Competition First, the Economist’s View. Market Structure Continuum Perfect Competition Monopoly...
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Transcript of Competition First, the Economist’s View. Market Structure Continuum Perfect Competition Monopoly...
Competition
First, the Economist’s View
Market Structure ContinuumPerfect Competition Monopoly
Monopolistic Competition Oligopoly
KinkedDemand
Many BuyersMany Sellers One Seller
Homogeneous Product
Unique Product
Few Sellers
Some Differentiation
Free Entry & Exit
Strong Barriers
Some Barriers
Perfect Information
Price Taker Price Searcher
LR Π = 0 LR Π > 0
Impersonal Competition
Personal Competition
My Market
Small Sellers Large SellerLarge Sellers
Perfect Competition1.Many Small Buyers2.Many Small Sellers3.Homogeneous product
RESULT
4.No Barriers to Entry
5.Perfect Information
• No market power on the buying side• Many alternative vendors• No product loyalty (very elastic)
EXTREMELY ELASTIC DEMANDPrice Taker (takes price as given)
• Profits will induce entry• Losses will induce exit• Zero economic profit in Long Run
• No mis-steaks (oops, no mistakes)
IMPLICATION: Firm & Market have different elasticities.
Separate Firm and Market graphs needed
Firm
• Firm (assumed to be one plant for simplicity)
• Cost curves
• Profit maximizes at Q where– Marginal Revenue = Marginal Cost
• Given Price (assumed fixed), sets Quantity
• Determines profit and whether to produce
Industry
• Collection of individual buyers determine Demand• Collection of firm decisions determines Supply• Equilibrium price set where
Quantity demanded = Quantity Supplied
• Total Equilibrium Quantity set• For Competition, Firm assumes market results
as given • Need
– One graph for industry (to set market price) and – One graph for firm (to set quantity for typical firm)
The Role of Price • Rationing –
– chase low-valued-use customers away– Allocate (scarce) resources to “best” use
• Allocation -– Move resources from surplus markets to shortage
markets
• Result:
The Invisible HandIndependent Individual Actions in Response to Incentives
– Resources used where most valuable– By those valuing the use the most
Market and Firm :Competitive Industry/Market
Long Run Equilibrium
P
Q
D
S
P1
Q1
P
Qfirm
ATC
MC
MarketFirm
P=Dfirm=MRfirm
Q1 firm
TFC
TVC
AVC
AFC
Competitive Firm with profit
P
Q
ATC
MC
P=Dfirm=MRfirm
Qfirm
MC = P => Qfirm
Profit (Π) = (P-ATC) x Q
Creates incentive for entry of new firms
π
AVC
TVC
TFC
Competitive Firm with a Loss
P
Q
ATC
MC
P=Dfirm=MRfirm
Qfirm
MC = P => Qfirm
Profit (Π) = (P-ATC) x Q < 0
Creates incentive for exit of new firms
Π(negative)
TVCTFC
AVC
Contribution to Overhead
Competitive Market and Firm:Effect of a Demand Increase
P
Q
D1
S1
P1
Q1
P
Qfirm
ATC
MC
MarketFirm
P1=Dfirm=MRfirm
Q1 firm
D2
P2=D=MR
P2
Q2 firm
Q2
D increase
Industry P and Q increaseFirm’s Demand (P) Rises
MC = P2 => Qfirm risesProfit (Π) = (P-ATC) x Q risesCreates incentive for entry of new firms
π
S2
Entry occurs until Long Run is re-attained. Π=0
Q3
TVC
TFC
Competitive Market and Firm:Effect of a Demand Decrease
P
Q
D1
S1
P1
Q1
P
Qfirm
ATC
MC
MarketFirm
P=Dfirm=MRfirm
Q1 firm
D2
P2P2
Q2 firm
Q2
Π(negative)
D decrease
Industry P and Q decrease
Firm’s Demand (P) Falls
MC = P2 => Qfirm falls
Profit (Π) = (P-ATC) x Q falls (< 0)
Creates incentive for exit of firms
S2
Q3
TVC
TFC
Market Adjustments
• Short Run– Industry price adjusted to get Qs = QD
– Firms raise or lower Q to equalize MC = P– Profits or Losses are earned
• Long run– Firms respond to Profits (enter) or losses (exit)– Price adjusts to change in supply– Firms adjust to new price– Eventually π = 0 and entry or exit stops
Competition Implications
• Long Run Profits are zero – Due to entry and exit
• Maximum surplus (producer + consumer)
• Price serves as signal for resource allocation
• Presumed when “invisible hand” invoked
• May not give “best” distribution or output– Public goods, externalities, equity
Inter-industry Adjustments
• Profits draw firms into industries decreasing profits for firms already in industry
• Losses drive firms out increasing profits for those remaining
• Relative profitability may attract firms from one industry to another– Toys-r-us (according to Jay Leno) says it may sell its
toy business (??)
• Risk differences (etc.) may leave some differences in profitability across industry
Efficiency
(Presumes Competitive Market)
Efficiency
• Cannot help one without hurting another– If Marginal benefit > Marginal cost,
• increase output
– If Marginal benefit < Marginal cost, • decrease output
– Efficiency<=>Marginal Benefit=Marginal Cost• In markets happens at D,S intersection
• Efficiency is most output, given input
• Equity is “fairness”
Why and How Efficiency?
• Why?– Maximum surplus– Buyers and Sellers satisfied
• Why is market equilibrium best?• The following affect output => efficiency down
– Price ceilings– Price floors– Taxes and Subsidies– Monopoly– External benefits and costs (effects on others: e.g.,
pollution)• Price vs non-price allocation
Efficiency, graphically
P
Q
D
S
P1
Q1
Producer Surplus
Consumer Surplus
Benefit for which the consumer does not pay.
Revenue without associated opportunity cost.
Effect of a Tax on Efficiency
P
Q
D
S
P2
Q2
Consumer Surplus
Producer Surplus
Deadweight Loss
Tax Revenue
S + tax
P2+tx
This is called dead weight loss because these (not produced) units are more valuable than their cost. That is, lost benefit without saved cost.
Tax
Q1
P1 Notice price consumer pays goes up (P1 to P2 + tax)
Notice price supplier receives goes down (P1 to P2)
Monopoly
The Firm as Market
Monopoly1. Many Small Buyers2. One Seller3. “Unique” product
RESULT
4. Barriers to Entry
5. Perfect Information
• No market power on the buying side• No alternative vendors• No close substitutes
LESS ELASTIC DEMANDPrice Setter (must choose price)
• Profits will not induce entry• Losses will not induce exit
• No mis-steaks (oops, no mistakes)
IMPLICATION: FIRM IS MARKET (one graph)
Monopoly decision process
• Profit maximization– Marginal Cost = Marginal Revenue– Recognize effect of price on quantity demanded– MC = MR < P (society’s value of product)
• Sources of Monopoly Power– Control of resources– Government intervention – Economies of Scale– Network economies (first mover, setting the standard)
Decision Process• How Much?
– MC = MR => Q*
– Given Q*: • P set on demand curve at Q*
• Ave. Total Cost determined from ATC at Q*
• Ave. Var. Cost determined from AVC at Q*
• Ave. Fixed Cost = ATC – AVC at Q*
• Whether?– If Price > Ave. Var. Cost at Q*, net cash flow +
• So produce—better off producing than not
• MR = ΔTR/ΔQ =revenue change per unit added
Net change in revenue is blue box minus yellowΔTR= P x ΔQ (+) + Q x ΔP (-)MR = {20 x (40-20) + 20 x (20-30)}/(40-20) = 10<20 = {40 x 20 – 30 x 20}/20 = 10
Marginal Revenue for Monopoly
Pric
e
Quantity
20
40
30
20
Revenue at higher price
Revenue at lower price
Revenue received at either price
(-)
(+)MR D
Profit Maximization for Monopolistic firmMonopoly
P
Q
DMR
Qfirm
P1
MC
ATCAVC
TVC
TFC
πATC1
AVC1
Qfirm based on MR = MC
P1 => max, given Qfirm
ATC1, given Qfirm
AVC1, given Qfirm
TVC = AVC1 x Qfirm
TFC = (ATC1 - AVC1) x Qfirm
π (profit)= (P1 – ATC1) x Qfirm
Notice: Q set using only marginals
Because of barriers to entry, these profits can persist.
TR
TR = P1 x Qfirm
Contribution Margin
P
Q
MC
ATC
AVC
Monopoly with a Profit
DMR
P1
Qfirm
ATC1
π
TFC
TVC
TC=TFC+TVC
TR = P x Q
Π = TR – TC = TR – TVC - TFC
P
Q
MC
ATC
AVC
Monopoly with a Loss
Still wanting to Produce
DMR
P1
Qfirm
ATC1
Π < 0
TFC
TVC
Contribution to overhead.
P
Q
MC
ATC
AVC
Monopoly with a Loss
Wanting to Shut Down
DMR
P1
Qfirm
ATC1
Π < 0TFC
TVC
Negative Contribution to overhead.AVC1
Effect of Monopoly on Efficiency
Monopoly
P
Q
DMR
Qfirm
P1
MC
Qfirm based on MR = MC
P1 => max, given Qfirm
Notice: P and Q set using only marginals
P1 is value of last unit sold
MC @ Qfirm is the cost of the last unit sold.
P>MC @ Qfirm so society loses this surplus
As long as P>MC, surplus exists
Lost surplus is the triangle
Dead Weight Loss
Notice that Setting P=MC (competitive result) will cause no lost surplus
Natural Monopoly
P
Q
LAC
D
LMC
MR
PMon
Qfirm
ATC1
πMon The key issue is the size of the firm relative to the market.
Economies of Scale are significant
Demand is such that only one firm has room to be profitable.
Profits would occur without regulation
Profits would attract entry => both firms would lose money
Rate regulations gives exclusive right to one firm, keeps price down,
Preg
πReg
QReg
& assures πIncreases Q,
Price Discrimination
• Separable Markets– Otherwise, people will buy in one market and well in
the other.
• Different Elasticities– Otherwise, there is no advantage to price
discrimination
• Raise price in inelastic (P insensitive) market• Lower price in elastic (P sensitive) market• Until MR is the same in each
Price Discrimination: Movies
P
Q
P
Q
Adults Kids
DMR
DMR
Assume constant Marginal Cost for simplicity.
MC
Find Qfirm as we always do => MC = MR for each section of market
QAdultsQKids
Set Price based upon Qfirm and the relevant demand curves.
PAdults
PKids
Notice: PAdults > PKids because adult Demand less elastic
Kids are distinguishable
Demand more elastic
Lower maximum price
Construct MR (MR <P) for each segment in same way as monopoly
Competition
The Practical Aspects
Competition Basics
• Know your competitors (knowledge)
• Selectively communicate
• Preannounce price increases
• SHOW willingness to defend
• Educate competitors (not worth price war)
When to Compete
• Cost competitive advantage
• Niche (claim the whole niche)
• Complementary products
• VERY Elastic market
To React or not to React• Think Long Term
• Is there a better response than price?– If not:
• Focus on @ risk customers• Focus on incremental value• Focus on competitor’s high margin area• Raise cost to competitor (educate his/her cust.)
– Second round?– Is it worth it?– Mk Share worth Saving?