econ 202: principles of microeconomics review session for exam 3 chapters 11-15

ECON 202: Principles of Microeconomics

Review Session for Exam 3

Chapters 11-15

Review Session 3 2ECON 202: Princ. of Microeconomics

Review Session 3

1. Perfect Competition.

2. Monopolistic Competition.

3. Oligopoly.

4. Monopoly.

5. Pricing Strategy.


Review Session 3

CHARACTERISTICPERFECT

COMPETITIONMONOPOLISTIC COMPETITION

OLIGOPOLY MONOPOLY

Number of firms Many Many Few One

Type of product Identical Differentiated Identical or

differentiated Unique

Ease of entry High High Low Entry blocked


1. Perfect Competition Conditions for perfect competitive market:

Many buyers and sellers, small relative to the market. Products are identical. No barriers to new firms entering the market.

Prices are determined by the interaction of aggregate demand and aggregate supply.

Firms are so small that cannot affect the price in the market. If raise prices, consumers switch to another firm. Price takers. Example: wheat farmers.

Firms face perfectly elastic demand.


1. Perfect Competition



In order to maximize profits is equivalent: To produce where difference between total revenue and total

cost is the greatest. To produce where marginal revenue is equal to marginal

cost.

In the case of firms in perfectly competitive markets, marginal revenue is equal to the price in the market.

Condition for maximizing profit: Price = Marginal Cost


1. Perfect Competition Remember that:

Total Revenue = Price x Quantity Total Cost = Average Total Cost x Quantity

Price and cost (dollars per bushel)

Quantity

P

Marginal Cost

Q

Profit Maximizing level of output

Total Revenue

Average Total Cost

Total Cost

Profit



Shut-down decision in the short run.

Price and cost (dollars per bushel)

Quantity

Marginal Cost

Average Total Cost

Average Variable Cost

P1

Q1

P2

Q2

PMIN

QSD

Supply Curve for the firm in the short run



In the long-run With economic profit, entry of new firms make price decrease

until firms are breaking even. With economic losses, exit of firms make price increase until

firms are breaking even. Resulting situation is Long-run competitive equilibrium.

Long run competitive equilibrium price is at minimum point of the Average Total Cost curve.

Economic profits disappear in the long run.



According to the slope of long-run supply curve Horizontal: constant-cost industries. Upward sloping: increasing-cost industries. Downward sloping: decreasing-cost industries.

In the long-run, perfect competition results in productive efficiency. When a good is produced at the lowest possible cost.

Also, perfect competition achieves allocative efficiency. A state of the economy in which production represents

consumer preferences Every good is produced up to the point where the last unit

provides a marginal benefit to consumers equal to the marginal cost of producing it.


2. Monopolistic Competition

Monopolistic Competition is market structure where: Many firms. Barriers to entry are low. Products are similar, but not identical.



Economic profits attract more firms: Shifts demand to the left. Makes demand more elastic.



Monopolistic Competitive firms have excess capacity. By increasing output, average cost can be reduced.

In monopolistic competition: Productive efficiency is not reached: products are not produced

at the lowest cost. Allocative efficiency is not reached: firms charge a price different

than marginal cost.

However, consumers benefit from differentiated products and more closed suited to their tastes.


3. Oligopoly

Oligopoly is market structure where: Few competitors. Identical or differentiated products. Restrictions to entry.

In case of oligopolistic markets, revenues of the firms depend on actions of other competitors.

Approach to analyze oligopolies: game theory.


3. Oligopoly

More than 40% indicates 4-firm concentration ratios per industry oligopolistic market.

Herfindahl-Hirschman Index (HHI) Sum of squared shares: 302 + 302 + 202 + 202 = 2,600 HHI > 1,800 : oligopolistic markets.

Barriers to entry. Economies of scale. Ownership of a key input. Government-imposed barriers.


3. Oligopoly

Duopoly: price competition between two firms.

Firms would collude, but is against the law.


3. Oligopoly

Dominant strategy The best strategy for a player, regardless of what the other

players decide.

Nash equilibrium. A situation where each player is choosing its best strategy, given

the others players’ strategies. A situation where no player has an incentive to change of

strategy.

In most business situations games are played repeatedly. Firms can collude implicitly to reach the cooperative equilibrium. Example: “low price guaranteed”


3. Oligopoly Sequential games to analyze business strategies.

Best strategy for WalMart is to build the large store, deterring entry from Target.


3. Oligopoly

Forces that determine the level of competition in an industry.


4. Monopoly A monopoly is a firm that sells a good that does not

have close substitutes. In other words, a monopoly is a firm that can ignore the

actions of all other firms. If it can ignore them, they are not producing close enough

substitutes. Reasons for monopolies

Entry Blocked by Government Action Patents and copyrights. Public franchises.

Control of a Key Resource Network Externalities Natural Monopoly


4. Monopoly


4. Monopoly Monopoly reduces economic efficiency.


4. Monopoly At the present, mergers of large firms have to be

approved by: Antitrust Division of the US Department of Justice. Federal Trade Commission.

Mergers guidelines Market definition

Relevant market is the market where by rising the prices of all the firms, profits increase.

Measure of concentration: Herfindahl-Hirschman Index (HHI)

0 1,000 1,800 10,000

Not concentratedModerately

concentratedHighly

concentrated

Mergers not challenged by

FTC & DoJ

If HHI rises > 100: mergers MAY be

challenged

If HHI rises > 50: mergers MAY be

challenged

If HHI rises > 100: mergers WILL be

challenged


4. Monopoly

Regulating Natural Monopolies


5. Pricing Strategy

Price discrimination: Charging different prices to different customers for the same

product. Price differences are not explained by differences in cost.

Requirements for successful price discrimination: Market power. Different types of customers (willingness to pay). Ability to separate types of customers (no arbitrage).


5. Pricing Strategy

Less elastic demand pays a higher price. More elastic demand pays a lower price.


5. Pricing Strategy Perfect price discrimination

If monopolist know the willingness to pay of all the customers, it can charge exactly this willingness to pay to them.


5. Pricing Strategy Two-part tariffs

When consumers pay one price (or tariff) for the right to buy as much of a related good as they want at a second price.

Disneyland, Ipods.


5. Pricing Strategy

Different types of customers and asymmetric information Firms know that customers have different willingness to pay for

goods, but their identification is difficult. They try to have customers reveal their type:

High-value customers to order the higher priced pack. Low-value customers to order the lower priced pack.


5. Pricing Strategy

Type Channels PriceHigh-value customer

Low-value customer

High-value 10 30 0 -15

Low-value 5 15 6.25 0

High-value 10 23.75 6.25 -8.75

Low-value 5 15 6.25 0

High-value 10 26 4 -11

Low-value 4 14 4 0

Cable company

profit

20Original

Packages offered Utility

New 23.75

New-new 26


5. Pricing Strategy

Because of difficulty to identify each type of customer, firm ends up: Giving some extra benefit to high-value customer in order to

make her reveal her identity. Selling a lower than efficient level of quantity to low-value

customer.

Price per channel is higher for the low value customer ($14 / 4 = $3.5) than for the high value customer ($26 / 10 = $2.6).

Quantity discounts are not only explained by differences in cost, but also by pricing strategies of firms.


Problems

Price

Quantity20 30 40 50

45

55

60

10

5

15

25

35

ATC

MC

Given this information for a firm in a perfect competitive market: How much will produce at a price of $55? What will be its profit? The firm will have economic losses if the price goes below: If in the long-run equilibrium there are 100 identical firms in this market, what will be the quantity supplied in the market? If in the long-run equilibrium aggregate demand shifts to the left, will firms enter or leave this market?


Problems

Price

Quantity

45

55

60

10

5

15

25

35

20 30 40 50

ATC

MC

DemandMR

Given this information for a firm in a monopolistic competitive market: What price maximizes profits for the firm? Will its profit be above or below $700? What is the productively efficient level of production?


Problems

Suppose that at initial point, they keep the level of tuition, do any school has incentives to change of strategy?

What is the dominant strategy for Texas M&A? And for t.u.? What is the Nash equilibrium?


Problems What is the quantity

produced by this monopolist? What is his profit? What is the Deadweight

Loss? What is the productively

efficient level of production?Suppose that there is only one

consumer in this market and that price in the demand curve when quantity is 600 is $82.

Would the monopolist make more profit by charging a two-part tariff?

How much would be the entry fee and the price per unit.

Price

Quantity300 500 700 900

50

30

10

100

130

110

90

70

ATCMC

Demand

MR


Problems What is the price and quantity that this monopolist will choose? What is his profit? If a regulatory agency wants the monopoly to produce the productively efficient level of output, how much would the monopolist produce? What is the profit of the monopolist in this case? What price and quantity should impose the regulatory agency to make sustainable the monopolist?Suppose that the monopolist is again free to decide how much to charge and produce How much will the monopolist collect from entry fees if decides to charge a two-part tariff? How much will the monopolist charge per unit of product? How much is his total profit in this case?

Price

Quantity300 500 700 900

125

75

25

100

325

275

225

175

ATC

MC

Demand

MR

ECON 202: Principles of Microeconomics

Review Session for Exam 3

Chapters 11-15

econ 202: principles of microeconomics review session for exam 3 chapters 11-15

Documents