Lesson 8: Market Power

Four Types of Policies Beneficial to a Regulated Industry:

1. Direct Subsidy 2. Control of entry of new rivals (barriers to entry) 3. Policies that affect substitutes and complements 4. Price fixing

Conditions for a Stable Cartel:

1. Share‐ a few firms own a large percent of actual and potential output. 2. Substitutes‐ consumers must deal with the cartel because there are few good substitutes for what the cartel produces. 3. Stability‐ Price are stable (i.e. there are no demand shocks). 4. Solidarity‐ it helps if there is some common bond outside of the market.

Sources of Market Power:

1. The elasticity of market demand. 2. The number of firms in the market. 3. Interactions among firms

Price Searcher

A firm with market power that is able to change its output and affect the price. The price searcher is able to choose from among several prices to determine which is most profitable.

Cartel

A group of firms who act price takers when acting separately, but acting together can be a price searcher.

Rule of Thumb for Pricing

A mathematical rule that relates the price of a good to the marginal cost of that good and the elasticity of demand for a firm's individual output.

Horizontal Mergers

A merger of two firms that produce the same product. The Department of Justice investigates mergers to attempt to predict effects on Market Concentration.

Herfindahl Index

A method of obtaining a measure of market concentration. The sum of the squared market percentages of the top 50 firms. For Example, HHI=50^2+25^2+15^2+10^2=3450. The maximum possible score would be 10,000 for a monopoly (100^2).

Single‐Price Monopolist

A price searcher that must choose output and price and charge all customers that same price

Economic Theory of Government

A theory of legislative and regulatory outcomes that assumes political markets are no different from economic markets in that organized groups seek to further their selfinterest.

Lerner Index of Monopoly Power

A way of determining the mark‐up percentage by using the elasticity of demand for an individual firm's output.

Market Power

Ability of a buyer or seller to affect the price.

Predatory Pricing

Also called Limit Pricing or Dumping. When an incumbent firm lowers price in order to drive out competition or limit entry into the market by challenger firms.

Collusion

An agreement between firms to lower output in order to raise price; this action is illegal.

Market Concentration

An attempt to measure competition by determining the number and market share of firms in an industry.

Second‐Degree Price Discrimination

Charging different prices for different levels of quantities.

First‐Degree Price Discrimination

Charging every consumer exactly what they are willing to pay for each unit purchased.

Parallel Conduct

Form of implicit collusion in which on firm consistently follows the action of another. For example, Firm A raises prices then Firm B follows.

Two‐Part Tariff

Form of pricing where customers pay a fixed fee and a price close to marginal cost

Anti‐Trust Laws

Laws designed to prevent firms from amassing market power

Barrier to Entry

Legal or Cost restriction that prevents new firms from entering the market.

Monopsony

Market with only one buyer. Will have market power

Monopoly

Market with only one seller. Will have market power.

Reservation Price

Maximum price that a person would be willing to pay for a particular good.

Rational Ignorance

Rational ignorance occurs when the cost of educating oneself on an issue exceeds the potential benefit that the knowledge would provide.

Public Interest Theory of Government

Regulation exists for the benefit of citizens.

Acquired Regulation

Regulation that actually benefits the regulated industry.

Mark‐Up

The difference in the price charged above marginal cost.

Price Discrimination

The practice of charging different prices to different consumers

Bundling

The practice of tying two or more separate goods together in a bundle so that the consumer cannot purchase any of the goods in the bundle without also buying the other(s).

Rent Seeking

When groups call for legislation or regulation that increases their profits or incomes

Natural Monopoly

When multi‐firm competition leads to costs that are higher than the costs of a single firm.

Production Quota

an amount of output that a firm agrees to as part of the collusion. This amount will be lower than what they would produce as a price taker.

The God Complex

No matter how complicated the problem, you have an absolutely overwhelming belief that you are infallibly right.

Block Pricing

Practice of charging different prices for quantities or "blocks" of goods.

Third‐Degree Price Discrimination

Practice of dividing consumers into two or more groups with separate demand curves and charging different prices to each group.

Intertemporal Price Discrimination

Separating high willingness‐to‐pay consumers from low willingness to‐pay consumers by charging different prices at different points in time.