Transcript Micro20102011Lecture1

Topic 7: Market Structures
Agenda, Friday 26th November 2010
A: Supply and Perfect Competition
B: Monopoly
C: Perfect Competition v. Monopoly
D: Oligopoly and Game Theory
A: Supply and Perfect
Competition
Firm Supply
 How
does a firm decide how much to
supply at a particular market price?
(Firm’s supply curve)
 This depends upon the firm’s
– goals (e.g. π max, revenue max, zero π,
… );
– technology (e.g. w, r, … );
– competitive environment/market
structure.
Perfect Competition
Assumptions
 There
are many buyers and sellers,
– each seller is (or at least acts as) a
price-taker
 Homogeneous product
 Freedom of entry and exit
 Perfect information (consumers
know all prices and producers know
all input prices/costs)
The Firm’s Short-Run Supply
Decision?
 Assume
each firm is a profitmaximizer
 Therefore, each firm chooses its
output level by solving: MR = MC
But MR = P in perfect competition
Therefore P = MC
The Firm’s Short-Run Supply
Decision?
P
pe
MCs(y)
y’
ys*
At y = ys*,
p = MC
and MC
slopes
upwards,
y = ys* is
profity maximizing.
P
The Firm’s Short-Run Supply
Decision?
pe
MCs(y)
y’
ys*
So a profitmaximizing
supply level
can lie only
on the
upwards
sloping part
of
the
firm’s
y
MC curve.
The Firm’s Short-Run Supply
Decision?
 The
firm will not supply any output if
p  AVC ( y )
Shut Down Point: P = AVC(y)
The Firm’s Short-Run Supply
Decision?
P
Shutdown
MC
(y)
s
point
ACs(y)
AVCs(y)
The firm’s short-run
supply curve
y
Short Run Market Supply Curve
P
S
Market
Supply Curve
is the sum of
all the firms
supply
curves
(MC)
Q
Perfect Competition: Equilibrium
 Short
run: (Excess, Abnormal,
Supernormal, Economic) Profits or Losses
(≤ TVC) possible
 Short run → Long run: Profits attracts
entry, market supply curve shifts to right,
market price falls, zero economic profits in
long run equilibrium
 Short run → Long run: Losses “attracts”
exit, …
Application: Tax Incidence In
Perfect Competition
Market
Supply
P
PC = PP
Market
Demand
Q
No tax: PC = PP (Consumer price = Producer price)
Application: Tax Incidence In
Perfect Competition
P
Market
Supply
PC
This is
the tax.
PP
Market
Demand
Q
The tax creates a wedge between the price firms
receive (Pp) and the price consumers pay (Pc). The
difference is the tax (which goes to the tax authorities).
Application: Tax Incidence In
Perfect Competition
P
Market
Supply
PC
This is
the tax
PP
Market
Demand
Q
In the short run, the burden of the tax is shared (not
necessarily on a 50/50 basis) between consumers and
producers.
Application: Tax Incidence In
Perfect Competition
In the short run,
 The producers receives less for the
product.
 Some firms will continue to produce
output at a loss (once the reduced price
is covering their average variable costs).
 Some firms will experience “excessive”
losses and so will exit the market.
 The supply curve shifts to the left and the
prices consumers and producers face
increases.
Application: Tax Incidence In
Perfect Competition
In the Long Run,
 Consumers pay all of the tax (100%)
 Producers pay none of tax (0%)
 There are no firms making losses
left in the market.
B: Monopoly
Monopoly: Why?



Natural monopoly (economies of scale or density)
- utility companies, e.g. electricity or natural gas
or cable or rail (transmission) network, household
waste collection
Statutory monopoly
– a patent; e.g. a new drug
– sole ownership of a resource; e.g. a toll bridge
Artificial monopoly, e.g. explicit formation of a
cartel, e.g. OPEC
Monopoly: Assumptions
 Many
buyers
 Only one seller i.e. not a price-taker
 (Homogeneous product)
 Perfect information
 Restricted entry (and possibly
restricted exit)
Monopoly: Market Behaviour
p(y)
Higher output y causes a
lower market price, p(y).
D
y=Q
Monopoly: Equilibrium
P
Demand
MR
y=q=Q
Monopoly: Equilibrium
MC
P
AC
MR
Demand
y
Monopoly: Equilibrium
MC
P
Output
Decision
AC
ym
MR
Demand
MC = MR
y
Monopoly: Equilibrium
Pm = price
MC
P
AC
Pm
ym
MR
Demand y
Monopoly: Equilibrium
 Firm
= Market
 Short run equilibrium diagram = long run
equilibrium diagram (apart from shape of
cost curves and possibility of exit)
 At qm, pm > AC therefore you have excess
(economic, supernormal, abnormal)
profits
 Short run losses are also possible
Monopoly: Equilibrium
MC
P
AC
Pm
ym
MR
The
shaded
area is
the
excess
profit
Demand y
Application: Tax Incidence in Monopoly
P
MC curve is
assumed to be
constant (for ease of
analysis)
MC
MR
Demand y
Application: Tax Incidence in Monopoly

Claim
When you have a linear demand curve, a
constant marginal cost curve and a tax
is introduced, price to consumers
increases by “only” 50% of the tax, i.e.
“only” 50% of the tax is passed on to
consumers. (Similarly, if tax is
eliminated, only 50% of price reduction
is passed on to consumers.)
Application: Tax Incidence in Monopoly
Output decision is as
before, i.e.
P
MC = MR
So Ybt is the output
before the tax is
imposed
MCbt
ybt
MR
Demand y
Application: Tax Incidence in Monopoly
Price is also the
same as before
P
Pbt = price before tax
is introduced.
Pbt
MCbt
ybt
MR
Demand y
Application: Tax Incidence in Monopoly
The tax causes the
MC curve to shift
upwards
P
Pbt
MCat
MCbt
ybt
MR
Demand y
Application: Tax Incidence in Monopoly
Price post tax is at Ppt
and is higher than
before.
P
Ppt
Pbt
MCat
MCbt
yat
ybt
MR
Demand y
C: Monopoly v. Perfect
Competition
Agenda
 Societal
Welfare/Economic Welfare:
Criteria?
Consumer Surplus
Producer Surplus
 Compare Monopoly and Perfect
Competition
Economic Welfare
 Consumer
surplus measures (net)
economic welfare from the
buyer/consumers’ perspective.
 Producer surplus measures (net)
economic welfare from the
seller/producers’ perspective.
Consumer Surplus
 Consumer
surplus is the amount a buyer
is willing to pay for a product minus the
amount the buyer actually pays.
 Consumer surplus is the area below the
demand curve and above the market price.
A lower market price will increase consumer
surplus (provided that the product is still
supplied, of course).
A higher market price will reduce consumer
surplus.
Producer Surplus
 Producer
surplus is the amount a seller is
paid for a product minus the total variable
cost of production.
 A higher market price will increase producer
surplus (provided that the product is still
demanded, of course).
 A lower market price will decrease producer
surplus.
 Producer
surplus is equivalent to
economic profit in the long run.
Economic Welfare
 Economic
welfare is (generally)
quantified as the sum of consumer
surplus and producer surplus, i.e.
equal weights are generally
assumed.
 Alternative relative weights are also
possible.
Consumer Surplus and Producer Surplus:
Market Equilibrium
Price A
D
Supply
Consumer
surplus
Equilibrium
price
E
Producer
surplus
B
Demand
C
0
Equilibrium
quantity
Quantity
Monopoly v. Perfect Competition
MC
Price is Ppc
P
Ppc
Qpc
Demand Q
Monopoly v. Perfect Competition
MC
P
Recall that for
monopoly, MR 
Demand
Output is set
where MC = MR
Ppc
Qm Qpc
MR
Demand Q
Monopoly v. Perfect Competition
MC
P
Pm
The monopoly
output is less than
the perfectly
competitive output.
(The monopoly
price is higher
than the perfectly
competitive price.)
Ppc
Qm Qpc
MR
Demand Q
Monopoly v. Perfect Competition
MC
P
Pm
The green area
represents the
deadweight
loss (triangle)
of Monopoly
Ppc
Qm Qpc
MR
Demand Q
Economic Efficiency:
Monopoly v. Perfect Competition
Comment
PC v. M
P = MC?
PC
MX
Productive Efficiency? Minimum point on AC
Curve?
PC
M X?
Excess profit?
+ Rent seeking?
PC
MX
X-inefficiency?
“Excessive” Costs?
PC
M?
Technical
progress/innovation?
Monopoly excess
profits can be
reinvested
PC ?
M?
Natural monopoly?
Perfect competition
impossible
PC X
M
Allocative
Efficiency?
D: Oligopoly & Game Theory
Oligopoly: Assumptions
 Many
buyers
 Very small number of major sellers (
actions and reactions are very important)
 Homogeneous product (usually, but not
necessarily)
 Complete information (usually, but not
necessarily)
 Restricted entry (usually, but not
necessarily)
Oligopoly & Game Theory: Models
1.
2.
3.
4.
Cournot Competition (1838)
(Bertrand Competition (1883))
Nash Equilibrium (1950s): Game
Theory
Oligopoly v. Perfect Competition v.
Monopoly
Some examples of Games
1. Cournot Competition
 Firms
compete in quantities (q1, q2)
 Real world examples?
 q1 = F(q2) and q2 = G(q1) or more
precisely
q1 = F(q2e) and q2 = G(q1e)
 Aim: Find q1and q2 and hence P, i.e.
find the equilibrium.
 Example: P = a – bQ and Ci = cqi
1. Cournot Competition: Example
q2
a  c  bq2
q1 
2b
COURNOT
EQUILIBRIUM
a  c  bq1
q2 
2b
q1
2. Cournot Competition & Bertrand
Competition: Nash Equilibrium
Cournot Nash (q1, q2): Firms compete in quantities,
i.e.
Firm 1 chooses the best q1 given q2 and
Firm 2 chooses the best q2 given q1
[Bertrand Nash (p1, p2): Firms compete in prices,
i.e.
Firm 1 chooses the best p1 given p2 and
Firm 2 chooses the best p2 given p1]
Nash Equilibrium (s1*, s2*): Player 1 chooses the
best s1 given s2* and Player 2 chooses the
best s2 given s1*
3. Perfect Competition v
Monopoly v Oligopoly (Cournot)
Qm < Qco < QPC
Pm > Pco > Ppc
4. Examples of Games: Advertising
Game (≈ Prisoners’ Dilemma)
Firm j
Advertise Don’t
Advertise
Firm Advertise (i=2,j=2)
i
(i=4,j=1)
Don’t
(i=1,j=4)
Advertise
(i=3,j=3)
4. Advertising Game (≈ Prisoners’
Dilemma)
 Nash
equilibrium = Advertise,
Advertise = [2,2]
 [2,2] < [3,3] i.e. Nash equilibrium can
be inefficient! (We are ignoring
consumer interests.)
 Government bans advertising (e.g.
for cigarettes or spirits or beer or
ban on below cost selling?)
4. Examples of Games: Eating Out
Game
Person j
Chinese Italian
Person Chinese (i=4,j=2) (i=1,j=1)
i
Italian
(i=1,j=1) (i=2,j=4)
4. Eating Out Game
 Nash
equilibrium = Chinese, Chinese
[4,2]
 Nash equilibrium = Italian, Italian =
[2,4]
 3rd Nash equilibrium = ? (It’s there
somewhere – I promise.)
 Multiple equilibria!
4. Examples of Games: Chicken
“Game”
Person j
Swerve
Don’t
Swerve
Person Swerve (i=2,j=2)
i
(i=1,j=4)
Don’t
(i=4,j=1)
Swerve
(i=0,j=0)
4. Chicken “Game”
 Nash
equilibrium = Swerve, Don’t
Swerve = [1,4]
 Nash equilibrium = Don’t Swerve,
Swerve = [4,1]
 3rd Nash equilibrium = ?
 Commitment mechanism?
4. Examples of Games: Matching
Pennies Game
Person j
Heads
Person Heads
i
Tails
Tails
(i=1,j=-1) (i=-1,j=1)
(i=-1,j=1) (i=1,j=-1)
4. Matching Pennies Game
 Nash
equilibrium = ?
 No pure strategy Nash equilibrium
 Mixed strategy Nash equilibrium =
50%, 50%
 Scissors, Rock, Paper: Mixed
strategy Nash equilibrium = ?