ECON 4631 Pricing Under Competition and Monopoly Part 2 Kailin Clarke September 10 2013 Lecture 9 10 Announcements Today we will finish finish Chapters 3 4 and start Chapter 5 Note that we spent extra time on cost curves so we are about half a day behind on the schedule 1 Same concept di erent equation Our preceding analysis depended on the profit equation p q C q In empirical applications we ll encounter this equation written as M s p p c F Let M denote the market size number of people look to buy Let s p be the share of the market that buys the good Let p c be the markup where p is price and c is marginal cost In other words in empirical applications it is convenient to assume constant marginal cost 2 Let s take a break from math and talk about firm organization and mergers Objective of a firm is generally to make profit Problem with neoclassical model Owner usually isnt operator of firm Who makes the choices of K and L The firm s owner In corporations managers are often left to make the decisions and report to the board and shareholders The book will talk in Chapter 12 abut the importance of oversight of these managers 3 The rise of corporations 3 forms of ownership Sole proprietorship single owner Partnership multiple owners Corporations Corporations are most important biggest We ll see pictures in a second 4 Why corporations Limited liability stock holders are not liable for debt with personal assets Financing Issuing stocks as a source of cash High risk high return Employees finance the firm in part by giving their labor at a discounted rate since they get stock options Diversification Can own stock in many companies People are risk averse 500 000 vs 1 000 000 or 0 5 Why do mergers happen What are the incentives for the owners Di erences in efficiency Reduced transaction costs economies of scope Complementaries e g complementary fleets Delta NWA non overlapping markets and Market power Merging reduces competition increases prices Managerial incentives Taking over badly run firms laying o some of the management increase worth of stock and make big gains 6 Benefits of merger depends on the type of merger vertical firm combines with its supplier horizontal firm combines with a direct competitor conglomerate firms in unrelated lines of businesses combine 7 Ownership vs Control So there s a gain in efficiency but greater difficulty monitoring managers and employees read about Enron in textbook therefore managers are often compensated by stock options can buy stocks at fixed price in future so they care about the firms profits 8 Let s look at some fun graphics about mergers and the rise of corporations 1104 QUARTERLY JOURNAL OF ECONOMICS 16 15 data mixture of gamma distributions lognormal distribution 13 12 11 10 9 8 7 6 0 1 2 3 4 5 6 s ln employees 7 8 9 10 FIGURE I Size Distribution of U S Firms in 2002 The remarkable fit of this distribution has been documented Downloaded from http qje oxfordjournals org at University of Min ln number of firms to right of s 14 9 Ownership Structure Reasons for Mergers Center for Research and Security Prices mergers happen in waves Merging Industries More technology less manufacturing Other market structures Market Structure Competition Monopoly Cartel Oligopoly Entry Barriers no yes yes yes Sellers many one few few Buyers many many many many Price takers setter setters depends Well talk monopoly today and cartels next time 10 Profit Maximization for a monopoly As in every market structure firm maximizes profits p Q Q First order condition M R Q Q C Q M C Q p p Q Q C 0 Q 11 Ways that monopolies are created All firms merge or act in concert as a monopoly would later A firm takes strategic actions that prevent entry by other firms also later Special knowledge can produce cheaper or something that no one else knows how to produce Government created monopolies e g patents medallions for taxicabs etc Natural monopoly one firms can produce the market quantity at a lower cost than 2 could In that case C Q C q1 C qk subadditivity is necessary for a natural monopoly e g economies of scale everywhere 12 Dominant firm with a competitive fringe This means there s one firm with a large market share that is a price setter it faces smaller price taking firms called fringe firms Entry may be free or restricted Possible ways a firm can become dominant Lower cost structure Superior product maybe through reputation e g apple iPod A group of firms may act together as a dominant firm cartel 13
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