econ 2001 microeconomics ii 2014 2 nd semester elliott fan economics, ntu lecture 2 microeconomics,...

ECON 2001

Microeconomics II2014 2nd semester

Elliott FanEconomics, NTU

Lecture 2Microeconomics, 2014-2Elliott Fan

Monopoly

Elliott Fan: Micro 2014-2 Lecture 2 2

Elliott Fan: Micro 2014-2 Lecture 2 3

Elliott Fan: Micro 2014-2 Lecture 2

Introduction• Interpretation of monopoly definition• Monopoly or market power

– Downward sloping demand curve

• Price setting and quantity– Welfare consequences

• Sources of monopoly power• Profitable pricing strategies

Slide 4


Competition recap

Slide 5


Introduction• Brotherhood for the Respect, Elevation, and

Advancement of Dishwashers• Impact of achieving goal

– SR life better for dishwashers– LR wages of dishwashers decrease by full amount of tips

Slide 6


Introduction• Why wages bid down by full amount of tips• Who benefits from tipping• Tools for analyzing competitive industry

Slide 7

THE COMPETITIVE FIRMSection 7.1

8


Competitive Firm• Firm sells any quantity wants at going market price

– Classic example farm

• Small part of market served by each firm– Horizontal demand curve

• Products are interchangeable• Buyers can easily buy from another producer

Slide 9


Revenue• TR = P X Q • MR ≡ P • MR curve is flat

– Coincides with demand curve

Slide 11


Firm’s Supply Decision• Produce good until MR = MC• Competitive firm produces a quantity where P =

MC– Note: P ≡ MR

• Supply curve– MC and supply are inverse functions– Supply curve looks like upward sloping portion of MC

curve as long as MC curve upward sloping– SR and LR supply curves exist for the firm

Slide 13


Shutdowns and Exits• Does the producer want to produce the good?• Two distinctions

– Shutdown: firm stops producing the good but still pays fixed costs

– Exit: firm leaves the industry entirely and no longer faces any costs

• Firms, in SR, can shutdown but not exit– Remains operational if P > AVC

• In LR, can exit

Slide 16


Short-Run Supply Curve• Firms SR supply curve identical to part of SRMC curve

that lies above AVC curve– Shutdown otherwise– Upward sloping due to AC and MC U-shape

• Diminishing marginal returns to variable factors of production

• Elasticity of supply– Percent change in quantity supplied resulting from a 1% change

in price

Slide 18

THE COMPETITIVE INDUSTRY IN THE SHORT RUN

Section 7.2

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Competitive Industry in the SR• All firms in industry competitive• SR is period of time in which no firm can enter or exit the

industry• Number of firms cannot change• LR is period of time in which any firm can enter or leave the industry

• Industry’s SR supply curve– Sum of SR individual firm supply curves– More elastic than individual supply curves

Slide 21


Supply, Demand, and Equilibrium

• Each firm operates where supply meets demand• Industry equilibrium consequence of optimizing behavior

on part of individuals and firms – Intersecting industry wide supply and industry wide demand

Slide 23


Competitive Equilibrium• Firms produces where supply (or MC) curve crosses

horizontal line at market going price• Increase in FC

– Price and quantity remain unchanged• Increase in VC

– Raises firms MC curve– Causes some firms to shutdown– Higher market equilibrium price– Firm’s output could go up or down

• Increase in industry demand– Higher market equilibrium price– Increase in firm’s output

Slide 24


Change in Fixed Cost• Increase in FC

– Price and quantity remain unchanged

Slide 26


Change in Variable Cost• Increase in VC

– Raises firms MC curve– Causes some firms to shutdown– Higher market equilibrium price– Firm’s output could go up or down

Slide 27


Change in Industry Demand• Increase in industry demand

– Higher market equilibrium price– Increase in firm’s output

Slide 29


Industry’s Costs• Sum of total cost of all individual firms• To minimize cost of all firms, use equimarginal principle

– Insure that MC same for all producers in industry– Automatic because all firms have same price

Slide 31

THE COMPETITIVE FIRM IN THE LONG RUN

Section 7.3

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Competitive Firm in the LR• Some fixed cost in SR become variable cost in the LR• Firms can enter and exit in the LR

Slide 33


Profit and the Exit Decision• Profit = TR – TC

– Costs includes all foregone opportunities

• SR versus LR supply response– Firm LR supply curve more elastic than SR supply curve

• Shuts down if price of output falls below average variable cost• Exits if price of output falls below average cost

Slide 34


LRMC and Supply• Firms operate where P = LRMC

– Remain in industry, LR supply curve identical to LRMC curve

• Exit decision is made at the point P=AC (note that there is no more fixed cost in the LR)

Slide 36

THE COMPETITIVE INDUSTRY IN THE LONG RUN

Section 7.4

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Competitive Industry in the LR• Firms wishing to enter or exit the market do so in the LR,

flatting out the LR supply curve• So unlike the case in the SR, the LR supply curve is a

horizontal line.• Important assumption: all firms are identical in costs• Break-even price plays an important role here (1) all

firms produce at the break-even price; (2) it determines the level of LR supply curve

Slide 39


Zero Profit Condition• Economic versus accounting profit

– Accounting profit refers to total revenue minus total financial cost

– Economic profit refers to accounting profit minus the value of the best foregone opportunity

Slide 41


Industry’s LR Supply Curve• All firms identical

– Industry supply curve flat at the break-even price• Break-even price and the LR supply

– Break-even price (P = AC) at which a seller earns zero profit

– LR supply curve identical with part of firm’s LRMC curve lying above LRAC curve

Slide 43


Flat LR Supply Curve• Flatness based on entry and exit• P < AC, all firms exit• P > AC, unlimited number of firms enter• LR zero profit equilibrium almost never reached

– Demand and cost curves shift so often that entry and exit never settles down

– Approximation to the truth

Slide 44


Equilibrium

• LR same as SR between firm and industry– Market price determined by intersection of industrywide

demand and supply– Firms face flat demand curves at market price

• Analysis of changes to equilibrium– Changes in FC– Changes in VC– Changes in demand

Slide 45


Application: Government as a Supplier

• In SR, government policy to build and operate apartment complex increasing housing

• In LR, supply curve does not shift– Determined by break-even price– Number of privately owned apartments withdrawn from the

market equals number of apartments built by government

Slide 49


Relaxing the Assumptions• Assumption 1: All firms are identical, have

identical cost curves– True in industries that do not require unusual skills

• Assumption 2: Cost curves do not change as industry expands or contracts– True in industries not large enough to affect input

prices

• Without these assumptions, all firms do not have the same break-even price

Slide 51


Constant Cost• Constant cost industry

– Satisfies the 2 assumptions

Slide 52


Increasing Cost• Increasing cost industry

– Break-even price for new entrants increases as industry expands

– Assumption 1 violated: Less-efficient firms– Assumption 2 violated: Factor-price effect– LR industry supply curve slopes upward

Slide 53

Elliott Fan: Micro 2014-2 Lecture 2 Slide 54


Decreasing Cost• Decreasing cost industry

– Break-even price for new entrants decreases as industry expands

– LR industry supply curve slopes downward

Slide 56


Applications• A tax on motel rooms• Tipping the busboy

Slide 58


Using the Competitive Model• Fundamentals of competitive analysis

– Industry versus firm demand and supply– SR versus LR– Entry and exit decisions

Slide 61

PRICE AND OUTPUT UNDER MONOPOLY

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Price• Pricing operates where MR = MC• MR curves lies everywhere below demand curve

Slide 63


Output• Lower price to increase output• Monopolist operates on elastic portion of demand curve

– Ex. Prices of gasoline, oranges, and music CDs• No supply curve

– No going market price

Slide 65


Measuring Monopoly Power

Slide 66


Welfare• Assumption about same industry wide MC curve for

competitive and monopolistic industries• Social welfare loss under monopoly

– Marginal value exceeds marginal cost– Monopolist could produce additional good

Slide 67


Subsidies and Public Policy• Subsidies for monopolist

– Induce monopolist to provide competitive quantity• Arises from “ideal” subsidy• Could encourage inefficient production• Creates price ceilings• Follows rate-of-return regulation

Slide 69


Sources of Monopoly Power• Natural monopoly

– Industry where AC curve decreasing at point where crosses market demand

– Industry survive only if monopolized

Slide 73


Sources, cont.• Welfare economics

– Monopoly outcome best for some• Imperfect competition

– Downward pressure on prices– Innovation

Slide 75


Other Sources of Monopoly Power

• Patents– Ex. photography

• Resource monopolies– Single firm controls productive input

• Legal barriers to entry

Slide 76


Monopoly, market, and government

• This video explains why the concept of monopolies are incompatible with the free market, and actually the result of non-market (government) forces.

77

https://www.youtube.com/watch?v=baxaay2m9yk


Price Discrimination• Charging different prices for identical items• Ability to prevent resell of low-price units

Slide 78


First Degree• First-degree

– Charging each customer most willing to pay– Welfare gains

Slide 79


Third-Degree• Charging different prices in different markets

– Groups of consumers identifiable– Different downward sloping demand curve– Producer profit– Production of goods where MR same in both markets and equal

to MC– More elastic demand group receives lower price

Slide 81


• Third-degree: the most common form of price discrimination (student discounts, senior citizens’ discounts). Suppose there are two groups of people and there is no resale. Then the monopolist’s profit maximization problem becomes

maxy1, y2 (=p1(y1)y1+ p2(y2)y2-c(y1+y2)). Hence FOC becomes

MR1(y1)=MC(y1+y2)=MR2(y2).

Slide 84


• Since MR1(y1)=p1(y1)[1-1/|1|] and MR2(y2)=p2(y2)[1-1/|2|], hence p1>p2 if and only if |1|<|2|. The market with lower absolute value of elasticity has a higher price. Quite sensible since elasticity measures how sensitive the group is to price changes.

• There are some other often-observed practices used by firms with monopoly power.

Slide 85


• Second-degree: also known as non-linear pricing since the price per unit of output is not constant, but depends on how much you buy. The monopolist can offer different price-quantity packages so that the consumers can self select.

• Note that the low-end consumer’s package is distorted so that the high-end consumer will not choose the low-end package.

Slide 86


• Compared to perfect price discrimination, without high-end, low-end is offered higher quantity but still ends up with zero surplus. Without low-end, high end gets zero surplus, now gets positive surplus and the quantity offered is the same.

• Applying this to air travels, by offering a downgraded product, the airlines can charge the consumers who need flexible travel arrangements more for their tickets.

Slide 88


Many many examples of PD• Coupons, rebates, free delivery, coffee lids……• The spirit of PD – to offer lower prices to customers who

are more sensitive to price. There is no point to offer coupons if everyone redeemed them, and there is no point to coupons if only a random set of customers redeemed them.

• Note: almost everything that appears to be price discrimination admits at least one alternative explanation. For example, coupon clippers temp to go shopping when the shop is not crowded.

Slide 89


Pricing strategies by monopolist:versioning

• Versioning is a practice of offering an inferior product to charge differently for different customers. For example, hardcopy and paperback of the same book. Another example is the same printers designed to print slower deliberately.

• Strictly speaking, versioning should not be considered as a form of PD in some cases as products involved are different.

Slide 90


Pricing strategies by monopolist:Two-Part Tariff

• First part• Entry fee allows purchase of goods or services

– Meaning of tariff

Slide 91


Pricing strategies by monopolist: Two-Part Tariff

• Second part• Customers are charged maximum willing to pay

– Charge competitive price as long as no difference in consumers– Charge low initial fee and high usage fee

Slide 92


Pricing strategies by monopolist: Two-Part Tariff

• By implementing the two-part tariff, a monopoly firm can produces at the competitive market level, enhancing the efficiency.

• Examples– Clubs that charge a member fee and an usage fee– Health insurance – copayment increases efficiency.

Slide 94


• packages of related goods are often offered for sale together: software suite (word processor, spreadsheet, presentation tool), cosmetic products, etc.

• Bundling may be cost saving or it may be due to complementarities among the goods involved. But there can be reasons involving consumer behavior. Consider the following example. Assume the marginal cost of producing is zero.

Pricing strategies by monopolist: Bundling

Slide 95


• Type of consumers word pro spreadsheet A 120 100 B 100 120 • Suppose the willingness to pay for the bundle

is the sum. If each item is sold separately, then revenue will be 400. If instead bundling two goods together, can get the revenue of 440. In other words, the dispersion of willingness to pay may be reduced.

Slide 96

econ 2001 microeconomics ii 2014 2 nd semester elliott fan economics, ntu lecture 2 microeconomics,...

Documents

price slide

lr slide

unchanged slide

producer slide

demand curve slide

competitive industry

elliott fan monopoly

average cost slide