Economics 3 Terms Monopoly A market wit a single seller that produces a product with no close substitute white A monopolist faces the downward sloping market demand A monopolist has no supply curve Reasons for Monopoly Government franchise Patent Ownership of a scares resource Natural Monopoly happens for very large economies of scale MR P doesn t apply here P MR This is because based on the price different quantity that customer wants More demand curve MR P 1 1 E In general for any firm facing a downward sloping demand curve P MR MR MC to maximize profit a firm should produce the quantity where MR MC MR MC the firm can increase profit by increasing output MR MC the firm can increase profit by decreasing output A profit maximizing monopolist will produce at level of output where P MR MC P MC A monopolist produces too little output for social efficiency If demand is linear the Marginal Revenue curve will have the same vertical intercept as the Demand Curve and it will be twice as steep double the slope Ex Demand P 100 2Q MC 20 Monopoly MR MC MR 100 4Q Double the slope MC 20 Q 20 P 60 Perfectly competitive P MR P MC Q 40 P 20 In general a monopolist will produce less output and charge a higher price than if the market were perfectly competitive A profit maximizing monopolist will never produce where demand is inelastic If demand is inelastic the firm can increase profit by raising price P increased TR increased P increased Q decrease TC decreased Profit increase MR P 1 1 E MC Lerner Index can know about market power ex Gasoline or tobacco how would tax impact on E If MC 0 than P MC P 1 E 1 Consumer Surplus the difference between what a consumer is willing to pay for a good and what they actually have to pay price We can estimate this as the area between the demand curve and above the price Producer surplus the difference between what a firm receives for a product price and the minimum they would be willing to accept to produce a unit of the good MC We can estimate this area under the price and above MC EX demand P 100 2Q MC 20 Monopoly MR 200 4Q MC 20 Q 20 P 60 TR CS PS 1200 Perfectly competitive P 200 2Q MC 20 Q 40 P 20 TR CS PS 1600 Dead weight loss potential cost that could be generated but thrown away Pareto efficiency a situation where there is no way to make someone better off without making someone else worse off when there is no more improvements to be made Monopoly is throwing Consumer Surplus Monopoly Perfect market Demand P 72 2Q MC 24 Q P CS PS TR Dwb Lerner Index 12 48 144 288 432 144 1 2 24 24 576 576 0 0 0 Oligopoly Oligopoly a market with a few dominant firms Airline industry wireless and soft drink company The firms are strategically interdependent Economist use Game theory to model the behavior of firms in an oligopoly A game consist of A payoff function that assigns a payoff to each player for all possible strategy combination High price Low price a set of player A set of strategies for each player EX Assume 2 player Firm 1 Firm 2 2 strategies High price Low price the players choose their strategies simultaneously one shot game each player only comes about their own payoff High price 100 100 25 150 Low price 150 25 50 50 Each player has dominant strategy Dominant strategy a strategy that always yields a higher payoff than any other strategy regardless of the strategies chosen by the other players Nash Equilibrium a combination of strategies where no player can improve their payoff by switching to a different strategy given the strategies chosen by the other players No dominant strategy for player 1 Dominant strategy for player 2 BR Nash equilibrium when both of the players cannot switch There can be more than one Nash Equilibrium Player 1 Top 0 Bottom 0 6 Bottom is the maxim in strategy L R 2 2 3 4 1 1 4 3 R L 0 75 100 14 8 13 0 06 1 A maxim in Strategy To find a player s maxim in strategy find the worst possible outcome for each of their strategies Choose the strategy that yields the highest payoff out of all the worst case payoff T B T B Social Security Game Monopolistic Competition Firm produces differentiated products Besides price 1 Demand is not perfectly inelastic Profit leads firm to enter the competition In Short Run MC ATC MR MC D Profit When firms enter a monopolistic competitive industry it lowers the individual demands that the existing firms face the new firms steal some customers from the original firms continues when firm makes P In Long Run P ATC MC Loss ATC becomes tangent to the Demand curve Loss no more entry or exit Zero economic profit In long run equilibrium ATC is NOT minimized in a monopolistic competitive industry Consumers get variety products Chart Price discrimination occurs when a firm changes different price to different consumers for the same product Ex student discount happy hour etc 1 The firm must face a downward sloping demand curve 2 The firm must be able to distinguish between to or more groups of consumers that have different price elasticity of demand 3 It must be difficult to resell the good Marginal Revenue a Pa 1 1 E MC Marginal Revenue b Pb 1 1 E MC Pa 1 1 E Pb 1 1 E Suppose Pa Pb Ea Eb Ea should inelastic than Eb The consumers with the more elastic demand are charge a lower price Different Degree of Price discrimination 1 1st degree price discrimination Perfect price discrimination The firm charges each customer exactly what they are willing to pay 2 2nd degree price discrimination the firm charges different prices based on how much of the good the consumer buys Ex Set fixed cost more use more spread of fixed cost Two part price The firm charges a flot fee The firm charges a price Lower price increase the value of T Lower price decreased dead weight loss To maximize profit using a two part pricing scheme set P MC T SC when P MC 3 3rd Degree Price discrimination The firm charges different groups of consumers different price Ex student non student Suppose a monopolist can identify two different types of consumers Demand MC 4 FC 0 Type A Q 80 2p p 40 Type B Q 80 3p p 20 If MC is constant and FC 0 then MC ATC Without price discrimination Market Demand P 20 Q 140 5p 20 p 40 Q 80 2p With Price discrimination Type A P 40 Q MR 40 Q 4 MC Qa 36 Pa 22 Profit A Q P MC 648 Type B P 20 1 3Q MR 20 2 3 Q 4 MC Qb 24 P 12 Profit B 192 With PD 840 Without PD …