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Introductory Microeconomics

by: Alan Doyle

Introductory Microeconomics ECON 115

Marketplace > Yale University > Economcs > ECON 115 > Introductory Microeconomics
Alan Doyle
GPA 3.89


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This 7 page Class Notes was uploaded by Alan Doyle on Thursday October 29, 2015. The Class Notes belongs to ECON 115 at Yale University taught by Staff in Fall. Since its upload, it has received 9 views. For similar materials see /class/231033/econ-115-yale-university in Economcs at Yale University.


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Date Created: 10/29/15
Monopoly Types of market structure The diamond market Monopoly pricing The social cost of monopoly power 1 2 3 4 Why do monopolies exist 5 639 Government regulation 7 Price discrimination z Announcements 0 We are going to cover sections 10171047 sections 11171127 and for all practical purposes skip chapter 1239 0 Ben Friedman will speak in class on March 23 on his book The Moral Consequences of Economic Growt 8 Types of M arket Structure ln the real world there is a mindeboggling array of different markets 0 ln some markets7 producers are extremely competitive evg grain 0 ln other markets7 producers somehow coordinate actions to avoid die rectly competing with each other evg breakfast cereals 0 ln others7 there is no competition evg ights out of TweedeNew Haven airport ln general we classify market structures into four types 0 perfect competition 7 many producers of a single7 unique good 0 monopoly 7 single producer of an unique good evg cable TV7 diamonds7 particular drugs 0 monopolistic competition 7 many producers of slightly differentiated goods evg fast food 0 oligopoly 7 few producers7 with a single or only slightly differentiated good evg cigarettes7 cell phones7 BDL to 0RD ights V What determines market structure 0 lt really depends on how dif cult it is to enter the market That depends on control of the necessary resources or inputs7 government regulations7 economies of scale7 network externalities7 or technological superiority lt also depends on how easy it is to differentiate goods 0 Soft drinks7 economic textbooks7 breakfast cereals can readily be made into different varieties in the eyes and tastes of consumers 0 Red roses are less easy to differentiate The Diamond M orket o Geologically diamonds are more common than any other gemequality colored stone But if you price them7 they seem a lot rarer 0 Why Diamonds are rare because The De Beers Company7 the worlds main supplier of diamonds7 makes them rare The company controls most of the worlds diamond mines and limits the quantity of diamonds supplied to the market 0 The De Beers monopoly of South Africa was created in the 1880s by Cecil Rhodes7 a British businessman ln 1880 mines in South Africa dominated the worlds supply of diamonds There were many producers until Rhodes bought them up 0 By 1889 De Beers controlled almost all the worlds diamond production 0 Since then large diamond deposits have been discovered in other African countries7 Russia7 Australia7 and lndia De Beers has either bought out new producers or entered into agreements with local governments o For example7 all Russian diamonds are marketed through De Beers 9 Monopoly o A monopolist is a rm that is the only producer of a good that has no close substitutes An industry controlled by a monopolist is know as monopoly 0 ln practice7 true monopolies are hard to nd in the US today because of legal barriers lf today someone tried to do what Rhodes did7 she would be accused of breaking antietrust laws 0 Oligopoly7 a market structure in which there is a small number of large producers7 is much more common Monopoly Pn39cz39ng o A monopolist7 unlike a producer in a perfectly competitive market7 faces a downward sloping demand curve 0 Average revenue is PQ X Q P Q Q is just the market demand curve 0 Recall from before break7 the pro t maximizing production condition was MR MC 0 Table 101 0 Figure 101 0 Recall a rm s pro t is the difference between its revenue and its costs 7rQ RQ CQ where pro ts total revenue total economic cost 0 Since a monopolist faces a downwardesloping demand curve7 At higher prices7 the monopolist sells less output The price it can charge depends negatively on the quantity it sells ln this case gtlt Q and the revenue function is curved o Marginal revenue is the change in total revenue generated by an addie tional unit of output lt is the slope of the revenue curvev o Pro ts are maximized where the slope of the pro t function is zero Am We 7 Am AQ AQ AQ o This implies that the rm maximizes pro ts when the marginal revenue is equal to marginal cost ARK ACltQgt AQ AQ M R M C 0 Pro t is maximized by producing the quantity of output at which marginal revenue of the last unit produced is equal to its marginal cost 0 Figure 103 0 Note W W 0 An increase in production by a monopolist has two opposing effects on revenue 1 A quantity effect One more unit is sold7 increasing total revenue by the price at which the unit is sold l X P P 2 A pn39ce effect ln order to sell the last unit7 the monopolist must cut the market price on all units sold This decreases total revenue Q X AP6Q o Thus7 www o 55 is the reciprocal of the elasticity of demand7 so 1 M R P P 5d 0 Since the pro t maximizing production decision is set MR IWC7 l M C Pl 7 5d MC P 1 Since ed is a negative number7 the denominator is less than one o A monopolist charges a price greater than marginal cost7 but by an amount that depends inversely on the elasticity of demand 0 ll demand is very elastic7 the markup of price over marginal cost will be small 7 Example Amtrak and its interecity fares 0 ll demand is very inelastic7 the markup of price over marginal cost will large 7 Example pharmaceutical drugs for lifeethreatening illnesses o What if marginal cost is zero Well rewrite the pricing equation as P 7 MC 7 l P 7 ed So if MC 07 it must mean ed 71 ll marginal cost is zero7 maximizing pro ts is equivalent to maximizing revenue Revenue is maximized when ed 7 A monopolist has no supply curve 0 Since the price charged depends on the elasticity of demand there is no oneetoone relationship between price and quantity produced 0 Figure 104 a and b o A monopolist always operates on the elastic region of the market de mand curve 7 That is7 the region in which the price elasticity of demand is between fl and 700 iSuppose the rm was operating in inelastic region of the demand curve lt could raise price7 reduce quantity7 but the price effect would dominate the quantity effect and total revenue would increase Since quantity goes down7 total cost goes down 7 lf revenue goes up and costs go down with a price increase in the inelastic region of the demand curve7 keep doing it until you are in the elastic region Why Do Monopolz39es Exist o For a pro table monopoly to persist there must be burners to entry That is7 something that prevents other rms from entering the industry 0 Barriers to entry can take several forms 139 Control of a scarce resource 0 De Beers and diamonds 2 Economies of scale 0 ln an industry with large Xed costs such public utilities7 often the largest rm has a huge cost advantage since it is able to spread the Xed costs over a larger volume 0 Hence a larger rm will have lower average Xed costs and lower average total costs than a smaller rm 0 Consider the laying of gas lines or water lines through out a com munity o A natural monopoly is a rm that produce the entire output of the market at a lower cost than what it would be if there were several rmsv 0 ln this case7 the marginal cost curve is always below the average cost curve7 so average cost is always declining 3 Technological superiority o A rm that is able to maintain a consistent technological advantage over potential competitors can establish itself as a monopolist o For example7 lntel computer chips7 though AMD occasionally rivals lntel 4 Network eXternalities 0 Consider Microsoftls Windows Operating System 0 Critics argue that Microsoft products are often technologically in ferior to competitors7 but try living without a Windows machine 5 Governmentrcreated barriers 0 Patents for goods such a pharmaceutical drugs usually last 20 years V o Copyrights granted to authors and composers usually last the life time of author plus 70 years 0 Patents and copyrights encourage innovation through the promise of monopoly pro ts AI The Social Costs of Monopoly Power oThere is a loss of consumer surplus and a deadweight loss from monopoly pricing 0 Figure 1010 0 Consider the case with constant marginal cost Government Regulation of Monopolz39es 0 Public ownership of natural monopolies 7 Examples include Amtrak US Post Of ce some publiclyeowned electric power companies wireless internet service in some towns 7Typically viewed as a bad idea See Gary Becker7s article in the reading packet 7 Wireless internet service seems to be a success 0 Price regulation Unlike in the perfectly competitive market case7 ime posing a price ceiling on a monopolist is not necessarily a bad thing 0 lmposing a price cap on a natural monopoly can increase consumer surplus 0 Figure 1012 0 But sometime the cure is worse than the disease There are deadweight losses due to monopolies but sometimes government control leads to the politicization of pricing and incentives for corruption The costs from these can sometimes be larger than the deadweight loss M onopsony o Refers to the case where there is a single buyer for a good 7 US Government with military equipment 7 US Government and pharmaceutical drugs 7 NOPE 7 Hospitals in small cities and nurses 7 WaleMart and some consumer goods 0 Can make a case for the minimum wage in the labor market case 0 This is a topic we can skip You can wait for Econ 150 to learn more about this Pn39ce Discn39mz39notion 0 ll someone is willing to pay a lot for a good7 why charge them only what the last person is willing to pay for the good 0 There is a surplus generated whenever there is a voluntary trade But there is nothing that guarantees that the surplus is evenly sharedv One side or the other may try to maximize their share of the surplus at the expense of the other side of the transaction 0 Why let the customer walk away with a big chunk of the surplus F irstDegree Price Discrimination 0 Recall that the demand curve is sometimes called the willingness to pay curve77 0 A person7s reservation price is the maximum price she is willing to pay for a good 0 The idea is the charge each customer what they are willing to pay and no less 0 Figure 112 0 Want the tailor the price to each consumer This is what negotiations are all about Why don7t new cars have xed7posted prices 0 Some consumers bene t because they may pay a lower price than if the rm was restricted to pay just a single price to all customers and thus these customers enter the market V 0 College and university tuition lf you want to pay less than full7price you need to turn over a tremendous amount of nancial data on your family and then Yale gures out how much your family would be willing to pay to attend Yale zz Third7Degree Price Discrimination 0 Practice of charging different prices to different market segments 0 What to distinguish between different consumer groups 0 Prices paid by customers on7board United Airlines Flight 815 from Chicago to Los Angeles on October 157 1997 Ticket Price Number of Passengers Average Advanced Purchase days 2000 or more 18 12 1000 to 1999 15 14 800 to 999 23 32 600 to 799 49 46 400 to 599 23 35 200 to 399 23 35 less than 200 34 26 0 19 7 0 OK 7 so some of the difference is due to rst7class versus coach7class tickets 0 Two types of consumers 7 Those with inelastic demand evg business travelers7 l need to tell her not to marry him77 7 Those with elastic demand evg l might y7 l might drive7 l might vacation elsewhere 77 0 ll the airline must charge a single price to all customers7 it has two options 7 Charge a high price and get as much as possible out of the business traveler market7 but lose the vacation traveler market 7 Charge a low price and attract both types of buyers7 but don7t make as much as it could o business travelers o What it wants to do is charge business travelers a high price and tourists a low price 0 Figure 115 vz 0 So how does the airline distinguish between business travelers and tourists 7 The Saturday7night stayover 7 Discounting tickets bought well ahead of time 0 See the reading packet on ticket pricing for Broadway shows Phil Leslie is a Yale PhD and former Econ 115 TA 0 Ticket pricing for movies 7 Senior citizens pay less for for movies than l do QZ Sales 0 Brooks Brothers puts blue blazers on sale twice or three times a year 0 Assume there are two types of customers 1 inelastic demand My blazer just ripped7 and l have a meeting tomorrow77 239 elastic demand l need to buy a new sport coat one of these days 0 Most of the year7 they just sell to the priceeinsensitive customers 0 Patient7 priceesensitive customers wait for the sale SecondeDegree Piice Discrimination 0 Practice of charging different prices per unit for different quantities of the same good or service 0 Quantity discounts o ldea is that consumers who buy a lot of a good are more likely to be priceesensitive than those who only buy a little s Piice Discrimination Bad 0 Compared to a single price monopolist7 price discrimination 7 even when it is not perfect 7 can increase the ef ciency of the market 0 lf sales to consumers formerly priced out of the market but now able to purchase the good at a lower price generate enough surplus to offset the loss in surplus to those now facing a higher price and no longer buying the good7 then total surplus increases when price discrimination is introduced 0 Of course there are issues of fairness o Typically7 governments worry about deadweight losses from monopolies rather than fairness Oligopoly 0 So most market are somewhere between monopoly and perfect compee titiont o Oligopoly is the most prevalent market structure 0 Foure rm concentration ratios Industry market share rms cigarettes 93 9 Philip Morris R J Reynolds Lorlllard Brown and Williamson batteries 9 Duracell Eneglzer Ra ovac beer a9 7 AnheuserrBusch Miller Coors Strohs light bulbs 33 9 Westinghouse General Electric breakfast cereals 32 9 Kellogg s General Mills Post Quaker Oats 0 ln these industries7 rms will want to take into account how their come petitors will response when making pricing decisions 0 Need to think strategically o This will lead us to game theory


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