2. Monopoly Goals of Course: 1. Understand how free exchange solves scarcity problem. 2. Understand ways in which free exchange fails to solve scarcity problem. Monopoly is market failure.
3. Competition vs Monopoly The important difference between monopoly and perfect competition The demand curve facing the firm. CompetitionMonopoly P P Firm Demand Firm Demand Q Q
4. Perfect Competition Supply in competitive markets: the supply curve tells you how much quantity will be supplied at a given price. 1. Implication: firms see price, decide how much to produce. 2. But aren't prices set by firms, and not just given to them? P Supply Peq Q Qfirm
5. Competitive Markets Firms in competitive markets have little to say about the price. They don't set the price, they accept it; it is given by the market. Perfect competition, characteristics: i. lots of firms ii. identical products (perfect substitutes) iii. no one firm dominates the market, produces a significant portion of output.
7. Competition vs Monopoly Demand faced by a single firm in a competitive market: perfectly elastic demand if he tries to sell at a price higher than the market price, he sells zero. If he sets a lower price, he is not maximizing profits. He is a price taker. Firm Market P P Market Supply PMKT PMKT Firm Demand Market Demand Q Q
38. Supply curve is MC curveP Firm Supply Decision MC=S PMKT D,MB Q QS MB=MC
39. Competitive Markets Consequence of Price Taking behavior P=MC for each firm P=MC for market P=Marginal value to consumers Optimal solution to scarcity problem: Each unit for which MB>MC is produced P Supply=MC PMKT Demand=MB Q QMKT
40. Definitions Fact: Coca-Cola’s share of the Italian Soft-drink market = 80% Q: Is Coca-Cola a Monopoly in Italy? A) Yes B) No
42. Definitions Fact: Coca-Cola’s share of the Italian Soft-drink market = 80% Fact: Coca-cola’s share of the beverage market in Italy is 10%
43. Definitions Fact: Coca-Cola’s share of the Italian Soft-drink market = 80% Fact: Coca-cola’s share of the beverage market in Italy is 10% Fact: Coca-cola’s share of sales of all products in Italy is < .1%
44. Definitions Fact: Coca-Cola’s share of the Italian Soft-drink market = 80% Fact: Coca-cola’s share of the beverage market in Italy is 10% Fact: Coca-cola’s share of sales of all products in Italy is < .1% Q: Is Coca-Cola a Monopoly in Italy? A) Yes B) No
45. Definitions Monopoly - only producer of a good. ambiguous: depends on how the market is defined (soft drinks or all beverages). How should market be defined? In terms of relevant substitutes What really matters is elasticity of Demand
46. Definitions Firm Demand A more Useful Definition: Market Power More inelastic demand more market power. What really matters: how many substitutes there are for a firm's product P D4 D1 to D4: Decreasing Market Power D3 D1 D2 Q
47. Market Power How much market power does Coca-cola have? Elasticity of demand = A) -.1 B) -.5 C) -1 D) -2 E) -9
48. Market power does not depend on supply being fixed. It is a demand concept. P P Supply This does This does not give you market power Demand Q Q
49. Price Taker vs Price Searcher When is a firm not a Price Taker? When they face less than perfectly elastic demand when there are not perfect substitutes for their product. P P0 P1 Firm Demand Q1 Q0 Q
50. Price Searcher Why Price Searcher, instead of Price Setter? Firms with market power are always searching for the best price. Their information is imperfect
51. Market Power Sources of Market Power: Exclusive Control over inputs Patents, copyrights Government licenses, franchises Economies of Scale Network economies
97. Market Power and Efficiency What’s bad about market power? First, a word about economic inefficiency Two kinds Something happens that shouldn’t (MB<MC) Something that should happen (MB>MC) but doesn’t
98. Market Power and Efficiency An example of the second kind of inefficiency: Gift-giving Question: Has anyone ever spent more on a gift for you than you would have beenwilling to spend on it? A) yes B) No C) I get no gifts
99. Market Power and Efficiency When MC (amount spent) > MB (value to recipient) inefficient gift giving. Who gave you the most inefficient gift? A) aunt/uncle B) Sibling C) Parent D)Boy/Girlfriend E) Grandparent F) Friend G) Other
100. Market Power and Efficiency Who do you think is most likely to give you cash/gift certificate? A) aunt/uncle B) Sibling C) Parent D)Boy/Girlfriend E) Grandparent F) Friend G) Other
101. Efficiency Deadweight Loss of Christmas(Joel Waldfogel) Those who know you least well tend to give the most inefficient gifts Those who know you least well are more likely to give cash Deadweight loss of Xmas = $8 billion
121. Maureen Supplize Yachts P Q = 2 P = 11 MC = 6 P>MC, inefficient: Ewing willing to pay 9, Penney willing to pay 7, but they do not get yachts Deadweight loss 13 11 9 MC 7 5 D MB 1 Q 3 2 1 4 5
122. Markup Pricing Objection! Firms don’t set prices this way. Don't they instead use simple markups? Ex. Calculate average cost, add 10% A markup is a benchmark. Markups increase as the elasticity of demand decreases. Rank the industries in order of increasing markups: Groceries, funerals, wheat A) Groceries, funeral, wheat B) Funeral, wheat, groceries C) wheat, groceries, funerals D) Groceries, wheat, funerals E) Funerals, groceries, wheat F) Wheat, funerals, groceries
123.
124. Some who value the good more than its marginal cost do not get it.
125. To serve them, must lower price to those willing to pay more
126. What if firm could charge different prices?Firm Supply Decision P MC PM P>MC, but MB<MC MC D MB Q QM QSO
128. Price Discrimination Price discrimination: charging different prices to different consumers Only possible when: Restrictions on resale Ability to target different customers with different prices
131. High elasticity, low priceP P Senior Citizens (shoppers) Others PO PSC MC MC DSC Do MB MB Q Q QO QSC
132. Price Discrimination Quantity Discounts Milk: $3.80/gal $5.50/ 2 gals. The shoppers (more price sensitive) buy in bulk) Different prices to the same customer: $3.80 for first, $1.70 for second
134. Price Discrimination First Degree price discrimination: financial aid "It's a zero-sum game. There's a finite number of prospective students out there. Are you going to get them, or is your competitor going to get them? You face the pressure and say, 'That feels burdensome to me; I don't want to deal with that.' Or you say, 'That's a pretty interesting challenge; I'm going to go out there and try to eat their lunch. I'm going to try to kick their ass.' That defines people who are more or less successful and those who stay in the position."
135. Financial Aid What is Pepperdine’s tuition? $36,650, catalog - the sticker price! How much financial aid (grants only)? A) 0-3000 B) 3001-6000 C) 6001-10,000 D) 10,001-15,000 E) 15,001+
136. Financial Aid Who gets financial aid? The shoppers: High SATs Athletes Underrepresented groups
139. Why? Firm can sell to those whose reservation price is above its MC, without having to lower the price to othersPrice discriminating firm can sell to more of these customers profitably P MC PM MC D MB Q QM QSO
140.
141. The firm gets a greater share of total surplus, and consumers get lessCS without discrimination P MC PM MC D MB Q QM QSO PS without discrimination
142.
143. The firm gets a greater share of total surplus, and consumers get lessCS without discrimination P MC PM MC D Different prices to different customers MB Q QM QSO PS without discrimination
