cola’s share of the Italian Soft-drink market = 80%<br />Fact: Coca-cola’s share of the beverage market in Italy is 10%<br />
  43. 43. Definitions<br />Fact: Coca-Cola’s share of the Italian Soft-drink market = 80%<br />Fact: Coca-cola’s share of the beverage market in Italy is 10%<br />Fact: Coca-cola’s share of sales of all products in Italy is &lt; .1%<br />
  44. 44. Definitions<br />Fact: Coca-Cola’s share of the Italian Soft-drink market = 80%<br />Fact: Coca-cola’s share of the beverage market in Italy is 10%<br />Fact: Coca-cola’s share of sales of all products in Italy is &lt; .1%<br />Q: Is Coca-Cola a Monopoly in Italy?<br />A) Yes B) No<br />
  45. 45. Definitions<br />Monopoly - only producer of a good.<br />ambiguous: depends on how the market is defined (soft drinks or all beverages).<br />How should market be defined?<br />In terms of relevant substitutes<br />What really matters is elasticity of Demand<br />
  46. 46. Definitions<br />Firm Demand<br />A more Useful Definition: Market Power<br />More inelastic demand  more market power.<br />What really matters: how many substitutes there are for a firm&apos;s product<br />P<br />D4<br />D1 to D4: Decreasing Market Power<br />D3<br />D1<br />D2<br />Q<br />
  47. 47. Market Power<br />How much market power does Coca-cola have?<br />Elasticity of demand =<br />A) -.1<br />B) -.5<br />C) -1<br />D) -2<br />E) -9<br />
  48. 48. Market power does not depend on supply being fixed. It is a demand concept.<br />P<br />P<br />Supply<br />This does<br />This does not give you market power<br />Demand<br />Q<br />Q<br />
  49. 49. Price Taker vs Price Searcher<br />When is a firm not a Price Taker?<br />When they face less than perfectly elastic demand<br />when there are not perfect substitutes for their product. <br />P<br />P0<br />P1<br />Firm Demand<br />Q1<br />Q0<br />Q<br />
  50. 50. Price Searcher<br />Why Price Searcher, instead of Price Setter?<br />Firms with market power are always searching for the best price.<br />Their information is imperfect<br />
  51. 51. Market Power<br />Sources of Market Power:<br />Exclusive Control over inputs <br />Patents, copyrights<br />Government licenses, franchises<br />Economies of Scale<br />Network economies<br />
  52. 52. Market Power<br /><ul><li>Consequences of Market Power (single price)
  53. 53. The decision to produce one more:
  54. 54. Downward sloping demand
  55. 55. To produce one more, must lower price to everyone</li></ul>Firm Supply Decision<br />P<br />P0<br />Revenue<br />D<br />Q<br />Q0<br />
  56. 56. Market Power<br /><ul><li>Consequences of Market Power (single price)
  57. 57. The decision to produce one more:
  58. 58. Downward sloping demand
  59. 59. To produce one more, must lower price to everyone</li></ul>Firm Supply Decision<br />P<br />P0<br />P1<br />Revenue<br />D<br />Q<br />Q0<br />Q0+1<br />
  60. 60. Market Power<br /><ul><li>Consequences of Market Power (single price)
  61. 61. The decision to produce one more:
  62. 62. Downward sloping demand
  63. 63. To produce one more, must lower price to everyone
  64. 64. MB=C-A < P1</li></ul>Firm Supply Decision<br />P<br />Revenue at Q0: A+B<br />Revenue at Q1 : B+C<br />P0<br />A<br />P1<br />B<br />C<br />D<br />Q<br />Q0<br />Q0+1<br />
  65. 65. Market Power<br /><ul><li>Consequences of Market Power (example)
  66. 66. To sell 10, P=100, R=1000</li></ul>Firm Supply Decision<br />P<br />100<br />R=1000<br />D<br />Q<br />10<br />
  67. 67. Market Power<br /><ul><li>Consequences of Market Power (example)
  68. 68. To sell 10, P=100, R=1000
  69. 69. To sell 11, P=99, R=1089</li></ul>Firm Supply Decision<br />P<br />100<br />99<br />R=1089<br />D<br />Q<br />10<br />11<br />
  70. 70. Market Power<br /><ul><li>Consequences of Market Power (example)
  71. 71. To sell 10, P=100, R=1000
  72. 72. To sell 11, P=99, R=1089
  73. 73. MB=89<P=99
  74. 74.  MB<P</li></ul>Firm Supply Decision<br />P<br />Lost revenue<br />100<br />Gained revenue<br />-10<br />99<br />+99<br />D<br />Q<br />10<br />11<br />
  75. 75. Market Power<br />Firm Supply Decision<br />Marginal analysis:<br />P<br />D<br />Q<br />
  76. 76. Market Power<br />Firm Supply Decision<br />Marginal analysis:<br /><ul><li>MB<P</li></ul>P<br />D<br />MB<br />Q<br />
  77. 77. Market Power<br />Firm Supply Decision<br />Marginal analysis:<br /><ul><li>MB<P
  78. 78. MC upward sloping</li></ul>P<br />MC<br />D<br />MB<br />Q<br />
  79. 79. Market Power<br />Firm Supply Decision<br />Marginal analysis:<br /><ul><li>MB<P
  80. 80. MC upward sloping
  81. 81. Produce every unit for which </li></ul>P<br />MC<br />D<br />MB<br />Q<br />
  82. 82. Market Power<br />Firm Supply Decision<br />Marginal analysis:<br /><ul><li>MB<P
  83. 83. MC upward sloping
  84. 84. Produce every unit for which
  85. 85. Stop when MB=MC</li></ul>P<br />MC<br />D<br />MB<br />Q<br />QM<br />MB=MC<br />
  86. 86. Market Power<br />Firm Supply Decision<br />Marginal analysis:<br /><ul><li>MB<P
  87. 87. MC upward sloping
  88. 88. Produce every unit for which
  89. 89. Stop when MB=MC
  90. 90. Price off of demand curve:</li></ul>P<br />MC<br />PM<br />D<br />MB<br />Q<br />QM<br />MB=MC<br />
  91. 91. Market Power<br />Firm Supply Decision<br />Marginal analysis:<br /><ul><li>MB<P
  92. 92. MC upward sloping
  93. 93. Produce every unit for which
  94. 94. Stop when MB=MC
  95. 95. Price off of demand curve:
  96. 96. P>MC</li></ul>P<br />MC<br />PM<br />MC<br />D<br />MB<br />Q<br />QM<br />MB=MC<br />
  97. 97. Market Power and Efficiency<br />What’s bad about market power?<br />First, a word about economic inefficiency<br />Two kinds<br />Something happens that shouldn’t (MB&lt;MC)<br />Something that should happen (MB&gt;MC) but doesn’t<br />
  98. 98. Market Power and Efficiency<br />An example of the second kind of inefficiency: Gift-giving<br />Question: Has anyone ever spent more on a gift for you than you would have beenwilling to spend on it?<br />A) yes <br />B) No <br />C) I get no gifts<br />
  99. 99. Market Power and Efficiency<br />When MC (amount spent) &gt; MB (value to recipient)  inefficient gift giving.<br />Who gave you the most inefficient gift?<br />A) aunt/uncle B) Sibling<br />C) Parent D)Boy/Girlfriend<br />E) Grandparent F) Friend<br />G) Other<br />
  100. 100. Market Power and Efficiency<br />Who do you think is most likely to give you cash/gift certificate?<br />A) aunt/uncle B) Sibling<br />C) Parent D)Boy/Girlfriend<br />E) Grandparent F) Friend<br />G) Other<br />
  101. 101. Efficiency<br />Deadweight Loss of Christmas(Joel Waldfogel)<br />Those who know you least well tend to give the most inefficient gifts<br />Those who know you least well are more likely to give cash<br />Deadweight loss of Xmas = $8 billion<br />
  102. 102. Market Power<br />Firm Supply Decision<br /><ul><li>Why is Market Power Inefficient?
  103. 103. P>MC
  104. 104. P = marginal value
  105. 105. MC= cost of 1 more
  106. 106. Someone is willing to cover the cost of one more, but does not get the product  inefficient</li></ul>P<br />MC<br />PM<br />MC<br />D<br />MB<br />Q<br />QM<br />
  107. 107. Market Power<br /><ul><li>Why is Market Power Inefficient?
  108. 108. Firm produces too little!
  109. 109. For every consumer willing to pay more than MC, there is a social loss.
  110. 110. Deadweight loss = value not created</li></ul>Firm Supply Decision<br />P<br />MC<br />PM<br />MC<br />D<br />MB<br />Q<br />QM<br />QSO<br />
  111. 111. Market Power<br /><ul><li>Why is Market Power Inefficient?
  112. 112. Social Optimal: where P=MC
  113. 113. Also the competitive output</li></ul>Firm Supply Decision<br />P<br />MC<br />PM<br />Social optimum<br />MC<br />D<br />MB<br />Q<br />QM<br />QSO<br />
  114. 114. Market Power<br /><ul><li>Why don’t firms with market power produce more?
  115. 115. Someone is willing to pay more than MC.
  116. 116. MB < P !
  117. 117. To serve another customer, must lower price for everyone (single price)
  118. 118. MB<MC</li></ul>Firm Supply Decision<br />P<br />MC<br />PM<br />P&gt;MC, but MB&lt;MC<br />MC<br />D<br />MB<br />Q<br />QM<br />QSO<br />
  119. 119. Maureen Supplize<br />5 potential customers<br />Reservation Price<br />J.P. Morgan 13 <br />J.D. Rockefeller 11 <br />J.R. Ewing 9 <br />J.C. Penney 7 <br />J.P. Kennedy 5 <br />Marginal Cost of each yacht: 6<br />
  120. 120. Maureen Supplize<br />Price Quantity Total Marginal yacht Demanded Revenue Revenue MC<br />$13 1 (Morgan) 13 13 &gt; 6 <br />$11 2 (+Rock.) 22 9 &gt; 6 <br />$ 9 3 (+Ewing) 27 5 &lt; 6 <br />$ 7 4 (+Penney) 28 1 &lt; 6 <br />$ 5 5 (+Kennedy) 25 -3 &lt; 6 <br />Sell 2 yachts, P=11<br />
  121. 121. Maureen Supplize<br />Yachts<br />P<br />Q = 2<br />P = 11<br />MC = 6<br />P&gt;MC, inefficient:<br />Ewing willing to pay 9, Penney willing to pay 7, but they do not get yachts<br />Deadweight loss<br />13<br />11<br />9<br />MC<br />7<br />5<br />D<br />MB<br />1<br />Q<br />3<br />2<br />1<br />4<br />5<br />
  122. 122. Markup Pricing<br />Objection! Firms don’t set prices this way. Don&apos;t they instead use simple markups?<br />Ex. Calculate average cost, add 10%<br />A markup is a benchmark. <br />Markups increase as the elasticity of demand decreases.<br />Rank the industries in order of increasing markups: Groceries, funerals, wheat<br />A) Groceries, funeral, wheat<br />B) Funeral, wheat, groceries<br />C) wheat, groceries, funerals<br />D) Groceries, wheat, funerals<br />E) Funerals, groceries, wheat<br />F) Wheat, funerals, groceries<br />
  123. 123. Price Discrimination<br /><ul><li>The firm with market power produces too little
  124. 124. Some who value the good more than its marginal cost do not get it.
  125. 125. To serve them, must lower price to those willing to pay more
  126. 126. What if firm could charge different prices?</li></ul>Firm Supply Decision<br />P<br />MC<br />PM<br />P&gt;MC, but MB&lt;MC<br />MC<br />D<br />MB<br />Q<br />QM<br />QSO<br />
  127. 127. Price Discrimination<br />Price discrimination: charging different prices to different consumers<br />
  128. 128. Price Discrimination<br />Price discrimination: charging different prices to different consumers<br />Only possible when:<br />Restrictions on resale<br />Ability to target different customers with different prices<br />
  129. 129. Price Discrimination<br /><ul><li>Simplest type: two kinds of customers:
  130. 130. Set price for each
  131. 131. High elasticity, low price</li></ul>P<br />P<br />Senior Citizens (shoppers)<br />Others<br />PO<br />PSC<br />MC<br />MC<br />DSC<br />Do<br />MB<br />MB<br />Q<br />Q<br />QO<br />QSC<br />
  132. 132. Price Discrimination<br />Quantity Discounts<br />Milk: $3.80/gal<br /> $5.50/ 2 gals.<br />The shoppers (more price sensitive) buy in bulk)<br />Different prices to the same customer: $3.80 for first, $1.70 for second<br />
  133. 133. Price Discrimination<br />First Degree: a different price for each customer.<br />Ex. Car sales<br />
  134. 134. Price Discrimination<br />First Degree price discrimination: financial aid<br />&quot;It&apos;s a zero-sum game. There&apos;s a finite number of prospective students out there. Are you going to get them, or is your competitor going to get them? You face the pressure and say, &apos;That feels burdensome to me; I don&apos;t want to deal with that.&apos; Or you say, &apos;That&apos;s a pretty interesting challenge; I&apos;m going to go out there and try to eat their lunch. I&apos;m going to try to kick their ass.&apos; That defines people who are more or less successful and those who stay in the position.&quot; <br />
  135. 135. Financial Aid<br />What is Pepperdine’s tuition?<br />$36,650, catalog - the sticker price!<br />How much financial aid (grants only)?<br />A) 0-3000<br />B) 3001-6000<br />C) 6001-10,000<br />D) 10,001-15,000<br />E) 15,001+<br />
  136. 136. Financial Aid<br />Who gets financial aid? <br />The shoppers:<br />High SATs<br />Athletes<br />Underrepresented groups<br />
  137. 137. Price Discrimination<br /><ul><li>Beneficial effects of Price discrimination
  138. 138. The firm produces more, closer to the social optimum
  139. 139. Why? Firm can sell to those whose reservation price is above its MC, without having to lower the price to others</li></ul>Price discriminating firm can sell to more of these customers profitably<br />P<br />MC<br />PM<br />MC<br />D<br />MB<br />Q<br />QM<br />QSO<br />
  140. 140. Price Discrimination<br /><ul><li>Other effects of Price discrimination
  141. 141. The firm gets a greater share of total surplus, and consumers get less</li></ul>CS without discrimination<br />P<br />MC<br />PM<br />MC<br />D<br />MB<br />Q<br />QM<br />QSO<br />PS without discrimination<br />
  142. 142. Price Discrimination<br /><ul><li>Other effects of Price discrimination
  143. 143. The firm gets a greater share of total surplus, and consumers get less</li></ul>CS without discrimination<br />P<br />MC<br />PM<br />MC<br />D<br />Different prices to different customers<br />MB<br />Q<br />QM<br />QSO<br />PS without discrimination<br />
  144. 144. Maureen Supplize<br />Perfect Price Discrimination<br />Price Quantity Total Marginal yacht Demanded Revenue Revenue MC<br />$13 1 (Morgan) 13 13 6 <br />$11 2 (+Rock.) 24 11 6 <br />$ 9 3 (+Ewing) 33 9 6 <br />$ 7 4 (+Penney) 40 7 6 <br />$ 5 5 (+Kennedy) 45 5 6 <br />
  145. 145. Maureen Supplize<br />Perfect Price Discrimination<br />Price Quantity Total Marginal yacht Demanded Revenue Revenue MC<br />$13 1 (Morgan) 13 13 &gt; 6 <br />$11 2 (+Rock.) 24 11 &gt; 6 <br />$ 9 3 (+Ewing) 33 9 &gt; 6 <br />$ 7 4 (+Penney) 40 7 &gt; 6 <br />$ 5 5 (+Kennedy) 45 5 &lt; 6 <br />Q = 4, P = different for each customer; socially efficient output<br />
  146. 146. Chapter 9, problem 7<br />
  147. 147. The End<br />Aw, no more schooling in the ways of science?<br />

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