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
Firm Supply Decision
Competitive Markets
P
Q
D100
Consequences of Price Taking• The decision to
produce one more:
MB = P • Ex. Say P=100
Firm Supply Decision
Competitive Markets
P
Q
D100
Consequences of Price Taking• The decision to
produce one more:
MB = P • Ex. Say P=100
Q=10, R=1000
10
R=1000
Firm Supply Decision
Competitive Markets
P
Q
D100
Consequences of Price Taking• The decision to
produce one more:
MB = P • Ex. Say P=100
Q=10, R=1000 Q=11, R=1100
1110
R = 1100
Firm Supply Decision
Competitive Markets
P
Q
D,MB100
Consequences of Price Taking• The decision to
produce one more:
MB = P • Ex. Say P=100
Q=10, R=1000 Q=11, R=1100 MB=P=100 1110
MB = 100
Firm Supply Decision
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
Firm Supply Decision
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
Fact: Coca-Cola’s share of the Italian Soft-drink market = 80%
Definitions
Fact: Coca-Cola’s share of the Italian Soft-drink market = 80%
Fact: Coca-cola’s share of the beverage market in Italy is 10%
Definitions
Fact: Coca-Cola’s share of the Italian Soft-drink market = 80%
Fact: Coca-cola’s share of the beverage market in Italy is 10%
Fact: Coca-cola’s share of sales of all products in Italy is < .1%
Definitions
Fact: Coca-Cola’s share of the Italian Soft-drink market = 80%
Fact: Coca-cola’s share of the beverage market in Italy is 10%
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
Firm Supply Decision
Q0
Revenue
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
Firm Supply Decision
Q0 Q0+1
P1
Revenue
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
MB=C-A < P1
Firm Supply Decision
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
Firm Supply Decision
10
R=1000
Market Power
P
Q
D
100
Firm Supply Decision
1011
99
R=1089
Consequences of Market Power (example)• To sell 10, P=100,
R=1000• To sell 11, P=99,
R=1089
Market Power
P
Q
D
100
Firm Supply Decision
1011
99
Consequences of Market Power (example)• To sell 10, P=100,
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
Firm Supply Decision
MB
Market Power
P
Q
D
Marginal analysis: MB<P MC upward sloping
Firm Supply Decision
MB
MC
Market Power
MB MC
P
Q
D
Marginal analysis: MB<P MC upward sloping Produce every unit
for which
Firm Supply Decision
MB
MC
MB MC
Market Power
MB MC
P
Q
D
Marginal analysis: MB<P MC upward sloping Produce every unit
for which Stop when MB=MC
Firm Supply Decision
MB
MC
MB MCQM
MB=MC
Market Power
MB MC
P
Q
D
Marginal analysis: MB<P MC upward sloping Produce every unit
for which Stop when MB=MC Price off of
demand curve:
Firm Supply Decision
MB
MC
MB MCQM
MB=MC
PM
Market Power
MB MC
P
Q
D
Marginal analysis: MB<P MC upward sloping Produce every unit
for which Stop when MB=MC Price off of
demand curve:• P>MC
Firm Supply Decision
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
Market Power and Efficiency
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
Market Power and Efficiency
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
Firm Supply Decision
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
Firm Supply Decision
MB
MC
QM
PM
MC
Why is Market Power Inefficient?
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
Firm Supply Decision
MB
MC
QM
PM
MC
Why is Market Power Inefficient?
Social Optimal: where P=MC• Also the competitive
output
QSO
Social optimum
Market Power
P
Q
D
Firm Supply Decision
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
Firm Supply Decision
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
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
Price Discrimination
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
Price Discrimination
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
Price Discrimination
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
Price Discrimination
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
Price 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
Price 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?
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