Econ Exam 4 Study Set

Second Degree

per unit price varies with quantity of units purchased. ex. if you stay 4 nights you get fourth night free... By three tires, get one free.

Which of the following is correct with regard to limit pricing AND predatory pricing?

Both limit pricing and predatory pricing involve charging a price below the profit-maximizing price

Cost-Plus Pricing (Case Study)

Company: Parker Hannifin Known as "The Death of Cost Plus Pricing" Essentially the old CEO would just mark up all their products at the same 35% percentage. New CEO cam in and based prices on what customers were willing to pay... he increased their profits from $130 million to $673 million.

Which of the following is true for perfect competition but not true for monopolistic competition and monopoly?

P = MC From last exam

A monopoly producing a chip at a marginal cost of $6 per unit faces a demand elasticity of −2.5. Which price should it charge to optimize its profits?

$10 per unit 1.) (-2.5) / (1 + (-2.5)) = 1.667 2.) 1.67 - 1 = 67% 3.) 67% x 6 = 4.02 4.02 + 6 = 10

Suppose P = 20 − 2Q is the market demand function for a local monopoly. The marginal cost is 2Q. The local monopoly tries to maximize its profits by equating MC = MR and charging a uniform price. What will be the equilibrium price and output?

$13.33, 3.33 units P = 20 − 2Q, MC = 2Q, MC = MR 1.) P = 20 − 2Q MR = 20 - 4Q 2.) 2Q = 20 - 4Q 6Q = 20 Q = 3.33 units 3. P = 20 - 2(3.33) P = 13.34

You are the manager of a gas station and your goal is to maximize profits. Based on your past experience, the elasticity of demand by Texans for a car wash is −4, while the elasticity of demand by non-Texans for a car wash is −6. If you charge Texans $20 for a car wash, how much should you charge a man with Oklahoma license plates for a car wash?

$18.00 MR = MC = P (1-1/e) 1.) MR = 20 (1-1/4) = 15 (cost) 2.) (-6) / (1 + (-6)) = 1.20 1.2 - 1 = .2 or 20% 3. .2 x 15 = 18

A monopoly produces widgets at a marginal cost of $10 per unit and zero fixed costs. It faces an inverse demand function given by P = 50 − Q. The monopoly price is:

$30. 1.) double slope of function P = 50 − Q MR = 50 − 2Q 2.) The firm produces at MR (1.) = MC (given) so, 50 − 2Q = 10 -2Q = -40 Q = 20 3.) Plug Q into original demand function P = 50 - (20) P = 30

Maximizing Profits Using 3rd Degree Price Discrimination Example Problem

One factory with two different markets: How much do we make in total? How much do we sell in each market? How much do we charge in each market? Given: Demand functions: Qa = 160 - P Qb = 140 - .5*P Cost Functions • ATC = MC • ATC = MC = .67Q Market A 1.) Invert demand function for market A to get demand curve: Qa = 160 - P Qa - 160 = -P P = 160 - Qa 2.) Double slope to get MR for market A: MR = 160 - 2*Qa 3.) Get Q on the left from 2.) MR = 160 - 2*Qa 2*Qa = 160 - MR Qa = 80 - .5MR 8a) Plug MC (7.) into MR (2a.) MR = 160 - 2*Qa 67 = 160 - 2*Qa -93 = -2*Qa 46.5 = Qa Answers: HOW MUCH WE ARE GOING TO SELL IN MARKET A 9a) Plug market a amount to sell (8a) into original demand function for a (Given) Qa = 160 - P 46.5 = 160 - P -113.5 = -P Pa = $113 Answers: THE PRICE YOU ARE GOING TO CHARGE IN MARKET A Market B 1.) Invert demand function for market B to get demand curve: Qb = 140 - .5*P Qb - 140 = -.5*P P = 280 - 2Qb MARKET B DEMAND CURVE HAS STEEPER SLOPE THAN A (1a.) SO IT IS MORE INELASTIC, therefore, we should charge a higher price in this market. 2.) Double slope to get MR for market B: MR = 280 - 4Qb 3.) Get Q on the left from 2.) MR = 280 - 4Qb 4Qb = 280 - MR Qb = 70 - .25MR 8b) Plug MC (7.) into MR (2b.) MR = 280 - 4Qb 67 = 280 - 4Qb -213 = -4Qb 53.25 = Qb Answers: HOW MUCH WE ARE GOING TO SELL IN MARKET B 9b) Plug market b amount to sell (8b) into original demand function for b (Given) Qb = 140 - .5*P 53.25 = 140 - .5*P -86.75 = -.5*P Pb = $173.5 Answers: THE PRICE YOU ARE GOING TO CHARGE IN MARKET B Higher because it is the more inelastic market. ALL PARTS TOGETHER: 4.) MRa (3a.) = MRb (3b.) = MC 80 - .5MR = 70 - .25MR Q total = 150 - .75MR 5.) Re-invert (4all) to get MR on the left: Qtotal = 150 - .75MR .75MR = 150 - Qtotal MRtotal = 200 - 1.333*Q 6.) Set MRtotal (5.) equal to MC (given in question) 200 - 1.333*Q = .67*Q 2*Q = 200 Qtotal = 100 THIS IS HOW MUCH YOU ARE GOING TO MAKE IN TOTAL 7.) Plug Qtotal (6.) into MC (Given) to get a number MC = .67*Q (Given) MC = .67 * (100) MC = 67 USE back in original split sections.

Using the correct answer to Question 5, and the market demand function from Question 2, what is the quantity that will be demanded in the market when you charge that limit price?

Q = 57 5.) Plug limit price(4.) into market demand curve(1.) Limit price = $116, P = 230-2Q 116 = 230-2Q -114 = -2Q 57 = Q

Which of the following formulas would correctly measure the profit (profit is "π") of a monopoly? Be careful...

π = TR − TC or π = (P − ATC)Q

You are the manager of a Mom and Pop store that can buy milk from a supplier at $3.00 per gallon. If you believe the elasticity of demand for milk by customers at your store is −4, then your profit-maximizing price is:

$4.00. 1.) (-4) / (1 + (-4)) = 1.33 elasticity 2.) 1.33 - 1 = 33% markup 3.) 3 x .33 = .99 3 + .99 3.99 or 4

Following directly from the two previous questions, what is the price you should charge for your product?

$40.50 From previous Insert total (2.5) into original demand function. So, P = 78 - 15(2.5) p = 40.50

Now, using the correct answer to Question 3, plug that "Q" into the ATC function to get a dollar amount. As described in the video, that dollar amount is TWO THINGS. First, it's the value of ATC when you are producing that "Q" and second, it's the "P" on the residual demand curve at that same Q. What is that dollar amount?

$76 3.) Plug Q (2.) into ATC curve (Given) ATC = 136 - 4(20) + .05(20)^2 P = 76

A local video store estimates its average customer's demand per year is Q = 7 − 2P, and it knows the marginal cost of each rental is $0.5. How much should the store charge for an annual membership in order to extract the entire consumer surplus via an optimal two-part pricing strategy?

$9 1.) Q = 7 − 2P Q - 7 = -2P -.5Q + 3.5 = P 2.) 3.5 - 0.5Q = 0.5 3 = 0.5Q 6 = Q 3.) (1/2) x (3.5 - 0.5) x 6 = 9

Oligopoly

- A small number of firms - Typically two to twelve - Difficult (but not impossible) To enter this market as a Seller... - Similar OR differentiated product - High degree of INTERDEPENDENCE among firms. -Example: mobile phone service, overnight delivery, television viewing (not through the air...)

Regulating a Natural Monopoly

- In the case of a natural monopoly, one company can serve the entire market more cheaply than two (or more) could - But this means higher than competitive prices so the government steps in and "Regulates" the price it charges so the monopoly can't shaft the customers. Regulating a monopoly often takes the form of "forcing it to price like a competitive firm" However, in this case of a natural monopoly, that would put the firm out of business. SO the government makes natural monopolies charge a price where P = ATC. The regulated price is P = ATC that allows monopolies to make just enough to stay in business. This gives the company and incentive to "inflate" its costs!!!

Wal-Mart example of predatory pricing

-1991 Faulkner County, Arkansas (Conway) Wal-Mart built store in Conway, in 1987, started selling pharmaceuticals, health & beauty aids, etc. - Competitors were local pharmacies and grocery stores - Wal-Mart admitted that it sold many items below invoice cost, everything from Crest toothpaste to Mylanta (heartburn relief) -Prices at this Wal-Mart were substantially lower than other nearby Wal-Marts that faced less competition! - 3 competitors sued Wal-Mart for anti-competitive action and predatory pricing under the Arkansas Unfair Trade Practices Act. RESULT: 1993: Wal-Mart found guilty! "The Act makes it unlawful for a business to sell or advertise for sale any article or product at less than the cost thereof. "Cost" in this instance is defined as the invoice or replacement cost of the article plus the cost of doing business." Ordered to pay $396,469 in damages to the 3 plaintiffs • Wal-Mart appealed the ruling to the Arkansas Supreme Court. • In 1995 Supreme Court overturned the lower court's decision REASONS WHY OVERTURNED: Reason #1: Wal-Mart only sold a few items below cost; most items priced above cost; company's books showed health aids and pharmaceuticals always made profits, indicating prices (on average) were above cost. Reason #2: Competitors did not go out of business; they remained profitable (if less profitable than before) indicating that Wal-mart's actions could be considered "competitive" but not "anti-competitive". Reason #3: U.S. Supreme Court had recently (1993), in another case on predatory pricing, found this: Predatory pricing occurs only if the predator - 1) sets a price below an appropriate measure of its costs AND - 2) has at least a reasonable opportunity of recouping its losses from the below-cost sales... In other words, it's not enough to lower prices below cost, at some point you have to raise them back up again. That didn't happen in the Wal-Mart case. They did the same thing and won in Oshkosh Wisconsin, and Edmond Oklahoma So they did it again in Germany... German High Court ruled that Wal-Mart supermarkets' low-price strategy "undermined competition" and ordered stores to raise prices... Wal-Mart appealed the ruling, and WON... Other side appealed the appeal, all the way up to German Supreme Court.. and Wal-Mart lost... Wal-Mart pulled out of Germany!!

The next three questions all use this same information. PROCEED EXACTLY AS WE DID IN THE VIDEO WHEN WE DID THAT PROBLEM WHERE THE MONOPOLIST PRODUCES THEIR PRODUCT IN TWO DIFFERENT FACTORIES. ALSO THIS IS GOING TO BE MUCH EASIER IF YOU USE FRACTIONS, NOT DECIMALS. REMEMBER, 1/3 IS THE SAME AS 2/6 AND 1/2 IS THE SAME AS 3/6. You are the manager of a monopoly that produces output in two plants. The demand for your firm's product is P = 78 − 15Q, where Q = Q1 + Q2. The marginal costs associated with producing in the two plants are MC1 = 3Q1 and MC2 = 2Q2. How much output should be produced in plant 1 in order to maximize profits? (Note: Do not be surprised if you get a total output number of "something point 5, like, 2.5 OR 3.5.)

1 Refer to (Math Steps) for help 1.) (1) MC = 3Q Invert: (1) Q = 1/3MC (2) (2) MC = 2Q Invert: (2) Q = 1/2 MC 2.) Q = 1/2MC + 1/3MC Qt = 5/6 MC 3.) Qt = 5/6 MC move 5/6 over 1/ (5/6) 1.2Q = MC 4.) P = 78 - 15Q Double MR = 78 - 30Q 5.) 1.2Q = 78 - 30Q -30Q - 1.2Q: -31.2Q 0 = 78 - 31.2Q -78 = -31.2Q 2.5 = Q 6.) 78 - 30 (2.5) = 3 7.) (1)Q = 1/3MC Q = 1/3(3) Q = 1

How do you find just how far you need to shift down your price?

1) IDENTIFY LEVEL OF OUTPUT WHERE COMPETITOR'S COST FUNCTION IS TANGENT TO RESIDUAL DEMAND CURVE. 2) USING COST FUNCTION, IDENTIFY DOLLAR AMOUNT ASSOCIATED WITH THAT "Q" 3) FROM THAT POINT, "BACK INTO" NEW INTERCEPT

Structural (Technological) barriers to entry

1. Economics of scale - Range where per unit costs decrease as output increases - Exist anytime there is a U-Shaped cost curve

Limit price example for test Given: Your demand curve: P = 320 - .5*Q Your potential competitor's AC curve: ATC = 100 - 1.25*Q+.05*Q^2 Find the limit price that successfully keeps your competition out of the market.

1. Find derivative to get ATC curve slope ATC = 100 - 1.25*Q+.05*Q^2 Slope of ATC = -1.25 + .1Q 2.) set (1.) equal to slope of DC (Given = -.5), and solve for Q -.5 = -1.25 + .1Q .75 = .1Q Q = 7.5 3.) Plug Q (2.) into ATC curve (Given) ATC = 100 - 1.25*(7.5) +.05*(7.5)^2 P = 93.4 4.) plug in P (3.) and Q (2.) to demand curve without given single number (intercept) P = 93.4, Q = 7.5, P = 320 (delete) - .5*Q 93.4 = -.5(7.5) Intercept = 97.15 Limit Price is $97.15 Refer to "SOLUTION Sample Problem 1 for Final Exam Limit Pricing.pdf" under module 13 for TR or how much profits change

from previous sections

1.) MC from ATC: If you have: ATC = a - b*Q + c*Q^2 Double "b" and triple "c" and you now have MC ex. ATC = 400 - .4Q + .002Q^2 MC = 400 - .8Q + .006Q^2 2.) ATC = TC/Q so, TC = 400 + 10Q then, ATC = 400/Q + 10 MC = 10 Therefore, at some point MC = ATC Average cost = Marginal cost and it is always $10. 3.) Consumer surplus: difference between price consumer has to pay and price the consumer would be willing to pay. Difference between value of the good to customer and price they have to pay... Represents collective benefit to customers. CS increases, consumers (as a whole) are better off; CS decreases, consumers (as a whole) are worse off. For Maximizing Profits Using 3rd Degree Price Discrimination Demand curve is more inelastic when the demand curve was really steep. Demand curve is more elastic when the demand curve was flat Demand curve is when P is on the left "Incumbent" is the firm already established in the market

Example Question: Incumbent firm hears that entrant is planning to enter market. Incumbent responds by increasing output and (accordingly) reducing price... Given: Market demand function: Q = 80 - .5P so market demand curve: p = 160 - 2Q each firm has same costs ATC = 100 - 3Q + .05Q^2 Would price of $80 be predatory under Areeda Turner?

1.) Take ATC and double "b" and triple "c" ATC = 100 - 3Q + .05Q^2 MC = 100 - 6Q + .15Q^2 2.) Plug Price ($80) into Demand Curve (P) P = 160 - 2Q 80 = 160 - 2Q -80 = -2Q Q = 40 3.) Plug Q (2.) into ATC (Given) ATC = 100 - 3(40) + .05(40)^2 ATC = $60 $4.) plug Q(2.) into MC (1.) MC = 100 - 6(40) + .15(40)^2 MC = $100 MC > ATC indicates that ATC is increasing therefore, P 0f 480 is not predatory under Areeda Turner

Following directly from the previous question, and using everything you did to answer that question, what is the output you should produce in plant 2?

1.5 All from previous question 7.) (continued) (2) Q = 1/2 (3) Q = 1.5

Following directly from the question above, you are the manager of a monopoly that faces a demand curve described by P = 230 − 20Q. Your total costs are TC = 5 + 30Q. Based on the answer to the previous question, your profit-maximizing price is:

130. Plug 5 form previous question into P = 230 − 20Q. 1.) P = 230 - 20(5) P = 130

You are the manager of a monopoly that faces a demand curve described by P = 230 − 20Q. Your total costs are TC = 5 + 30Q. So the profit-maximizing output for your firm is:

5. 1.) Times price x Quantity P = 230 - 20Q is now, TR= 230Q -20Q^2 2.) Derivative of TR TR = 230Q - 20Q^2 (from step 1) MR = 230 - 40Q 3.) Derivative of TC = 5 + 30Q MC = 30 4.) Set MC = MR 30 = 230 - 40Q 40Q = 200 Q = 5

Which is correct regarding predatory pricing?

A key part of the definition of predatory pricing is that the company must increase its price after the competitor has left the market

Maximizing Profits Using 3rd Degree Price Discrimination Example Problem (Continued)

ALL FROM PREVIOUS: Market A: Q = 46.5 (8a), P = 113.5 (9a) 1.) TR = 46.5 x 113.5 = $5,277.75 (Market A Revenue) Market B: Q = 53.25 (8b), P = 173.5 (9b) 2.) TR = 53.25 x 173.5 = $9,238.87 (Market B Revenue) Together: 3.) Add Market A Revenue (1.) to Market B Revenue (2.) 9,238.87 + 5,277.75 = $14,516.62 (Total Revenue) 4. Get average total costs. Q = 100 (6.) MC = 67 (7.). (6.)*(7.) 100 x 67 = 6,700 (Total Costs) 5.) Subtract total costs (4.) from total revenue (3.) 14,516.62 - 6,700 = 7,816.62 Total Profits = $7,816.62 Answers: WHAT ARE OUR TOTAL PROFITS?

Predatory Pricing

Another strategic barrier to entry Aggressively cutting the price of a product in an attempt to either - drive out an entrant OR prevent the entrant from entering in the first place! Cutting the price to a level that is BELOW-COST. Assumption: Prices will increase again after entrant has exited the market. • In predatory pricing, P is below MC. unlike limit pricing, where P above MC. "Although there is no universally accepted definition of predatory pricing, a general definition is pricing at a level calculated to exclude from the market an equally or more efficient competitor." -Viscusi and Vernon & Economics of Regulation and Antitrust

Two-Part Tariff Summary (second degree)

Assumption: We know the individual's demand function... Assumption: The "benefit" to consumer of purchasing any quantity = consumer surplus + price paid. Assumption: As long as "benefit" exceeds "cost" to customer, customer will buy. PUNCHLINE" Set P = MC and "entry fee" = (almost) entire consumer surplus!

Monopolies with two separate plants (two separate cost structures)

At some point it's cheaper to produce in the second factory. Ex. It's cheaper to produce products in Factory A up to a point. At that point the next unit is cheaper is the first unit in factory B. You want to produce the quantity where MCa = MCb + MR Because if costs of producing are not equal across factories, you should shift production form one factory to the other to maximize joint profits. This distribution maximizes the firm's profits Change the distribution 1 unit - in either direction- and profits are lower!!!

Price Discrimination

Charging 2 different customers 2 different prices for the same good or service. First degree: Charge each customer exactly what he/she is willing to pay. Ex. Ebay auction, selling new cars and used cars based on haggling Second degree: per unit price varies with quantity of units purchased. ex. if you stay 4 nights you get fourth night free... Third degree: Customers split into groups; charge different prices based on elasticity. ex. movie ticket for student vs. non-student. Senior citizen's Denny's discount. paying instate and out of state tuition. Airline ticket 2 weeks ahead vs. 3 days ahead.

Third Degree Price Discrimination

Charging 2 different customers 2 different prices for the same good/service. ex. in-state and out of state tuition Three Necessary Conditions: 1. Firm must have control over the price (some amount of market power) 2. Customers must have different willingness to pay AND firm must be able to identify separate groups based on elasticity 3. Firm must be able to prevent re-sale. MOST IMPORTANT... this is why you can't resale an airline ticket Firms who do this, adjust the amount of tickets being sold to where Marginal Revenue (group a) = Marginal Revenue (group b) - If either side is unbalanced, then they sell more on the other side. When MR (a) = MR (b), you cannot improve your situation by changing the other side.

Peak-Load Pricing

Charging a higher price during "peak" times of high-demand and a lower price during "slow" periods... Is used to maximize profits Ex. Often done with utilities. • Example: Parking Garage Assume: Has capacity of 1,000 cars 1.) Has a fixed capacity. 2.) Filled to capacity from 7am to 6pm 3.) After 6pm, never even close to full... 4.) Marginal Cost? Almost nothing (electricity) and Marginal Cost doesn't vary with "Q" UNTIL you hit capacity G4 THEN, marginal cost becomes (essentially) infinite. 5.) Marginal cost would be cost of expanding the garage! MRpeak is not equal to MRoff-peak You cannot "move" one unit to the higher priced market... you're at capacity!

Block Pricing (second degree)

Classic Second Degree Price Discrimination Much larger profits and revenues under block pricing compared to normal profit maximization. Rather than charging "profit maximizing price" by setting MR = MC. Charging different price for different quantities purchased... By creating the blocks, you're capturing the consumer surplus from this customer. - When you "capture" consumer surplus, customer is "worse" off; producer is "better" off!! Assumptions: - Demand function is for 1 customer... - Customers purchase multiple units.. - All customers have similar demand.. Capturing the consumers surplus by blocking reaches its pinnacle in the form of a two-part tariff.

Conditions for a firm to engage in price discrimination...

Consumers are partitioned into two or more types, with one type having a more elastic demand than the other. The firm has a means of identifying consumer types. There is no resale market for the good.

Two-Part Tarriff (second degree)

Customer pays one price (initial charge) for the right to buy as much of a related good at another price. Examples: 1. Admission to amusement park & tickets to individual rides 2. Annual fee for a country club & fee for each round of golf 3. Admission to Sam's Club and then ability to buy goods there Same Assumption: This is ONE CONSUMER'S demand curve consumers benefit still exceeds their costs but firm has "captured" most of the consumer surplus. If you keep lowering the price then you will have much larger profits from a larger consumer surplus (entrance fee). Ultimately you lower the price to P = MC and therefore, you charge that price per round but charge almost the entire consumer surplus as a fee.

Third degree

Customers split into groups; charge different prices based on elasticity. ex. movie ticket for student vs. non-student. Senior citizen's Denny's discount. paying instate and out of state tuition. Airline ticket 2 weeks ahead vs. 3 days ahead. EXCEPTION: If there are cost differences or quality differences it does NOT constitute price discrimination. Ex. First-class seat v. coach seat on the same flight. Balcony seat v. floor seat at the same concert. Donut at 1:45pm v. donut at 2:05 pm at KU Union.

How do we tell if pricing is predatory??

Famous test: Areeda-Turner Test: • If P < MC, pricing is predatory IF ATC is decreasing... • If ATC is increasing, P < MC may not be predatory. Difficult to measure MC; often AVC is used as a proxy in real-world cases... We will go ahead and use MC for this class Areeda Turner Logic Any price < MC will cause the firm to lose money on some units of output... Also, P < MC is economically inefficient BUT.. A P that is < MC but above ATC is sustainable.. Not optimal but sustainable Therefore, it does not exclude equally efficient rivals... Cannot be considered anti-competitive

Cost-Plus Pricing

How much to mark up prices 1. Take the average cost at some level of production.. 2. Add a "mark-up" to that... that's your price. -One way to spread fixed-costs over multiple products... AND... generally, an incredibly bad idea! UNLESS you do it right!! PUNCHLINE Placing "mark up" on the product with more inelastic demand = • Revenues are less affected, benefiting firm • Consumer surplus is less affected, benefiting customers.. • Sometimes called "Ramsey pricing" The Magic Formula: P = MC * (elasticity / elasticity + 1) or (Elasticity / Elasticity + 1) = (1 + markup Remember: Elasticity is a NEGATIVE number We charge a higher price for the less elastic product! More inelastic = Higher price charged

Natural Monopoly Test

If the market demand curve intersects to the left of the minimum average cost then it is a natural monopoly. View star in photos Natural Monopoly if price (P) is lower than quantity (Q) 1. Find the minimum point on the ATC curve - Find the first derivative of the ATC function -set to zero and solve Answer is where ATC function is minimized ( Q =) 2. Plug Q back into ATC function to get ATC 3. Insert Q into inverted market demand equation (may have to invert if P is not on the left) to get P. If P is lower than Q and less than ATC, then you have a natural monopoly.

Price discrimination Illegal?

In most cases price discrimination is not illegal... Robinson-Patman Act (9136) Cannot discriminate when: Applies to commodities but not to services Applies to purchases but not to leases Must be (Applies to) of "like grade and quality" Must be (Applies to) injury TO competition ^ It has to be an injury to the entire market of competition not just one firm. Ex. losing a customer because your competitor price discriminated is not an injury to competition.

Module 13 - Limit Pricing

Limit pricing is a strategic barrier to entry A way to keep a potential entrant (competitor) out of the market. Firms already in the market choose a price below profit-maximizing price. Why? To keep a potential competitor OUT... Limit Pricing Assumption 1. Incumbent firm has market power... 2. Incumbent and entrant sell products that are near perfect substitutes... 3. Incumbent firm has knowledge of competitor's costs. - Reasonable assumption if near-identical products; identical products = identical costs Incumbent's Goal: Set a price such that no level of output is profitable for entrant At same time, set this price as close to profit-maximizing price as possible How does it do that? Lower the price YOU CHARGE to shift DOWN the entrant's residual demand curve! Similar to predatory pricing (which we'll do next) except... • In limit pricing is P above MC • In predatory pricing, P is below MC... Predatory pricing is also illegal in the US

Which of the following is the best example of monopoly?

Local utility industry in a small town

As discussed in the videos, which of the following is a correct representation of the profit maximization condition for a monopoly?

MC = MR

Consider a monopoly where the demand function for its product is given by Q = 40 - .2*P. Invert the demand function to get the demand curve, and based on that what is the marginal revenue curve for this monopoly?

MR(Q) = 200 − 10Q. 1.) invert Q = 40 - .2*P Q - 40 + = -.2*P 1Q/-.2 - 40/-.2 -5Q - 200 = P 2.) Just multiply # in front of Q by 2 so, -5Q - 200 = P is now -10Q - 200 = P

Peak-Load Pricing Exam Question EX.

Marginal cost: Fixed at some level up to capacity; after that, infinite - For off-peak, find Q where MRoffpeak = MC - Find "P" associated with that Q - For peak, simply find "P" associated with "Q" at capacity. Example Question: Peak demand: Q = 61 - ¼*p Off Peak demand: Q = 30 - (1/3)*P MC = 6 up to capacity... Capacity is maxed at Q = 28 What prices will you charge, peak and off-peak? Peak Load Pricing 1.) Invert Q = 61 - (1/4)*P Q - 61 = (1/4)*P P = 244 - 4Q 2.) Double Q so, MR = 244 - 8Q 3.) Plug in 1.) given "maxed Q" 244 - 4(28) Peak p = 132 Off-Peak 1.) Invert Q = 30 - (1/3)*P Q - 30 = -(1/3)*P P = 90 - 3Q 2.) Double Q so, MR = 90 - 6Q 3.) Set MRoffpeak = MC so, 90 - 6Q = 6 Q = 14 4.) Plug into Off-peak 1.) So, 90 - 3(14) = 48 Off-Peak P = 48

Residual Demand Curve

Market Demand "left over" by incumbent firm Same slope as incumbent's demand curve... but it has a different (usually lower) intercept. Begins at price where where you stopped

Monopolist demand curve

Monopolist's demand curve is the market demand curve... It is downward slopping Monopolist (Chooses Q) maximizes profits where MR = MC Profit per unit is P - ATC

MONOPOLY - MODULE 11

Monopoly - Single firm provides this good or service - The good or service has no substitutes Ex: Local water company

Barriers To Entry- Anything that keeps new firms out of the industry when firms are earning economic profits

Monopoly and oligopoly characterized by barriers to entry. Barriers to entry are something that keeps new firms from successfully entering the market when existing (incumbent) firms are making profits... Competitors cannot successfully enter the market so there is never a change in the demand curve. Therefore, the monopolist just sits there earning crazy high profits. Two types: Structural and Strategic Structural: something having to do with the way the product is made (the technology). Characteristics of the market....Economies of scale Strategic: Behavior on the part of the existing firms such as limit pricing or predatory pricing that managers do to keep other firms out of the market. Actions taken by firms in the market. Issues: Abnormally high profits that are never competed away and customers who are held captive

LIMIT PRICING. You are going to use this info for this question plus the next 4 questions. As we did in the videos, assume 2 firms exist, one incumbent (already serving market) and one potential entrant These 2 firms have identical cost structures: ATC = 136 - 4Q + .05Q^2 so, MC = 136 - 8Q + .15Q^2 AND ALSO ASSUME Market Demand Function is Q = 115 - (.5)*P You are going to follow the procedure we went through in the videos. First, above, you have the market demand function; which of the following is the correct equation for the market demand curve?

P = 230 - 2*Q 1.) Invert Q = 115 - (.5)*P Q = 115 - (.5)*P Q - 115 = -.5P -2Q + 230 = P

Based on the correct answer to Question 2, as we did in the videos, take the slope of the market demand curve and the slope of the ATC curve and set them equal to each other and solve for "Q". This is the "Q" where the two curves will just be tangent to each other. What is that "Q"?

Q = 20 1. Find derivative to get ATC curve slope ATC = 136 - 4Q + .05Q^2 Slope of ATC = -4 + .1Q 2.) set (1.) equal to slope of DC (Previous = -2), and solve for Q -2 = -4 + .1Q 2 = .1Q 20 = Q

Monopolies with two separate plants (Math Steps)

Part 1: Step 1: Take each MC function and invert it to get Q as a function of MC. (Move Q to the left) Step 2: Add the two inverted functions together and combine and keep Q's (now Q total (Qt)) on the left Step 3: Re-invert Qt function to get MC back on the left Step 4: Take the given demand function with P on the left (May have to invert) and double the number in front of Q to get the MR. MR just replaces P Step 5: set MR (step 4) and MR (step 3) equal to each-other and solve for Q. Gives you the Total Quantity to produce as this monopolist. Part 2: Find how much you'll make in factory A and B. Step 6: Plug Qt (step 5) into the MR function (step 4) Gives you MR = # Step 7: Plug MR# (step 6) into BOTH separate inverted equations (q on the left) from Step 1. Gives you answers (quantity) for each firm to produce Step 8: Gives you amount to produce for each factory. should add up to answer value from Step 5. If not, it's wrong.

Limit price example Given: P = 160 - .8*Q So residual demand curve is P = ___-.8*Q Cost Function is ATC = 80 - 1.65*Q + .03*Q^2

Point of tangency: slope of cost function = slope of residual demand curve Slope of cost function is first derivative. 1.) ATC = 80 - 1.65*Q + .03*Q^2 so derivative, - 1.65 + .06Q 2.) set (1.) equal to -.8 (Given), and solve for Q -.8 = -1.65 + .06Q .85 = .06Q Q = 14 (Point of tangency "rounded") 3.) Plug Q (2.) into ATC curve (Given) ATC = 80 - 1.65*(14) + .03*(14)^2 P = 62.69 or $63 rounded 4.) plug in P (3.) and Q (2.) to residual demand curve P = 63, Q = 14 63 = -.8*(14) 63 = -11.2 Intercept = 74.2 $74.2 is your limit price (what you set your price to)

Cinemas sometimes give senior citizens discounts. What is the possible privately motivated purpose for them to do so?

Senior citizens have a more elastic demand for movies than ordinary citizens.

Following from Question 6, when you produce the "Q" in question 6 and charge the limit price identified in Question 5, what will be your total revenues (TR)?

TR = $6,612 1.) Limit price (4.) times Quantity (5.)

Which of the following is NOT a condition for a firm to engage in price discrimination?

The consumers are sincere in revealing their true natures.

The correct dollar amount identified in Question 4, along with the correct "Q" identified in Question 3, make up one P/Q combination on the Residual Demand curve. As I did in the video, use this P/Q combination to solve for the intercept term of the Residual Demand Curve. That intercept term IS your limit price. What is the limit price?

The limit price is $116 4.) plug in P (3.) and Q (2.) to demand curve without given single number (intercept) P = 76, Q = 20, P = 240 (delete) - 2*Q 76 = -2(20) Intercept = 116 Limit Price is $116

Which of the following statements is true?

The more elastic the demand, the lower the profit-maximizing markup.

Which was the company used as an example in the video of having a history of being accused of predatory pricing?

Wal-Mart

Natural Monopoly

When - because of economies of scale - it's cheaper for one firm to serve the entire market than it is for multiple firms to serve the same market. U-cost curve at the lowest point with natural monopolies It all depends on what the cost curves look like Most efficient way to produce a product but there is certain bad things about them. You get a natural monopoly when market demand curve intersects the cost curve to the left of the cost curves lowest point. (Refer to pictures 1 & 2 in photos for visualization). On firm will always be able to sell at a lower price because they can produce the items at a lower price because of economies of scale. Economies of scale are a barrier to entry for other firms. Do economies of scale create a barrier to entry in this market? means the same thing as: Is this a natural monopoly?

Maximizing Profits Using 3rd Degree Price Discrimination

You charge the higher price in 3rd degree pricing where demand is more inelastic. Assumptions: 1.) A single firm serving two markets 2.) The two markets have different demand elasticities 3.) Firm's costs are the same regardless of what market it's selling to We want to end up where MR (a) = MR (b), AND they both = marginal cost If you charge our distribution by one unit on either end (MR (a) = MR (b)) then we will have lower profits... Our conclusion: One firm serving two markets, find Q and P across the two markets such that MRmarket a = MRmarket b = MC We should end up charging a higher price where demand is more inelastic or steep...

Sample Problem: Cost-Plus Pricing

You have two products: Qa = 400 - 2 * P Qb= 360 - 3 * P • You anticipated selling 150 of product A and 120 of Product B You have to mark up the products to cover unexpected increase in overhead costs... • Which do you mark up more, and by how much more? PRODUCT A 1.) Insert Quantity a (Given) into a function (Given) Qa = 400 - 2 * P 150 = 400 - 2 * P 2 * P = 250 P = 125 So we now know P = 125, Q = 150, Coefficent = (-2) 2.) Find elasticity = (Coefficient) * (P/Q) Elasticity = (-2) * (125/150) Elasticity of A = -1.67 3.) Find Mark-up: (elasticity)/ (1 + elasticity) ((-1.67)/(1+-1.67) = 2.49 4.) Subtract 1 to get mark-up percentage: 2.49 - 1 = 1.49 or 149% markup PRODUCT B 1.) Insert Quantity B (Given) into B function (Given) Qb= 360 - 3 * P 120 = 360 - 3 * P 240 = 3 * P P = 80 So we now know P = 80, Q = 120 , Coefficent = (-3) 2.) Find elasticity = (Coefficient) * (P/Q) Elasticity = (-3) * (80/120) Elasticity of B = -2 3.) Find Mark-up: (elasticity)/ (1 + elasticity) (-2)/ (1 +(-2)) = 2 4.) Subtract 1 to get mark-up percentage: 2 - 1 = 1 or 100% markup Notice how we charged a higher mark-up on the product that was more inelastic (less negative)

Limit Pricing example

You own a service like TruGreen, which fertilizes lawns and sprays for dandelions and weeds. You are the only provider in town. Your customers sign a 9-month contract. You hear a new lawn service is THINKING about setting up shop in your town. Your customers are "locked in" for 9 months, but you don't want him getting any OTHER customers, and you worry about next year!

As discussed in the videos, economies of scale exist whenever:

average total costs decline as output increases.

In limit pricing, when the average cost curve lies above the entrant's residual demand curve, an entrant:

cannot profitably enter the market.