Welcome to Day 16 - PowerPoint Presentation

Welcome to Day 16 Principles of Microeconomics

What we learned last class.1) When a firm losing money should shut-down. 2) The firm’s supply curve in the short-run and market equilibrium3) Entry, Exit, and long-run equilibrium.4) Increasing, constant, and decreasing cost industries.

Chapter 10Monopoly

3 Properties of Monopoly1) One Seller 2) No Close Substitutes3) Extremely High Barriers to Entry

What are the barriers to entry?1) Government Restrictions – Patents 2) Economies of Scale – Natural Monopoly3) Restricted Ownership of Raw Material - ALCOA

Monopoly and MicrosoftComputers in the early 1980’s 1) Apple II2) Commodore PC3) Atari 400 (48k)4) TRS-80 5) IBM PC

All had incompatible operating systems

Next Generation – Mid 1980’s 1) Early Macs 2) Commodore Amiga 3) Atari ST 4) --- 5) IBM 386’s, 486’s

The Amiga and Atari ST are dying of software suffocation.

By the late 1990’s, only the IBM and its clones, and the Mac are left. IBM doesn’t have near monopoly because of the clones, but Microsoft does for Windows

Microsoft starts to use this monopoly of Windows to take over word processing and web browsing

Government Antitrust Suit Against Microsoft (1999)

Bush wins the election of 2000 and the Republican lawyers drop the case in return for Microsoft’s promise not to do it again.

This is a variation of the economies of scale. How can you make a computer/operating system to compete with Microsoft when the software industry is designed to work with Windows? You would have to provide your own software, which would mean starting on a huge scale.

If this is the market demand curve for the monopoly’s product, what is the monopoly firm’s demand curve? Q P D Q2 Q1 P1 P2 Market Q P ? Firm

The firm’s demand curve is the same as the market’s because the firm is the market. Q P D Q2 Q1 P1 P2 Market Q P Firm P2 P1 Q2 Q1 =

What’s the relationship between price and marginal revenue for a monopoly? Q P TR MR 0 $10 $0 -- 1 $8 $8 $8 2 $6 $12 $4 3 $4 $12 $0 4 $2 $8 -$4 5 $0 $0 -$8

What’s the relationship between price and marginal revenue for a monopoly? Q P TR MR 0 $10 $0 -- Marginal revenue is 1 $8 $8 $8 below price because 2 $6 $12 $4 each additional unit 3 $4 $12 $0 you sell causes the 4 $2 $8 -$4 price of the other 5 $0 $0 -$8 units to drop also.

Suppose McDonalds is currently selling 100 hamburgers at 50 cents each. TR = $50 They lower their price to 40 cents and now sell 150. Will their total revenue rise by 50 hamburgers times 40 cents = $20?

No. Total revenue rises by 50 hamburgers times 40 cents minus 100 hamburgers times 10 cents = $10. Let’s double-check. Q x P = TR 100 hamburgers x 50 cents = $50 150 hamburgers x 40 cents = $60 Yep, it checks.

How to graph the demand and marginal revenue curve for a monopoly. Q P D MR For straight lines, the MR curve hits the horizontal axis halfway between where the demand curve does and the origin. 0 0

So how much will the monopolist produce, and what price will he charge? Q P TR TC π MR MC 0 $10 $0 $ 0 $0 --- --- 1 $8 $8 $3 $5 $8 $3 2 $6 $12 $6 $ 6 $4 $3 3 $4 $12 $9 $3 $0 $3 4 $2 $8 $12 -$4 -$4 $3 5 $0 $0 $15 -$15 -$8 $3

The Marginal Decision Rule Again Produce the Quantity Where MR=MC Then up to the demand curve to determine the price.

Profit or Loss? Same rule as before. P>ATC Profit P<ATC Loss

Price and quantity of donuts in a market with perfect competition. Q P D 0 0 MC=ATC Pc=0.4 Qc=600 Perfect Competition P=ATC

Price and quantity of donuts in a monopoly. Q P D 0 0 MC=ATC Pc=0.4 Qc=600 Monopoly MR=MC MR Qm =300 Pm=0.7 m for monopoly c for competitive

With perfect competition, the price of donuts is 40 cents and 600 are made. With monopoly, the price of the donuts is 70 cents and 300 are made.The monopolist makes less of the product to create a scarcity and raise the price up.

What we learned this class.1) 3 properties of monopoly.2) Why marginal revenue is below price for a monopoly. 3) Graphing the profit maximizing choices for a monopoly. 4) Comparison of monopoly and perfect competition prices and quantity.

Welcome to Day 17 Principles of Microeconomics

What we learned last class. 1) 3 properties of monopoly.2) Why marginal revenue is below price for a monopoly. 3) Graphing the profit maximizing choices for a monopoly. 4) Comparison of monopoly and perfect competition prices and quantity.

Price discrimination is charging different prices to different customers.

Q P D 0 0 You would like to charge a higher price to the customers at the higher end of the demand curve.

Who are these people? Sometimes they are richer people. What traits are associated with being poor?

What traits are associated with being poor? Traditionally, retired seniors have been poor, and students.

It costs $6 to make dinners at your restaurant. When you charge $12, you get one customer, when you charge $10, you get two. Would you rather charge $12 or $10? Can you do better with price discrimination?What if you have noticed the additional customers when it is cheaper are mostly seniors?

Charge straight $12Profit = $12 - $6 = $6 Charge straight $10Profit = $20 - $12 = $8Charge one customer $12 and the other (senior) $10. Profit = $22 - $12 = $10

This could also explain student discounts at the movie theater.What else could distinguish people from the high price end of the demand curve and the lower end?

Q P D 0 0 Think about men and women if this was demand for baseball tickets. And what if it was demand at the hair salon?

There’s a reason the Washington Nationals have ladies night and not mens night. There’s a reason California hair salons were sued for charging women higher prices.

What about quantity discounts? There’s a reason bakers give a free donut if you buy a dozen. Donuts price = $1. Cost of making donuts = 50 cents. Sell 8 and charge for them all.Profit = $8 - $4 = $4Sell 13 and charge for 12. Profit = $12 - $6.50 = $5.50

NEW YORK NYC Human Rights Commission Drops Charges Against Chinese Restaurant By Meg Marco May 2, 2007 The case of the Wisconsin man who filed a complaint with the NYC Human Rights Commission has come to a close with the commission dropping charges against the restaurant.

… “We saw other customers getting a different menu. We were told we could order from it if we spoke Chinese.” The Chinese menu had prices that were, on average, $1 cheaper per dish.

Soon after the dust-up, Mayor Bloomberg urged a boycott of the shady Chinese restaurant. “It’s unconscionable to use race on any of these things, in terms of what kind of service, or how you charge, or whatever,” Bloomberg told the Daily News.

The Human Rights Commission dropped the charges after the guy from Wisconsin settled with the restaurant for an undisclosed sum and, “a promise to change its menu – by “listing identical prices in English and Chinese for the same dishes,”

Chapter 11Monopolistic Competition and Oligopoly

Monopolistic Competition1) Many Sellers 2) Similar Products or Differentiated Products3) Easy Entry/Exit

Restaurants are the “typical” example of monopolistic competition that we are usually going to use. Other examples are barbers and hair salons, and auto-repair shops.

So what does the demand curve look like for a firm in monopolistic competition? Q P Q P D D Perfect Competition Monopoly

If McDonalds raises the price of the Big Mac by 10 cents, do they lose all of their customers? Do they have to lower their price to sell more?

So McDonalds demand curve slopes down like a monopoly. It does probably lose more customers with a price increase than a monopoly, so it will be flatter. Q P Q P D D Monopolistic Competition Monopoly

You don’t have to worry about drawing it flatter. We’ll assume the units on the axis take card of that. Q P Q P D D Monopolistic Competition Monopoly

Since the demand curve slopes down showing that Rosa has to lower the price of all her spaghetti dinners to sell more, her marginal revenue is below price. Q P D Monopolistic Competition MR MC

Now it is simply adding the MC and setting MR=MC as before. Q P D Monopolistic Competition MR MC P1 Q 1

And guess what? The rule about showing a profit and loss is the same too. P> ATC then profit. P<ATC then loss. Q P D MR MC P1 Q 1 ATC

What about profits in the long-run?What happens when you have both easy entry and differentiated goods?

Imagine restaurants in Bakersfield are making positive economic profits. What will happen to the number of restaurants?

These new restaurants will keep opening until profits for the typical restaurant are driven to $0. Does this mean all restaurants are making $0 profit like the wheat farms in perfect competition?

Some places, probably only a few, will be able to differentiate themselves enough from the their competitors to keep their profits.

So the result will be that profits usually go to zero in the long-run, but not always. Though even if you have a better restaurant in some way and can make profits even in the long-run, it will be hard to maintain that advantage.

Oligopoly1) Few Sellers2) Identical or Differentiated Products 3) High Barriers to Entry

Most of the famous brand name competition you know falls in this category: 1) Ford, GM, Chrysler 2) Coca-Cola and Pepsi 3) Nike and Adidas

The high barrier to entry is often that the factories have economies of scale, so there is a high fixed cost to enter. There might also be strong brand loyalty and its associated high advertising cost.

What we learned this class.1) Monopoly price discrimination. 2) 3 properties of monopolistic competition. 3) Profit maximizing diagram for monopolistic competition. 4 ) Profits in monopolistic competition in the long-run. 5) 3 properties of oligopoly.

Welcome to Day 18 Principles of Microeconomics

What we learned last class. 1) Monopoly price discrimination.2) 3 properties of monopolistic competition. 3) Profit maximizing diagram for monopolistic competition. 4 ) Profits in monopolistic competition in the long-run. 5) 3 properties of oligopoly.

For once we don’t have a demand curve and the rule to set MC=MR.Why not?

Ford currently has price P1 and is selling Q1 cars. What happens if they have a 20% off sale? D1 – GM doesn’t change price D2 – GM cuts price 10% D3 – GM cuts price 20% P1 P2 Q1 ? ? ?

Unless Ford knows how GM is going to respond, they don’t know many additional sales they are going to get with a price cut. The key word for oligopoly is interdependence.

Why haven’t we worried about how competitors respond to our price changes before?

1) Monopolies don’t have competitors.2) In Perfect Competition, we don’t lower our price. If we did, our competitors would laugh at us and keep charging the equilibrium price. 3) What about Monopolistic Competition?

400 restaurants in Bakersfield. Rosa’s Italian Restaurant serves 200 dinners in a typical night. Rosa cuts her price by 20% and gains 20% more customers. BTW, what is her elasticity of demand if this happens?

Rosa’s gets 40 more customers a night. How many customers do most of the 400 other restaurants in Bakersfield lose? So how do they respond?Rosa's Italian Restaurant Open everyday! (661) 872-1606

Q P D 0 0 This is Rosa’s demand curve for her spaghetti dinners. What am I assuming the other restaurants are doing as she lowers her price from P1 to P2? P1 P2 Q1 Q2

Can I make the same assumption between Ford and GM?So what are we going to do?

Q P D 0 0 East U.S. Steel and West U.S. Steel are the two competing steel companies in the country. Steel costs $10 a ton to make. Currently they are competing and have a price of $11 a ton . $10 MC MR $11 Qa

Q P D 0 0 If they cooperate in setting a price that will make the most money for them jointly, how would you find that price? $10 MC MR $11 Qa

Q P D 0 0 Act like a monopoly, reduce output and raise price until MR = MC. Now the price is $13 and they are jointly producing Qm . $10 MC MR $11 $13 Qm Qa

These two firms are price fixing. Price fixing is when firms agree to jointly produce less output and raise the price. A cartel is a group of businesses that are price fixing or in collusion.

This is in many cases illegal. But it is like everything else, it is only illegal if you get caught. You don’t announce it or admit it … unless you get caught.

So, is that it? Big firms will always successfully collude unless the government stops them? No, there is something else, something called the Prisoner’s Dilemma.

Suppose the police pick up 2 men they suspect of bank robbery. They have enough evidence to convict them for illegal possession of a gun, but need a confession to get them for bank robbery.

Prisoner 2 Prisoner 1 Hold Out Confess Hold Out Confess Pris 1: 1 Year Pris 2: 1 Year Pris 1: 0 Years Pris 2: 20 Years Pris 1: 20 Years Pris 2: 0 Years Pris 1: 10 Years Pris 2: 10 Years

Cooperation in holding out is the best joint outcome, but it is hard to get their because, given what the other person has done, confessing is always the best choice for each individual to make.

The Dark Knight Film Clip

So what does this all have to do with cartels?

Firm 2 Firm 1 Keep Agreement Cheat Keep Agreement Cheat Firm 1: $60 Firm 2: $60 Firm 1: $10 Firm 2: $90 Firm 1: $90 Firm 2: $10 Firm 1: $30 Firm 2: $30

So we have two forces acting on the firms at the same time.1) The awareness that they make more money if they cooperate than if they both don’t. 2) The awareness each has that he makes the most money if he says he will cooperate, but then doesn’t.

So it is not certain in this model what will happen, but that fits real life, where many different outcomes have occurred.

What makes a cartel more likely to work?1) Less Firms 2) More Personal Trust3) Easier to Watch the Other Guy4) A Way to Punish the Other Guy5) Stable Demand For the Product 6) Repeated Opportunities

Suppose it costs $100 to fly someone from LAX to SFO. The airlines could agree on a price of $200 but would be vulnerable to the prisoner’s dilemma

What if they can get the government to set them a price of $160? Are they safe from the prisoner’s dilemma?

How else to airlines compete besides price?

This quality of service competition raises the cost of flying a passenger up close to $160. So are the airlines making high profits from their guaranteed high price of $160?

The same story explains why banks famously used to give something away when you opened a bank account.

What happened to the free toasters?

What we learned this class.1) Why there is no demand curve for oligopoly.2) Cartel theory. 3) The prisoner’s dilemma. 4 ) What makes a cartel more likely to work.

Welcome to Day 19 Principles of Microeconomics

What we learned last class. 1) Why there is no demand curve for oligopoly.2) Cartel theory. 3) The prisoner’s dilemma. 4 ) What makes a cartel more likely to work.

Test Prep

Welcome to Day 20 Principles of Microeconomics

Unit Test #2