Transcript Ch9 - YSU

Chapter 9: Imperfect Competition
• Imperfectly competitive firms have some control of price
– Long-run economic profits possible
– Reduce economic surplus
• Three types
1. Monopoly has only one seller, no close substitutes
2. Monopolistic competition has many firms with
differentiated products
• These products are all close substitutes
3. Oligopoly is a small number of firms producing close
substitutes
1
Monopolistic Competition
Number of
Firms
Price
Entry and Exit
Product
Economic
Profits
Decisions
Monopolistic
Competition
Perfect
Competition
Many firms
Many firms
Limited flexibility
Free
Price taker
Differentiated
Free
Standardized
Zero in long run
Zero in long run
P, Q, product
differentiation
Q only
2
Oligopoly
Number of
Firms
Oligopoly
Perfect
Competition
Few firms,
each large
Many firms
Price
Entry and Exit
Some flexibility
Large size firm
Product
Differentiated or
standardized
Standardized
Economic
Profits
Possible
Zero in long run
Decisions
P, Q, differentiation,
advertising
Q only
Price taker
Free
3
Market Power
• Market power is the firm's ability to raise its price
without losing all its sales
• Any firm facing a downward sloping demand curve
– Firm picks P and Q on the demand curve
• Market power comes from factors that limit competition
Perfectly
Competitive Firm
Price
Price
Imperfectly
Competitive Firm
D
D
Quantity
Quantity
4
Five Sources of Market Power
1. Exclusive control over inputs
2. Patents and copyrights
3. Government licenses or franchises
4. Economies of scale (natural
monopolies)
5. Network economies
5
Economies of Scale
•
Returns to scale refers to the percentage change in
output from a given percentage change in ALL inputs
– Long-run idea
– Constant returns to scale: doubling all inputs
doubles output
– Increasing returns to scale: output increases by
a greater percentage than the increase in inputs
• Average costs decrease as output increases
• Natural monopoly: a monopoly that results from
economies of scale
6
Network Economies
•
Network economies occur when the value of the
product increases as the number of users increases
– VHS format for video tapes, Blu-ray for DVDs
– Telephones
– Windows operating system
– eBay
– Facebook and MySpace
7
Economies of Scale and Start-Up Costs
• New products can have a large fixed development cost
• If marginal cost is constant,
Marginal cost = Average variable cost
• Total cost is fixed cost (F) plus variable cost
TC = F + (M) (Q)
– Total cost increases as output increases
• Average total cost is
ATC = F / Q + M
– Average total cost decreases as output increases
8
TC = F + M Q
F
Average cost ($/unit)
Total cost ($/year)
Economies of Scale
ATC = F/Q + M
M
Quantity
Quantity
9
Video Game – Different Volumes
Nintendo
Playstation
Annual Production
(000s)
1,000
1,200
Fixed Cost ($000s)
$200
$200
Variable Cost ($000s)
$800
$960
Total Cost ($000s)
$1,000
$1,160
ATC per game
$1.00
$0.97
10
Video Games – Different Production Levels
Nintendo
Playstation
Annual Production
(000s)
500
1,700
Fixed Cost ($000s)
$10,000
$10,000
$100
$340
Total Cost ($000s)
$10,100
$10,240
ATC per game
$20.20
$6.08
Variable Cost ($000s)
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Market Power – Economies of Scale
Intel's Advantage
• Development cost of a new chip
• Marginal cost of making a chip
• Dominating the market
$2 billion
Pennies
Priceless
• Intel supplies more than 80% of the processors for PCs
12
Monopolist
Monopoly Demand and Marginal Revenue
• To sell more, price has
to go down;
• And, a lower price
applies to all the units;
• Marginal revenue is
smaller than price ( lies
below demand curve).
Price
a
a/2
D
MR
Q0
Q0/2
Quantity
13
Monopoly and Profit Maximization
6
Price ($/unit of output)
• A monopolist knows his demand
and marginal revenue curves
• Marginal cost is also known
• If he operates at P = $3 and Q =
12, MC > MR
• Decrease output
– If the firm operates at Q = 8,
then MC = MR = 2
• The demand curve sets
the price, P = $8
– At any output below 8,
MC < MR
MC
4
3
D
2
MR
12
8
Quantity (units/week)
Monopoly Losses and Profits
Economic profit
= $400,000/day
0.12
Price ($/minute)
ATC
0.10
MC
0.05
MR
D
20
24
Minutes (millions/day)
Price ($/minute)
Economic loss
= $400,000/day
0.10
0.08
ATC
MC
0.05
MR
D
20
24
Minutes (millions/day)
The Invisible Hand Fails
6
The monopolist's optimal
amount occurs where
MC = MR, Q = 8 units
and P = $4
4
Marginal Cost
The socially optimal
amount occurs where
MC = MB, Q = 12 units
and P = $3
3
2
MR
D
8
12
Quantity (units/week)
24
Monopoly and Perfect Competition
Price Discrimination
• Price discrimination means charging different buyers
different prices for essentially the same good or service
– Separate the groups
– No side trades among buyers
• Many forms of price discrimination
– Hurdle method: discounts for identifiable groups
(e. g., students, AARP)
– Perfect discrimination: negotiate separate deals with
each customer
18
An Example: Carla the Editor
• Opportunity cost of Carla's time is $29
Student
A
B
C
D
E
F
G
Reservation
Price
Total
Revenue
$40
38
36
34
32
30
28
$40
$76
$108
$136
$160
$180
$196
MR
$40
$36
$32
$28
$24
$20
$16
Carla Offers a Rebate
If reservation price < $36, mail in rebate
Reservation
Price
Total
Revenue
A
$40
$40
B
38
76
C
36
108
Student
MR
$40
36
32
Discounted Price Submarket
MR
D
$34
$34
$34
E
32
64
30
F
30
90
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Carla's Choices
Program
Social
Optimum
Single
Price
Perfect
Discriminator
Hurdle
Papers Edited
6
3
6
5 = (3 + 2)
Price
$30
$36
Reservation
$36, $4
rebate
Total Revenue
$180
$108
$210
$172
Carla's Time
$174
$87
$174
$145
Economic Profit
$6
$21
$36
$27
Total Surplus
$36
$27
$36
$35
Hurdle Method of Price Discrimination
• The hurdle method of price discrimination is the
practice of offering a discount to all buyers who
overcome some obstacle.
– Temporary Sales
– Hard cover and paperback books
– Multiple car models from one manufacturer
– Commercial air carriers
– Movie producers and phased releases
– Scratch and Dent appliance sales