AP ECON UNIT 2
Price Discrimination 4 Requirements: ONE
A firm must have some market power (ability to set its own prices). A perfectly competitive firm cannot price discriminate.
ENTRY BARRIERS: EVIL
big firms have a lot of money at their disposal, will have corrupt ways to bring others down
If P = ATC, the firm is?
breaking even
Price Discrimination
charging different customers different prices for the same product. Not every firm can price discriminate.
Price Discrimination 4 Requirements: FOUR
No resale of the good by those who get to pay less.
MONOPOLISTIC COMPETITION (cont.) - We assume that, in the short run, there isn't time for new firms to enter so the number of firms remains _____________. But in the long run, the firms can do what?
constant, change
ENTRY BARRIERS: legal protection
gov. only allows one firm (cable, certain places only have one... why not just jack up prices, but gov. also regulates their rates)
The long-run profit potential for a monopoly is potentially high because high entry barriers do what?
keep competition out and prevent prices from being lowered
If the price is high enough to cover the variable cost of production, with some money left over, then the firm is making enough to do what?
keep producing units and something on those is better than paying nothing.
ENTRY BARRIERS: control of a rare input
limiting the ability to get an input of a good so other firms trying to join the industry can't get it
If the result is negative, the firm is?
losing money
When you draw ATC, it must intersect MC at the ___________ point on the ATC curve (the bottom of the U) . When MC is below ATC, it brings ATC ________. When MC is above ATC it brings ATC ________.
lowest, down, up
Entry Barriers
make it difficult or even impossible for a new firm to enter the industry
What happens when short-run profits are being made?
new firms will be attracted into the industry. Since there are no barriers, new firms are entering and pushing prices down until economic profits are eliminated. Long run profit potential is zero. (Same as perfect comp.)
Tacit collusion
two firms agree to play a certain strategy without explicitly saying so; not stated, but understood
Perfect Price discrimination
where every customer is charged the MAX that each person is willing to pay. In this case, consumer surplus = zero
ENTRY BARRIERS: - copyrights and paten
you have to apply for it
MR Curve is BELOW the D-curve, but it extends past the x-axis. MR can be negative!
- At any given quantity, the marginal revenue (change in revenue from selling one more unit) is less than the price of a good
MARKET TYPE #4: Oligopoly
- Definition = A small number of large firms - Each is large enough to influence the market as a whole
Market Type #2: Monopoly
- Definition: One firm in the industry - high entry barriers keep out new firms. No competition - the firm IS the industry. one graph - not two. Short-run and long-run analysis the same because of those entry barriers
MARKET MODELS: 1) Perfect Competition What would happen if competition among businesses in an industry were taken to the absolute extreme? FOUR CHARACTERISTICS: TWO?
- Freedom of entry and exit (no entry barriers) - Very easy for new firms to enter the industry and for existing firms to leave
"Shutdown point"
- If a perfectly-competitive firm is losing money (P < ATC). Should it go out of business and shut down? - we assume that, in the short run, a firm has at least some outstanding fixed commitments, such as contracts, that have to be paid even if the firm shuts down
What is key for oligopolies, why don't we draw graphs for these markets?
- Interdependence - Decisions made by firms are influenced by decisions made by other firms. - So, we don't draw typical graphs for these firms since interdependence makes that too difficult.
MARKET MODELS: 1) Perfect Competition What would happen if competition among businesses in an industry were taken to the absolute extreme? FOUR CHARACTERISTICS: ONE?
- Lots of small firms and lots of customers - No single firm or customer is big or strong enough to influence the market price.
BUT... IMPORTANT CAVEAT What is the only curve above the AVC curve? What happens if price falls below AVC?
- MC Curve - the firm shuts down and there is no supply at all. So, supply is MC above AVC.
MARKET MODELS: 1) Perfect Competition What would happen if competition among businesses in an industry were taken to the absolute extreme? FOUR CHARACTERISTICS: FOUR? PERFECT INFORMATION
- every customer knows what every firm is charging - no firm can get away with charging a higher price than the others because everyone will know it
Most common form of competition among oligopoly firms:
- product differentiation - trying to convince people what you're selling is BETTER... may not be cheaper, but BETTER, buy ours instead
MARKET MODELS: 1) Perfect Competition What would happen if competition among businesses in an industry were taken to the absolute extreme? FOUR CHARACTERISTICS: THREE? HOMOGENEITY OF PRODUCT
- the product that all of the firms in the industry sell are identical - customers have no preference in terms of who they buy from. They just want the lowest price.
ENTRY BARRIERS: Economies of a scale
- when big companies start up, it's hard for smaller companies to gain an advantage, this is how big companies always have the advantage - entry barrier that leads to "natural monopoly"
Profit can be shown as a shaded box: Step 1:
1) Find where ATC crosses your quantity of production (where MC= MR)
On a long-run graph, ATC must be drawn so that:
1) It crosses MC at the lowest point on ATC. 2) It is tangential to demand AT the point on demand which corresponds with output and price. (0 economic profit)
Supply is Marginal cost (MC)! Why? Reason 1
1) The firm will always be producing at some price-quantity combination on the MC curve. - Since a supply curve shows price-quantity combos at which the firm could produce, the MC curve therefore fulfills the function of a supply curve.
Profit can be shown as a shaded box: Step 2:
2) Extend a dashed line from that point to the y-axis
Supply is Marginal cost (MC)! Why? Reason 2
2) The firm produces where MC=MR. Equilibrium is where S=D. Well, D=MR, so S must equal MC.
Profit can be shown as a shaded box: Step 3:
3) That line and the demand are top and bottom sides of your profit box, which goes from the y-axis to your quantity of production
dominant strategy
As strategy that is the best option for a "player," Regardless of what the other player does
WHY is MR curve BELOW the D-curve but extends past the x-axis?
Because the D-curve slopes downward, the firm must lower the price to sell an additional unit. But the firm cannot lower the price for just the new customers. They must lower it for all. So, they gain revenue - equal to the price- from the new customer, but this is offset in part by revenue lost from existing customers who are now paying less.
On graphs, we often draw only the right side of the "U" where MC is increasing because?
But, at some point, MC begins to rise as methods are "maxed out" and resources are strained reducing efficiency.
Long-run profit potential = zero economic profit →
Can still make positive accounting profit so do not say that such firms go out of business.
Price Discrimination 4 Requirements: THREE
Customers you're asking to pay more cannot be able to easily find ways to pay less.
Market Type #3: Monopolistic Competition (do not confuse it with monopoly) FOUR CHARACTERISTICS: TWO:
Freedom of entry and exit (no entry barriers) (just like freedom of competition)
MR = marginal revenue (extra revenue gained from selling one more unit)
Here, it is equal to the price because the firm can sell any number of units at that price.
Market Type #3: Monopolistic Competition (do not confuse it with monopoly) FOUR CHARACTERISTICS: FOUR:
Heterogeneity of product: Products sold by firms DO vary slightly from those sold by other firms. Customers can prefer one over another. A firm that raises its price will lose some customers but not all, since some will still prefer its product and be willing to pay more for it.
Market Type #3: Monopolistic Competition (do not confuse it with monopoly) FOUR CHARACTERISTICS: ONE:
Lots of small firms and lots of customers. (Just like perfect competition)
So, the point where ATC stops decreasing and starts increasing is where it equals what?
MC
When we draw graphs for this market, we typically draw two graphs side by side: The industry and the firm. What is the order of how you draw it the graph?
MR, AR, MC, ATC
Profit Potential of a perfectly competitive firm: - short run:
Not enough time for new firms to enter the industry or for existing firms to leave. So, the number of firms remains constant.
The firm isn't enough to pay off any of its commitments if what is true?
P </= AVC
The firm goes further into debt by producing, and should shut down and flee if what?
P<AVC
if such a firm is losing money in the short run, it should stay open as long as what?
P>AVC (or TR>TVC)
Market Type #3: Monopolistic Competition (do not confuse it with monopoly) FOUR CHARACTERISTICS: THREE:
Perfect information. (Just like perfect competition)
How do you show profit or loss? (what's the equation)
Profit = (P - ATC) x Q
Nash Equilibrium
Stable state where neither player has a reason to unilaterally change strategy -If both sides have a dominant strategy, Nash Equil. is where each adopts that strategy. If one side has a dominant strategy, the nash equil. is where that side adopts that strategy and the other chooses its better option in response.
Average Revenue (AR)
TR/Q. In this case, equal to the price.
Price Discrimination 4 Requirements: TWO
These customers you're asking to pay more must have somewhat inelastic demand.
price war
a series of competitive price cuts that lowers the market price below the cost of production - NOT common
At lower levels of production, MC can decline as output increases as the firm does what?
employs more efficient bulk production methods
We assume in the long run all fixed legal commitments have __________. So, if P<ATC in the long run, the firm does what?
expired, shut down ( since there are no contracts, etc, to warrant staying open)
long run:
firms can enter or leave
Price leadership
if a big firm raises prices, other firms raise their prices too
Finally, we add average total cost (ATC). This is also a "U" shape. Declines initially as output increases because average fixed cost declines. But why does it eventually start increasing?
it starts increasing as MC rises.
The firm in a perfectly competitive market is a ________-______, meaning that it must charge the prevailing _________ _________. Why can't it charge above the price? Why can't it charge less?
price-taker, market price, - If it charges above that price, it loses all customers. It cannot charge less because the price is already as low as it can go without firms going out of business.
But, in the long run ... if short-run profits are being made, new firms will be attracted into the industry in the long run. (NO ENTRY BARRIERS) This pushes the industry supply curve to the _________, pushing ___________ the market price. This continues until price falls so far that economic profits are _____________.
right, DOWN, eliminated
In which run can a firm in this industry earn economic profits?
short run
cartel action
specific agreements that actually work out (usually illegal - violates antitrust law, prevents most cartel action... most powerful one is OPEC)
Marginal cost (MC)
the cost of making one more unit. Often depicted in some sort of "U" shape.
Next, we draw a dashed line to the x-axis from where MC crosses D. This is where MC = MR, and is what?
the profit-maximizing quantity.
