Week 6 Notes Econ201 Haynes, online course
Week 6 Notes Econ201 Haynes, online course ECON201 Online, Stephen Haynes
Popular in Econ201
Popular in Department
This 20 page Class Notes was uploaded by Kathryn Sternberger on Monday February 16, 2015. The Class Notes belongs to ECON201 Online, Stephen Haynes at University of Oregon taught by Stephen Haynes in Winter2015. Since its upload, it has received 67 views.
Reviews for Week 6 Notes Econ201 Haynes, online course
Report this Material
What is Karma?
Karma is the currency of StudySoup.
You can buy or earn more Karma at anytime and redeem it for class notes, study guides, flashcards, and more!
Date Created: 02/16/15
ECON Week 6 Chapter 9 and 10 Notes Chapter 9 Perfect Competition 9 Exploring decisions firms make in different markets 9 In perfectly competitive market hundreds or even thousands of firms sell a homogenous product 9 Each firm is a price taker there is no reason to decrease or increase the price because they can sell as much as they want at the market price a buyer or seller that takes the market price as given 9 5 features of a perfectly competitive market 1 There are many sellers 2 There are many buyers 3 The product is homogenous 4 There are no barriers to market entry 5 Both buyers and sellers are price takers 9 Perfect competition is unrealistic 9 How pricetaking firms use information on revenues and costs to decide how much output to produce 9 Outline the logic behind the market supply curve and the law of supply 91 Preview of the Four Market Structures Distinguishing between a market demand curve and a demand curve for an individual rm 0 The firmspecific demand curve shows the relationship between the price charged by a speci c firm and the quantity that rm can sell 0 Market demand curve shows the relationship between the price and the quantity that suppliers can sill in the market assuming all firms charge the same price 0 In a monopoly rmspeci c demand curve is the same as the market demand curve because the rm is the only supplier I Can choose any point on the market demand curve will sell a smaller quantity at a higher price 0 For perfectly competitive markets the curve is horizontal I Perfectly elastic I Can sell as much as they want at the market price I If raise the price a penny they will sell nothing Most markets lie between the two extremes of perfect competition and monopoly o Monopoly a single firm serving the whole market occurs when barriers to enter the market are large large economies of scale government policy limiting number of firms Example US postal service 0 Monopolistic competition no barriers to entering market many firms each firm sells a slightly different product Example coffee shops grocery store toothbrushes o Oligopoly just a few firms due to economics of scale and limiting government policies Examples automobiles airline travel breakfast ECON Week 6 Chapter 9 and 10 Notes cereal Large economies of scale with automobile production a result of large startup costs Figure 91 pg 209 make sure you understand why they are curved differently Professor Haynes made it clear in his summary checklist of chapter 9 to know table 91 cold Table 91 Characteristics of the Four Market Structures 0 O Q So we are going to need to basically be able to recreate this table if without looking at our book notes If you are able to do that then you know it cold I am going to practice creating the table from memory so that on the test I can recreate it on scratch paper and go from there Or you can just remember the characteristics of the different markets 9ATTENTION if you have your book open to the table you can just look at it the following 4 bullets in bold are just a recreation of the table not an explanation If you have read the table you don t need to bother with reading them Perfect competition 0 O O O 0 Many firms Homogenous product Perfectly elastic demand No entry barriers Examples corn plain T s Monopolistic competition 0 O O O 0 Many firms Differentiated products Elastic demand not perfectly elastic No entry barriers Examples toothbrushes music stores groceries coffee shops Oligopoly O O O 0 Few firms Homogenous or differentiated product Demand is less elastic than for monopolistically competitive firms Large barriers of entry from economies of scale and government policy 0 Examples air travel automobiles beverages cigarettes cell phone service Monopoly 0 One firm 0 Unique product 0 Firm faces market demand curve 0 Large barriers of entry from economies of scale or government 0 Examples local phone service local cable patented drugs ECON Week 6 Chapter 9 and 10 Notes Application 1 Wireless women in Pakistan How do entry costs affect the number of rms in a market Phone service in developing world Service provided by thousands of wireless women Invest 310 in equipment Sell services to neighbors charging per minutesecond Make net income of 2 pday 3x average per capita income Features of a perfectly competitive market 0 O O 0 Easy entry Standardized good Large of suppliers Buyers and sellers take market price as given 92 The Firm s ShortRun Output Decision Individual rm s decision about how much to produce 0 O O 0000 Firms objective is to maximize economic pro t Economic pro t total revenue economic costs Recall economic cost includes ALL opportunity costs implicit amp explicit Cost of production varies with quantity produced Economic pro t varies with quantity produced Recall economic pro t differs from the traditional understanding of pro t Using the market of plain Tshirts to illustrate decision making in a perfectly competitive market The Total Approach Computing Total Revenue and Total Cost 0 Compute economic pro t at different quantities and then pick the option generating highest pro t I Revenue side in a perfectly competitive market is straightforward I Total revenue money it gets from selling product I Total revenue price of product X quantity sold I Firm sells 8 Tshirts at 12 total revenue 96 I If producer has economic cost of 63 pro t 33 I you subtract economic cost from total revenue to nd pro t 9 Table 92 page 211 illustrates the process of choosing how much to produce for our ctional Tshirt company I The table illustrates one way to choose a quantity of output I Looking for the largest pro t which is detected by the largest difference between total revenue TR and total cost TC I The table shows pro t maximized at 33 ECON Week 6 Chapter 9 and 10 Notes TR TC Output of7 84 51 33 Output of 8 96 63 33 I When a rm reaches it s highest pro t level at two outputs we assume they will produce at the higher output The Marginal Approach relies on the marginal principal pretty obvious o Marginal revenue the change in total revenue resulting from selling one more shirt 0 A perfectly competitive market takes the price as given so the marginal revenue the price 0 The rm will maximize pro t by choosing the quantity at which price equals marginal cost 9 Have your book open to pg 213 looking at Figure 93 o The horizontal line shows the price taken as given 0 Where the line intersects the marginal cost curve in red is the quantity of Tshirts that satis es the marginal principle 8 shirts o The output decision is the same with the marginal approach as the total approach 0 The advantage of the marginal approach is that it is easier to apply 0 Marginal principle can be used to ne tune its decisions until it reaches the output satisfying the principle price marginal cost 0 Total approach requires way more information and calculation Economic pro t and the Break Even Price 0 One way to calculate a rm s total economic pro t Economic pro t price average cost X quantity produced Using Figure 93 at 8 shirts as an example Economic pro t 12 7875 X 8 4125 X 8 33 0 In gure 93 profit is indicated by the area height X width of the shaded rectangle o How would a decrease in price affect a rms output decision I Shifts the marginalrevenue price line downward I It will intersect the marginal cost line lower down ECON Week 6 Chapter 9 and 10 Notes I Firm would produce less output I In our example of the Tshirt rm A decrease in price to 7 Quantity produced decreases to 6 shirts What is economic pro t at the price of 7 If you look at point c on gure 93 you will see it rests on the average cost curve in purple where marginal cost 7 At the price of 7 economic pro t will be zero break even price Break even price is shown by the minimum point of the ATC curve where marginal cost average cost V V VVVV Application 2 The Break Even Price for Switch grass a Feedstock for Biofuel What is the breakeven price The break even price for switchgrass varies with land fertility 76 on average 95 for most fertile land 56 for least fertile land To get farmers to switch to switch grass the price has to be at least 56 p ton The price would need to be higher for more fertile land 93 The rm s Shut Down Decision Sometimes rms have to make decisions when they are loosing money 0 When total revenue is less than total cost 9 Take a look at Table 93 on page 215 o The marginal principle tells the rm to produce 4 shirts at the price of 17 but even though marginal cost and marginal revenue equal at 4 shirts the rm is still loosing pro t TR TC 0 The question is should the rm continue to produce or shut down Total Revenue Variable Cost and the Shut Down Decision 0 Decision to shut down is a short run decision 0 The decision making rule I Operate if total revenue is greater than variable cost I Shutdown if total revenue is less than variable cost 0 We are saying in the book example that we are hiring workers at the beginning of each day and therefore the decision is made at the beginning of each day 0 Costs that aren t variable machines factory do not count because they are not affected by the decision to shut down 0 Revenue and cost per minute can be used to compare total revenue and variable cost 0 In our example in Figure 93 at 4 Tshirts the rm is better off operating look at the table and use what we just learned to gure out why ECON Week 6 Chapter 9 and 10 Notes 0 Producing at 4 shirts the rm s total revenue is still 3 more than it s variable cost 9 Now we take a look at Figure 94 on page 216 this is where things get pretty tricky I nd it is useful to spend a good 5 to 10 minutes really examining the graph until it all makes sense to me I am not able to just glance at it and produce an instant understanding of what is happening there Alright lets work through this one 0 Point A I The point where marginal cost marginal revenue I The quantity the marginal principle tells us the rm should produce at o The gap between Point A and Point B I Point B rests on the marginal cost curve at 750 I Point A rests at 400 I We take the difference 750 400 350 I The rm looses 350 p shirt I The shaded rectangle shows the rms total loss of 14 gt The height of the rectangle is 350 loss gt The width of the rectangle is 4 shirts produced gt 350 x 4 a total loss of 14 I Total revenue is 16 4 shirts sold at 4 I Total revenue 16 Total loss 14 3 I So it still makes sense to keep the rm open I The AVC curve s lowest point is the shutdown price which is 3 for our example The Shutdown Price 0 We can determine whether or not a rm should operate looking at price just as we can from looking at total revenue I Operate if price is greater than average variable cost I Shut down if price is less than average variable cost 0 Shutdown price price at which a rm is indifferent between operating and shutting down I Minimum point on AVC curve I Below the price indicate by the lowest point of the AVC curve it would be impossible to generate enough revenue to cover a rm s variable costs I At the shutdown price a rm is just as well off shutting down as it is operating Fixed cost and Sunk Costs 0 Decision to operate or shutdown DOES NOT include xed costs 0 Sunk cost a cost that a rm has already paid or committed to pay so it cannot be recovered ECON Week 6 Chapter 9 and 10 Notes 0 Decisions are based on costs that depend on what we do 0 Don t cry over spilt milk example hahaha I Dairy farmer delivering 300 gal of milk I 200 gal falls of the truck on the way I Farmer should ignore the 200 gal lost I Does the cost of delivering the remaining 100 gal to the ice cream facility exceed the revenue paid from the 100 gal of milk I If not then the driver should keep going to deliver the milk Application 3 Straddling the Zinc Cost Curve Applying the Concepts What is the shutdown price Zinc a variable cost of steel production The shutdown price varies as well 94 Short Run Supply Curves The Firm s ShortRun Supply Curve 0 Shows relationship between the market price and the quantity supplied by the rm in the short run over a period of time in which the production facility cannot be changed 0 Prices below the shut down price 0 The supply curve indicates that supply will be zero for any price below the shut down price The Shortrun Market Supply Curve 0 Shortrun market supply curve shows the relationship between the market price and the quantity supplied by rms as whole in the short run 9 Take a look at Figure 95 the market supply curve and the individual supply curve on page 218 I think it is very straightforward if you read the short paragraph to the left of the graphs 0 If we have the individual supply curve and the market supply curve we can multiply the quantity supplied by the typical rm by the amount of rms in the market in our example 600 shirts Market Equilibrium 9 Figure 96 on page 219 shows a shortrun individual and market supply curve for a perfectly competitive market 0 The two conditions to have a shortrun equilibrium 1 At the market level quantity supplied quantity demanded 2 Typical market maximizes pro t given market price 0 For a longrun equilibrium must satisfy the 2 former conditions plus 1 Each rm in the market earns zero economic pro t Zero incentive to leave the market and zero incentive to enter ECON Week 6 Chapter 9 and 10 Notes Application 4 Shortrun Supply Curve for Cargo Why is the shortrun supply curve positively sloped Shipping prices Lower price fewer ships slower speed to economize If price is a little higher It is worth using less ef cient ships to get the job done At a very high price all ships including the least ef cient ships will be used 95 The LongRun Supply Curve for an Increasingcost Industry Longrun market supply curve shows the relationship between the market price and the quantity supplied by all rms in the long run a period long enough that rms can enter or leave the market 0 Increasingcost industry the average cost of production increases as the total output increases because 1 Increasing input price competition driving up the prices of inputs 2 Less productive inputs rms may be forced to use less productive inputs like less skilled labor more labor time more labor costs Production Cost and Industry Size 9 Table 94 on page 221 our make believe data for our Tshirt company 0 To compute the total cost of the typical rm cost of facility cost of labor cost of materials 0 Notice in the Table the average cost per shirt increases as of rms increases Drawing the LongRun Market Supply Curve 0 How much output will be produced at each price in the long run when of rms in the market can change 0 Longrun equilibrium each rm makes zero economic pro t so price the average cost of production 0 As long as each rm is earning zero economic pro t no one will enter the market 0 Say the price rises and rms begin earning economic pro t 0 Firms will enter the market until the market average cost price again 9 Figure 97 page 222 at each point market price average cost of production It is positively sloped because it is an INCREASING COST INDUSTRY Increase in price initially increases pro tability of rms in the market More rms enter the market and produce more Has the effect of increasing the average cost of producing the product in terms of our example shirts OOOO ECON Week 6 Chapter 9 and 10 Notes 0 What does a positively slowed curve tell us I The market wont increase quantity produced unless price rise to cover the higher average cost of producing associated with a larger industry Examples of Increasing Cost industries Sugar and Apartments 0 The sugar industry I Increasing cost industry I 11 cents per pound pro table in areas with low production costs I 14 cents per pound some other countries will join in I 24 cents per pound US enters the market Application 5 Chinese Coffee Growers Obey the Law of Supply How do producers respond to an increase in price Between 2009 to 2012 world price of coffee beans doubled Farmers doubled acreage of coffee 0 Apartment I Firms compete for small amount of land zoned off for apartments I Price of land increases I So the rent increases 96 Shortrun and Long run Effects of Changes in Demand 0 Using the two supply curves shortrun and longrun to explore effects of change in demand in a perfectly competitive market The Shortrun Response to an Increase in Demand 0 I don t know about you but this chapter is getting a little repetitive but here we go 9 Alright so Figure 98 offers shortrun supply curves for a market and an individual firm The principles to this are the same as we have seen in previous examples 0 There is an initial demand 0 When demand increases the new curve intersects the supply curve at a higher price 0 At a higher price suppliers will produce more 0 Firms will continue entering the market until the price drops to make economic profit back to zero 0 For example why isn t point B equilibrium Because each firm is making positive economic pro t The LongRun Response to an Increase in Demand 0 Shortrun supply curve is much steeper than longrun why I Diminishing returns in the short run 0 In the Longrun firms can enter the market make more facilities 0 In the longrun an upward jump in price after an increase in demand is followed by a downward slide to a new equilibrium ECON Week 6 Chapter 9 and 10 Notes 0 Longrun supply curve is relatively at why I Firms enter and build new factories I No diminishing returns to increase production costs Application 2 The Upward Jump and Downward Slide of Wine Prices Why is the time path of market prices after an increase in demand Shortrun supply of wine is in exible o Eager consumers compete 0 Prices soar Longrun suppliers increased production 0 Then they ended up having more supply than demand 0 Prices fell dramatically 97 LongRun Supply for a ConstantCost Industry gt ConstantCost Industry industry whose average cost is constant meaning it doesn t change as the industry expands LongRun Supply Curve for a ConstantCost Industry 0 We are gonna use birthday cake candles I As industry grows it will utilize more workers wax wicks however but because it is a small part of labor and material the prices of the inputs won t change I Average cost of production won t change as the industry grows o The longrun supply curve for a constantcost industry is a horizontal line at the average cost of production 0 If the price were lower price no rational rm would produce candles 0 At any higher price rms would enter the market like crazy until the price settled to a constant 9 Look to Figure 910 on page 226 Hurricane Andrew and the price of Ice 0 Ice was needed to cool and preserve food in areas without electricity Price before hurricane 1 per bag Price after hurricane 5 per bag This happened in the shortrun In the longrun Firms entered the market Price gradually dropped And eventually the price settled at what it was before the hurricane In this case the longrun was just a few days OOOOOOOO Application 7 Economic Detective and the Case of Margarine Prices How does a permanent decrease in demand affect the equilibrium price in a constantcost industry Between 200 and 2009 health concerns decreased demand ECON Week 6 Chapter 9 and 10 Notes Consumption in the US was cut in half The price was about the same as it was in 2000 in real terms Example of a constantcost industry Price of key inputs doesn t change Decrease in demand decreased the equilibrium price but unpro table rms leave the industry causing the price to rise in the longrun Chapter 10 Monopoly and Price Discrimination o Monopoly a market in which a single rm sells a product that does not have any close substitutes o In contrast from a perfectly competitive market or price taking rm a monopolist is a price making rm 0 Market power the ability to affect the price of its product I Of course the law of demand still applies 0 Monopolies occur when barriers prevent new producers from entering a pro table market I Patents the exclusive right to sell a new good for some period of time I Network externalities the value of a product to a consumer increases with the number of other consumers who use it I Licensing one rm by the government ie off street parking national park vendors television stations I If a rm controls a resource they can refuse to sell the input to other rms ie DeBeers diamonds in Africa Aluminum Company of America I A natural monopoly when the economies of scale in production are so large that only a single rm can earn a pro t If another rm entered the market both would loose money 0 This chapter focuses on unnatural monopolies which result from arti cial barriers I Production decisions I Pricing decisions I Implications for society I lnef ciency from society s perspective too little output I Tradeoffs with patents leading to higher prices innovation I Price discrimination issue occurs when rm sells at a different price to different types of consumers 101 The Monopolist s Output Decision 0 The revenue side of the pro t picture Total Revenue and Marginal Revenue 0 Right now we are assuming the rm charges the same price for each consumer 9 Figure 101 on page 235 shows the demand curve and the marginal revenue curve The table shows how to use a demand schedule to compute total and marginal revenue 0 Take a look at the table this confused me for a bit ECON Week 6 Chapter 9 and 10 Notes 0 As the price decreases quantity sold increases consistent with the law of demand but Total Revenue decreases at rst I was puzzled as to why this happened but if you go through the table and do the math you will see that it does make sense because even though more people are demanding the product at the cheaper price because the price is too low the total revenue decreases despite and increase in demand 0 When a monopolist cuts price to sell a larger quantity two things happen 1 Good news the rm collects whatever the new price is from a new consumer in our example it is 10 2 Bad news the rm cuts the price for all consumers meaning the rm gets less revenue from the customers who were willing to pay the higher price With a price decrease from 10 to 12 the rm collects 2 less from each of the original customers 0 A key feature of monopoly marginal revenue is less than price 0 For a perfectly competitive rm marginal revenue price NOT the case for a monopoly A Formula for Marginal Revenue Marginal revenue o The rst part of the formula is the from selling one more unit 0 The second part is the from selling one more unit 0 Let s try one I Monopolist wants to increase quantity sold from 2 to 3 I Cuts price from 12 to 10 I New price 10 I Old quantity 2 units I Slope of demand curve 392 Marginal revenue I I 6 0 We can do the same to sell the 5 units Marginal revenue 6 I 2 per unit x 4 units 2 0 Marginal revenue is negative because the 8 lost from the original customers exceeds the 2 gained Using the Marginal Principle 0 Make believe example company called Curall holds a patent on medication curing the common cold need to decide how much to produce 9 Look to Figure 102 on page 237 because it is a monopoly the market demand line ECON Week 6 Chapter 9 and 10 Notes Refers only to the company in question showing how much the rm will sell at each price Demand curve is negatively sloped as is consistent with Law of Demand Take a few minutes to examine this graph and table It is straightforward but contains a lot of information It takes time o In this example the slope of the demand curve is 001 per dose Change in price is so small it can be ignored 0 Use a matched pair of prices from the demand curve to approximate marginal revenue 0 This doesn t make sense to me how do you just ignore the slope of the market demand curve and come up with an answer 0 Marginal revenue 18 001 x 600 12 0 Back to gure 102 notice where the marginalrevenue curve intersects the marginal cost curve at 900 doses this is the most pro table point of production 0 For consumers to purchase at this quantity price must be 15 0 The average cost of production is 8 per dose point c Can compute pro t in two ways 1 Pro t total revenue total cost Pro t 15 pdose x 900 doses 8 pdose x 900 doses 6300 2 Pro t pro t pdose x quantity of doses Pro t pdose is the price minus the average cost 15 8 7 Pro t 7 pdose x 900 doses 6 300 o What happens if the rm chooses another quantity I Firm should continue to produce as long as the marginal revenue exceeds marginal cost I In our example up to 900 doses 0 Why should they stop at 900 doses I Beyond this point marginal revenue is less than marginal cost I Even if the rm dropped its price in order to increase quantity sold they would still be loosing revenue Application 1 Marginal Revenue from a Baseball Fan How does a monopolist maximize pro t 0 MLB quantity of fans 0 Choose quantity where MR MC ECON Week 6 Chapter 9 and 10 Notes 0 Marginal cost of an additional fan is close to 0 pro t maximization would occur at MR0 o For a typical team MR negative 0 How to explain this I Ticket price 24 I Sell 20000 tickets I Slope of demand curve is 0002 I Marginal revenue l6 MR 24 0002 X 20000 16 0 What does it mean that marginal revenue is negative I Team could increase total revenue by increasing ticket price and decreasing quantity sold 0 Why don t teams do this I Concessions I When expand our de nition of marginal revenue to include concessions the owners choice is actually consistent with pro t maximization 102 The Social Cost of Monopoly 0 Why should a society be concerned about monopoly I Changes how we slice the pie more for producers than consumers I Creates inef ciency resulting in a smaller pie for everyone to share Deadweight Loss from Monopoly 0 Let s look at a one company as a monopoly vs a perfectly competitive market 0 Monopoly rst Panel A I Longrun average cost of production is a constant 8 p dose I If average cost is constant marginal cost average cost 9 Look to Figure 103 on page 240 to view graphs for a monopoly side by side with the same company framed as being within a perfectly competitive market I Longrun marginal cost curve longrun average cost curve I Monopolist will maximize pro t where marginal revenue marginal cost point A I Would produce 200 doses phour at 18 pdose o Perfectly competitive market Panel B I Still assuming constantcost industry I Longrun market supply is horizontal at the long run average cost of producing 8 p dose I Horizontal long run supply curve intersects the demand curve point C equilibrium quantity 400 doses phour ECON Week 6 Chapter 9 and 10 Notes 0 Looking at consumer surplus I Say we had a perfectly competitive market that turned in to a monopoly the arthritis drug used in our example I How would this shift affect consumer surplus 9 Illustrated by a graph on page 241 Figure 104 v Consumer surplus is shown as the area between the demand curve and the horizontal price line v Consumer surplus with the monopoly is shown by triangle A 339 Consumer surplus with the perfectly competitive market is shown by the larger triangle consisting of areas A B and D v The consumer cost of a monopoly is a decrease in consumer surplus of areas B and D To compute this with geometry Area of rectangle B base X height Area of rectangle B 200 doses X 10 per dose 2000 The switch to monopoly increases the price by 10 p dose Pay an extra 10 on the 200 doses they buy from monopolist There is a consumer loss of 2000 VVV Area of triangle 12 X base X height Area of triangle 12 X 200 doses X 10 pdose 1000 Switch to monopoly increases price decreasing quantity demanded Lose consumer surplus on the doses they would have consumed This loss is calculated to 1000 as shown above V VVV Total loss of consumers is the sum of the areas rectangle B and triangle D 3000 0 Consumers loose from a monopoly but what about monopolists I In a perfectly competitive market each firm makes 0 economic profit I Monopolists make positive economic profit shown by rectangle B 339 Pro t per dose 10 339 Profit 2000 339 2000 gain comes at an eXpense to consumers 339 There is a net loss from switching to a monopoly 339 Consumers lose rectangle B and triangle D ECON Week 6 Chapter 9 and 10 Notes 339 Monopolist gains only rectangle D 339 Deadweight loss of monopoly is triangle D measure of inef ciency from monopoly equal to the decrease in market surplus net loss Rent Seeking Using Resources to Get Monopoly Power 0 Monopolies earn a pro t rms are willing to pay to persuade government to create barriers for market entry ie licenses franchises tariffs o In the previous example a rm would be willing up to 2000 per hour to get a monopoly on the arthritis drug 0 Hire lobbyists to persuade legislators 0 Rent seeking is the process of using public policy to gain economic pro t I Inef cient because it uses resources that could be used in other ways I Lobbyists employed could instead be employed to produce goods and services I If monopolist spent its potential pro t on rentseeking the loss to society would be areas B and D not just area D I Firms spent up to 30 of total revenue trying to gain monopoly power Application 2 A Casino Monopoly in Creswell Oregon What is the value of a monopoly 0 Newspaper announcement Vote to approve casino Developer gives citizens 2 million pyear Each adult would receive a payment of 1250 p year Why was the developer willing to make this deal Rent seeking OOOOO Monopoly and Public Policy 0 Government uses policies to intervene in monopolies o Policies used to promote competition leading to lower prices and higher production 103 Patents and Monopoly Power 0 Government patents are one source of monopoly power giving a rm the exclusive right to produce a product for 20 years 0 Patents encourage innovation because producers know they will be rewarded with monopoly pro ts 0 Monopoly power through patents may be ef cient from a social perspective in that it encourages development that may not have been developed otherwise Incentives for Innovation 0 Using an arthritis company example ECON Week 6 Chapter 9 and 10 Notes 0 Say the rm hadn t started development yet but believed the potential costbene ts to be I Economic cost of research and development 14 million I Estimated annual economic pro t from monopoly 2 million I Competitors well need 3 years to develop and produce their own version of the drug the rm only has 3 years of monopoly patent without a government patent 0 Based on these numbers the rm won t produce the drug unless they receive a patent lasting at least 7 years 9 that s the time the rm needs in monopoly to cover development costs of 14 million Tradeoffs from Patents 0 Monopoly power brings a rm to charge higher prices and produce less than the quantity demanded in a perfectly competitive market o Is the government patent for our theoretical arthritis drug bene cial from societal perspective I In a perfectly competitive market society gets 400 doses best outcome for society I In a monopoly society gets 200 doses not as good I Without a monopoly the rm won t develop the drug at all so therefore monopoly is bene cial to society 0 What if we look at a company that whose cost of production is signi cantly less 5 million for research and development I This company would earn economic pro t in just a 3 year patent I The rm would develop the drug even without the patent o Merit of patents I Sensible when granted for patents that wouldn t otherwise be created I Government cannot know which products will be developed without patents and which ones won t I Some patents allow for new products while others only prolong monopoly power Application 3 Bribing the Makers of Generic Drugs What happens when a patent expires and a monopoly ends New rms enter market Competition for consumers decreases prices and increases quantities Brand name drug expires Other rms produce generic versions virtually identical at lower price Producers of branded drugs have incentive to delay introduction of generic drugs Federal Trade Commission has addressed allegations of brand name rms making deals with generic suppliers to keep generic drugs off the market 0 Cash payments 0 Exclusive licenses for new versions 0 Another tactic is claiming generics to be not as good as the branded drug ECON Week 6 Chapter 9 and 10 Notes 104 Price Discrimination o The practice of selling a good at different prices to different consumers I Airlines offer lower prices for people more exible with departure time I Movie theaters for senior citizens I Only legal restriction is that price discrimination cannot be used to put another firm out of business 0 A firm has an opportunity for price discrimination if 3 conditions are met 1 Market power The firm must have control over price Any firm with negatively sloped demand curve can exercise price discrimination The only type of firm that can t participate in this practice is a perfectly competitive market 2 Different Consumer Groups There has to be diversity of willingness to pay The firm must be able to identify different groups of consumers 3 Resale is not possible Must be impractical for one consumer to sell to another The possibility of resale causes price discrimination to break down 0 One approach identify consumers unwilling to pay regular price offer a discount I Discounts on airline tickets tourists are willing to pay less than business travelers Discounts are also offered for people who plan ahead I Discount coupons for groceriesfood typical couponclipper is not willing to spend as much as the typical customer I Manufacturers rebates for appliances a person who takes the time to mail the rebate form to the company is not willing to pay as much as typical customer I Seniorcitizen discounts on airline tickets restaurant food drugs and entertainment seniors have more time to shop for bargains therefore more price sensitive Other seniors have a relatively low income and are willing to pay less I Student discounts on movies and concerts typical student has less income than the typical consumer 9 Amazon price discrimination scandal Experimenting on consumers wow Senior Discounts in Restaurants 0 Restaurant with customers in two categories senior citizen amp other 0 Demand curve for senior citizens is lower than for nonsenior other 9 Figure 105 page 246 Marginal Principle and Price Discrimination o Firm divides potential customers in to two groups and applies marginal principle 0 On the graphs the profit maximizing prices are 3 for seniors and 6 for non seniors ECON Week 6 Chapter 9 and 10 Notes 0 Price discrimination maximizes the restaurants total pro t in each segment of the market Price Discrimination and the Elasticity of Demand 0 Recall when demand is elastic there is a negative relationship between price and total revenue when price increases percentage demanded decreases Price cut for seniors brings both good and bad news to the restaurant I Good news demand is highly elastic so total revenue increases by a large amount I Bad news more meals are served so total cost increases If senior demand for meals is highly elastic Ed is above 10 then the goof news will dominate the bad news meaning the increase in revenue will outweigh the increase in cost On the other side if the rm goes from charging everyone 5 and decreases the price for seniors and increases the price for other customers there is both good news and bad news I Good news fewer meals are served so total cost decreases I Bad news demand is highly elastic so total revenue decreases by a small amount If the demand for nonseniors is mildly elastic then the good news will dominate the news Savings in production cost will exceed the revenue loss Examples Movies vs Popcorn and Hardback vs Paperback Books 0 Movies vs popcorn I Seniors pay less for movie tickets but the same for popcorn and concesions I A senior discount is not an act of generosity for a rm it is a way to reach pro t maximization I Price discrimination increases pro t I Why don t they have a senior discount on popcorn I It can be easily transferred between consumers I Admissions as long as tickets are checked when entering movies are not transferable o Hardback vs Paperback I Cost of producing hardback book is typically 20 higher than to produce a paperback book I Price is usually 3 times higher for the hardback copy I Purpose to distinguish between consumers those willing to pay a lot and those willing to pay a little I Eager readers pay high prices when book is rst released with hardback I Casual readers wait for the paperback copy I Price discrimination strikes again ECON Week 6 Chapter 9 and 10 Notes Application 4 Why does movie popcorn cost so much When do rms have an opportunity to charge different prices to different consumers OOOOO 4 bucket of popcorn costs less than 010 to produce Moviegoers vary in their willingness to pay to see a movie Theaters have incentive to identify high demanders and charge them more Theater charges 10 for admission and 4 for popcorn Low demander willing to pay 11 I Will purchase only the ticket I Left with 1 surplus High demander willing to pay 15 I Will purchase ticket popcorn I Left with 1 surplus If instead the theater picked a price of 12 the low demanders would not go and they would miss out on money from the high demanders if they charged only 010 for popcorn
Are you sure you want to buy this material for
You're already Subscribed!
Looks like you've already subscribed to StudySoup, you won't need to purchase another subscription to get this material. To access this material simply click 'View Full Document'