Economics of P-Setting Firms (emphasis on monopoly)

1
Chapter 13

• Economics of P-Setting Firms (emphasis on
  monopoly)

2
Key Topics

• Alternative market structures
• Perfect competition
• Imperfect competition
• Barriers to entry
• Revenue concepts for a price-taking firm
• P AR
• MR
• TR

3
Key Topics (contd)

• 4. Operating decisions for a price-taking firm
• TR max ( sales max)
• ? max
• Rent-seeking actions
• Price discrimination
• 5. Revenue concepts and operating decisions for a
  P-setting firm
• 6. Monopolies and roles of government
• Restrict market power
• Grant regulate natural monopolies

4
Characteristics of perfectly competitive markets

• Many firms each relatively small compared to the
  size of the entire market or industry.
• Firms produce homogeneous products.
• Relative ease of firm entry in to or exit out of
  the market.
• Information about prices and production costs
  widely available.
• Firms have no control over prices and are price
  takers.
• In long run, product price minimum average cost
  marginal cost (i.e. no excess profits or
  losses).

5
Characteristics of imperfectly competitive
markets

• Limited number of firms so each has a relatively
  significant share of total output for the
  industry or market.
• Firms produce heterogeneous products.
• Relative difficulty of firm entry in to or out of
  the market.
• Information about prices and production costs NOT
  widely available.
• Firms have some control over prices charged for
  their products and are price setters.
• In long run, product price gt average cost and
  price gt marginal cost.

6
General types of imperfectly competitive markets

• Monopolistic competition
• Many firms selling slightly differentiated
  products
• Oligopoly
• Few firms selling products with varying degrees
  of differentiation
• Monopoly
• ONE firm selling product that has no (or few)
  close substitutes

7
Barriers to entry

• Government franchises exclusive licenses to
  sell product/services
• Why?
• - Economies of scale (i.e. greater efficiency ?
  lower production costs)
• - Greater governmental control (e.g. alcohol)
• Patents exclusive right to sell a product or
  use a process to the inventor (for 20 years)
• Why?
• - To promote research, scientific progress

8
Barriers to entry (contd)

• High capital costs (e.g. production, marketing)
• Ownership of scarce factor of production

9
Prices charged by imperfectly competitive firms

• They are a choice decision, not given (or taken)
• They are constrained by consumer demand for the
  firms product (i.e. can set either P or Q, but
  NOT both).

10
Demand Curve Constraint
P
D curve facing P-setting firm (shows max P Q
combinations)
a
Not possible
Pa
q
qa
11
Recall, P MR for P-taking (competitive firm)

P MR AR
q

• However, MR lt P for P-setting firm

12
MR for P-setting firm of lowering P to sell 1
more Q (graph)
P
P1

?P
-
P2

q
q1
(q11)

?q 1
13
MR for P-setting firm of lowering P to sell 1
more Q (math)

• ?TR (note MR if ?q 1, because MR ?TR/?q)
• TR2 TR1
• P2(q11)-P1(q1)
• P2?q-?Pq1
• P2-?Pq1 (note ? MR lt P2)
• Q effect P effect
• ?TR due to ?Q at new P ?TR due to ?P on
  previous Q
• If lower P (? ?P lt 0)
• Q effect gt 0, P effect lt 0
• ? ? TR if Q effect gt P effect (else ? TR)

14
P ( AR), MR, and TR for P-setting firm

• P AR a bq (b gt 0)
• MR a 2bq (same vert. axis intercept,
  twice the slope)
• TR P q (a-bq)q aq bq2
• e.g. P 11 q (b 1)
• MR 11 2q
• TR 11q q2

15
MR and TR max vs p max

• MR slope of TR
• TR max sales max ? MR 0
• ( D curve mid point)
• ? max ? MR MC

16
TR max example

• P 11-q
• TR max P ? P mid point 5.50
• q at P 5.50 11 5.50 5.50
• Max TR (5.50)(5.50) 30.25

17
TR max vs p max (graph)
MR0 ? TR max

TC
MRMC ? p max
TR
q
18
Monopoly (vs Perfect Competition)

• Profits can persist LR (entry blocked)
• Output less price higher (? loss of consumer
  surplus)
• May act to preserve profits ( rent-seeking
  behavior)

19
Price Discrimination

• charging different prices to different groups
  of buyers (i.e. different markets)
• Examples
• Airlines, movie theatres, golf courses,
  restaurants, telephone companies, utility
  companies

20
Price Discrimination (graph)


PB
Pa
MC ATC
dA
MRa
dB
MRB
q
q
Mkt B
Mkt A
21
Monopolies and the Roles of Government

• Promote competition/restrict market power
• ? antitrust laws
• - Sherman Antitrust Act, 1890 (restraint of
  trade illegal)
• - Clayton Act, 1914 (anticompetitive mergers
  and tying
• contracts illegal)
• - Federal Trade Commission Act, 1914
  (established FTC as regulatory agency and made
  unfair methods of competition illegal)
• Other legality issues rule of reason vs. per
  se conduct vs structure remedies consent
  decrees, treble damages, etc.

22
Monopolies and the Roles of Government

• 2. Grant monopolies (natural) and regulate so
  consumers benefit from economies of scale

23
Proof MR a 2bq (if P a-bq)

• ?TR TR2 TR1
• P2q2 P1q1
• ?Pq1 P2?q
• MR ?TR / ?q P2 (?P / ?q) q1
• P2 bq1
• a bq2 bq1
• a 2bq (for given point on demand curve or
  an infinitesimal ? in q ? q2 q1 q)