Open Market Price Searchers or Monopolistic Competition

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Lecture 17
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Open Market Price Searchers or Monopolistic
Competition

• Description
• markets characterized by relatively large number
  of independent price searchers, each with some
  locational or product advantage
• no restrictions on entry in the long run
• Examples
• Toothpaste
• Soap
• Cold remedies

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Price and Output in the Short Run

• Essentially the same as closed-market price
  searchers or monopolies
• equate MR and MC to maximize profit
• Because there are many firms producing relatively
  close substitutes demand tends to be more elastic
• less of a difference between demand and marginal
  revenue

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Price and Output in the Short Run
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Price and output in the long run

• Since there are no restrictions on entry, new
  firms will enter if existing firms are making
  positive profits in the short run
• Entry of new firms increases the substitutes
  available to consumers
• new firms offer slightly different products or
  locations
• each firms demand curve becomes more elastic

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Price and Output in the Long Run

• With more firms in the market, less demanded from
  each individual firm
• each firms demand curve shifts down (to the
  left)
• Increase in number of firms bids up prices of
  inputs
• ATC and MC increase
• Entry continues until firms are making zero
  economic profit
• as long as firms can do better than their
  next-bet alternative they will enter the industry

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Comparison of Short-Run and Long-Run Price and
Output
Short Run
Long Run
P
P
MC
Profit
MC
ATC
ATC
P
P
DAR
DAR
MR
MR
Q
Q
Q
Q

• As new firms enter, demand facing each firm is
  reduced and is more elastic.

• Assuming an increasing cost industry, entry of
  new firms also bids up the price of
• inputs, raising average and marginal costs.

• Entry continues until economic profit is zero,
  so price equals ATC.

• Even though economic profit is zero, there is
  still a welfare loss since price is
• greater than MC.

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Open-Market Price-SearchersLong-Run Price and
Output
Price
MC

• Because entry and exit are free, competition
  will eventually drive prices down to the
  level of ATC. When profits (losses) are
  present, the demand curve will shift inward
  (outward) until the zero profit equilibrium
  is restored.

ATC
P

• Again, the price searcher establishes its
  output level where MC MR.

• At q the average total cost is equal to the
  market price. Zero economic profit is present.
  There is no tendency for firms to either
  enter or exit the market.

d
MR
q
Quantity /Time
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Price and Output in the Long Run

• Comparison of open-market price searcher long-run
  equilibrium with price taker long-run equilibrium
• since there are no restrictions on entry, in both
  cases make zero profit
• price searcher does not operate at minimum ATC
• even though price searcher does not operate at
  min. ATC, not necessarily true that output is
  inefficient
• must weigh higher production cost against
  increased value from variety

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Comparing Price-Taker and Price-Searcher Markets

• Below we illustrate the long-run equilibrium
  conditions in price taker and price searcher
  markets when entry barriers are low.

• In both cases P ATC, and economic profits are
  equal to zero.

• Because the price-searcher confronts a
  downward-sloping demand curve for its product,
  its profit-maximizing price exceeds marginal
  cost. In contrast with the price-takers
  market, the price-searchers output is not large
  enough to minimize ATC when the market is in
  long-run equilibrium.

• Even though the two markets have the same cost
  structure, the price in the price-searchers
  market is higher than that for the price-taker (
  P2 gt P1 ).

• The higher price in monopolistically competitive
  markets may simply be the premium society
  pays for variety (product differentiation).

P2
P1
q2
q1
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Price Searcher Pricing Tactics

• Have shown that when a price searcher charges a
  single price, not all gains from trade are
  realized
• MC lt MV for some units that are not produced
• Price searcher could not reap al the gains from
  trade because lowering price to increase sales
  would mean lowering price to all customers and
  decreasing profit
• if not constrained to charge a single price, may
  be able to increase profits

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Capturing Consumer Surplus
/Q
If price is raised above P, the firm will lose
sales and reduce profit.
Quantity
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Capturing Consumer Surplus

• PQ single P Q _at_ MCMR
• A consumer surplus with P
• B PgtMC consumer would buy
• at a lower price
• P1 less sales and profits
• P2 increase sales and reduce
• profits
• PC competitive price

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Capturing Consumer Surplus
Question How can the firm capture the consumer
surplus in A and sell profitably in B?
/Q
Pmax
A
P1
P
B
Answer Multipart Pricing Price Discrimination
P2
MC
PC
D
MR
Quantity
Q
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Multipart Pricing to a Single Customer

• Definition
• charging lower prices for additional units (to a
  given consumer) without lowering the price on
  previous units
• Can increase profit of firm and consumer surplus
  as well
• efficient since both consumer and seller gain

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Multipart Pricing to a Single Customer
/Q
Quantity
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Multipart Pricing to a Single customer
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Multipart pricing to a single customer

• problems
• need to have information about consumer demand
• must prevent resale
• incentive to buy additional units and sell to
  those who have not bought any

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Multipart pricing to a single customer

• perfect multipart pricing
• if knew demand precisely, would want to charge
  most consumers are willing to pay for each unit

P
MC
DAR
MR
Q
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Multipart pricing to a single customer

• perfect multipart pricing
• all units for which MVMC are produced and sold
• welfare loss is eliminated
• consumer surplus is eliminated
• all gains from trade go to the producer

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Multipart pricing to a single customer

• two-part tariffs
• similar to perfect multipart pricing
• way of collecting all of the gains from trade
• charge a lump-sum admission fee plus MC for
  each unit

P
Admission fee
MCAC
DAR
Q
Q
Per unit price
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Multipart pricing to a single customer

• two-part tariffs
• examples
• amusement park
• pay to enter
• pay for rides and food within the park
• country club
• pay to join
• pay greens fee to play golf
• problems
• must know demand curves
• optimal admission fee is different for consumers
  with different demands

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(Inter-customer) Price Discrimination

• Definition
• charging different people different prices for
  the same good or service where the price
  differences are not based on differences in cost
• Rationale
• if different groups of people have different
  demands then the profit-maximizing price will be
  different for each
• want to operate where MRMC for each group and
  charge the appropriate price to each

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(Inter-customer) Price Discrimination

• Rationale
• charge higher price to group with the more
  inelastic demand
• the more elastic the demand, the closer price is
  to MR, so that equal MR means charging lower
  prices for more elastic demanders
• intuitively, if groups demand is more inelastic
  than average, can raise price to them without
  losing much business, so optimum price is higher

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Example Movie Theater Pricing
/Q
Quantity
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(Inter-customer) Price Discrimination

• welfare effects
• elastic group of consumers gains
• inelastic group of consumers is made worse off
• net effect on all consumers as a whole is
  uncertain
• producer can potentially increase profits

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The Economics of Price Driscrimination

• Consider the market for airline travel where the
  MC per traveler is 100.

• If the airline charges all customers the same
  price, profits will be maximized where MC MR
  (P 400 and q 100). Net Operating Revenue is
  equal to TR (40,000) - operating costs
  (10,000).

• If the airline charges different prices (price
  discrimination), it will be able to increase
  net revenues. If the firm charges a higher price
  (600) to business travelers (who have a
  highly inelastic demand) and a lower price (300)
  to other travelers (who have a more elastic
  demand), it is able to increase Net Operating
  Revenue to 42,000.

• If sellers can segment their market, they can
  gain by charging higher prices to consumers
  with a less elastic demand and offering discounts
  to those with a more elastic demand.

100
60
120
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(Inter-customer) Price Discrimination

• producers problems in trying to price
  discriminate
• must be able to distinguish groups with different
  demand elasticities and determine appropriate
  price for each
• must prevent low-price group from reselling to
  high-price group

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(Inter-customer) Price Discrimination

• methods of carrying out price discrimination
• demographic characteristics
• time of service
• valuation of other goods

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EndLecture 17