microeconomics ch 11 firm behavior
microeconomics ch 11 firm behavior ECON 211
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This 3 page Class Notes was uploaded by Addie Pearson on Saturday April 23, 2016. The Class Notes belongs to ECON 211 at Clemson University taught by prof fiore in Winter 2016. Since its upload, it has received 17 views. For similar materials see Micro Economics in Economcs at Clemson University.
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Date Created: 04/23/16
Firm Behavior and Market Power ch 11 and 13 MARKET POWER - If a firm has MARKET POWER, it is able to raise price above the equilibrium price without losing all of its customers - How much can market power a seller has depends on the closeness of substitutes o When subs are very close (demand is elastic), a seller loses many customers if it attempts to raise price o When subs are NOT very close (demand inelastic) a seller loses relatively few customers if it attempts to raise price - Recall equilibrium outcome - For a market to operate exactly at the equilibrium price and quantity, sellers must be producing PERFECT SUBS o Competition among sellers forces price to the equilibrium level - Es: apple farmers o World market for red apples vs demand for one farmers red apples - This is known as a PERFECTLY COMPETITIVE market o Such markets are often reasonable approx. but not necessarily realistic o In many markets, relatively few sellers produce imperfect subs Coke and pepsi Iphone and droid o In markets where subs are not perfect, firms have market power DIFFERENT LEVELS OF COMPETITION - Perfect competition: many sellers with no market power - Oligopoly: few sellers with some market power - Monopoly: one seller with market power - Ch 11 --> pg 193-196 - Ch 13 - How do firms with market power choose the best price? o Suppose a firm (monopolist) with a market power raises price? o Two things happen: It sells fewer units (not good for firm) It gets a higher price for each unit it sells (good for firm) o Thus, even a monopolists is constrained in its ability to raise price by the downward-sloping demand curve for its product o A firms goal is not to charge the highest price, but to make the highest profit Profit = total revenue – total cost o A firm will only change price if the change in revenue is greater than the change in cost If marginal revenue is greater than marginal cost, DO IT o The profit max price is where the marginal revenue equals marginal cost - Ex: onopolist facing a demand of Q0 = 10 – P - ((( INSERT CHART AND GRAPH))) - The less elastic the demand a firm faces, the more market power it has… the more market power a firm has, the larger the markup - (((( more graphs)))) HOW DOES A FIRM WITHOUT MARKET POWER CHOOSE THE BEST PRICE? - It has no choice! - Firms facing perfectly elastic demand must accept the market price or sell none at all - These firms are called “Price Takers” MARKET POWER AND EFFICIENCY - When price is raise above eq. price, total gains from trade are reduced! - The fact that some surplus is redistributed from consumer to producer has no efficient implications o Of course consumers prefer more surplus SO IS MARKET POWER A “BAD THING?” - The answer depends on the source of market power o Patent o Better product o Cartel o Government regulation restricting entry - Firms can increase their market bower by reducing the relative attractiveness of substitute products o By “differentiating” its product, making its demand LESS ELASTIC - How does this affect consumers? o If the firm does this by producing a “better” product, consumers are better off o If the firm does this by reducing competition and consumer choice, consumers are worse off (ex. Cartel) STATIC VS DYNAMIC EFFICIENCY - Consider a copyright or a patent o Each is a lawful grant of temporary monopoly power (market power) - If monopolies produce deadweight losses, why grant a patent? o Profits provide an important incentive for innovation and improvement o The static (at this moment in time) effect is to create a DWL o The dynamic (over time) effect is to inspire innovation - Our legal system is set up to balance these two effects THE ROLE OF PROFITS - The prospect of high profits inspre firms to act to capture them. - Profits act like a magnet, attracting ENTRY to the high profit sector o Profits include competition that results in valuable goods and services o If the goods/services are not valuable, profits will not result o For that reason, we don’t need to worry that profits are “too high” as they will not last long. - The prospect of higher profits also inspires firms to attempt to restrict competiton - If high profits persist, we now that either o There is something we are not accounting for (e.g. risk) o Something is preventing entry (e.g. regulation, cartel)
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