Week 7, Imperfect Competition

Consumer Surplus, Producer Surplus, and Efficiency

-Consumer surplus, as previously learned is the area of the triangle with Q sold as the base and the largest reservation price on demand curve minus the actual price as the height. -Producer surplus would be the upside down triangle under consumer surplus (CS) with the same base of Q, and the height being the price sold. --In other words, PS is the area below the price and above MC curve --In monopolistic/price setting models, PS is not a triange, but a trapezoid, because firms don't set price=to MC but rather where demand is above where MR and MC intersect -Total surplus = CS+PS -Because Monopolies don't set price equal to MC, and limit the supply to drive up price, there is a loss in efficiency. THis loss in efficiency is represented on the graph by the right pointing triange on the right edge of the PS trapezoid. This is called "deadweight Loss from Monopoly"

How to calculate Marginal Revenue from demand curve

-Just the change in total revenue/change in total quantity --MR= change in TR / Change in Q -MR will always be below current price (demand curve) 0For a straight line demand curve, the monopolist's marginal revenue curve: --has the same intercept as demand --lies below demand --has twice the slope of demand

Monopoly Profit Maximization

-Perfectly competitive firm chooses Q where P=MC --this equates marginal revenu (P) and Marginal cost -Firm with market power applies same cost benefit principle (MR=MC) --but, MR is no longer equal to the price --need to derive MR from market demand curve ---change in TR/change in Q -Central tradeoff --lower price generates higher unit sales --surrenders revenue on existing sales -Monopoly will make money as long as MR is greater than MC --should sell as long as MR>MC ==>this is Q that maximizes profits ---not as simple as selling as selling at Price where MC and MR intersect, since demand will cause more than the desired Q to be sold ---Instead must go up to the demand curve directly above where MR and MC intersect, that will be the profit maximizing Q

Price Discrimination

-The practice of charging different buyers different prices for essentially the same good or service, based on differences in willingness to pay -ex/ student discounts, airline advance purchase restrictions, coupons -even monopoly pricing leaves consumers with lots of surplus, but price discrimination is a means of transferring that surplus to producers --reason is because, when charging monopoly price, some people simply won't pay and seats may go unfilled, but by utilizing price discrimination, you can find way to charge less only for those unwilling to pay the monopoly price and fill those seats. -Ideal situation would be to charge each customer his/her willingness to Pay (WTP) --pick every persons reservation price --perfect price discrimination means closing the sale at the reservation price every time, leaving no consumer surplus

Hurdle Method

-form of price discrimination -find group of customers unwilling to do "something inconvenient" and separate them from other group that is willing to do that inconvenient thing, and charge them different prices -ex/ airlines with advanced purchase restrictions==> buy tickets further in advance generally for leasure, lower willingness to pay vs. business travelers who buy tickets a couple days ahead of time and higher willingness to pay -get all customers to buy, and get them to pay closer to reservation price -ex/ coupons, mail in rebate==>not everyone takes time to utilize

Two Landmark Antitrust laws

1) Sherman Act of 1890 -declared monopolization illegal 2) Clayton Act of 1914 -outlawed transactions that would "substantially lessen competition" -ex/ Mergers

Imperfect Competition

3 Types 1) Monopoly: one seller, no close substitutes ex/Debeers diamonds 2)Oligopoly: small number of firms producing close substitutes ex/apple and android 3) Monopolistic competition: many firms, differentiated product ex/cereal: many firms that compete but a few big names that dominate and compete with eachother ex/cars All imperfectly competitive firms face a key decision: -Pricing==>comes from "market power"

Horizontal vs. vertical mergers

Horizontal Merger: between firms offering the same product. -Ex/ Comcast/Time Warner Cable -issues: --effect on competition in affected market --will consumers be harmed, either now or later? --Could be via higher prices, stifled innovation, or other Vertical Merger: Mergers at different points in supply chain -Ex/ Time Warner inc (media content) and At&T (distribution)

Market Power vs Perfect Competition

Market Power -MC=MR -P>MR -P>MC -Deadweight Loss Perfect Competition -MC=MR -P=MR -P=MC -No Deadweight Loss

Market Power

Market power is the firm's ability to raise its price without losing all its sales -means that the firm faces a downward sloping demand curve -firms picks P and Q on the demand curve