Why are we Speed Reviewing? 1.Having you review on your own wouldnt be effective 2.Lecturing about...

Why are we “Speed Reviewing”?1. Having you review on your own wouldn’t be effective2. Lecturing about every concept would be too boring.

“Speed Reviewing” will help you identify what you need to study.

So you must come see me about specific things you don’t understand.

Unit IV: Unit IV: Imperfect Imperfect

CompetitionCompetition

Half Way

Imperfect Competition1. The cost curves are the same2. The MR= MC rule still applies3. Shut down rule still applies4. All have a downward sloping

demand curve. To sell more a firm must lower its

price.5. All are inefficient.6. MR < Demand

Characteristics Characteristics of Monopoliesof Monopolies

5 Characteristics of a Monopoly5 Characteristics of a Monopoly

3. “Price Maker”2. Unique good with no close substitutes

• The firm can change the price by changing the quantity it produces

• The Firm IS the Industry1. Single Seller

4. High Barriers to Entry•New firms CANNOT enter market•No immediate competitors

5. Some “Nonprice” Competition

Drawing Drawing MonopoliesMonopolies

1 2 3 4 5 6

MR is below Demand

P Qd TR MR

$11 0 0 -

Why is MR less than Demand?

P Qd TR MR

$11 0 - -

$10 1 10 10

P Qd TR MR

$11 0 - -

$10 1 10 10

$9 2 18 8

P Qd TR MR

$11 0 - -

$10 1 10 10

$9 2 18 8

$8 3 24 6

$8 $8 $8

P Qd TR MR

$11 0 - -

$10 1 10 10

$9 2 18 8

$8 3 24 6

$7 4 28 4

$8 $8 $8

$7 $7 $7 $7

P Qd TR MR

$11 0 - -

$10 1 10 10

$9 2 18 8

$8 3 24 6

$7 4 28 4

$6 5 30 2

$8 $8 $8

$7 $7 $7

$6 $6 $6 $6

P Qd TR MR

$11 0 - -

$10 1 10 10

$9 2 18 8

$8 3 24 6

$7 4 28 4

$6 5 30 2

$5 6 30 0

$8 $8 $8

$7 $7 $7

$6 $6 $6 $6

$5$5 $5 $5 $5 $5

P Qd TR MR

$11 0 - -

$10 1 10 10

$9 2 18 8

$8 3 24 6

$7 4 28 4

$6 5 30 2

$5 6 30 0

$4 7 28 -2

$8 $8 $8

$7 $7 $7

$6 $6 $6 $6

$5$5 $5 $5 $5 $5

$4 $4 $4 $4 $4 $4 $4

P Qd TR MR

$11 0 - -

$10 1 10 10

$9 2 18 8

$8 3 24 6

$7 4 28 4

$6 5 30 2

$5 6 30 0

$4 7 28 -2

$8 $8 $8

$7 $7 $7

$6 $6 $6 $6

$5$5 $5 $5 $5 $5

$4 $4 $4 $4 $4 $4 $4

P Qd TR MR

$11 0 - -

$10 1 10 10

$9 2 18 8

$8 3 24 6

$7 4 28 4

$6 5 30 2

$5 6 30 0

$4 7 28 -2

$8 $8 $8

$7 $7 $7

$6 $6 $6 $6

$5$5 $5 $5 $5 $5

$4 $4 $4 $4 $4 $4 $4

MR IS LESS THAN PRICE

Elastic vs. Inelastic Elastic vs. Inelastic Range of Demand Range of Demand

CurveCurve

1 2 3 4 5 6

Elastic and Inelastic Range

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

Q0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

Elastic

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

Total Revenue TestIf price falls and

TR increases then demand is

elastic.

Inelastic Range

Elastic Range

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18Q

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

TR falls then demand is inelastic.

When MR goes negative, TR will fall

TR increases then demand is

elastic.

Putting Putting Demand, MR, Demand, MR,

and Cost and Cost TogetherTogether

Profit =$5

MR = MC Rule Still Applies

0 1 2 3 4 5 6 7 8 9 10

How much is the TR, TC and Profit or Loss?

140 Loss

0 1 2 3 4 5 6 7 8 9 10

How much is the TR, TC, and Profit or Loss?

Monopolies and Monopolies and EfficiencyEfficiency

Monopolies are inefficient because they…1. Charge a higher price2. Under produce• Not allocativly efficiency

3. Produce at higher costs • No productive efficiency

4. Have little incentive to innovate

EFFICIENCY OF PERFECT COMPETITION

S = MC

An industry in pure competition

INEFFICIENCY OF PURE MONOPOLYP

S = MC

At MR=MCA monopolist will sell less units at a

higher price than in competition

CS and PS of a MonopolyP

S = MC

Result is DEADWEIGHT LOSS

to society

0 1 2 3 4 5 6 7 8 9 10

eAre Monopolies Productively Efficient?

Does Price = Min ATC?

No. They are not producing at the lowest

cost (min ATC)

0 1 2 3 4 5 6 7 8 9 10

eDo Monopolies Have Allocative Efficiency?

Does Price = MC?

No. Price is greater. The monopoly is under

producing.

Regulating Regulating MonopoliesMonopolies

How do they regulate?•Price controls: Price Ceilings

Why Regulate?Why would the government regulate

an monopoly? 1. To keep prices low 2. To make monopolies efficient

1.Socially Optimal PriceP = MC (Allocative Efficiency)

Where should the government place the price ceiling?

2. Fair-Return Price (Break–Even)

P = ATC (Normal Profit)NOT THE SAME AS PRODUCTIVE EFFICIENCY

Monopoly PriceMR = MC

REGULATED NATURAL MONOPOLY

Fair-Return PriceNormal Profit Only

TR = TC

Socially-OptimumPrice

P = MC

Price Price DiscriminationDiscrimination

Requires the following conditions:•Firm must have monopoly power•Firm must be able to segregate the market •Consumers must not be able to resell product

PRICE DISCRIMINATION

Definition:Practice of selling the same products to different buyers at different prices

A perfectly discriminating can charge each person differently so the Marginal Revenue = Demand

What output do they make? Where is Consumer Surplus?

Profit withprice discrimination

Where is the Profit?

Why does MR equal Demand?

P Qd TR MR

$11 0 - -

$10 1 10 10

$9 2 19 9

$8 3 27 8

$7 4 34 7

$6 5 36 6

$5 6 35 5

$4 7 39 4

Why does MR equal Demand?

$10 $9

$10 $9 $8

$10 $9 $8 $7

$5$10 $9 $8 $7 $6

$10 $9 $8 $7 $6 $5 $4

What’s the Point?•Perfectly price discriminating firms:

•Make more profit•Produce more •Produce at allocative efficiency

Monopoly Practice FRQ

Monopolistic CompetitionMonopolistic Competition

Market Structure Continuum

PureCompetition

PureMonopoly

MonopolisticCompetition Oligopoly

FOUR MARKET MODELSMonopolistic Competition:

•Relatively Large Number of Sellers•Differentiated Products•Some control over price•Easy Entry and Exit•Non-price competition (Advertising)

Examples:1. Fast Food Restaurants2. Furniture companies3. Jewelry stores4. Hair Salons5. Clothing Manufacturers

Differentiated Products• Goods are NOT identical.• Firms seek to capture a piece of the

market by making unique goods.• Since these products have substitutes,

firms use NON-PRICE Competition

Monopolistic Qualities• Control over price of own good due

to differentiated product.• D > MR • Plenty of non-price competition• Not efficient

“Monopolistic” +”Competition”

Perfect Competition Qualities• Large number of smaller firms• Relatively easy entry and exit• Zero Economic Profit in Long-Run

since firms can enter.

Drawing Drawing Monopolistic Monopolistic CompetitionCompetition

Short-RunEconomic

Profits

What Happens?

PRICE AND OUTPUT INMONOPOLISTIC COMPETITION

Quantity

New Firms Enter

Quantity

Short-RunEconomic

Profits

Normal Profit

LONG- RUN EQUILIBRIUM

Quantity

Short-RunEconomic

What happens? MC

Quantity

Long-Run EquilibriumNormalProfitOnly

MONOPOLISTIC MONOPOLISTIC COMPETITIONCOMPETITION

AND EFFICIENCYAND EFFICIENCY

MONOPOLISTIC COMPETITIONAND EFFICIENCY

• Not Productively Efficient Minimum ATC

• Not Allocatively EfficientPrice MC

• Firm has Excess Capacity

Graphically…

Excess Capacity• The gap between the minimum

ATC output and the profit maximizing output

• Given current resources, the firm can produce at minimum ATC, but they decide not to.

P3 = A3

Quantity

Long-Run Equilibrium

Excess Capacity

Oligopoly

Market Structure Continuum

PureCompetition

PureMonopoly

MonopolisticCompetition Oligopoly

FOUR MARKET MODELSOligopoly:•A Few Large Producers•Identical or Differentiated Products•Mutual Interdependence

•Firms use Strategic Pricing•High Entry Barriers•Examples: Cereal Companies, Car Producers

Oligopolies occur when only a few large firms start to control an industry.

High barriers to entry keep others from entering.

Types of Barriers to Entry• Economies of Scale• High Start-up Costs• Ownership of Raw Materials

HOW DO OLIGOPOLIES OCCUR?

Game Theory

What is game theory?

The study of how people behave in strategic situations

A thorough understanding of game theory helps firms in an oligopoly

maximize profit.

OLIGOPOLY BEHAVIORA Game-Theory Overview

High LowU

’s P

yRareAir’s Price Strategy

$12 $15

$12 $6

High LowU

’s P

$12 $15

$12 $6

Greatest Combined Profit if both Sell High

OLIGOPOLY BEHAVIOR

High LowU

’s P

$12 $15

$12 $6

Each firm recognizes that more profit is made if they lower price

OLIGOPOLY BEHAVIOR

High LowU

’s P

$12 $15

$12 $6

BUT if both lower price they end up in the Worst Case

OLIGOPOLY BEHAVIOR

High LowU

’s P

$12 $15

$12 $6

To make more profit, firms may try to cooperate (collude)

OLIGOPOLY BEHAVIOR

High LowU

’s P

$12 $15

$12 $6

OLIGOPOLY BEHAVIORTo make more profit, firms may try to cooperate (collude)

High LowU

’s P

$12 $15

$12 $6

But now each firm has the incentive to cheat.

OLIGOPOLY BEHAVIOR

What did we learn?1. Oligopoly pricing must be

strategic2. Oligopolies have a tendency to

collude to gain profit.(Collusion is the act of cooperating

with rivals in order to “rig” a situation.)

3. Collusion results in the incentive to cheat.

Oligopoly Graph

Not one standard model because there are

colluding Oligopolies and noncolluding Oligopolies

Colluding Oligopoly

A cartel is a group of producers that create a formal agreement to fix prices high.

Cartel = Colluding Oligopoly

CARTELS AND COLLUSION

1. Cartels set price and output at an agreed upon price

2. Firms require identical or highly similar demand and costs

3. Cartel must have a way to punish cheaters

4. Together they act as a monopoly

Colluding Oligopolists WillSplit the Monopoly Profits.

EconomicProfit

MR = MC

CARTELS AND OTHER COLLUSION

Non Colluding Oligopoly

1. Match price-If one firm cuts it’s prices, then the other firms follow suit causing inelastic demand

Kinked Demand Curve Model

Noncollusive firms are likely to react to competitor’s pricing in two ways:

2. Ignore change-If one firm raises prices, others maintain same price causing elastic demand

MR1Quantity

KINKED DEMAND THEORY:

The demand and MR curves if other firms match lower pricing

If this firm lowers its price and

others follow, Qd will increase

mildly

Quantity

KINKED DEMAND THEORY:

The demand and MR curves if other firms ignore higher pricing

If this firm increases its price and others ignore it, Qd for this firm will decrease significantly

MR1Quantity

Two sets of curves based on the pricing decisions of other firms

The firm’s demand andmarginal revenue curves

MR1Quantity

Rivals tend tofollow a price cut

MR1Quantity

Rivals tend tofollow a price cut

or ignore aprice increase

MR1Quantity

Effectively creatinga kinked demand curve

Quantity

Effectively creatinga kinked demand curve

MR1Quantity

What about MR?

MR1Quantity

Since we use sections of both MR curves, the MR has a

vertical gap. P

rice MR2

Quantity

Profit maximizationMR = MC occurs

at the kink.

KINKED DEMAND THEORY:NONCOLLUSIVE OLIGOPOLY

ce MR2

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