1. Recht und Ökonomie (Law and Economics) LVA-Nr.: 239.203 WS 2011/12 Microeconomics (Repetition Part 2) 1 of 20 Prof. Dr. Friedrich Schneider Institut für Volkswirtschaftslehre http://www.econ.jku.at/schneider

2. 2 of 20 Recht und Ökonomie WS 2011/12Microeconomics – Repetition Part 2Prof. Dr. Friedrich Schneider Outline of the Section on Microeconomics 1Basic concepts and tools 2Consumer theory 3Theory of the firm 4Interactions of households and firms (Imperfect Competition, Consumer & Producer Surplus)

3. 3 of 20 Recht und Ökonomie WS 2011/12Microeconomics – Repetition Part 2Prof. Dr. Friedrich Schneider 4Imperfect competition Monopoly just one supplier (firm) in a market Monopolistic competition many firms with differentiated products Oligopoly only a few firms (2, 4, 7, …?) in a market Other forms, e. g. price leadership, spatial competition, …

4. 4 of 20 Recht und Ökonomie WS 2011/12Microeconomics – Repetition Part 2Prof. Dr. Friedrich Schneider 4.1 Monopoly The monopolist faces the market demand curve. A monopolist maximizes her profit by producing a quantity where MC = MR The price will be higher than MC (and MR). The price (quantity) will be higher (lower) than the price (quantity) under perfect competition >> deadweight loss (= lower welfare).

5. 5 of 20 Recht und Ökonomie WS 2011/12Microeconomics – Repetition Part 2Prof. Dr. Friedrich Schneider Lost profit P1P1 Q1Q1 Lost profit MC AC Quantity per unit of output D = AR MR P* Q* 4.2 Profit maximizing monopolist P2P2 Q2Q2

6. 6 of 20 Recht und Ökonomie WS 2011/12Microeconomics – Repetition Part 2Prof. Dr. Friedrich Schneider 4.3 Measuring welfare Consumer surplus equals total consumption benefit minus total cost of purchases; equals the area below the demand curve and above the market price. Producer surplus equals the area below the market price and above the supply curve; equals profits plus fixed cost.

7. 7 of 20 Recht und Ökonomie WS 2011/12Microeconomics – Repetition Part 2Prof. Dr. Friedrich Schneider Demand Curve Consumer surplus Actual Expenditure 4.4 Consumer surplus Rock Concert Tickets Price ( per ticket) 23456 13 01 14 15 16 17 18 19 20 Market Price

8. 8 of 20 Recht und Ökonomie WS 2011/12Microeconomics – Repetition Part 2Prof. Dr. Friedrich SchneiderD P*P*P*P* Q*Q*Q*Q* ProducerSurplus 4.5 Producer surplus for a market Price ( per unit of output) OutputS

9. 9 of 20 Recht und Ökonomie WS 2011/12Microeconomics – Repetition Part 2Prof. Dr. Friedrich Schneider Producer Surplus Consumer Surplus 4.6Consumer and producer surplus Quantity 0 Price S D 5 Q0Q0 Consumer C 10 7 Consumer BConsumer A

10. 10 of 20 Recht und Ökonomie WS 2011/12Microeconomics – Repetition Part 2Prof. Dr. Friedrich Schneider B A Lost Consumer Surplus Deadweight Loss C 4.7 Deadweight loss from monopoly power Quantity AR MR MC QCQC PCPC PmPm QmQm /Q

11. 11 of 20 Recht und Ökonomie WS 2011/12Microeconomics – Repetition Part 2Prof. Dr. Friedrich Schneider 4.8Monopolistic Competition In a competition surrounding a large number of firms sells differentiated products. Monopolistic competition means: Firms face a downward sloping demand curve. Profit maximum at MR = MC, with P > MC. Positive profits will attract additional firms. In the long run profits will be zero with still P > MC. thus: no Pareto-efficient allocation.

12. 12 of 20 Recht und Ökonomie WS 2011/12Microeconomics – Repetition Part 2Prof. Dr. Friedrich Schneider 4.9A monopolistically competitive firm in the short and long run Quantity /Q Quantity /Q MC AC MC AC D SR MR SR D LR MR LR Q SR P SR Q LR P LR Short runLong run

13. 13 of 20 Recht und Ökonomie WS 2011/12Microeconomics – Repetition Part 2Prof. Dr. Friedrich Schneider Deadweight- loss MCAC 4.10 Comparison of monopolistically competitive equilibrium and perfectly competitive equilibrium /Q Quantity /Q D = MR QCQC PCPC MCAC D LR MR LR Q mc P mc Perfect competitionMonopolistic competition

14. 14 of 20 Recht und Ökonomie WS 2011/12Microeconomics – Repetition Part 2Prof. Dr. Friedrich Schneider 4.11 Oligopoly Characterized by a small number of firms. Consequence: the action of one firm will be noticed by the other firm(s). The other firm(s) will react. Essentially how to model this action and reaction of the small number of competitors. Example: Cournot model. Two firms decide (simultaneously) how much to produce treating the other firms output as given.

15. 15 of 20 Recht und Ökonomie WS 2011/12Microeconomics – Repetition Part 2Prof. Dr. Friedrich Schneider MC 1 50 4.12Firm 1s output decision Q1Q1 P1P1 D 1 (0) MR 1 (0) If firm 1 thinks, firm 2 will produce nothing at all, its demand curve, D 1 (0), is the market demand curve. D 1 (50) MR 1 (50) 25 If firm 1 thinks, firm 2 will produce 50 units its demand curve, D 1 (1), will be shifted to the left by this amount.

16. 16 of 20 Recht und Ökonomie WS 2011/12Microeconomics – Repetition Part 2Prof. Dr. Friedrich Schneider Firm 2s reaction curve Q 2 *(Q 1 ) 4.13 Reaction curves and Cournot equilibrium Q2Q2 Q1Q1 255075100 25 50 75 100 Firm 1s reaction curve Q* 1 (Q 2 ) x x x x Firm 1s reaction curve shows how much it will produce as a function of how much it thinks firm 2 will produce. Cournot- equilibrium

17. 17 of 20 Recht und Ökonomie WS 2011/12Microeconomics – Repetition Part 2Prof. Dr. Friedrich Schneider 4.14 Cournot and Nash equilibrium In Cournot equilibrium, each firm correctly assumes the amount that its competitor will produce and thus maximizes its own profit. Cournot equilibrium is an example of a Nash equilibrium. Nash equilibrium: Each firm is doing the best it can, given what its competitors are doing.

18. 18 of 20 Recht und Ökonomie WS 2011/12Microeconomics – Repetition Part 2Prof. Dr. Friedrich Schneider 4.15Duopoly example Q1Q1 Q2Q2 Firm 2s reaction curve 30 15 Firm 1s reaction curve 15 30 10 Cournot equilibrium Market demand is equal to P = 30 – Q, and both firms marginal cost are equal to 0.

19. 19 of 20 Recht und Ökonomie WS 2011/12Microeconomics – Repetition Part 2Prof. Dr. Friedrich Schneider Firm 1s reaction curve Firm 2s reaction curve 4.16 Competition, oligopoly, and collusion Q1Q1 Q2Q2 30 10 Cournot equilibrium 15 Competitive equilibrium (P = MC, profit = 0) Collusion curve 7.5 Collusive equilibrium Collusion is best for the firms, followed by Cournot equilibrium.

20. 20 of 20 Recht und Ökonomie WS 2011/12Microeconomics – Repetition Part 2Prof. Dr. Friedrich Schneider 4.17 Other market forms Cartels: see collusive equilibrium above Price leadership: leader and follower(s) Dominant firm(s): by size (market share) Spatial competition: additional dimension, competition may not lead to efficiency Monopsony (or oligopsony): one (or a small number of) buyer(s) Bilateral monopoly: one seller and one buyer