MICRO 251 EXAM 3
MC< ATC
ATC is decreasing when
AVC
ATC is higher than ... because ATC includes fixed costs
MC>ATC
ATC is increasing when
cost curve
ATC- U shaped and on "top" AVC- U shaped and on "bottom" MC- J shaped and intersects AVC and ATC at their minimum
Marginal Revenue (MR)
Additional TR from selling one more unit MR= change in TR per Q
Fixed cost
(ATC-AVC)*(Q)=
Profit
(P-ATC(Q))*Q or TR-TC
Cournot outcome
- each firm is better off than if they were in PC - both would be better off if they cooperated as a CARTEL - BR response to your opponent choosing cartel strategy is to defect
Monopoly
1 firm, many buyers, 1 type of good, barriers to entry - price maker - wont lose customers to competitors - ALL market power - rare!
Steps to strategic interaction
1. Consider all possible outcomes and possibilities - using a Payoff Table 2. Think about "what ifs" separately 3. Play your Best Response 4. Put yourself in someone else shoes
HHI
Higher HHI = more market power - more firms, smaller the HHI ex: suppose 1000 equally sized firms si= 0.1 HHI= .1^2+.1^ (1000 times)= 10 ex: 3 equal firms with 33.33% HHI= 33.33^2 (3 times) = 3333 2 of them merged HHI= 33.33^2+66.67^2=5555
Rational Rule for Sellers
Keep selling until MR = MC - determines MAX profit - below D curve due to discount effect
Reservation Price
Max P a consumer is willing to pay for a good - set YOUR P just below MB of consumer
hurdle method
Offer lower prices only to buyers who are willing to overcome some hurdle to pay a lower price - paper coupons, bad customer service, waiting periods
Hurdle method
Offer lower prices only to those buyers who are willing to overcome some hurdle to receive discount - for those who do not disclose RP What counts as hurdle: - Alternative versions can create hurdle - selective discount - Haggling for lower P is hurdle - Fluctuating P - coupons and rebates - slightly worse service
economic profit is ZERO
P = ATC
TR=
P*Q
profit margin=
P-MC
MR
P=
Group Pricing
PD by charging different prices to different groups of people - bc we dont know RP, they tailor P for diff groups - charge higher P to those who value your market - charger lower P to those who are very price sensitive (students) ex: movie theatre- student, elderly, kid, adult prices promising PD strategy
P=MC -P is measure of marginal benefit when comparing with market power vs perfect competition
Perfect competition achieves...
P<AVC, but Q=0
Shut down if...
P=AVC
Shut down or dont
ATC
TC/ Q
Average Revenue
TR/Q - d curve= avg rev curve
explicit costs
The actual payments a firm makes to its factors of production and other suppliers. - wages, rent, raw materials
Prisoners Dilemma
a game in which pursuing dominant strategies results in noncooperation that leaves everyone worse off - failure to cooperate!
Cost curve
a graph of the costs of production as a function of total quantity produced.
exit market
a long-run decision to leave the market when P<ATC
Nash Equilibrium
a situation in which each firm chooses the best strategy, given the strategies chosen by other firms - cell with both check marked - tragedy of commons leads to NE due to failure of coop and only taking your fair share
club goods
excludable but non rival
Oligopoly
few firms, many buyers, same good or differentiated goods, barriers to entry - strategic interactions btwn firms is what YOU do affects what another firm does and vise versa which affects market power - imperfect comp
profit > 0
firms ^, supply ^, P goes down when...
Total costs =
fixed costs + variable costs
Bundling
grouping two or more products together and pricing them as a unit
patents and copyrights
helps protect monpolies
exit industry
if profits < 0 in long run...
MR
left side of D curve is elastic, right side of D curve is inelastic bc this is where D curve and ... intersect
MR
lies below D curve and reflects discount effect - STEEPER than D curve bc discount effect is bigger, then you sell larger Q
DWL
lost benefit from transactions that didn't occur as a result of higher P charged by monopolist When P goes up, Qsold goes down
Monopolistic Competition
many firms, many buyers, differentiated goods, free entry/ exit - more ELASTIC d curve because there are many close substitutes so consumers are responsive to price change - higher competition - imperfect comp
Perfect competition
many firms, many buyers, same type of good, free entry/ exit - price taker= charge market P - LEAST market power - rare!
MC intersects bottom of ATC
minimum ATC when...
cournot equation
n/(n+1)*(Q)
long run
new rivals may enter or expand into your market, and existing rivals may leave - planning decisions - ex: enter or exit an industry, add new expensive equipment or tech, unexpected outcomes, factors of production - exit v. shut down
public good
non excludable and non rival
short run
number and type of competitors is fixed - pricing decisions! - ex:change output and LABOR - shut down rule
Natural Monpoly
one firm that produces goods at lowest cost - NO comp - When MC goes down, Q goes up
implicit costs
opportunity costs - forgoing salary, benefits forgone wages + forgone interest - salary + $ invested in business * interest rate
profit margin per unit
price - ATC or Avg rev - ATC
shutdown
refers to a short-run decision not to produce anything during a specific period of time because of current market conditions - cant cover AVC then shut down
private good
rival and excludable
common resource
rival but non excludable
1st degree price discrimination
seller able to charge each buyer their entire willingness to pay - seller gets ALL ES
Price Discrimination
selling the same good at different prices to different buyers - higher P for some, and lower P for others - LEADS to HIGHER PROFITS bc increased Qsold 1. charge higher P to those willing to pay them - ES goes from buyer --> seller 2. Offer discounts to induce new customers to buy - ES goes up for both seller and buyer
Discounts
solves underproduction problem - MR= P charged to buyers - offers opportunity for more revenue
Firms D curve
summarizes buyers demand from your firm as P changes
market power
the ability of a company to change prices and output like a monopolist without losing customers - mkt power= mkt failure - competition leads to lower P and higher Q
Free exit
the ability of a firm to exit an industry without encountering legal or technical barriers - fewer competitors = your business in the market will becomes more profitable over time - firms will keep leaving as long as economic profit is (-) - Steepens YOUR firms D curve - Higher demand
Accounting profit
total revenue - explicit costs
economic profit
total revenue - explicit costs - implicit costs - determines if its worth it to start the business or not
total profit
total revenue - total cost or profit margin * Qsold
multiple equilibria
when there is more than one equilibrium
Rational rule for entry
you should enter a market if you expect to earn a positive economic profit, which occurs when P > ATC - costs = financial + explicit costs
coordination game
your best response is same choice as other player
anti-coordination game
your best response is to take a different action than the other player
Perfect Price Discrimination
Charging each customer their reservation P - max willingness to spend - MB curve shows RP
Best Response
Choice that yields highest payoff given other players choice - put check mark on BR
HOW TO OUTCOMPETE NEW FIRMS
1. Demand-side: create customer lock-in - switching costs: impediment making it difficult or costly for consumers to buy from other firms ex: auto pay, new iphone (existing apps and info), rewards - Reputation: customer loyalty! - Network effects: more people use product, product becomes more useful 2. Supply-side: develop unique cost advantage - firm has lower costs than other firm, so higher economic profit - learning by doing: experience= gaining market share > increasing production > lower costs - benefits of mass production can prevent small firms from succeeding = less comp - research and development - relationship with suppliers = cheaper costs - access to key inputs can freeze competitors out - long-term contracts 3. Regulatory strategy: gov policy - patents give you right to be only producer - other firms cannot compete, grants monopoly effectively! - regulations make it hard for new firms to enter - gov required license can limit competition - lobbying can build regulatory barriers - connections with lobbyists 4. Entry deterrence: convince rivals you'll crush them - build more production capacity so rivals expect fierce comp -higher fixed costs today will allow you to produce at lower MC in future - Financial resources signal you can survive a costly fight - Brand proliferation can ensure theres no profitable niches for rivals to exploit - Reputation for fighting can be helpful too
Segmenting markets
1. Find groups w different D curves - group pricing - set P as close as possible to RP 2. Target group discounts based on verifiable characteristics - age, student status, address - ensures ppl cannot lie 3. Base group discounts on difficult-to-change characteristics - avoids potential of customers switching into diff groups in order to get lower P
STEPS for pricing differences
1. Find where MR=MC 2. Go up and find P to charge on D curve
Vertical merger
2 firms at different stages of production process merge ex: dairy farmer buys shipping company
Horizontal merger
2 or more firms selling the same product merge ex: t mobile and sprint, spirit and jet blue
Diminishing marginal revenue
A level of production in which the product of labor decreases as the number of workers increases.
Free entry
A situation where firms can enter the market without restriction - pushes economic profit to ZERO - each new competitor pushes down profits - new rivals will keep entering as long economic profit is (+) - flattens YOUR firms D curve - lower demand
P>AVC
Do not shut down IF...
Rational rule for exit
Exit the market if you expect to earn a negative economic profit, which occurs if the P < ATC - creates fewer rivals = more market power = higher profit for sellers still in market
Highly concentrated industry
HHI above 1800 - Few firms with large shares
Unconcentrated industry
HHI below 1000 - many small firms
ATC
Total costs/ Q = fixed costs/ Q + variable costs/ Q - rises as Q produced increases - d curve above ATC curve= economic profit
AVC
VC/Q
MC
What curve increases based on increasing difficulty and and cost of production?
Price= ATC
When economic profit = 0....
Strategic interaction
best choice may depend on what others choose, and their best choice may depend on your choice - our decisions are interconnected to others decisions - includes partners and rivals
MC
change in TC/change in Q - additional cost of producing one more unit = variable costs
2nd degree price discrimination
charging different prices for different quantities
3rd degree price discrimination
charging different prices to different groups of consumers with varying elasticities - GROUP PRICING
Conflict in oligopoly
collusion or CARTEL by jointly acting as a monopoly - they join because average comp btwn firms drives prices down making less profit, so this would be seen as a more profitable approach
variable costs
costs that change as output changes
fixed costs
costs that remain constant as output changes
long run profitability
depends on barriers to entry
Quantity discounts
discounts offered to encourage customers to buy in larger amounts ex: buy 1 get one 50% off
D curve
downward sloping and reflects market power
