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Chapter 7 The Firm. Business Firm. Employs factors of production Produces goods and services Sells to consumers, other firms, or the government We work for and buy from firms. Market. Two sides Buyers Utility is major decision making device Sellers How do they make decisions.

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Chapter 7 the firm l.jpg
Chapter 7The Firm


Business firm l.jpg
Business Firm

  • Employs factors of production

  • Produces goods and services

  • Sells to consumers, other firms, or the government

  • We work for and buy from firms


Market l.jpg
Market

  • Two sides

    • Buyers

      • Utility is major decision making device

    • Sellers

      • How do they make decisions


How do the two sides come together l.jpg
How do the two sides come together?

  • Market Coordination

    • Invisible Hand (Adam Smith)

    • Market guides individuals into activities at which they are the most efficient

    • Pushes sellers to produce certain things and buyers to instruct what to produce

    • Equates supply and demand


How does the firm decide what to produce l.jpg
How does the firm decide what to produce?

  • Managerial Coordination

    • Guides individual firm production decisions

    • Thus…invisible hand of the firm


Why follow this invisible hand l.jpg
Why follow this invisible hand?

  • Firms are formed because greater benefits of working as a team than working as individuals


Problem with teamwork l.jpg
Problem with teamwork

  • Shirking

    • Putting forth less effort than your originally agreed to

    • Problem because shirker gains ALL benefits from shirking but costs are spread over the entire team


Can shirking increase or decrease l.jpg
Can shirking increase or decrease?

  • Yes!!

  • As the benefits of shirking increase so does the amount

  • If the shirker must bear the full cost of shirking then shirking will decrease


How can we decrease shirking l.jpg
How can we decrease shirking?

  • Manager’s duty or MONITORING

  • Reward productive workers and punish shirkers

  • Preserves the benefit of team production

  • Reduces the benefits of shirking


Who monitors the monitor l.jpg
Who monitors the monitor?

  • Salary usually tied into production

  • Called Residual Claimant

    • Person who shares in the profits of the firm

    • More shirkers?? Less Production…so less pay for monitor


Another way to ward off shirking l.jpg
Another way to ward off shirking?

  • Pay higher than equilibrium wages

  • Decreases shirking because cost of losing job is greater.

  • Don’t need monitor because high wage makes worker monitor themselves

  • Called efficiency wage theory


Why do people submit to being monitored l.jpg
Why do people submit to being monitored??

  • Monitoring decreases shirking

  • Monitoring increases benefits of teamwork

  • Monitoring maximizes benefits that can be achieved


Objective of the firm l.jpg
Objective of the firm

  • Profit Maximization

  • Now…want to move to the Firm to see how they achieve this objective


Chapter 8 production and costs l.jpg
Chapter 8Production and Costs

© South-Western College Publishing 1998


Cost side l.jpg
Cost Side

  • Explicit Cost

    • Actual money is exchanged

    • COST

  • Implicit Cost

    • Value of resources used in the production or acquisition of a good

    • No monetary payment

    • OPPORTUNITY COST


Sacrifice l.jpg
Sacrifice

  • In order to have a cost, sacrifice must have taken place

  • Forfeited something else

  • No money must change hands for sacrifice to take place


Profit l.jpg
Profit

  • Two types

    • Accounting

      • Difference between total revenue and explicit costs

      • Acct Profit = TR – EXPLICIT COSTS

    • Economic

      • Difference between total revenue and total cost (implicit and explicit)

      • Econ Profit = TR – Explicit Cost – Implicit Cost


Which do you think is lower l.jpg
Which do you think is lower??

  • Economic Profit

  • Usually lower but never higher

  • How can it be “usually” lower?

  • Implicit cost can equal 0 so accounting and economic profit would be equal



Zero economic profit l.jpg
Zero Economic Profit

  • Total Revenue-explicit cost-implicit costs = 0

  • Also called NORMAL PROFIT

  • Equilibrium of profit for the firm

  • Would we want zero accounting profit?

  • NO!!! Implicit costs would not be covered


Sunk versus fixed costs l.jpg
Sunk versus Fixed Costs

  • Sunk

    • Incurred in the past

    • Cannot be changed by a current decision

    • Cannot be recovered

    • Example: Time spent in school

    • Can’t recover so let it go…Release it

  • Fixed

    • Possibility of recovering some money for selling the good

    • Example: Land, equipment…


Production l.jpg
Production

  • Takes time to produce

  • Costly to produce

  • Direct link between production, costs, and time


Two types of time l.jpg
Two types of time

  • Short Run

    • Fixed and variable inputs

  • Long Run

    • All inputs are variable


Short run l.jpg
Short Run

  • Fixed input

    • Quantity can not be changed

    • Independent of output produced

    • Example: Building, land…

  • Variable input

    • Quantity can be changed as output changes

    • Example: Labor


Costs l.jpg
Costs

  • Fixed Cost (FC)

    • Associated with fixed inputs

    • Do not change with output

    • Example: Insurance premiums

  • Variable Costs (VC)

    • Associated with variable inputs

    • Changes as output changes

    • Example: Hire more people and must pay more wages


Total fixed cost l.jpg
TotalFixed Cost


Total variable cost l.jpg
TotalVariableCost



Total costs l.jpg
Total Costs

  • Variable Cost + Fixed Cost


Total cost l.jpg
TotalCost


Other costs of importance l.jpg
Other costs of importance…

  • Average Variable Cost (AVC)

  • Average Fixed Cost (AFC)

  • Average Total Cost (ATC)


Average variable cost l.jpg
AverageVariableCost


Average fixed cost l.jpg
Average FixedCost



Marginal cost l.jpg
Marginal Cost

  • Change in TC that results from a change in output

  • Additional cost of producing an additional unit of output


Why change in total cost or total variable cost l.jpg
Why Change in Total Cost or Total Variable Cost????

  • Since total fixed cost doesn’t change the “additional” total fixed cost is zero



In class exercise 9 using the knowledge l.jpg

In-class exercise #9Using the knowledge


Shapes of curves l.jpg
Shapes of Curves

  • Law of diminishing marginal returns

    • As larger amounts of a variable input are combined with fixed inputs eventually the Marginal Physical Product (MPP) declines


Marginal physical product mpp l.jpg
Marginal Physical Product (MPP)

  • What is the variable input?

  • What is the variable cost?


Slide41 l.jpg
So…

  • As more labor (VARIABLE INPUT) are added to land (FIXED INPUT) the variable inputs would yield smaller and smaller additions to output



Crowding problem l.jpg
Crowding Problem

  • The point at which MPP declines

  • Shows the law of diminishing returns


Average physical productivity l.jpg
Average Physical Productivity

  • Output divided by Inputs (usually labor)

  • Good for comparing firms or countries.


So find that l.jpg
So find that…

  • MC and MPP are related

  • What is the relationship?


In class exercise 10 does mpp show diminishing returns l.jpg

In –class exercise 10 Does MPP show Diminishing Returns???




Does this relationship make sense l.jpg
Does this relationship make sense?

  • Yes..

  • If productivity increases what would happen to costs??

    • Decrease (MPP increase & MC decrease)

  • Productivity decreases??

    • Increase (MPP decreases & MC increases)


Mpp determines shape of mc l.jpg
MPP determines shape of MC

  • MPP must have a declining part because of diminishing returns

  • Can also define MC as:


In class exercise 11 l.jpg

In-class exercise 11

How do we calculate these costs??

Give two ways to get to the cost…


Average marginal rule l.jpg
Average-Marginal Rule

  • Can use to see what the ATC and AVC curve look like

  • Tells us what happens when MC is above or below the “average” curves

  • If MC is above AVC and ATC

    • AVC and ATC are rising

  • If MC is below AVC and ATC

    • AVC and ATC are falling


From average marginal rule can infer l.jpg
From Average-Marginal Rule can infer…

  • MC intersects the AVC and ATC curves at their MINIMUM POINTS

  • Cannot infer anything about AFC




Slide56 l.jpg
So…

  • MC gains it shape from???

    • MPP and law of diminishing marginal returns

  • MC below ATC: What is ATC curve doing?

    • Falling

  • MC above ATC: What is ATC curve doing?

    • Rising



Tying products to costs l.jpg

Tying Products to Costs

A CLOSER LOOK

MPP

Variable Input

When MC is below

ATC, AVC

MC

Production in the

short run: at

least one fixed input

When MC is above

ATC, AVC

MPP

Variable Input

MC


Now switching to the long run l.jpg
Now switching to the Long Run

  • When does Long Run start?

    • As soon as all inputs (costs) are VARIABLE

    • No fixed costs

  • Important curves

    • LRTC

    • LRATC

    • LRMC


Short run vs long run l.jpg
Short Run vs. Long Run

  • Short Run assumes FIXED plant size

  • Each plant size has a unique ATC curve associated with it

    • SRATC

  • LRATC combines all the SRATC curves

  • Which points of the SRATC???

  • Minimum points


Why minimum l.jpg
Why minimum?

  • LRATC shows the lowest average cost at which a firm can produce any given level of output

  • LRATC is the lower ENVELOPE of the SRATC curves

  • Called envelope curve



Isn t the lratc curve smooth l.jpg
Isn’t the LRATC curve smooth??

  • Yes!!

  • Have infinitely many SRATC curves so it would be smooth if use all curves

  • Each SRATC curve touches the LRATC curve only once


Shape of lratc l.jpg
Shape of LRATC

  • U-shaped

  • Decreasing, Flat, then Increasing

  • Important when finding optimal long run output level



Economies of scale l.jpg
Economies of Scale

  • Downward part of LRATC

  • Average costs decrease as output increases

  • If have a 1% increase in input usage what happens to output??

    • Increases by MORE than 1%

  • Specialization


Constant returns to scale l.jpg
Constant Returns to Scale

  • Flat portion of LRATC

  • Costs remain the same as increase output

  • If have a 1% increase in input usage what happens to output??

    • Output increases by EXACTLY 1%

  • First point of constant returns to scale is called MINIMUM EFFICIENT SCALE


Diseconomies of scale l.jpg
Diseconomies of Scale

  • Upward sloped portion of LRATC

  • Costs are rising as we increase output

  • If have a 1% increase in input usage what happens to output?

    • Increases by LESS THAN 1%

  • Why???

    • Firm too large (bad communication or coordination problems)



Are economies diseconomies and constant returns to scale in sr lr or both l.jpg
Are economies, diseconomies, and constant returns to scale in SR, LR, or both???

  • LONG RUN ONLY!!!

  • Why?

    • Inputs necessary for production are able to be changed

    • No fixed inputs


Is this the same as diminishing returns l.jpg
Is this the same as diminishing returns? in SR, LR, or both???

  • NO

  • Diminishing returns is from using ONE plant size intensely

    • Short run

  • Economies of scale is from CHANGING plant size

    • Long run


Review l.jpg
Review in SR, LR, or both???

  • Economies of Scale

    • LRATC falling

  • Constant Returns to Scale

    • LRATC flat

  • Diseconomies of Scale

    • LRATC rising


Why does economies of scale exist l.jpg
Why does economies of scale exist? in SR, LR, or both???

  • Large firms offer more opportunity for workers to specialize

  • Growing firms can take advantage of efficient mass production techniques

    • Smooth cost over more units produced


Why does diseconomies of scale exist l.jpg
Why does diseconomies of scale exist? in SR, LR, or both???

  • Communication problems

  • Shirking

  • Management problems


Why is minimum efficient scale important l.jpg
Why is minimum efficient scale important? in SR, LR, or both???

  • Lowest output level at which ATC are minimized

  • Which has a cost advantage??

    • Small firm at minimum efficient scale point

    • Larger firm producing more output but still within constant returns to scale area

    • Neither




Where would you expect to find less firms using mes l.jpg
Where would you expect to find less firms? (using MES) in SR, LR, or both???

  • Firms with higher MES

  • Why??

    • Produce until MES

    • If MES is higher then each firm will be producing more…so need less firms to cover quantity wanted by economy

  • Many SHOE companies (MES = .2)

  • Few REFRIGERATOR companies (MES = 14)


Efficient number of firms l.jpg
Efficient Number of Firms in SR, LR, or both???

  • 100 divided by MES

  • 100% of goods are wanted by consumers

  • MES is the percentage of consumption each firm will provide

  • Cigarette firm’s MES = 6.6

    • Need 15 firms

  • Petroleum firm’s MES = 1.9

    • Need 52 firms

  • Thus a larger MES means less firms needed


What cause srtc lrtc and mc to shift l.jpg
What cause SRTC, LRTC, and MC to shift? in SR, LR, or both???

  • Taxes

    • Does it affect FC??

      • Only if it is a lump sum tax (tax for existing)

      • If it is a per unit tax then FC doesn’t change

    • How does it change curves??

  • Input prices

    • How does it change curves??

  • Technology

    • Either improves production process (use less inputs) or lower input prices

    • How does it change curves??


Homework due monday may 19th l.jpg
Homework due Monday May 19th in SR, LR, or both???

  • Chapter 8

    • Questions: 3, 5, 10, and 11

  • Working with numbers and graphs

    • Questions 3, 6, and 7


In class exercise 12 l.jpg

In-class exercise 12 in SR, LR, or both???

Do we understand Chapter 8??


Chapter 9 l.jpg

Chapter 9 in SR, LR, or both???

Perfect Competition


Assumptions l.jpg
Assumptions in SR, LR, or both???

  • Many buyers and sellers

    • None powerful enough to alter price

  • Homogenous good

  • Full information

  • Easy entry and exit


Price takers l.jpg
Price Takers in SR, LR, or both???

  • Those who can’t influence price

  • Why can’t they??

    • Just a small fish in a large sea

  • Who sets the price then??

    • The market


Examples l.jpg
Examples in SR, LR, or both???

  • Agriculture market

  • Milk Market

  • Pork Market

  • Beef Market


Demand curve l.jpg
Demand Curve in SR, LR, or both???

  • Individual Market

    • Perfectly Horizontal

    • Horizontal where??

      • At the market price

  • Industry

    • Downward Sloping



Slide89 l.jpg
Why??? in SR, LR, or both???

  • Price Taker

  • Horizontal Demand means…

    • At price lower firm would sell ALL its output

    • At price higher firm would sell NOTHING


Would a firm sell at price lower than market price l.jpg
Would a firm sell at price lower than market price? in SR, LR, or both???

  • No!!

  • Why??

    • Wouldn’t maximize profit

    • Could increase price and not lose customers


Why horizontal though l.jpg
Why horizontal though?? in SR, LR, or both???

  • What happens to elasticity as increase the number of substitutes for the good?

    • Increases

  • How many substitutes exist for a homogenous good?

    • Many

  • What type of elasticity does this demand have?

    • Perfectly elastic


Does this go against the law of demand l.jpg
Does this go against the Law of Demand? in SR, LR, or both???

  • What is the Law of Demand??

    • Increases in the price decrease the quantity demanded for the good

  • Go against??

    • NO!!

    • Just pricing situation a single firm finds themselves in

    • Each firm produces small amount so can’t change price


Total revenue l.jpg
Total Revenue in SR, LR, or both???

  • Price * Quantity

  • Marginal Revenue (MR)


Slide94 l.jpg


Slide96 l.jpg
So… in SR, LR, or both???

  • For perfectly competitive the MR curve is the same as the Demand curve

    • MR = D

  • Since price taker – Demand horizontal at the market price

    • D = price

  • So…MR = D = P


Example l.jpg
Example in SR, LR, or both???



What if assumptions don t hold l.jpg
What if assumptions don’t hold? Competitive Firm

  • Depends on degree to which assumptions don’t hold

  • Difference small?

    • Will approximately act like a perfectly competitive market

  • Difference big?

    • Will be categorized as a different “type” of market


When will firm produce l.jpg
When will firm produce?? Competitive Firm

  • Produce as long as MC < MR

  • Do not produce if MC > MR

  • Maximize profit where MC = MR

  • Remember if Maximize profit you implicitly mean you minimize costs


Profit maximization rule l.jpg
Profit Maximization Rule Competitive Firm

  • Produce at the quantity where MR just equals MC

  • True for all market types not just perfect competition

  • Point we are interested in

    • MR = MC


Since l.jpg
Since… Competitive Firm

  • P = MR

  • Profit Maximization is MR = MC

  • Can rewrite profit maximization rule as

    • P = MC



Four cases produce or not l.jpg
Four Cases: Produce or not? Produce

  • Price equals ATC

  • Price above ATC

  • Price below AVC

  • Price below ATC but above AVC

  • Each case must start with profit maximization rule

  • What was that rule???

    • Price = MC = MR


Price equals atc l.jpg
Price equals ATC Produce

  • Called Normal profit or Zero Economic Profit

  • Breakeven point

  • No profit or loss


Price above atc l.jpg
Price above ATC Produce

  • Profit



Price below avc l.jpg
Price below AVC Produce

  • Loss

  • Firm fails to cover even variable costs of firm

  • Should Shut Down!!


Shut down rule l.jpg
Shut Down Rule Produce

  • If P < AVC should shut down

  • Why?

    • Minimize loses

    • If continue to produce have to pay variable and fixed costs

    • If shut down have to pay only fixed costs



Price below atc but above avc l.jpg
Price below ATC but above AVC Produce

  • Loss

  • Continue to operate

    • Covering variable costs and some fixed costs

    • Minimize losses by continuing operation

  • Overtime alter production to cover all fixed costs




Can we do this with numbers too l.jpg

Can we do this with numbers too????? Produce

In-class exercise 13


Slide115 l.jpg

Now.. Produce

Firm Supply Curve


What is the shut down rule l.jpg
What is the shut down rule?? Produce

  • Shut down if Price < AVC

  • So…produce if Price > AVC

  • Supply Curve is portion of MC above the AVC

  • Why??

  • Indicates quantities at which the firm would consider producing


Perfectly competitive firm s short run supply curve l.jpg
Perfectly Competitive Firm's ProduceShort-Run Supply Curve


How find the market supply curve l.jpg
How find the market supply curve? Produce

  • What is the individual firm’s supply curve?

    • MC above AVC

  • Horizontally sum all individual supply curves to get the market supply curve

  • Why are market supply curves upward sloping??

    • Horizontal sum of upward sloped curves

    • Law of diminishing marginal returns



Job security and fixed costs l.jpg
Job Security and fixed costs? Produce

  • Is this the Short Run or Long Run?

    • Short because have fixed costs

  • Increases in FC/TC ratio means more job security

  • Why?

    • If true … FC is a larger portion of TC

    • TR can fall more before firm shuts down



Firm x has more job security l.jpg
Firm X has more job security!! Produce

  • Unions know this so usually negotiate more benefits for workers before wages

  • Why??

    • Benefits are a fixed cost

    • Must pay for them even if workers aren’t using the benefit


Will there be the same number of firms in the short and long runs l.jpg
Will there be the same number of firms in the short and long runs?

  • Probably not!!

  • If there is a profit

    • More firms will be in the long run

  • If there is a loss

    • Less firms will be in the long run

  • If there is normal profit

    • The same amount of firms will be in the long run


Long run competitive equilibrium l.jpg
Long Run Competitive Equilibrium runs?

  • Zero Economic Profit (normal profit)

    • P = SRATC

    • Incentive for no firms to enter or exit

  • Produce where P = MC

  • No incentive to change plant size

    • SRATC = LRATC where P = MC

    • Production is at optimal scale



Summary of incentives present at long run equilibrium l.jpg
Summary of Incentives present at Long Run Equilibrium runs?

  • No incentive for firms to enter or exit

  • No incentive for firms to produce more or less

  • No incentive to change plant size


Perfect competition l.jpg
Perfect Competition runs?

  • Resource Allocative Efficiency

    • Value of product to consumers = opportunity cost of resources

    • P = MC

  • Productive Efficiency

    • Producing at the lowest per unit cost

    • Long run equilibrium ATC = P at minimum point of ATC curve

    • Efficiently using resources (not wasting)


Do we understand chapter 9 l.jpg

Do we understand Chapter 9??? runs?

In-class exercise 14


Homework due friday may 30th l.jpg

Homework runs?due Friday May 30th

Chapter 9

Questions 1, 6, 16

Working with Graphs and Numbers

Questions 1 and 9


Chapter 10 l.jpg

Chapter 10 runs?

MONOPOLY


Assumptions131 l.jpg
Assumptions runs?

  • One seller

    • Firm is the industry

  • No substitutes for good

  • Many barriers to entry


Government can grant monopoly power in three ways l.jpg
Government can “grant” monopoly power in three ways… runs?

  • Public franchise

    • Exclusive provider

      • Power companies, water companies

  • Patents

    • Exclusive provider for 17 years

    • Encourages people to invent new things

      • Zantac, Tagament

  • Licenses

    • Must have to operate

      • Cabs in New York City


Monopolies exist because l.jpg
Monopolies exist because: runs?

  • Legal mandate

    • Government allows or doesn’t allow you to operate

  • Economic rational

    • Natural Monopolies

      • One firm can produce more efficiently than many

    • Exclusive ownership of resource to make the good


Two types of monopolies l.jpg
Two types of Monopolies runs?

  • Government monopolies

    • Legally protected from competition

  • Market monopolies

    • Protected from competition due to economies of scale


Price maker l.jpg
Price maker runs?

  • Firm is the market

  • Firm has some control over the price it sets

  • Law of Demand still hold

    • Price increases leads to less quantity demanded


Demand curve136 l.jpg
Demand Curve runs?

  • Remember the individual firm is the market

  • What does the demand curve look like??

    • Downward sloped

    • Want to sell more must lower the price


Example137 l.jpg
Example runs?


What differs here from perfect competition l.jpg
What differs here from Perfect Competition?? runs?

  • Price doesn’t equal MR!!!

    • Price > MR

  • Monopolist’s demand curve and marginal revenue curves are DIFFERENT

  • After the first point Marginal Revenue falls twice as fast as Demand


Example139 l.jpg
Example runs?



Slide141 l.jpg
Goal runs?

  • Profit Maximization

  • What is the profit maximization rule?

    • MR = MC

  • Want to charge the highest price per unit of quantity sold



Three cases l.jpg
Three cases runs?

  • P > ATC

  • P < ATC

  • P=ATC

  • Where is AVC??

    • Since monopoly is the industry no need to segment total cost

    • If suffer a loss can just increase prices to cover the loss



Differences between monopoly and perfect competition l.jpg
Differences between monopoly and perfect competition runs?

  • P = MR for perfect competition but P > MR for monopoly

  • P = MC for perfect competition but P > MC for monopoly

  • Monopolist can change prices


Similarities l.jpg
Similarities runs?

  • Both try to maximize profits

  • Both are constrained by their demand curves

  • Both equate MR and MC


Long run profits l.jpg
Long Run Profits runs?

  • Perfect Competition

    • Zero Economic Profit (normal profit)

  • Monopoly

    • No entry

    • Profits can be reduced in two ways

      • Capitalization of profits

      • Monopoly rent seeking


Capitalization of profits l.jpg
Capitalization of Profits runs?

  • Firm owner eventually may sell the business

  • When sell…include profits into the price

    • Include in TFC

  • New owner will face a higher ATC than previous owner

    • Includes old owner’s profits

  • Increase in ATC eliminates profit for new owner



Economic rent l.jpg
Economic Rent runs?

  • Profits that can’t be reduced by new entrants

  • Payment in excess of opportunity cost (profit)

  • May bring about Rent Seekers

    • Try to find markets that can gain monopoly status

    • Time and resources expended to try to get monopoly reduces economic rent


Monopolies are inefficient compared to perfect competition l.jpg
Monopolies are inefficient compared to Perfect Competition runs?

  • Welfare cost of monopoly

    • Lower levels of output produced with monopoly than perfect competition

    • Perfect competition produce where P=MC

    • Monopoly produce where MR=MC and P > MC

    • Welfare cost is about 1% of total output

  • Rent seeking is socially wasteful

    • Use resources not in production but to gain monopoly power



X inefficiency l.jpg
X-inefficiency runs?

  • Monopoly has no competition

  • No incentive to operate at lowest cost


Does monopolist have to charge same price to everyone l.jpg
Does monopolist have to charge same price to everyone? runs?

  • No!!

  • Called Price Discrimination

  • Three types

    • First degree (perfect price discrimination)

    • Second degree (bulk pricing)

    • Third degree (group pricing)


Perfect price discrimination l.jpg
Perfect Price discrimination runs?

  • Highest price willing and able to pay is charged to each person

  • Price determined by placement on demand curve

  • Discrimination among units

    • Ex. Schools


Bulk pricing l.jpg
Bulk Pricing runs?

  • Different prices for different quantities sold

  • Discrimination among quantities

  • Ex. costco


Group pricing l.jpg
Group Pricing runs?

  • Different prices for different segments of the market

  • Ex. Senior citizen discounts, coupons, different seats in movie or plane…


Why price discriminate l.jpg
Why Price Discriminate? runs?

  • To gain some of the consumer surplus lost when charge everyone the same price

  • If successfully perfectly price discriminate

    • P=MR for all units sold

    • MR and TR increase

    • Eliminate consumer surplus


Why doesn t everyone price discriminate l.jpg
Why doesn’t everyone price discriminate? runs?

  • Seller must be a price maker

  • Seller must know each consumer’s willingness to pay

  • Must be impossible for consumers to resell to others

    • Arbitrage

    • Buy for a low price and sell at a higher price


Does a monopolist exhibit resource allocative efficiency l.jpg
Does a monopolist exhibit resource allocative efficiency? runs?

  • Perfect competition does!!

    • P = MC

  • Monopolist doesn’t!!

    • P > MC

  • Perfectly Price Discriminating Monopolist does!!

    • P = MC



So does one person paying high prices mean that another can pay low prices l.jpg
So does one person paying high prices mean that another can pay low prices??

  • No!!

  • Perfect Price Discrimination means that each person pays the highest price they are willing and able to pay


Would firms rather be a monopoly l.jpg
Would firms rather be a monopoly? pay low prices??

  • Yes!!

  • Rent seekers try to “buy” monopoly positions.

  • Why?

    • Fewer constraints on production behavior

    • Ability to charge different prices to different segments of the population


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Homework pay low prices??

Chapter 10

Question 1

Working with graphs and numbers

Questions 5, 6, and 7


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Homework pay low prices??

Chapter 10

Questions 1 and 4

Working with graphs and numbers

Questions 4, 5, and 6


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Finally Chapter 11 pay low prices??

Monopolistic Competition, Oligopoly, and Game Theory


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Monopolistic Competition pay low prices??Four Assumptions

  • Many buyers and sellers

  • Heterogeneous Products

    • Brand names, location, services…

    • Real or Imagined

  • Easy Entry and Exit

  • Some control of prices


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Examples pay low prices??

  • Retail clothing

  • Restaurants

  • Textbooks

  • Gas Stations

  • What about cereals??

    • No…many different brands but very few firms that produce them (GM, Post…)


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Monopolistic is combination of Perfect Competition and Monopoly

  • Downward Sloped Demand Curve

    • Price Maker (Searcher)

  • Demand Curve more elastic than Monopoly

    • Easy entry limits control over price

    • More elastic because more substitutes

  • P > MR

    • No resource allocative efficiency

  • Most likely -- Zero Economic Profit in the long run

    • Not productive efficient


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Why most likely???? Monopoly

  • Heterogeneous products

  • Not differentiated enough

    • Entry eats up profits

  • Differentiated

    • Barriers to entry

    • Profits

    • Example…7-up “The only uncola”


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Still have three cases Monopoly

  • P = ATC

  • P > ATC

  • P < ATC



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Differs from perfect competition… Monopoly

  • Produce less than perfectly competitive

  • Excess Capacity

    • Rid only with min ATC tangent to demand curve

    • Possible only with horizontal demand curve

  • Higher prices than perfectly competitive



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The more we differentiate our product the closer we get to monopoly. If we can’t differentiate our product we are closer to perfect competition.


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Oligopoly monopoly. If we can’t differentiate our product we are closer to perfect competition.


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Oligopoly monopoly. If we can’t differentiate our product we are closer to perfect competition.Four assumptions

  • Few sellers and many buyers

    • Firms mutually interdependent

  • Homogeneous or Heterogeneous Goods

  • Price Maker (Searcher)

    • Limited number of firms

  • Barriers to entry

    • Economies of scale, patents, legal barriers…


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How find??? monopoly. If we can’t differentiate our product we are closer to perfect competition.

  • Concentration Ratio

    • Measures the % of some factor that is controlled by a certain number of firms in the industry

    • Employment, sales, assets, output…


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So… monopoly. If we can’t differentiate our product we are closer to perfect competition.

  • High concentration ratio?

    • Oligopoly likely

    • Small number of firms controls much of the output

  • Small concentration ratio?

    • Oligopoly unlikely

    • Large number of firms control the outpu


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Question… monopoly. If we can’t differentiate our product we are closer to perfect competition.

How do firms react to actions of other firms??? Important since they are interdependent!


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Three theories monopoly. If we can’t differentiate our product we are closer to perfect competition.

  • Kinked Demand Curve Theory

  • Price Leadership Theory

  • Cartel Theory


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Kinked Demand Theory monopoly. If we can’t differentiate our product we are closer to perfect competition.

  • General Theory

    • If one firm decreases price all firms will match

    • If one firm increases price others many not match

  • So…each firm has a kink in the demand curve at the prevailing price

    • Why???

    • That is where decisions must be made


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Demand Curve monopoly. If we can’t differentiate our product we are closer to perfect competition.

  • Flatter above kink

    • More elastic

    • Increase price and people freak out

  • Steeper below kink

    • Less elastic

    • Decreases in price won’t increase quantity demand much

    • Why?

    • All firms decrease price


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Why kinked monopoly. If we can’t differentiate our product we are closer to perfect competition.

  • Made up of two separate demand curve with their own MR curves

  • One demand more elastic

  • One demand less elastic

  • Only use portions of demand curve that is relevant

    • More elastic above price and less elastic below


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So… monopoly. If we can’t differentiate our product we are closer to perfect competition.

  • MR is not continuous

  • Expect price to remain at or near kink

  • Called sticky prices


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Kinked Demand Curve Theory monopoly. If we can’t differentiate our product we are closer to perfect competition.


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Criticisms monopoly. If we can’t differentiate our product we are closer to perfect competition.

  • Doesn’t say where price comes from

  • Real oligopolies don’t behave like this

    • Most will follow a price increase by one firm

    • Why wouldn’t they match???

    • Gain larger portion of market


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Price Leadership Theory monopoly. If we can’t differentiate our product we are closer to perfect competition.

  • Tries to explain where kinked price comes from

  • Assumption

    • One firm (dominate firm) sets the market price and other firms (fringe firms) take price as given


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Price Leadership Theory monopoly. If we can’t differentiate our product we are closer to perfect competition.


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So… monopoly. If we can’t differentiate our product we are closer to perfect competition.

  • Dominate firm

    • Sets price to maximize its profits

    • Price Maker (Searcher)

    • Own supply and demand curve

  • Fringe Firm

    • Takes price as given

    • Price Taker

    • MC > AVC is supply curve



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How derive demand curve? be the one with the lowest cost!!

  • Dominate firm

    • See how much is left over for it to supply at a given price


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From Demand Curve be the one with the lowest cost!!

  • Find price that will equate MR = MC

  • Fringe firms take price as given

  • At equilibrium price fringe firms cover all market demand


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Cartel Theory be the one with the lowest cost!!

  • Several firms ban together and act as a monopoly

  • Produce less quantity and charge higher prices than if operated alone

  • Gain profits…then split among group members


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Benefits of a Cartel (to Cartel Members) be the one with the lowest cost!!


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Problems for a cartel be the one with the lowest cost!!

  • May be illegal

  • Expensive to set up

    • Free rider

    • Own priorities

    • Self interest

  • Profits may entice other firms to “try” to enter industry

  • Incentive to Cheat


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Why Cheat??? be the one with the lowest cost!!

  • Can increase output to increase individual profit

  • If one firm cheats…all will eventually cheat

  • Cartels will not stay in tact for long


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The Government tries to keep some cartels together be the one with the lowest cost!!

  • Farmers

    • Acreage allotment program

  • Airlines

  • Each tends to increase price, TR, and profits


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Game Theory be the one with the lowest cost!!

  • Mathematical technique used to analyze behavior of decision makers

    • Each player knows game is interactive

    • Needs to anticipate outcomes of other person

  • Matter of Trust


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Prisoner’s dilemma be the one with the lowest cost!!

  • Two prisoners in separate rooms being questioned

  • Two ways to answer

    • Confess

    • Not confess

  • Four outcomes


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Prisoner's Dilemma be the one with the lowest cost!!


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Cartels and Prisoner's Dilemma be the one with the lowest cost!!


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Do we understand be the one with the lowest cost!!Chapter 11?

In-class exercise 16


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Homework due be the one with the lowest cost!!Monday June 9th

Chapter 11

Questions 1, 2, 5, and 6


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