micro quiz 6

conditions for price discrimination

there must be at least two different types of buyers and the firm must be able to prevent resale of the product or service

distinguishing groups of buyers

- a firm must be able to distinguish groups of buyers with different price elasticities - firms can generate more revenue by charging more to customers with inelastic demand and less to customers with elastic demand - restaurants offer "early bird specials" (families with kids, retirees, and those on a limited budget); these dinners not only have lower demand but also represent demand that is more elastic; they eat out only if the price is low enough - this strategy enables the restaurants to serve more customers and generate additional revenue

preventing resale

- a firm must prevent resale of the product or service - in some cases it is easy; airlines require that electronic tickets match the passenger's ID to prevent a passenger who received a discounted fare from reselling it to another passenger who would be willing to pay more - this enables airlines to charge more to groups of flyers with more inelastic demand, such as business travelers - it also works well for restaurants offering early-bird specials, because the restaurants can easily distinguish between customers who arrive in time for the specials and those who arrive later

strategic behavior and the dominant strategy

- in an oligopoly, there is mutual interdependence -- a rival's business choices affect the earnings the other rivals can expect to make

game theory

a branch of mathematics that economists use to analyze the strategic behavior of decision-makers - helps us determine what level of cooperation is most likely to occur - a game consists of a set of players, a set of strategies available to those players, and a specification of the playoffs for each combination of strategies - usually represented by a playoff matrix - it is presumed that each player acts simultaneously or without knowing the actions of others

oligopoly

a form of market structure that exists when a small number of firms sell a differentiated product in a market with high barriers to entry - because an oligopolist sells in a market with significant barriers to entry and fewer rivals, they have more market power than a firm operating under monopolistic competition - because an oligopolist market has more than one seller, no single oligopolist has as much market power as a monopolist

cartel

a group of two or more firms that act in unison

escaping the prisoner's dilemma in the long run -- tit-for-tat

a long run strategy that promotes cooperation among participants by mimicking the opponent's most recent decision with repayment in kind - one in which you do whatever your opponent does - because the joint payoffs for cooperation are high in a prisoner's dilemma, tit-for-tat begins with the players cooperating - in subsequent rounds, the tit-for-tat strategy mimics whatever the other player did in the previous round - it changes the incentives and encourages cooperation - pepsico and coca-cola advertise; because the companies react to each other's moves in kind, any effort to exploit the dominant strategy of advertising will ultimately fail - this dynamic can alter the incentives the firms face in the long run and lead to mutually beneficial behavior - tit-for-tat makes it less desirable to advertise by eliminating the long run benefits - in the short run, the firm that advertises could earn $25 million extra, but in every subsequent round, if the rival responds in kind, the firm should expect profits of $100 million because its rival will also be advertising - as a result, there is a long run opportunity cost for not cooperating - if they both stop advertising, they will find themselves making $125 million in the long run; but this has not happened because they do not trust each other enough

mutual interdependence

a market situation where the actions of one firm have an impact on the price and output of its competitors - as a result, a firm's market share is determined by the products it offers, the prices it charges, and the action of its rival

monopolistic competition

a type of market structure characterized by low barriers to entry, many different firms, and product differentiation - a combination of market power and competition - falls between competitive markets and monopoly in terms of number of sellers, the types of products sold, and competing firm's ability to enter and exit the market - in markets that are monopolistically competitive, firms sell differentiated products; this differentiation gives the monopolistic competitor some market power, though not as much as a monopolist, which controls the entire market - monopolistically competitive firms have a small amount of market power that enables them to search for the most profitable price

collusion

an agreement among rival firms that specifies the price each firm charges and the quantity it produces

antitrust laws

attempt to prevent oligopolies from behaving like monopolies

comparing oligopoly to other market structures

competitive market - many sellers - similar products - free entry and exit monopolistic competition - many sellers - differentiated product - easy entry and exit oligopoly - a few sellers - differentiated product (most of the time) - barriers to entry monopoly - one seller - unique product without close substitutes - significant barriers to entry

competitive markets, monopolistic competition, and monopoly

competitive markets - many sellers - similar products - free entry and exit monopolistic competition - many sellers - differentiated products - low barriers to entry and exit monopoly - one seller - a unique product without close substitutes - significant barriers to entry and exit

clayton act (1914)

targets corporate behaviors that reduce competition - strengthened the sherman antitrust act activities deemed socially detrimental - price discrimination if it lessens competition or creates monopoly - exclusive dealings that restrict a buyer's ability to deal with competitors - tying arrangements that require the buyer to purchase an additional product in order to purchase the first - mergers and acquisitions that lessen competition, or situations in which a person serves as a director on more than one board in the same industry

switching costs

the costs incurred when a consumer changes from one supplier to another ex -- switching music from one format to another (MP3 to itunes) - when consumers face switching costs, the demand for the existing product becomes more inelastic - as a result, oligopolists not only leverage the number of customers they maintain in their network, but also try to make switching to another network more difficult (ex -- firms promote customer loyalty through frequent flier benefits to create higher switching costs)

markup

the difference between the price the firm charges and the marginal cost of production - possible when a firm enjoys some market power

sherman antitrust act (1890)

the first federal law limiting cartels and monopolies - created in response to the increase in concentration ratios in many leading US industries - certain cooperative actions became criminal - antitrust laws are essential in maintaining a competitive business environment

product differentiation

the process firms use to make a product more attractive to potential customers - use product differentiation to contrast their product's unique qualities with competing products - differences can involve subtle changes in packaging, quality, availability, and promotion, or the differences can be significant

backward induction

the process of deducing backward from the end of a scenario to infer a sequence of optimal actions - if one player goes first, the game has a predictable conclusion

advertising and costs

- each firm engages in competitive advertising to win new customers and keep the old ones; as a result, the impact on each individual firm's demand largely cancels out - advertising creates higher costs but no change in quantity produced and a decrease in profit - also causes prices to raise for consumers if they have an inelastic demand

pricing based on age or student status

- movie attendance is highest among 13 to 24 year olds and declines thereafter with age; given the strong demand among teenagers, it is not surprising that "child" discounts are phased out at most theaters by age 12 - because interest in going to the movies declines with age, the "senior" discount actually provides an incentive for a population that might not otherwise go to a movie theater

price discrimination at the movies

- movie theaters price discriminate based on the time of day, age, student status, and whether or not you buy snacks

advertising and game theory

- oligopolists function like monopolistic competitors in that they sell differentiated products - advertising is commonplace in markets with a differentiated product - in the case of an oligopoly, mutual interdependence means that advertising can create a contest between firms trying to gain customers - the result may be skyrocketing advertising budgets and little, or no, net gain of customers - therefore, oligopolists have an incentive to scale back their advertising, but only if their rivals also agree to scale back - the two companies each have a dominant strategy to advertise - we can see this strategy by observing that coca-cola and pepsico each make $25 million more profit by choosing to advertise - as a result, they both end up in the upper left box earning $100 million profit when they could have each made $125 million million profit in the lower right box if they had agreed not to advertise - the dilemma is that each firm needs to advertise to market its product and retain its customer base, but most advertising expenditures end up cancelling each other out and costing the companies millions of dollars

dominant strategy

exists when a player will always prefer one strategy, regardless of what his opponent chooses - they know that if they keep quiet, they will spend one year in jail; the dilemma occurs because both suspects are most likely to to testify and get 10 years in jail - the choice to testify is obvious for two reason -- neither suspect can monitor the actions of the other after they are separated and once each suspect understands that his partner will save jail time if he testifies, he realizes that the incentives are not in favor of keeping quiet

decision tree

illustrates all of the possible outcomes in a sequential game - in a sequential game, the first player can restrict the set of outcomes to one of the branches at the top of the decision tree - because azelea has full information about all of the playoffs in the matrix, she knows that iggy will choose at the end of each set of branches - this knowledge allows her to use backward induction to earn $50,000 for herself by selecting agree with full knowledge that iggy will choose disagree

output effect

occurs when a change in price affects the number of customers in a market

price leadership

occurs when a dominant firm in an industry sets the price that maximizes its profits and the smaller firms in the industry follow by setting their prices to match the leader price - it not illegal because it does not involve collusion; rather, it relies on an understanding that an effort to resist changes implemented by the price leader will lead to both increased competition and lower profits for every firm in the industry - because the firms act in accordance with one another, this practice is commonly known as tacit collusion ex -- smaller airlines follower the prices that major airlines set

excess capacity

occurs when a firm produces at an output level smaller than the output level needed to minimize average total costs Excess capacity is a condition that occurs when demand for a product is less than the amount of product that a business could potentially supply to the market. When a firm is producing at a lower scale of output than it has been designed for, it creates excess capacity.

perfect price discrimination

occurs when a firm sells the same good or service at a unique price to every customer - to achieve this result, a business would have to know exactly what any particular customer would be willing to pay and charge him or her exactly that price - many jewelry stores and automobile dealerships attempt to practice perfect price discrimination by posting high sticker prices and then bargaining with each customer to make a deal - it is hard to implement, so most firms settle for charging two or three prices based on sorting customers into a few easily identified groups

price discrimination

occurs when a firm sells the same good or service at different prices to different groups of customers - it is beneficial to both sellers and buyers - when a firm can charge more than one price, markets work more efficiently - price discrimination enables firms to make more money by dividing their customers into at least two groups: those who get a discount and those who pay more - to practice price discrimination, a firm must be a price maker; it must have some market power before it can charge more than one price - monopolies and non-monopolistic companies use price discrimination - some examples are movie theatre tickets, restaurant menus, college tuition, airline reservations, discounts on academic software, and coupons

nash equilibrium

occurs when all economic decision-makers opt to keep the status quo The Nash equilibrium states that the optimal strategy for an actor is to stay the course of their initial strategy while knowing the opponent's strategy and that all players maintain the same strategy, as long as all other players do not change their strategy. - if each suspect reasons that the other will testify, the best response is also to testify - each suspect may wish that he and his partner could coordinate their actions and agree to keep quiet - however, without the possibility of coordination, neither has an incentive to withhold testimony; so they both think strategically and decide to testify

prisoner's dilemma

occurs when decision-makers face incentives that make it difficult to achieve mutually beneficial outcomes - two prisoners are being interrogated separately about a crime they both participated in, and each is offered a plea bargain to cooperate with the authorities by testifying against the other - if both refuse to cooperate, neither can be convicted of a more serious crime, though they have to spend time in jail - but the police have offered full immunity if one cooperates; each suspect has an incentive to betray each other - if they both confess, they will spend more time in jail - this situation makes the payoff for cooperating with the authorities more attractive than the result of keeping quiet - a noncooperative "game" and changes the incentives each party faces

predatory pricing

occurs when firms deliberately set their prices below average variable costs with the intent of driving rivals out of the market - the firm suffers a short run loss in order to prevent rivals from entering the market or to drive rival firms out of business in the long run - once the rivals are gone, the firm should be able to act like a monopolist - it is illegal, but difficult to prosecute - can look like competition - the concern is the effect on the market when all rivals fail

network externality

occurs when the number of customers who purchase or use a product influences the quantity demanded - when a network externality exists, firms with many customers often find it easier to attract new customers and to keep their regular customers from switching to other rivals - most network externalities involve the introduction of new technologies (ex - cell phone) - as new markets develop, the first firm into an industry often gains a large customer base - when there are positive network externalities, the customer base enables the firm to grow quickly - also, consumers are often more comfortable purchasing from an established firm; these two factors favor the formation of large firms and make it difficult for smaller competitors to gain customers - as a result, the presence of significant positive network externalities causes small firms to be driven out of business or forces them to merge with larger competitors

price effect

reflects how a change in price affects the firm's revenue

one price versus price discrimination

- a firm that charges a single price uses MR=MC to earn a profit - when a firm price-discriminates, it takes in more profit than a firm that charges a single price. the discriminating firm increases its revenue by charging some customers more and other customers less, as shown in the dark green areas. the increase in profit is partly offset by the loss of revenue from existing customers who receive a lower price, as shown in the red area. - airlines can change prices from day to day and even hour to hour; all of these price changes reflect efforts to price-discriminate - because passengers cannot resell their tickets or easily change their plans, airlines can effectively price-discriminate

monopoly outcome

- a monopolist faces no competition and price decisions do not depend on the activity of other firms - a monopolist can search for a price that brings the most profit; total revenue peaks at $54,000 - at this point, the price is $90 per month and 600 customers sign on - the monopoly price is higher and the quantity sold is lower; the result is loss of efficiency

monopolistic competition in the short run and the long run

- a monopolistically competitive firm sells a differentiated product and for this reason has some market power - in perfect competition, each firm sells the same product, so competitors' products are perfect substitutes, which means that demand is perfectly elastic (flat) - in monopolistic competition, each competitor provides a differentiated product, so competitors' products are imperfect substitutes for one another, which means that demand is relatively elastic (less flat), but still flatter (more elastic) than monopoly - the monopolistic competitor uses the profit-maximizing rule, MR=MC, and locates the corresponding point on its demand curve to determine the best price to charge and the best quantity to produce - whether the firm earns a profit, experiences a loss, or breaks even is a function of other firms entering and exiting the market; entry and exit don't take place in the short run - in the long run, firms are free to enter an industry when they see a potential for profits or leave if they are making losses; therefore, entry and exit regulate how much profit a firm can make in the long run

truth in advertising

- advertising is designed to produce a psychological response - it can be manipulative - there is a temptation to lie about the product to attract more customers - the FTC regulates advertising to protect consumers - firms often engage in price deception or tricks to make you think a price is lower than it really is

advertising under monopolistic competition

- advertising is widespread under monopolistic competition because firms have differentiated products - because each pizza is slightly different from pizza companies, each firm's advertising increases the demand for its product and changes the slope of the demand curve - the gains from advertising go directly to the firm spending the money - these benefits generate a strong incentive to advertise to gain new customers or to keep customers from switching to other products

monopolistic competition and competitive markets

- both market structures drive economic profit to zero in the long run - monopolistic competitors enjoy some market power, which is a crucial difference

quality

- budget conscious customers can eat at taco bell, while those with a larger budget and a taste for higher Mexican food can consider Moe's as another option

concession pricing

- by limiting outside food and drink, movie theaters push people with inelastic demand for snacks to buy from the concession area - as long as some movie-goers are willing to buy concession fare at high prices, the theater will generate more revenue; most theaters cannot prevent smuggling of snacks - they separate their customers into two groups: a price-inelastic groups of concession-area snackers and a price-elastic group of non-snackers and smugglers who fill up the remaining seats

style or type

- clothing stores can vary by the type of clothing they sell and vary from other stores - each store hopes to attract a specific type of customer - consumers' differing tastes make it possible for a wide range of food vendors to compete side by side with rivals who provide many good substitutes

advertising in competitive markets

- competitive firms sell nearly identical products at an identical price - advertising raises a firm's costs without directly influencing its sales - advertising for an undifferentiated good functions like a public good for the industry as a whole: the benefits flow to every firm in the market through increased market demand for the product - an individual firm that advertises in this market is at a competitive disadvantage because it will have higher costs that it cannot pass on to the consumer - although individual firms do not benefit from advertising, competitive industries as a whole can

competitive outcome

- competitive markets drive prices down to the point at which marginal revenue is equal to the marginal cost - if the market if highly competitive and the marginal cost is zero, we would expect the final price of cell phone service to be zero and the quantity supplied to be 1,200 customers -- the number of people who live in the small town - at this point, everyone who desires cell phone service would be able to receive it without cost; the result would be socially efficient - but its unrealistic - cell phone companies sell a good that is nonrival and excludable (club good); because these firms are in the business to make money, they will not provide something for nothing

product differentiation

- differentiation can occur in a variety of ways, including style or type, location, and quality

tuition

- families that qualify are eligible for grants and low-interest loans, which effectively lower the tuition cost for low- and medium-income families; therefore, the FAFSA enable colleges to separate applicants into two groups based on income - in-state students get a discount on tuition, while out-of-state students pay a much higher rate; part of the difference is attributable to state subsidies that are intended to make in-state tuitions more affordable for residents - in state students pay less because their parents have been paying taxes to the state, often for many years, and the state then uses some of those tax dollars to support its subsidies of higher education - out-of-state tuition is higher than it would be if all students paid the same price because out-of-state students are generally less sensitive to price than in-state students - out-of-state students have a much more inelastic demand - because price is a big factor in choosing an in-state institution, it is not surprising that in-state demand is more elastic - selective private colleges can rice-discriminate by offering scholarships based on financial need, while also guaranteeing placements for the children of wealthy alumni and others willing to pay the full sticker price - at the margin, students who commit to an early decision or visit campus have more inelastic demand than those who only apply for regular admission; this is another way colleges fine-tune student aid packages based on observed behavior

varying degrees of product differentiation

- high levels of differentiation occurs when the firm has an especially attractive location, style, type, or quality of a product that is high in demand among consumers and that competitors cannot easily replicate - consumers have strong brand loyalty for the clothes these firms sell, so the demand curve is quite inelastic - - the relatively steep slope of the demand curve means that the pint of tangency between the demand curve and the average total curve occurs at a high price, which produces a large amount of excess capacity - firm B sells a product only slightly different from its competitors' - consumers have only weak preferences for a particular firm and consumer demand is elastic - the relatively flat nature of the demand curve means that the point of tangency between demand and average total cost occurs at a relatively low price, which produces a small amount of excess capacity - monopolistic competition leads to substantial product variety and greater selection and choice, all of which are beneficial to consumers; any policy to reduce inefficiency by lowering prices they can charge will have the unintended consequence of limiting the product variety in the market - consumers are willing to pay a little more for product variety in order to look different from everyone else

scale and output

- in a competitive market, the profit-maximizing output is equal to the most efficient scale of operation; this result is guaranteed because each firm sells an identical product and must therefore set its price equal to the minimum point on the average total cost curve - under monopolistic competition, the profit-maximizing output is less than the minimum efficiency scale - monopolistically competitive firms have the capacity to produce more output at a lower cost; but if they produced more, they would have to lower their price - because a lower price decreases the firm's marginal revenue, it is more profitable for the monopolistic competitor to operate with excess capacity

duopoly outcome

- in a duopoly, the two firms can decide to cooperate, even though it is illegal in the US - if they cooperate, they collude - the firms that collude can act like a single monopolist to maximize their profits - many countries prohibit cartels - in the US, antitrust laws prohibit collusion - even if collusion were legal, it would probably fail more often than not - two phone companies agree to form a cartel and serve 300 customers at a price of $90 per month - but one company lowers their price to $75 per month, has 700 customers, and makes more revenue - the other company would match it; it would lower its price to $75 per month and attract 350 customers, but they would make less revenue - oligopolists want to emulate the monopoly outcome, but the push to compete with their rivals makes it difficult to maintain a cartel - when a stable cartel is not achieved, firms in oligopoly fall short of maximizing profits; but they also do not compete to the same degree as firms in competitive markets - when a market is an oligopoly, output is likely to be higher than under a monopoly and lower than within a competitive market - the higher output makes oligopoly prices generally lower than monopoly prices, and the lower output makes oligopoly prices higher than those found in competitive markets

comparing perfect price discrimination with perfect competition and monopoly

- in a perfectly competitive market, there are no barriers to entry and no firm has market power - in the long run, the price will be equal to the marginal cost - in the example of airline tickets, the price is driven down to $100 and 200 tickets are sold; the entire area above the marginal cost curve is consumer surplus, because the willingness to pay - as determined along the demand curve - is at least as great as the price - because the ticket price is the same as the marginal cost, the producer surplus is zero - because every customer who is willing to pay $100 or more can find a ticket, there is no deadweight loss - under perfect competition, the market structure favors consumers - a monopoly holds substantial market power, so the firm sets a price using the profit-maximizing rule, MR=MC, without having to worry about competition driving the price down to marginal cost - the monopolist's profit-maximizing price, or $300, is higher than the $100 price under perfect competition - the higher price reduces the amount of consumer surplus and creates a producer surplus - in addition, because the number of tickets sold falls to 100, there is now a deadweight loss; economic activity associated with DWL no longer exists, and the total welfare of society is now limited to consumer and producer surplus - monopoly causes a partial transfer of consumer surplus to producers and a reduction in total welfare for society - a firm that can practice perfect price discrimination is able to charge each customer a price exactly equal to the price that customer is willing to pay - this strategy enables the firm to convert the entire area of consumer surplus that existed under perfect competition into producer surplus - for the firm to capture the entire area of available consumer surplus, it must lower some prices all the way down to marginal cost; at that point, the number of tickets sold returns to 200, the market is once again efficient, and the deadweight loss disappears - perfect price discrimination transfers the gains from trade from consumers to producers, but it also yields maximum efficiency - perfect describes any market that produces no deadweight loss

monopolistic competition in the short run

- in panel a, the firm makes a profit; panel b shows the same firm incurring a loss after a new competitor opens nearby - in each case, the firm uses the profit-maximizing rule to determine the best price to charge by locating the point at which marginal revenue equals marginal cost; this establishes the profit-maximizing output (Q) along the vertical dashed line - the firm determines the best price to charge (P) by following the dashed horizontal line from the demand curve to the vertical axis - in panel a, we see that because price is greater than average total cost, the firm makes a short-run economic profit; in panel b, because P<ATC, the firm experiences a short-run economic loss - the only difference between the panels is the location of the demand and marginal revenue curves - the demand curve in panel a is high enough for the firm to make a profit - in panel b, there is not enough demand because some customers switched to a different firm - even though the monopolistic competitor has some market power, if demand is too low, the firm may not be able to price its product high enough to make a profit

monopolistic competition in the long run

- in the long run, when firms can easily enter and exit a market, competition will drive economic profit to zero - if a firm is making an economic profit, that profit attracts new entrants to the business; then the larger supply of competing firms will cause the demand for an individual firm's product to contract - eventually as more firms enter the market, it is no longer possible for existing firms to make an economic profit; a reverse process unfolds in the case of a market experiencing a loss - in this case, some firms exit the industry; then consumers have fewer options to choose from, and the remaining firms experience an increase in demand and eventually, demand increases to the point at which firms no longer experience a loss - price is just equal to the average total cost of production at the profit-maximizing rate of output (Q) - at this point, firms are experiencing zero economic profit, as noted by P=ATC along the vertical axis; the market reaches a long run equilibrium at the point where there is no reason for firms to enter or exit the industry - the demand curve is drawn tangent to the average total cost curve (touching one place); if demand were any larger, the result would look like panel a (short run) and firms would experience an economic profit - conversely, if demand were any lower, the result would look like panel b and firms would experience an economic loss - where entry and exit exist, profits and losses are not possible in the long run; in this way, monopolistic competition resembles a competitive market - as long run profits occur in the short run, other competitors will be encouraged to enter, while short run losses will prompt some existing firms to close

measuring the concentration of industries

- industry out is highly concentrated among a few large firms with only a few sellers - economists use concentration ratio as a measure of the oligopoly power present in an industry - the most common measure, known as the four-firm concentration ratio, expresses the sales of the four largest firms in an industry as a percentage of that industry's total sales - this ratio is determined by taking the output of the four largest firms in an industry and dividing that output by the total production in the entire industry - in highly concentrated industries like search engines, wireless telecommunications, and satellite TV providers, the market share held by the four largest firms approaches 100% - domestic automobile manufacturers dominate the industry and have significant market power (general motors, fiat, chrysler, ford, and toyota) - when evaluating market power in an industry, it is important to be aware of international activity - in several industries, including automobile and tire manufacturing, intense global competition keeps the market power of US companies in check - the concentration ratio is a rough gauge of oligopoly power, not an absolute measure

a caution about game theory

- it is a decision-making tool, but not all games have dominant strategies that make player decisions easy to predict - the preferred choice is strictly a function of what the other player selects - winning at business in the long run often occurs because you are one step ahead of the competition, not because you deploy a strategy that attempts to take advantage of a short run opportunity - because we cannot say what each player will do from one point to another, there is no nash equilibrium - we cannot expect every game to include a prisoner's dilemma and produce a nash equilibrium

students discounts

- local merchants in search of college customers can provide student discounts without lowering their prices across the board - this means that they can charge more to their regular clients while providing the necessary discounts to get college students to make the trek off campus - students typically receive discounts for campus activities like concerts and sporting events; because students generally have elastic demand, price discrimination provides greater student access to events than charging a single price does

location

- many businesses attract customers because of their convenient location - when consumers prefer to save time and avoid the inconvenience of shopping for a better deal, a firm with a more convenient location will have some pricing power - producers who sell very similar products can generate some market power by locating their businesses along routes to and from work or in other areas where customers frequently travel

monopolistic competition, inefficiency, and social welfare

- monopolistic competition produces a higher price and a lower level of output than a competitive market does - efficiency is a way to determine whether a firm's decisions are consistent with an output level beneficial to society - a monopolistic competitor has costs slightly above the lowest possible cost, so the average total costs of a monopolistically competitive firm are higher than those of a firm in a competitive market; this result is not efficient - to achieve efficiency, the monopolistically competitive firm could lower its price to what we would find in competitive market; however, because their goal is to make profit, there is no incentive for the firm to lower its price - every monopolistic competitor has a downward sloping demand curve, so the demand curve cannot be tangent to the minimum point along the average total cost curve - markup is a second source of inefficiency; for a monopolistically competitive firm at the profit maximizing level, P>MC by an amount equal to the markup - the price reflects the customer's willingness to pay, and this amount exceeds the marginal cost of production; a reduced markup would benefit consumers by lowering the price and decreasing the spread between the price and the marginal cost - if the firm did away with the markup and set P=MC, the output level would benefit the greatest number of consumers, but it would not be practical; at the point where the greatest efficiency occurs, the demand curve would be below the average total cost curve and the firm would lose money - increased efficiency could be achieved through government regulation; possible but not desirable - monopolistically competitive firms have a limited amount of market power, so they cannot make a long-run economic profit like monopolists do - also, regulating the prices that firms in a monopolistically competitive market can charge would put many of them out of business; for consumers, this would be less convenient and they will have fewer choices - regulating monopolistic competition through marginal cost pricing or setting P=MC would create many problems - the scale of the regulatory effort would be enormous - because implementing marginal cost pricing would result in widespread losses, the government would need to find a way to subsidize firms, but they would be higher taxes

the relationship between price, marginal cost, and long-run average cost

- monopolistically competitive firms have some market power, which enables them to charge slightly more than firms in competitive markets - a firm in a market characterized by monopolistic competition, shown in panel a, notice that the price is greater than the marginal cost of making one more unit; this is known as the markup - you can observe the result of a markup in panel a, where the price under monopolistic competition is higher than the price in a competitive market, shown in panel b - because a monopolistic competitor has a downward-sloping demand curve, the point of tangency between the demand curve and the ATC curve is different from the pint of tangency in a competitive market - the point where P=ATC is higher under monopolistic competition - panel b shows that the demand curve just tangent to the ATC curve at ATC's lowest point in a competitive market; therefore, monopolistic competition produces higher prices than a competitive market does - recall that entry and exit do not ensure the lowest possible price, only that the price is equal to the average total cost of production - in a competitive market, where the demand curve is horizontal, the price is always the lowest possible average total cost of production; this is not the case under monopolistic competition - the price in monopolistic competition often reflects quality; cheap food is cheap for a reason - firms may charge more for higher quality food, but there will still be zero economic profit

the welfare effects of price discrimination

- price discrimination increases the welfare of society because a price discriminator charges a high price to some and a low price to others, more consumers are able to buy the good - if a firm is able to perfectly price-discriminate, it can pick up the additional profit; by charging higher prices to those willing to pay more than $300, the firm is able to capture the additional profit - by charging a different fare to every customer, they can also increase the quantity of tickets sold to 200 - in the long run, a perfectly competitive firm would charge a price just equal to marginal cost and this outcome mirrors the result of a government-regulated monopolist that uses the marginal cost pricing rule, P=MC, to enhance social welfare; this process maximizes the quantity sold, the efficiency of the market improves, and the firm generates more profit

the negative effects of advertising

- raise costs and can be deceitful

price discrimination on campus

- some students pay full price, while other have a full ride - some students receive the in-state rate, while out-of-state students pay substantially more - once you get to campus, there are discounts for students everywhere

oligopoly with more than two firms

- the addition of a third firm complicates efforts to maintain a cartel and increases the possibility of a more competitive result - when a third firm enters the market, there are two effects to consider -- price and output - if a third firm builds a cell phone tower, it will increase the overall capacity to provide cell phone service - if the total number of cell phone contracts increases, all the firms must charge a lower price - because the marginal cost of providing cell phone service is essentially zero, the price each firm charges is substantially higher than the marginal cost of adding a new customer to the network; when the firm sells an additional unit, it generates additional revenue for the firm - the price and output effect make it difficult to maintain a cartel when there are more than two firms - as the number of firms grows, each individual firm becomes less concerned about its impact on the overall price, because any price above marginal cost creates a profit - therefore, individual firms are more willing to lower prices because doing so creates a large output effect for the individual firm and only a small price effect in the market - increased output at smaller firms will have a negligible impact on overall prices because small firms represent only a tiny fraction of the market supply - at large firms, decisions at the firms will have a substantial impact on price and output because the overall amount supplied in the market will change appreciably - the decisions of one firm directly affect other firms

advertising as a monopolist

- the fact that consumers have few, if any, good alternatives when deciding to buy the good makes the monopolist less likely to advertise than a monopolistic competitor - when consumer choice is limited, the firm does not have to advertise to get business - the competitive aspect is missing, so there is no need to advertise to prevent consumers from switching to rival products - a monopolist may wish to advertise to inform the consumer about its product and stimulate demand; this strategy can be beneficial as long as the gains from advertising are enough to cover the cost of advertising

why firms advertise

- the goal of advertising is to drive additional demand for the product being sold - advertising is designed to highlight an important piece of information about the product - a successful advertising campaign will change the demand curve in two dimensions: it will shift the demand curve to the right and alter its shape (more inelastic, slightly more vertical) - this happens because the product is more attractive and more customers want to buy it - because demand is more inelastic after advertising, the firm increases its market power and can raise its price - advertising also conveys information that consumers may find helpful in matching their preferences - advertising tells us about the price of the goods offered, the location of products, and the introduction of new products - firms also use advertising as a competitive mechanism to underprice one another - an advertising campaign signals quality - its highly unlikely that a firm would spend a great deal on advertising if it did not think the process would yield a positive return

duopoly and the prisoner's dilemma

- the prisoner's dilemma example suggests that cooperation can be difficult to achieve - each company has a dominant strategy to serve more customers by lowering its price. but when both firms pursue that strategy, they end up in a nash equilibrium where both firms are worse off than if they'd both chosen differently. they earn just $26,250, when $27,000 was seemingly within reach.

pricing based on the time of the show

- to encourage customers to attend movies during the afternoon, theaters discount ticket prices for matinees; it makes sense because customers who can attend matinees (retirees, people on vacation, and those who don't work during the day) either have less demand or are more flexible, or price elastic - theaters discount matinee prices to encourage moviegoers who have elastic demand and are willing to watch at a less crowded time; also discount these shows because they pay to rent films, so it is in their interest to show a film as many times as possible during the week - because the variable cost of being open during the day is essentially limited to paying a few employees relatively low wages, the theater can make additional profits even with a relatively small audience - on weekends, matinees also offer a discount to families - those with inelastic demand have less-flexible schedules and must pay higher prices to attend in the evening

collusion and cartels in a simple duopoly example

- two conflicting tendencies found in oligopoly: oligopolists would like to act like monopolists, but they end up competing like monopolistic competitors - duopoly -- an industry consisting of only two firms (ex: boeing and airbus in the wide-body jet market) - they are rare in national and international markets, but not that uncommon in small, local markets - in a small town, there are only two providers that have cell phone towers - they are a sunk cost; both towers were built to service all of the customers in the town, so each carrier has substantial excess capacity when the customers are divided between the two carriers - also, because there is extra capacity on each network, the marginal cost of adding additional customers is zero - there is a downward sloping demand curve - duopoly sits between competition and monopoly - competition still exists, but it is not as extensive in competitive markets, which drives the price down to cost - the result does not always mirror that of monopoly, where competitive pressures are completely absent - in an oligopoly, a small number of firms feel competitive pressures and also enjoy some of the advantages of monopoly