second meeting pjj ecn3101: microeconomics semester 2, 2011/2012

SECOND MEETING PJJ ECN3101: MICROECONOMICS

SEMESTER 2, 2011/2012

Chapter 8

Perfect Competition Market Structure,Profit Maximization and Competitive

Supply

©2005 Pearson Education, Inc. Chapter 8 3

Topics to be Discussed

Perfectly Competitive Markets

Profit Maximization

Marginal Revenue, Marginal Cost, and Profit Maximization

Choosing Output in the Short-Run

The Competitive Firm’s Short-Run Supply Curve

Short-Run Market Supply

Choosing Output in the Long-Run


Perfectly Competitive MarketsBasic assumptions of perfectly competitive markets Many buyers and sellers Each buys and sells only a small fraction of the

total amount exchanged in the market Standardized or homogeneous product Buyers and sellers are fully informed about the

price and availability of all resources and products Firms and resources are freely mobile Individual firms have no control over the price Price is determined by market supply and demand Firm is free to produce whatever quantity

maximizes profit


Perfectly Competitive Markets

1.Price Taking The individual firm sells a very small share of

the total market output and, therefore, cannot influence market price.

Each firm takes market price as given – price taker

The individual consumer buys too small a share of industry output to have any impact on market price.


Perfectly Competitive Markets2. Product Homogeneity

The products of all firms are perfect substitutes. Product quality is relatively similar as well as

other product characteristics Agricultural products, oil, copper, iron, lumber

3. Free Entry and Exit There is no barriers or special costs that make it

difficult for a firm to enter (or exit) an industry Buyers can easily switch from one supplier to

another. Suppliers can easily enter or exit a market.



Profit maximizing output for any firm whether perfectly competitive or not basically focuses on Profit () = Total Revenue - Total CostTotal Revenue (R) = Pq

Costs of production depends on outputTotal Cost (C) = Cq

Profit for the firm, , is difference between revenue and costs

)()()( qCqRq



Total revenue curve shows that a firm can only sell more if it lowers its price

Slope in total revenue curve is the marginal revenue

Slope of total cost curve is marginal costAs output rises, revenue rises faster than

costs leading to increasing profitProfit is maximized where MR = MC or where

slopes of the R(q) and C(q) curves are equal


Profit Maximization – Short Run

0

Cost,Revenue,

Profit($s per

year)

Output

C(q)

R(q)A

B

(q)q0 q*

Profits are maximized where MR (slope at A) and MC (slope at B) are equal

Profits are maximized where R(q) – C(q) is maximized



Profit is maximized at the point at which an additional increment to output leaves profit unchanged

MCMR

MCMR

q

C

q

R

q

CR

0

0


The Competitive Firm

d$4

Output (bushels)

Price$ per bushel

100 200

Firm Industry

D

$4

S

Price$ per bushel

Output (millions of bushels)

100

Demand curve faced by an individual firm is a horizontal line – implies that firm’s sales have no effect on market price

Demand curve faced by whole market is downward sloping


The Competitive Firm

The competitive firm’s demandIndividual producer sells all units for $4

regardless of that producer’s level of output.MR = P with the horizontal demand curveFor a perfectly competitive firm, profit

maximizing output occurs when

ARPMRqMC )(


Choosing Output: Short Run

The point where MR = MC, the profit maximizing output is chosenMR=MC at quantity, q*, of 8At a quantity less than 8, MR>MC so more

profit can be gained by increasing outputAt a quantity greater than 8, MC>MR,

increasing output will decrease profits


q2

A Competitive Firm

10

20

30

40

Price

50

MC

AVC

ATC

0 1 2 3 4 5 6 7 8 9 10 11Outputq*

AR=MR=PA

The point where MR = MC, the profit maximizing

output is chosen q*= 8

q1 : MR > MCq2: MC > MRq0: MC = MR

q1

Lost Profit for q2>q*

Lost Profit for q2>q*


A Competitive Firm – Positive Profits

10

20

30

40

Price

50

0 1 2 3 4 5 6 7 8 9 10 11Outputq2

MC

AVC

ATC

q*

AR=MR=PA

q1

D

C B Profits are determined

by output per unit times quantity

Profit per unit = P-AC(q) = A to B

Total Profit = ABCD


A Competitive Firm – Losses

Price

Output

MC

AVC

ATC

P = MRD

At q*: MR = MC and P < ATC

Losses = (P- AC) x q* or ABCD

q*

A

BC


Choosing Output in the Short Run

Summary of Production DecisionsProfit is maximized when MC = MRIf P > ATC the firm is making profits.If P < ATC the firm is making losses


Short Run ProductionFirm has two choices in short run

Continue producingShut down temporarilyWill compare profitability of both choices

When should the firm shut down?If AVC < P < ATC the firm should continue

producing in the short runCan cover some of its variable costs and all of

its fixed costsIf AVC > P < ATC the firm should shut-down.

Can not cover even its fixed costs


A Competitive Firm – Losses

Price

Output

P < ATC but AVC so firm will continue to produce in short run

MC

AVC

ATC

P = MRD

q*

A

BC

Losses

EF


Competitive Firm – Short Run Supply

Supply curve tells how much output will be produced at different prices

Competitive firms determine quantity to produce where P = MCFirm shuts down when P < AVC

Competitive firms supply curve is portion of the marginal cost curve above the AVC curve


A Competitive Firm’s Short-Run Supply Curve

Price($ per

unit)

Output

MC

AVC

ATC

P = AVC

P2

q2

The firm chooses theoutput level where P = MR = MC,

as long as P > AVC.

P1

q1

S

Supply is MC above AVC


MC3

Market Supply in the Short Run

$ perunit

MC1

SSThe short-runindustry supply curve

is the horizontalsummation of the supply

curves of the firms.

Q

MC2

15 21

P1

P3

P2

1082 4 75


Choosing Output in the Long Run

In short run, one or more inputs are fixedDepending on the time, it may limit the

flexibility of the firm

In the long run, a firm can alter all its inputs, including the size of the plant.

We assume free entry and free exit.No legal restrictions or extra costs


Long-run Profit Maximization

In the short run a firm faces a horizontal demand curveTake market price as given

The short-run average cost curve (SAC) and short run marginal cost curve (SMC) are low enough for firm to make positive profits (ABCD)

The long run average cost curve (LRAC)Economies of scale to q2

Diseconomies of scale after q2


q1

BC

AD

In the short run, thefirm is faced with fixedinputs. P = $40 > ATC.Profit is equal to ABCD.

Output Choice in the Long RunPrice

Output

P = MR$40

SACSMC

q3q2

$30

LAC

LMC


Output Choice in the Long Run

Price

Outputq1

BC

ADP = MR$40

SACSMC

q3q2

$30

LAC

LMC

In the long run, the plant size will be increased and output increased to q3.

Long-run profit, EFGD > short runprofit ABCD.

FG

E

Economies of scale Diseconomies of scale

q3 is profit-maximizing output


Long-run Competitive Equilibrium

Entry and ExitThe long-run response to short-run profits is

to increase output and profits.Profits will attract other producers.More producers increase industry supply

which lowers the market price.This continues until there are no more profits

to be gained in the market – zero economic profits


Long-Run Competitive Equilibrium – Profits

S1

Output Output

$ per unit ofoutput

$ per unit ofoutput

LAC

LMC

D

S2

$40 P1

Q1

Firm Industry

Q2

P2

q2

$30

•Profit attracts firms•Supply increases until profit = 0


Long-Run Competitive Equilibrium – Losses

S2

Output Output

$ per unit ofoutput

$ per unit ofoutput

LAC

LMC

D

S1

P2

Q2

Firm Industry

Q1

P1

q2

$20

$30

•Losses cause firms to leave•Supply decreases until profit = 0


Long-Run Competitive Equilibrium

1. All firms in industry are maximizing profits MR = MC

2. No firm has incentive to enter or exit industry Earning zero economic profits

3. Market is in equilibrium QD = QD

Chapter 10

Market Power: Monopoly



CharacteristicsAverage and Marginal RevenueMonopolist’s output decisionMeasuring monopoly powerThe Social Costs of Monopoly PowerRegulating monopoly


Monopoly One seller (but many buyers), one product (no

substitutes), there are barriers to entry and price maker

The monopolist is the supply-side of the market and has complete control over the amount offered for sale.

Monopolist controls price but must consider consumer demand

Profits will be maximized at the level of output where MC = MR

For monopolist’s P = AR = DD Its MR curve always below the demand curve


Total, Marginal, and Average Revenue

1. Revenue is zero when price is $6 - nothing is sold

2. At lower prices, revenue increases as quantity sold increases

3. When demand is downward sloping, the price (average revenue) is greater than marginal revenue

4. For sales to increase, price must fall 5. When MR is positive, TR is increasing with quantity but when MR

is negative, TR is decreasing


Average and Marginal Revenue

Output1 2 3 4 5 6 70

1

2

3

$ perunit ofoutput

4

5

6

7

Average Revenue (Demand)

MarginalRevenue

Observations:1. To increase sales the price must fall2. MR < P3. Compared to perfect competition MR

= P


Monopolist’s Output Decision

1. Profits maximized at the output level where MR = MC

2. Cost functions are the same

MRMCor

MRMCQCQRQ

QCQRQ

0///

)()()(


Lostprofit

P1

Q1

Lostprofit

MC

AC

Quantity

$ perunit ofoutput

D = AR

MR

P*

Q*

Monopolist’s Output Decision

P2

Q2

1. At output levels below MR = MC the decrease in revenue is greater than the decrease in cost (MR > MC).

2. At output levels above MR = MC the increase in cost is greater than the decrease in revenue (MR < MC)

MC=MR


Quantity0 5 15 20

$

100

150

200

300

400

50

R = TOTAL REVENUE

10

Profits

r

r'

c

c’

Example of Profit MaximizationC = TOTAL COST

When profits are maximized, slope of rr’ and cc’ are equal: MR=MC


Profit

AR

MR

MC

AC

Profit Maximization

Quantity0 5 10 15 20

P=30

$/Q

10

20

40

AC=15

Profit = (P - AC) x Q = ($30 - $15)(10) = $150


MonopolyMonopoly pricing compared to perfect

competition pricing:Monopoly

P > MCPrice is larger than MC by an amount

that depends inversely on the elasticity of demand

Perfect CompetitionP = MCDemand is perfectly elastic so P=MC


MonopolyIf demand is very elastic, Ed is a large

negative number thus price will be close to MC – monopoly will look much like a perfectly competitive market. So there is little benefit to being a monopolist.

Note also that a monopolist will never produce a quantity in the inelastic portion of demand curve (Ed < 1) In inelastic portion, can increase revenue by

decreasing quantity and increasing price


Elasticity of Demand and Price Markup

P*

MR

D

$/Q

Quantity

MC

Q*

P*-MC

The more elastic isdemand, the less the

Markup – little monopoly power.

D

MR

$/Q

Quantity

MC

Q*

P*P*-MC

The more inelastic isdemand, the more the

Markup – more monopoly power.


Monopoly Power

Pure monopoly is rare.However, a market with several firms,

each facing a downward sloping demand curve will produce so that price exceeds marginal cost.

Firms often product similar goods that have some differences thereby differentiating themselves from other firms


Measuring Monopoly Power

How can we measure monopoly power to compare firms

What are the sources of monopoly power?


Measuring Monopoly Power

• An important distinction between Perfect Competition and Monopoly: PC : P = MC ; Monopoly : P > MC

•To measure monopoly power – look the extent to which profit maximizing P exceeds MC

•Use the markup ratio of P – MC / P as the rule of thumb for pricing

•This measure of monopoly power is called as Lerner Index of Monopoly Power : L = (P-MC) / P

•The Lerner Index always has a value between 0 to 1

•The larger the value of L the greater the monopoly power


The Social Costs of MonopolyMonopoly power results in higher prices and lower

quantities.Perfectly competitive: produce where MC = D

PC and QCMonopoly produces where MR = MC PM and QMThere is a loss in consumer surplus when going

from perfect competition to monopolyA deadweight loss is also createdThe incentive to engage in monopoly practices is

determined by the profit to be gained.The larger the transfer from consumers to the firm,

the larger the social cost of monopoly.


BA

Lost Consumer SurplusBecause of the higher price,

consumers lose A+B and

producer gains A-C.

C

Deadweight Loss from Monopoly Power

Quantity

AR=D

MR

MC

QC

PC

Pm

Qm

$/Q

Deadweight Loss


Regulating MonopolyGovernment can regulate monopoly

power through price regulation.

Price regulation can eliminate deadweight loss with a monopoly.

Some countries use antitrust law to prevent firms from obtaining excessive market power


Natural MonopolyA firm that can produce the entire output of

an industry at a cost lower than what it would be if there were several firms.

Usually arises when there are large economies of scale

We can show that splitting the market into two firms results in higher AC for each firm than when only one firm was producing


MC

AC

ARMR

$/Q

Quantity

Setting the price at Pr giving profits as large as possible without going out

of business

Qr

Pr

PC

QC

If the price were regulate to be Pc,

the firm would lose moneyand go out of business.

Can’t cover average costsPm

Qm

Unregulated, the monopolistwould produce Qm and

charge Pm.

Regulating the Price of a Natural Monopoly

Chapter 11

Pricing with Market Power (Price Discrimination by

Monopoly)

©2005 Pearson Education, Inc. 52

Introduction

Pricing without market power such as in perfect competition is determined by market supply and demand.

Pricing with market power (imperfect competition) requires the individual producer to know much more about the characteristics of demand as well as manage production.

The main objective of all pricing strategies is to capture consumer surplus and transfer it to the producer


Price DiscriminationMonopoly increases it profit by charging higher prices

to those who value the product more. The practice of charging difference prices to different

customers is called price discrimination

• Conditions:

• Demand curve must slope downward – the firm has some market power and control over price

• At least two groups of consumers for the product, each with a different price elasticity of demand

• Ability, at little cost, to charge each group a different price for essentially the same product

• Ability to prevent those who pay the lower price from reselling the product to those who pay the higher price


Types of Price Discrimination

First Degree Price DiscriminationCharge a separate price to each customer: the maximum or

reservation price they are willing to pay.Second Degree Price Discrimination

In some markets, consumers purchase many units of a good over timePractice of charging different prices per unit for different

quantities of the same good or service

Third Degree Price DiscriminationPractice of dividing consumers into 2 or more groups with

separate demand curves and charging different prices to each group

1.Divides the market into two-groups.2.Each group has its own demand function.


First-Degree Price Discrimination

Examples of imperfect price discrimination where the seller has the ability to segregate the market to some extent and charge different prices for the same product:Lawyers, doctors, accountantsCar salesperson (15% profit margin)Colleges and universities (differences in financial

aid)


Quantity

$/Q

D

MR

Pmax

MCPC

P*

Q*

First Degree Price Discrimination

P1

Q1

P2

Q2

P3

Q3 Q4 Qc

P4


Second-Degree Price Discrimination

Practice of charging different prices per unit for different quantities of the same good or service

Example- water, electricity, fuel, quantity discounts

Quantity discounts are an example of 2nd degree price discrimination (bulk buying)

Block pricing – the practice of charging different prices for different quantities of ‘blocks’ of a good. Ex: electric power companies charge different prices for a consumer purchasing a set block of electricity


$/Q

Quantity

D

MR

P0

Q0Q1

P1

1st Block

P2

Q2

2nd Block

P3

Q3

3rd Block

1. Different prices are charged for different quantities or “blocks” of same good

2. Without PD: P = P0 and Q = Q0. With second-degree discrimination there are three blocks with prices P1, P2, & P3.

Second-degree Price Discrimination

ACMC


Third-Degree Price Discrimination Practice of dividing consumers into two

or more groups with separate demand curves and charging different prices to each group

1. Divides the market into two-groups.

2. Each group has its own demand function.

Most common type of price discrimination. Examples: airlines, discounts to students

and senior citizens, frozen v. canned vegetables


Third degree Price Discrimination

1. Suppose the consumer are sorted into 2 groups with different demand elasticities2. Assume the firm produces at a constant LRAC and MC =$1.003. At a given price, price elasticity of demand (panel b, elastic-more sensitive to

price) is greater than in panel a (inelastic).4. The firm maximizes profit by finding the price in each market that equates

MC=MR5. So consumers with lower price elasticity pay $3.00 and those with higher price

elasticity pay $1.50

Chapter 12

Monopolistic Competition and Oligopoly



Monopolistic CompetitionOligopolyPrice CompetitionCompetition Versus Collusion: The

Prisoners’ DilemmaImplications of the Prisoners’ Dilemma

for Oligopolistic PricingCartels


Monopolistic Competition Characteristics

1. Many firms2. Free entry and exit3. Differentiated product

The amount of monopoly power depends on the degree of differentiation.

Examples of this very common market structure include: Toothpaste Soap Cold remedies


A Monopolistically CompetitiveFirm in the Short and Long Run

Short-runDownward sloping demand – differentiated

productDemand is relatively elastic – good

substitutesMR < PProfits are maximized when MR = MCThis firm is making economic profits



Long-runProfits will attract new firms to the industry

(no barriers to entry)The old firm’s demand will decrease to DLRFirm’s output and price will fallIndustry output will riseNo economic profit (P = AC)P > MC some monopoly power

©2005 Pearson Education, Inc.


Quantity

$/Q

Quantity

$/QMC

AC

MC

AC

DSR

MRSR

DLR

MRLR

QSR

PSR

QLR

PLR

Short Run Long Run

©2005 Pearson Education, Inc.

Deadweight lossMC AC

Monopolistically and Perfectly Competitive Equilibrium (LR)

$/Q

Quantity

$/Q

D = MR

QC

PC

MC AC

DLR

MRLR

QMC

P

Quantity

Perfect Competition Monopolistic Competition

Excess capacity


Monopolistic Competition & Economic Efficiency

The monopoly power yields a higher price than perfect competition. If price was lowered to the point where MC = D, consumer surplus would increase by the yellow triangle – deadweight loss.

With no economic profits in the long run, the firm is still not producing at minimum AC and excess capacity exists.


Monopolistic Competition and Economic Efficiency

Firm faces downward sloping demand so zero profit point is to the left of minimum average cost

Excess capacity is inefficient because average cost would be lower with fewer firmsInefficiencies would make consumers worse

off


Oligopoly – Characteristics Small number of firms Product – identical or differentiation Barriers to entry

Scale economies Patents Technology Name recognition Strategic action

Examples Automobiles Steel Aluminum Petrochemicals Electrical equipment


OligopolyIn oligopoly the quantity sold by any one firm

depends on that firm’s price and on the other firm’s prices and quantities sold

So the main management challenges facing oligopoly firms are to determineThe strategic actions to deter entry

Threaten to decrease price against new competitors by keeping excess capacity

Rival behaviorBecause only a few firms, each must consider how

its actions will affect its rivals and in turn how their rivals will react.


Oligopoly – Equilibrium

If one firm decides to cut their price, they must consider what the other firms in the industry will doSome might cut price , the same amount, or

more than firmCould lead to price war and drastic fall in

profits for all


Models in OligopolySeveral models were developed to explain the

prices and quantities in oligopoly marketsThe Cournot ModelCollusion Model: CartelsStackelberg ModelBertrand ModelPrice Rigidity and Kinked Demand Curve

ModelGame Theory : The Prisoners’ DilemmaThe Dominant Firm Model


Oligopoly – EquilibriumDefining Equilibrium

Equilibrium refers to situation where firms are doing the best they can and have no incentive to change their output or price

All firms assume competitors are taking rival decisions into account.

Nash EquilibriumEach firm is doing the best it can given what its

competitors are doing. (Each firm interact with one another choosing the

best strategy given the strategies the others have chosen)


Oligopoly

The Cournot ModelOligopoly model in which firms produce a

homogeneous good, each firm treats the output of its competitors as fixed, and all firms decide simultaneously how much to produce

Firm will adjust its output based on what it thinks the other firm will produce


MC1

50

Firm 1’s Output Decision

Q1

P1

12.5 25

D1(0)

MR1(0)

MR1(75) MR1(50)D1(50)

D1(75)

1. Assuming MC is constant at MC1.

2. Firm 1’s profit-maximizing output depends on how much it thinks that Firm 2 will produce

3. If firm 1 thinks Firm 2 will produce nothing – D1(0) is the market DD curve. MR1(0) intersects Firm 1’s MC1 at Q=50 units

4. If firm 1 thinks that Firm 2 will produce 50 units, its demand curve = D1(50). Profit maximization output=25 units

5. If Firm 1 thinks that Firm 2 will produce 75, Firm 1 will produce only 12.5 units

Firm 1 Firm 2

50 0

25 50

12.5 75


First Mover Advantage – The Stackelberg Model

In Cournot Model it is assumed that two duopolists make their output decisions at the same time. In Stackelberg Model one firm sets its output before other firms do.

Two main questions are : First, is it advantageous to go first? Second, how much will each firm produce?

AssumptionsOne firm can set output firstFirm 1 sets output first and Firm 2 then makes an

output decision after seeing Firm 1 output


First Mover Advantage – The Stackelberg Model

ConclusionGoing first gives firm 1 the advantageFirm 1’s output is twice as large as firm 2’sFirm 1’s profit is twice as large as firm 2’s

Going first allows firm 1 to produce a large quantity. Firm 2 must take that into account and produce less unless wants to reduce profits for everyone


Price Competition with Homogenous Products – The Bertrand Model

Competition in an oligopolistic industry may occur with price instead of output.

The Bertrand Model (developed by French economist, Joseph Bertrand, 1883)It is a model of price competition between

doupoly firms which results in each charging the price that would be charged under perfect competition (known as marginal cost pricing)

In which each firm treats the price of its competitors as fixed, and all firms decide simultaneously what price to charge


Price Competition – Bertrand Model

The questions is , what is the Nash Equilibrium in this case?

N.E. is where each firm interact with one another choosing the best strategy given the strategies the others have chosen

In this case because there is an incentive to cut prices, the N.E is the competitive outcome where both firms will set P=MC

Both firms earn zero profit


Game Theory and The Prisoners’ Dilemma Game theory examines oligopolistic behavior as a series of

strategic moves and countermoves among rival firms

It analyzes the behavior of decision-makers, or players, whose choices affect one another

Provides a general approach that allows us to focus on each player’s incentives to cooperate or not

There are 3 main features:1. Rules 2. Strategies3. Payoffs

Payoff matrix is a table listing the rewards or penalties that each can expect based on the strategy that each pursues. The numbers in the matrix indicate the prison sentence in years for each based on the corresponding strategies


Example: Prisoners’ Dilemma - Payoff Matrix

Suppose Art and Bob have been caught for stealing and will receive a sentence of 2 years for the crime.

During investigation it is suspected that A and B were responsible for a bank robbery sometime ago. To proof this they were placed in separate room to investigate.

If both confess – each will get 3 years sentence If one confess and other deny – the one who confess gets 1 year

and the other one will get 10 year sentenceEach of them have 2 option or strategies : confess or denyPayoffs – both confess

both deny Art confess and Bob denies

Bob confess and Art denies


Prisoners’ Dilemma Payoff Matrix

Art’s Strategies

Confess Deny

Confess

Deny

Bob’s Strategies

3 years

10 years

1 year

1 year 2 years2 years10 years

1. The equilibrium of the game occurs when player A takes the possible action given the action of player B and the player B takes the best possible action given the action of player A

2. In the case of prisoners’ dilemma, the equilibrium occurs when Art makes his best choice given Bob’s choice and when Bob makes his choice given Art’s choice.

3. Art’s point of view – if Bob confess, Art also must confess because he gets 3 years compared to 10 years. If Bob does not confess, it still pays Art to confess because he receives 1 year rather than 2 years – so the best action for Art is to confess

4. Bob’s point of view – if Art confess, Bob must confess because he gets 3 years rather than 10 years. If Art does not confess, it still pays Bob to confess because he receives 1 years rather than 2 years – Bob’s best action is to confess

5. Thus the equilibrium of the game is to confess and each gets 3-year prison term

3 years


Price Rigidity and Kinked Demand Curve Model

In other oligopoly markets, the firms are very aggressive and collusion is not possible.a. Firms are reluctant to change price because of the

likely response of their competitors.

b. In this case prices tend to be relatively rigid.

Price rigidity – characteristic of oligopolistic markets by which firms are reluctant to change prices even if costs or demands change Fear lower prices will send wrong message to

competitors leading to price war Higher prices may cause competitors to raise theirs


A Kinked Demand Curve Oligopoly Model

Assumption:

i. Firms believe that rivals will follow if they cut prices but not if they raise prices

ii. Assume the elasticity of demand in response to an increase in price is different from the elasticity of demand in response to a price cut – which result a ‘kink’ in the demand for a single firm’s product

With a kinked demand curve, marginal revenue curve is discontinuous

Firm’s costs can change without resulting in a change in price


The Kinked Demand Curve$/Q

D

P*

Q*

MC

MC’

So long as marginal cost is in the vertical region of the marginal

revenue curve, price and output will remain constant.

MR

Quantity

1. Above P*, demand is very elastic.2. If P>P*, other firms will not follow3. Below P*, demand is very inelastic. 4. If P<P*, other firms will follow suit


Price Signaling and Price Leadership

Generally it is difficult to make collusion on pricing as cost and demand conditions are always changing. So firms adopt price signaling or price leadership.

Price Signaling Implicit collusion in which a firm announces a price

increase in the hope that other firms will follow suitPrice Leadership

Pattern of pricing in which one firm (leader) regularly announces price changes that other firms (price followers) then match


Signaling and price leadership might lead to an antitrust lawsuit especially when there is a large firm which naturally emerge as a leader

Price leadership also serve as a way for oligopolistic firm to deal with firms that are reluctance to change prices ( fear for being undercut). As demand and cost change, firms may find it necessary to change price


Cartels

Producers in a cartel explicitly agree to cooperate in setting prices and output.

Typically only a subset of producers are part of the cartel and others benefit from the choices of the cartel

If demand is sufficiently inelastic and cartel is enforceable, prices may be well above competitive levels


Cartels

Examples of successful cartelsOPEC International Bauxite

AssociationMercurio Europeo

Examples of unsuccessful cartelsCopperTinCoffeeTeaCocoa


A Summary of Market StructuresPerfect

CompetitionMonopolistic Competition

Oligopoly Monopoly

Assumptions

Number of firms Very many Many Few One

Output of different firms

Standardized Differentiated Standardized or Differentiated

-

View of pricing Price taker Price setter Price setter Price setter

Barriers to entry or exit

No No Yes Yes

strategic interdependence

No No Yes No

Predictions

P and Q decisions MC = MR MC = MR Through strategic interdependence

MC = MR

Short-run profit Positive, zero, negative

Positive, zero, negative

Positive, zero, negative Positive, zero, negative

Long-run profit zero zero Positive or zero Positive or zero

Advertising never Almost always Maybe, if differentiated Sometimes

second meeting pjj ecn3101: microeconomics semester 2, 2011/2012

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