Why are we “Speed Reviewing”? Having you review on your own wouldn’t be effective Lecturing about every concept would be too boring. “Speed Reviewing” will help you identify what you need to study. So you must come see me about specific things you don’t understand.

Unit IV: Imperfect Competition Half Way Unit IV: Imperfect Competition

Imperfect Competition To sell more a firm must lower its price. The cost curves are the same The MR= MC rule still applies Shut down rule still applies All have a downward sloping demand curve. To sell more a firm must lower its price. 5. All are inefficient. 6. MR < Demand

Characteristics of Monopolies

5 Characteristics of a Monopoly 1. Single Seller The Firm IS the Industry 2. Unique good with no close substitutes 3. “Price Maker” The firm can change the price by changing the quantity it produces 4. High Barriers to Entry New firms CANNOT enter market No immediate competitors 5. Some “Nonprice” Competition

Drawing Monopolies

MR is below Demand P $100 80 60 40 D Q 1 2 3 4 5 6 MR

Why is MR less than Demand? P Qd TR MR $11 -

Why is MR less than Demand? P Qd TR MR $11 - $10 1 10 $10

Why is MR less than Demand? P Qd TR MR $11 - $10 1 10 $9 2 18 8 $10 $9 $9

Why is MR less than Demand? P Qd TR MR $11 - $10 1 10 $9 2 18 8 $8 3 24 6 $10 $9 $9 $8 $8 $8

Why is MR less than Demand? P Qd TR MR $11 - $10 1 10 $9 2 18 8 $8 3 24 6 $7 4 28 $10 $9 $9 $8 $8 $8 $7 $7 $7 $7

Why is MR less than Demand? P Qd TR MR $11 - $10 1 10 $9 2 18 8 $8 3 24 6 $7 4 28 $6 5 30 $10 $9 $9 $8 $8 $8 $7 $7 $7 $7 $6 $6 $6 $6 $6

Why is MR less than Demand? P Qd TR MR $11 - $10 1 10 $9 2 18 8 $8 3 24 6 $7 4 28 $6 5 30 $5 $10 $9 $9 $8 $8 $8 $7 $7 $7 $7 $6 $6 $6 $6 $6 $5 $5 $5 $5 $5 $5

Why is MR less than Demand? P Qd TR MR $11 - $10 1 10 $9 2 18 8 $8 3 24 6 $7 4 28 $6 5 30 $5 $4 7 -2 $10 $9 $9 $8 $8 $8 $7 $7 $7 $7 $6 $6 $6 $6 $6 $5 $5 $5 $5 $5 $5 $4 $4 $4 $4 $4 $4 $4

Why is MR less than Demand? P Qd TR MR $11 - $10 1 10 $9 2 18 8 $8 3 24 6 $7 4 28 $6 5 30 $5 $4 7 -2 $10 $9 $9 $8 $8 $8 $7 $7 $7 $7 $6 $6 $6 $6 $6 $5 $5 $5 $5 $5 $5 $4 $4 $4 $4 $4 $4 $4

Why is MR less than Demand? P Qd TR MR $11 - $10 1 10 $9 2 18 8 $8 3 24 6 $7 4 28 $6 5 30 $5 $4 7 -2 $10 $9 $9 MR IS LESS THAN PRICE $8 $8 $8 $7 $7 $7 $7 $6 $6 $6 $6 $6 $5 $5 $5 $5 $5 $5 $4 $4 $4 $4 $4 $4 $4

Elastic vs. Inelastic Range of Demand Curve

Elastic and Inelastic Range P $100 80 60 40 D Q 1 2 3 4 5 6 MR

Elastic and Inelastic Range $200 150 100 50 Dollars Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 $750 500 250 Dollars Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

Elastic and Inelastic Range $200 150 100 50 Total Revenue Test If price falls and TR increases then demand is elastic. Dollars MR D Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 $750 500 250 Dollars TR Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

Elastic and Inelastic Range $200 150 100 50 Total Revenue Test If price falls and TR increases then demand is elastic. Dollars MR D Q Total Revenue Test If price falls and TR falls then demand is inelastic. 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 $750 500 250 Dollars When MR goes negative, TR will fall TR Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

Putting Demand, MR, and Cost Together

MR = MC Rule Still Applies How much is the TR, TC and Profit or Loss? Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price, costs, and revenue $9 8 7 6 5 4 3 2 MC ATC Profit =$5 D MR

How much is the TR, TC, and Profit or Loss? Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price, costs, and revenue MC ATC 140 Loss AVC D MR Q

Monopolies and Efficiency

Monopolies are inefficient because they… Charge a higher price Under produce Not allocativly efficiency Produce at higher costs No productive efficiency Have little incentive to innovate

EFFICIENCY OF PERFECT COMPETITION An industry in pure competition MB=MC P S = MC CS Pc PS D Q Qc

INEFFICIENCY OF PURE MONOPOLY S = MC At MR=MC A monopolist will sell less units at a higher price than in competition Pm Pc D MR Q Qm Qc

Result is DEADWEIGHT LOSS to society CS and PS of a Monopoly P Result is DEADWEIGHT LOSS to society S = MC CS Pm Pc PS D MR Q Qm Qc

Are Monopolies Productively Efficient? No. They are not producing at the lowest cost (min ATC) Does Price = Min ATC? Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price, costs, and revenue MC ATC D MR

Does Price = MC? Do Monopolies Have Allocative Efficiency? No. Price is greater. The monopoly is under producing. Does Price = MC? Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price, costs, and revenue MC ATC D MR

Regulating Monopolies

Why Regulate? How do they regulate? Why would the government regulate an monopoly? To keep prices low To make monopolies efficient How do they regulate? Price controls: Price Ceilings

1.Socially Optimal Price Where should the government place the price ceiling? 1.Socially Optimal Price P = MC (Allocative Efficiency) OR 2. Fair-Return Price (Break–Even) P = ATC (Normal Profit) NOT THE SAME AS PRODUCTIVE EFFICIENCY

REGULATED NATURAL MONOPOLY Monopoly Price MR = MC P Pm Price and Costs ATC MC D MR Q Qm

REGULATED NATURAL MONOPOLY Fair-Return Price Normal Profit Only TR = TC Price and Costs ATC Pf MC D MR Q Qf

REGULATED NATURAL MONOPOLY Socially-Optimum Price P = MC Price and Costs ATC MC Pr D MR Q Qr

Price Discrimination

PRICE DISCRIMINATION Definition: Practice of selling the same products to different buyers at different prices Requires the following conditions: Firm must have monopoly power Firm must be able to segregate the market Consumers must not be able to resell product

A perfectly discriminating can charge each person differently so the Marginal Revenue = Demand MC P ATC Price and Costs MR=D D Q Q1 Q2

What output do they make? Where is Consumer Surplus? MC P ATC Price and Costs MR=D D Q Q2

Where is the Profit? Profit with price discrimination MC P ATC Price and Costs MR=D D Q Q2

Why does MR equal Demand?

Why does MR equal Demand? P Qd TR MR $11 - $10 1 10 $9 2 19 9 $8 3 27 8 $7 4 34 7 $6 5 36 6 $5 35 $4 39 $10 $10 $9 $10 $9 $8 $10 $9 $8 $7 $10 $9 $8 $7 $6 $10 $9 $8 $7 $6 $5 $10 $9 $8 $7 $6 $5 $4

What’s the Point? Perfectly price discriminating firms: Make more profit Produce more Produce at allocative efficiency

Monopoly Practice FRQ

Monopolistic Competition

FOUR MARKET MODELS Monopolistic Competition: Relatively Large Number of Sellers Differentiated Products Some control over price Easy Entry and Exit Non-price competition (Advertising) Market Structure Continuum Pure Competition Monopoly Monopolistic Oligopoly

Differentiated Products Goods are NOT identical. Firms seek to capture a piece of the market by making unique goods. Since these products have substitutes, firms use NON-PRICE Competition Examples: Fast Food Restaurants Furniture companies Jewelry stores Hair Salons Clothing Manufacturers

“Monopolistic” +”Competition” Monopolistic Qualities Control over price of own good due to differentiated product. D > MR Plenty of non-price competition Not efficient Perfect Competition Qualities Large number of smaller firms Relatively easy entry and exit Zero Economic Profit in Long-Run since firms can enter.

Drawing Monopolistic Competition

MONOPOLISTIC COMPETITION PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION MC What Happens? ATC $4 $2 Price and Costs Short-Run Economic Profits D MR Q1 Quantity

MONOPOLISTIC COMPETITION PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION MC New Firms Enter ATC $4 $2 Price and Costs Short-Run Economic Profits D MR Q1 Quantity

LONG- RUN EQUILIBRIUM MC ATC Normal Profit D MR Price and Costs $4 $2 $1 D MR Q1 Quantity

MONOPOLISTIC COMPETITION PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION MC What happens? ATC $7 Price and Costs $1 Short-Run Economic Loss D MR Q1 Quantity

MONOPOLISTIC COMPETITION PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION MC Long-Run Equilibrium Normal Profit Only ATC $7 Price and Costs D MR Q3 Quantity

MONOPOLISTIC COMPETITION AND EFFICIENCY

MONOPOLISTIC COMPETITION AND EFFICIENCY Not Productively Efficient  Minimum ATC Not Allocatively Efficient Price  MC Firm has Excess Capacity Graphically…

MONOPOLISTIC COMPETITION AND EFFICIENCY Excess Capacity The gap between the minimum ATC output and the profit maximizing output Given current resources, the firm can produce at minimum ATC, but they decide not to.

MONOPOLISTIC COMPETITION AND EFFICIENCY MC Long-Run Equilibrium ATC P3 = A3 Excess Capacity Price and Costs D MR Q3 Quantity

Oligopoly

FOUR MARKET MODELS Oligopoly: A Few Large Producers Identical or Differentiated Products Mutual Interdependence Firms use Strategic Pricing High Entry Barriers Examples: Cereal Companies, Car Producers Market Structure Continuum Pure Competition Monopoly Monopolistic Oligopoly

HOW DO OLIGOPOLIES OCCUR? Oligopolies occur when only a few large firms start to control an industry. High barriers to entry keep others from entering. Types of Barriers to Entry Economies of Scale High Start-up Costs Ownership of Raw Materials

Game Theory

The study of how people behave in strategic situations What is game theory? The study of how people behave in strategic situations A thorough understanding of game theory helps firms in an oligopoly maximize profit.

A B C D A Game-Theory Overview OLIGOPOLY BEHAVIOR $12 $15 $6 $8 RareAir’s Price Strategy High Low B A D C $12 $15 $6 $8 High Low Uptown’s Price Strategy

Greatest Combined Profit if both Sell High OLIGOPOLY BEHAVIOR Greatest Combined Profit if both Sell High RareAir’s Price Strategy High Low B A D C $12 $15 $6 $8 High Low Uptown’s Price Strategy

Each firm recognizes that more profit is made if they lower price OLIGOPOLY BEHAVIOR Each firm recognizes that more profit is made if they lower price RareAir’s Price Strategy High Low B A D C $12 $15 $6 $8 High Low Uptown’s Price Strategy

BUT if both lower price they end up in the Worst Case OLIGOPOLY BEHAVIOR BUT if both lower price they end up in the Worst Case RareAir’s Price Strategy High Low B A D C $12 $15 $6 $8 High Low Uptown’s Price Strategy

To make more profit, firms may try to cooperate (collude) OLIGOPOLY BEHAVIOR To make more profit, firms may try to cooperate (collude) RareAir’s Price Strategy High Low B A D C $12 $15 $6 $8 High Low Uptown’s Price Strategy

To make more profit, firms may try to cooperate (collude) OLIGOPOLY BEHAVIOR To make more profit, firms may try to cooperate (collude) RareAir’s Price Strategy High Low B A D C $12 $15 $6 $8 High Low Uptown’s Price Strategy

But now each firm has the incentive to cheat. OLIGOPOLY BEHAVIOR But now each firm has the incentive to cheat. RareAir’s Price Strategy High Low B A D C $12 $15 $6 $8 High Low Uptown’s Price Strategy

What did we learn? Oligopoly pricing must be strategic Oligopolies have a tendency to collude to gain profit. (Collusion is the act of cooperating with rivals in order to “rig” a situation.) Collusion results in the incentive to cheat.

Oligopoly Graph

Not one standard model because there are colluding Oligopolies and noncolluding Oligopolies

Colluding Oligopoly

Cartel = Colluding Oligopoly CARTELS AND COLLUSION Cartel = Colluding Oligopoly A cartel is a group of producers that create a formal agreement to fix prices high. Cartels set price and output at an agreed upon price Firms require identical or highly similar demand and costs Cartel must have a way to punish cheaters Together they act as a monopoly

Colluding Oligopolists Will Split the Monopoly Profits. CARTELS AND OTHER COLLUSION Colluding Oligopolists Will Split the Monopoly Profits. D MC ATC MR Economic Profit MR = MC Price and costs Q0 P0 A0

Non Colluding Oligopoly

Kinked Demand Curve Model Noncollusive firms are likely to react to competitor’s pricing in two ways: 1. Match price-If one firm cuts it’s prices, then the other firms follow suit causing inelastic demand 2. Ignore change-If one firm raises prices, others maintain same price causing elastic demand

KINKED DEMAND THEORY: The demand and MR curves if other firms match lower pricing If this firm lowers its price and others follow, Qd will increase mildly Price D1 Quantity MR1

KINKED DEMAND THEORY: The demand and MR curves if other firms ignore higher pricing If this firm increases its price and others ignore it, Qd for this firm will decrease significantly Price D2 MR2 Quantity

Two sets of curves based on the pricing decisions of other firms The firm’s demand and marginal revenue curves Price D2 MR2 D1 Quantity MR1

Two sets of curves based on the pricing decisions of other firms Rivals tend to follow a price cut Price D2 MR2 D1 Quantity MR1

Two sets of curves based on the pricing decisions of other firms Rivals tend to follow a price cut or ignore a price increase Price D2 MR2 D1 Quantity MR1

Two sets of curves based on the pricing decisions of other firms Effectively creating a kinked demand curve Price D2 MR2 D1 Quantity MR1

Two sets of curves based on the pricing decisions of other firms Effectively creating a kinked demand curve Price D Quantity

Two sets of curves based on the pricing decisions of other firms What about MR? Price D2 MR2 D1 Quantity MR1

Two sets of curves based on the pricing decisions of other firms Since we use sections of both MR curves, the MR has a vertical gap. MR2 Price D Quantity MR1

NONCOLLUSIVE OLIGOPOLY KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Profit maximization MR = MC occurs at the kink. MR2 Price D Quantity MR1