micro for consulting

7/29/2019 Micro for Consulting

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Microeconomicsin 25 Slides or Less

Professor Michael Gibbs


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Overview

Tools supply & demand curves

Industry Types perfect competition, monopoly, oligopoly,

monopolistic competition

Advanced Topics pricing strategies

network effects & lock-in

Notes

http://gsbwww.uchicago.edu/fac/michael.gibbs/teaching/micro.htm


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Capitalist Tools


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Cost Curves

TC = FC + VC

ATC = TC/Q = AFC + AVC

MC = TC/Q = VC/Q

[ = dTC/dQ = dVC/dQ ]

MC generally rising in Q MC intersects ATC &AVC at their minimums

ATC

AVC

AFC

MC

FC

TC

VC


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Economies of Scale

Economies of Scale: ATC declining with Q

Dis-economies of Scale: ATC rising with Q

EOS are driven primarily by FC

EOS determines efficient size of firm

extreme EOS can lead to oligopoly or natural monopoly

Typical Natural Monopoly

ATC

ATC

Q

$

Q

$ Minimum

Efficient Scale


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Economies of Scope

Economies of Scope: producing one good lowers costs

of producing another (synergies)

When a firm has economies of scope, it is often optimal

to produce both goods

What can drive economies of scope? sharing assets or management (esp. support

functions) sharing customers or distribution

related knowledge / expertise

production by-products


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Supply Curves

In competitive industries,

firms are price takers

Firm should only produce if P min AVC in short run

(FC sunk in short run)

P min ATC in long run

Continue selling if P > MC

since MC is typicallyrising, produce until P =MC

thus MC = supply curve

$

Q

Supply


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Demand Curves

DCs plot what someone is

willing to pay for each unitpurchased or how many can be sold at

each price

Always slope down (why?)

2 useful properties elasticity

consumer surplus

$

Q

Demand


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Elasticity of Demand

= %Q/%P = (Q/Q)/(P/P) = (Q/P)(P/Q)

[ = (dQ/dP)(P/Q) ]

Intuitively % change in sales for a given % change in price

measures price sensitivity of your customers

A units-free measure of how sales vary with price

always negative; often referred to informally inabsolute value terms

inelastic demand: small elasticity close to zero

elastic demand: large elasticity approaching


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Determinants of Elasticity of Demand

Availability of substitutes

Use with complements

Budgets & incentives of customers


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Why Elasticity is Useful

Monopoly

Oligopoly

Monopolistic Competition

Perfect Competition

| | smaller

| | = A simple, rough measureof monopoly power

Very important in pricing


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PS

CS

Consumer Surplus

CS = difference between: maximum someone is

willing to pay (height ofdemand curve)

what they actually pay(price)

Why do we care? measure of welfare

business opportunity!

PS area above supply, below

price

equals profit ignoring FC

of less practical use

$

Q

Demand

P

Supply


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Market Equilibrium

How does a market come toequilibrium?

How does it adjust if S,D shift?

What are PS, CS before &

after?

What happens if governmentregulates P? Q?

$

Q

S

2

D

2

P2

Q

2

D

1

S

1

Q

1

P1


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Industry Types

Monopoly

Oligopoly


Perfect Competition

| | smaller

| | =


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The Extremes

Perfect competition theoretical ideal that industries gravitate toward over

time no barriers to entry or exit; firms are price takers strategy is simple

short run, produce if P min AVC; long run, if P minATC

produce until MC = P competition drives P to min ATC profit = zero

Monopoly

rare outside natural monopoly barriers to entry, or large EOS; not a price taker strategy relatively simple

protect barrier to entry produce until MC = MR

P = MR(1+1/) P < MC profit > 0

more sophisticated pricing strategies possible


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Oligopoly

Small # of firms w/ large market share

Strategy becomes complex

each firms action has large direct effects on theother

game theoretic intuition applies develop strategy considering competitors strategy &

likely reactions

considerations include: first mover advantage pre-commitment

tacit collusion

expectations; credibility of threats


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Many firms, few if any dominate market share but not perfectly competitive

each firm has some monopoly power, if only a little

Firms too small to have large effects on each other game theoretic intuition not as important

Strategy product differentiation, switching costs, etc., to get

(some, short run) monopoly power

pricing strategies


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Advanced Topics


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Pricing Strategies

Offering a single price ignores 2 profit opportunities CS implies some paid less than they were willing to

other customers didnt buy b/c price was too high

More elaborate pricing strategies allow the firm toconvert CS into PS: profits


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Two-Part Pricing

One approach: charge fixed

entry fee F, &per-unit fee P revenue = F + PQ

For given P, largest possible

F = CS profit = F + (PMC)Q FC

Profit max at P=MC, F=CS set P to maximize value/

usage of product toconsumer

use F to turn CS intoprofit

Problem: 2PP ineffective w/

heterogeneous customers

CS

P

MC

Q

Pro

fit


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P1

P2

Price Discrimination

Another approach: charge

different prices to different

customers

1st

degree: charge downdemand curve e.g., Priceline; auctions;

college aid

3rd degree: segment marketinto groups; monopoly pricing

in each (e.g., P1,P2) e.g., airlines

Pk = MC(1+1/k) > MC

markup of Pk over MC is higher,

the more inelastic is segment k( |k| closer to 0)

$

Q

D

P0

MC


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Notes on Price Discrimination

Requires 3 conditions must have some monopoly power must sort customers, or get them to self-sort, by

willingness to pay check IDs how much of, where, or when good is bought discounts to better informed customers bundle

must prevent arbitrage across segments restrict resale

adulterate the product to make it less valuable to others limit purchases

Special cases quantity discounts (2nd degree) intertemporal p.d.; peak-load pricing

Closely related: quality discrimination


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Bundling

Bundling: selling 2 or more goods together

many reasons to do so economies of scope: shoes evading price controls

assuring quality: Kodak film

Tying: selling 2 goods in some combination, but notfixed proportions

e.g., copiers & toner

often used to meterdemand for 2nd degree PD

sometimes illegal


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Making a Bundle

Gone With

the Wind

Getting

Gertie's Garter

A 12,000 3,000B 10,000 4,000

Suppose 2 theaters are willing to pay these prices for 2 movies sold separately, max revenue = 2$13K ($3K for Gertie;

$10K for Wind)

sold together, max revenue = 2$14K in effect, extracts extra $1K CS from A on Wind, B on Gertie

Thus, bundling can be a subtle form of price discrimination requires negatively correlated demands for 2 goods


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Network Effects

Network Effects exist if a product is more valuable to

consumers, the more others also use it a standard is important

how is it set?

if the standard is privately owned, network effectscreate monopoly power

Strategic implications first-mover advantage

price wars possible winner take all

coopetition

Monopoly network effects are often hyped too much evidence suggests usually short term


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Notes


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Economic Attitude

Opportunity cost

Whats your market? Think broadly!

Competition always wins in the end

but exploit short-run monopoly power

The Coase Theorem: Lets Make a Deal A little analytical thinking can go a long way


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Good Luck!

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