Transcript COMPETITION AND THE SEARCH FOR AN HONEST BUCK

COMPETITION AND THE
SEARCH FOR AN HONEST
BUCK
TIP
AVOID
‘PERFECT’
COMPETITION
Instructional Goals:
You will understand
• How to measure consumers'
surplus (level one)
• What a residual demand curve
is (level one) and how to use
one (level two)
Under perfect competition YOU
cannot earn more than a normal
return on your investment
Characteristics of perfect competition
• Perfectly homogeneous goods
[corollary: Perfect divisibility of output]
• Perfect information [corollaries: No
transaction costs, No externalities]
• Price taking
The only way to earn the
highest possible return
on your investment is to
change markets so these
conditions do not obtain
or take advantage of
situations where they
cannot
How to measure consumers’
surplus
• Demand schedule shows willingness
and ability to pay
• Supply schedule shows willingness and
ability to sell.
• Consumer surplus is the difference
between what customers are willing to
pay and the price paid. It is measured
by the area under the demand schedule
and above the price line.
• Producer surplus is the area above the
supply schedule and below the price
line.
Consumer Surplus
Elasticities and the Residual
Demand Curve
• price elasticity of demand or
supply
• the demand curve facing a
single organization's product
or service: the residual
demand curve
TIP
Understand how the
elasticity of the residual
demand curve shows
that a price competitive
organization cannot
affect price
Elasticities of Demand and Supply
• The price elasticity of demand at price p and
quantity Q is approximately the percentage
change in quantity divided by the percentage
change in price (∆Q/Q) ÷ ∆p/p) = (p/Q) (∆Q/∆p)
• The technical definition of the price elasticity is
(p/Q)(dQ/dp) -- always a negative number
• The elasticity of supply is the percentage
change in quantity supplied in response to a 1
percent change in price --usually, but not
always, positive.
Computing Price Elasticities
Unitary elasticity is
where a 1 percent
change in price
causes a 1 percent
change in the
quantity demanded,
and total revenues
remains constant.
If elasticity is less than
1, demand is inelastic
Price competitive
Organizations and the
Residual Demand Curve
Residual demand
curve: the
demand curve
facing a particular
organization
Dr(p) = D(p) - So(p)
If So(p) is greater
than D(p), Dr(p) is
zero
Residual Elasticity (for a single
organization in a competitive
Industry)
Given n identical orgs
in a market, the
elasticity of demand
facing each i is: i =
n - o n/(n - 1),
where  is the
elasticity of
demand; o is the
elasticity of supply;
(n -1) is the number
of other
organizations.
Example
Suppose market demand is Q = 100 -p. What is the
market price elasticity of demand? If the supply curve
of the individual organization is q = p and there are 50
identical organizations in the industry, what is the
residual demand facing any one organization? What is
the residual demand elasticity facing each
organization at the market equilibrium?
Coase Theorem
Instructional Goals: You will understand:
•The importance of property rights
•The nature of externalities or spillover
•The Coase theorem.