econ210 lecture 7 slides

Introductory Microeconomics

Monopoly, orPrice Searching

Monopoly

Goals of Course:1. Understand how free

exchange solves scarcity problem.

2. Understand ways in which free exchange fails to solve scarcity problem.

Monopoly is market failure.

Competition vs Monopoly

The important difference between monopoly and perfect competition• The demand curve facing the firm.

Competition Monopoly

P P

Q Q

Firm Demand Firm

Demand

Perfect Competition Supply in

competitive markets: the supply curve tells you how much quantity will be supplied at a given price.• 1. Implication: firms

see price, decide how much to produce.

• 2. But aren't prices set by firms, and not just given to them?

P

Q

Supply

Peq

Qfirm

Competitive Markets Firms in competitive markets have little to

say about the price. • They don't set the price, they accept it; it is

given by the market.

Perfect competition, characteristics:• i. lots of firms• ii. identical products (perfect substitutes)• iii. no one firm dominates the market, produces

a significant portion of output.

Competitive Markets Examples

• Commodities• financial markets • PCs• certain airline

routes (NY to LA)

Competition vs Monopoly

P P

Q Q

Firm Demand

Market Demand

Demand faced by a single firm in a competitive market: perfectly elastic demand• if he tries to sell at a price higher than the

market price, he sells zero.• If he sets a lower price, he is not maximizing

profits.• He is a price taker.

Firm MarketMarket Supply

PMKT PMKT

Competitive Markets

P

Q

DPMKT

Consequences of Price Taking

Firm Supply Decision

Competitive Markets

P

Q

DPMKT

Consequences of Price Taking• The decision to

produce one more:

MB = P

Q+1Q


Competitive Markets

P

Q

D100


produce one more:

MB = P • Ex. Say P=100


Competitive Markets

P

Q

D100


produce one more:


Q=10, R=1000

10

R=1000


Competitive Markets

P

Q

D100


produce one more:


Q=10, R=1000 Q=11, R=1100

1110

R = 1100


Competitive Markets

P

Q

D,MB100


produce one more:


Q=10, R=1000 Q=11, R=1100 MB=P=100 1110

MB = 100


Competitive Markets

MB MC

P

Q

D,MBPMKT

Marginal Analysis• Produce every

unit for which

• Stop when MB=MC

MB=P=MC Supply curve is

MC curve

MC=S

QSMB MCMB=MC


Competitive Markets

Consequence of Price Taking behavior• P=MC for each firm• P=MC for market• P=Marginal value to

consumers Optimal solution to

scarcity problem:• Each unit for which

MB>MC is produced

P

Q

Supply=MC

Demand=MB

PMKT

QMKT

Definitions

Fact: Coca-Cola’s share of the Italian Soft-drink market = 80%

Q: Is Coca-Cola a Monopoly in Italy?

A) Yes B) No

Definitions


Definitions


Fact: Coca-cola’s share of the beverage market in Italy is 10%

Definitions



Fact: Coca-cola’s share of sales of all products in Italy is < .1%

Definitions



Fact: Coca-cola’s share of sales of all products in Italy is < .1%

Q: Is Coca-Cola a Monopoly in Italy? A) Yes B) No

Definitions

Monopoly - only producer of a good.• ambiguous: depends on how the market

is defined (soft drinks or all beverages).• How should market be defined?

In terms of relevant substitutes• What really matters is elasticity of

Demand

Definitions

A more Useful Definition: Market Power• More inelastic

demand more market power.

• What really matters: how many substitutes there are for a firm's product

D4

D1 D2

D3

P

Q

Firm Demand

D1 to D4: Decreasing Market Power

Market Power

How much market power does Coca-cola have?

Elasticity of demand = A) -.1 B) -.5 C) -1 D) -2 E) -9

Market power does not depend on supply being fixed. It is a demand concept.

P

Q

P

Q

Supply

Demand

This does not give you market power

This does

Price Taker vs Price Searcher

When is a firm not a Price Taker?• When they face less than perfectly

elastic demand when there are not perfect substitutes for

their product.

Firm Demand

P

Q

P0

P1

Q1Q0

Price Searcher

Why Price Searcher, instead of Price Setter?• Firms with market

power are always searching for the best price.

• Their information is imperfect

Market Power

Sources of Market Power:• Exclusive Control over inputs • Patents, copyrights• Government licenses, franchises• Economies of Scale• Network economies

Market Power

P

Q

D

P0

Consequences of Market Power (single price)• The decision to

produce one more:

Downward sloping demand

To produce one more, must lower price to everyone


Q0

Revenue

Market Power

P

Q

D

P0


produce one more:




Q0 Q0+1

P1

Revenue

Market Power

P

Q

D

P0


produce one more:



MB=C-A < P1


Q0 Q0+1

P1

B

A

C

Revenue at Q0: A+B

Revenue at Q1 : B+C

Market Power

P

Q

D

100

Consequences of Market Power (example)• To sell 10, P=100,

R=1000


10

R=1000

Market Power

P

Q

D

100


1011

99

R=1089


R=1000• To sell 11, P=99,

R=1089

Market Power

P

Q

D

100


1011

99


R=1000• To sell 11, P=99,

R=1089• MB=89<P=99• MB<P

Gained revenue

Lost revenue

-10

+99

Market Power

P

Q

D

Marginal analysis:Firm Supply Decision

Market Power

P

Q

D

Marginal analysis: MB<P


MB

Market Power

P

Q

D

Marginal analysis: MB<P MC upward sloping


MB

MC

Market Power

MB MC

P

Q

D

Marginal analysis: MB<P MC upward sloping Produce every unit

for which


MB

MC

MB MC

Market Power

MB MC

P

Q

D


for which Stop when MB=MC


MB

MC

MB MCQM

MB=MC

Market Power

MB MC

P

Q

D


for which Stop when MB=MC Price off of

demand curve:


MB

MC

MB MCQM

MB=MC

PM

Market Power

MB MC

P

Q

D


for which Stop when MB=MC Price off of

demand curve:• P>MC


MB

MC

MB MCQM

MB=MC

PM

MC

Market Power and Efficiency

What’s bad about market power?• First, a word about

economic inefficiency• Two kinds

Something happens that shouldn’t (MB<MC)

Something that should happen (MB>MC) but doesn’t

Market Power and Efficiency An example of the

second kind of inefficiency: Gift-giving

Question: Has anyone ever spent more on a gift for you than you would have been willing to spend on it?

A) yes B) No C) I get no gifts


When MC (amount spent) > MB (value to recipient) inefficient gift giving.

Who gave you the most inefficient gift?A) aunt/uncle B) SiblingC) Parent D)Boy/GirlfriendE) Grandparent F) FriendG) Other


Who do you think is most likely to give you cash/gift certificate?

A) aunt/uncle B) SiblingC) Parent D)Boy/GirlfriendE) Grandparent F) FriendG) Other

Efficiency Deadweight Loss of

Christmas (Joel Waldfogel)

Those who know you least well tend to give the most inefficient gifts• Those who know

you least well are more likely to give cash

• Deadweight loss of Xmas = $8 billion

Market Power

P

Q

D


MB

MC

QM

PM

MC

Why is Market Power Inefficient?

P>MC• P = marginal value• MC= cost of 1 more• Someone is willing

to cover the cost of one more, but does not get the product inefficient

Market Power

P

Q

D


MB

MC

QM

PM

MC


Firm produces too little!

For every consumer willing to pay more than MC, there is a social loss.

Deadweight loss = value not created QSO

Market Power

P

Q

D


MB

MC

QM

PM

MC


Social Optimal: where P=MC• Also the competitive

output

QSO

Social optimum

Market Power

P

Q

D


MB

MC

QM

PM

MC

Why don’t firms with market power produce more?• Someone is willing to

pay more than MC.• MB < P !• To serve another

customer, must lower price for everyone (single price)

• MB<MC QSO

P>MC, but MB<MC

Maureen Supplize 5 potential customers Reservation

PriceJ.P. Morgan 13 J.D. Rockefeller 11 J.R. Ewing 9 J.C. Penney 7 J.P. Kennedy 5

Marginal Cost of each yacht: 6

Maureen Supplize Price Quantity Total Marginal yacht

Demanded Revenue Revenue MC $13 1 (Morgan) 13 13 > 6 $11 2 (+Rock.) 22 9 > 6 $ 9 3 (+Ewing) 27 5 < 6 $ 7 4 (+Penney) 28 1 < 6 $ 5 5 (+Kennedy) 25 -3 < 6

Sell 2 yachts, P=11

Maureen Supplize

P

Q

D

Yachts

MB

MC

3

13

21 4 5

11

9

7

5

1

Q = 2

P = 11

MC = 6

P>MC, inefficient:

Ewing willing to pay 9, Penney willing to pay 7, but they do not get yachts

Deadweight loss

Markup Pricing Objection! Firms

don’t set prices this way. Don't they instead use simple markups?• Ex. Calculate

average cost, add 10%

A markup is a benchmark. • Markups increase as

the elasticity of demand decreases.

Rank the industries in order of increasing markups: Groceries, funerals, wheat

A) Groceries, funeral, wheat

B) Funeral, wheat, groceries

C) wheat, groceries, funerals

D) Groceries, wheat, funerals

E) Funerals, groceries, wheat

F) Wheat, funerals, groceries

Price Discrimination

P

Q

D


MB

MC

QM

PM

MC

The firm with market power produces too little• Some who value the

good more than its marginal cost do not get it.

• To serve them, must lower price to those willing to pay more

• What if firm could charge different prices?

QSO

P>MC, but MB<MC


Price discrimination: charging different prices to different consumers

Price Discrimination Price

discrimination: charging different prices to different consumers

Only possible when:• Restrictions on

resale• Ability to target

different customers with different prices


P P

Q Q

DSC Do

Simplest type: two kinds of customers:• Set price for each• High elasticity, low price

MCMC

MBMB

QOQSC

PO

PSC

Senior Citizens (shoppers)

Others


Quantity Discounts Milk: $3.80/gal $5.50/ 2 gals.

• The shoppers (more price sensitive) buy in bulk)

• Different prices to the same customer: $3.80 for first, $1.70 for second


First Degree: a different price for each customer.

Ex. Car sales

Price Discrimination First Degree price discrimination: financial aid "It's a zero-sum game. There'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, 'That feels burdensome to me; I don't want to deal with that.' Or you say, 'That's a pretty interesting challenge; I'm going to go out there and try to eat their lunch. I'm going to try to kick their ass.' That defines people who are more or less successful and those who stay in the position."

Financial Aid

What is Pepperdine’s tuition?• $36,650, catalog - the sticker price!

How much financial aid (grants only)? A) 0-3000 B) 3001-6000 C) 6001-10,000 D) 10,001-15,000 E) 15,001+

Financial Aid

Who gets financial aid? The shoppers:

• High SATs• Athletes• Underrepresented groups


P

Q

DMB

MC

QM

PM

MC

Beneficial effects of Price discrimination

The firm produces more, closer to the social optimum• Why? Firm can sell to

those whose reservation price is above its MC, without having to lower the price to others QSO

Price discriminating firm can sell to more of these customers profitably


P

Q

DMB

MC

QM

PM

MC

Other effects of Price discrimination

The firm gets a greater share of total surplus, and consumers get less

QSO

CS without discrimination

PS without discrimination


P

Q

DMB

MC

QM

PM

MC

Other effects of Price discrimination

The firm gets a greater share of total surplus, and consumers get less

QSO

CS without discrimination

PS without discrimination

Different prices to different customers

Maureen Supplize Perfect Price Discrimination Price Quantity Total Marginal yacht

Demanded Revenue Revenue MC $13 1 (Morgan) 13 13 6 $11 2 (+Rock.) 24 11 6 $ 9 3 (+Ewing) 33 9 6 $ 7 4 (+Penney) 40 7 6 $ 5 5 (+Kennedy) 45 5 6

Maureen Supplize Perfect Price Discrimination Price Quantity Total Marginal yacht

Demanded Revenue Revenue MC $13 1 (Morgan) 13 13 > 6 $11 2 (+Rock.) 24 11 > 6 $ 9 3 (+Ewing) 33 9 > 6 $ 7 4 (+Penney) 40 7 > 6 $ 5 5 (+Kennedy) 45 5 < 6

Q = 4, P = different for each customer; socially efficient output

Chapter 9, problem 7

The End

Aw, no more schooling in the ways of science?

econ210 lecture 7 slides

Business

market price

beverage market

market failure

market powerhow

market powerdemandqq

lower price

given price

price setter