Lecture 6 Flashcards
What is defined as monopoly?
only one firm sells a product with NO CLOSE SUBSTITUTES
has market power- the ability to influence the market price of the product it sells. A competitive firm has no market power.
BECAUSE BARGAINING STRENGTH COMES THROUGH SCARCITY. (if you control scarce resource, can dictate terms of transaction(price,qty,qlt) )
Why do monopolies arise?
barriers to entry — other firms cannot enter the market.
What are the sources of BTE?
What is the source of BTE for natural monopoly?
single firm owns a key resource
government gives a single firm the exclusive right to produce the good.
Natural Monopoly:
when a single firm can produce the entire market Q at lower cost than several firms.
In competitive markets, what is the market demand curve and the individual firm’s demand curve?
Market : Downward sloping
Individual: Horizontal
In competitive markets, why is the individual firm’s market demand horizontal?
price taker, can sell many units as it wants at market price
Can increase quantity without fall in price, as its actions are insignificant as compared to the entire market
What is the shape of the monopolists’ market demand curve and why?
monopolist is the only seller,
so it faces the market demand curve.
To increase Q,
the monopolist lower P.
Thus MR ≠ P.
How does a monopoly sell more units?
must lower price on ALL units it sells
Explain the effect of increase in Q on revenue
Increase in Q results in
Output effect: Increase Q lead to Increase Revenue
Price effect: Price decrease leads to revenue decrease
To sell more units,must lower price on ALL units it sells
When is MR negative?
when price effect dominates the output effect
Explain how monopoly charges price?
maximizes profit by producing the quantity where MR = MC.
sets the highest price consumers are willing to pay for that quantity
determines this price from the demand curve.
How does monopoly result in deadweight loss?
In a competitive market equilibrium,
P = MR = MC and total surplus is maximized. Price or the value to consumers = cost to producers
In the monopoly equilibrium,
P > MR = MC.
The value to buyers of an additional unit (P ) exceeds the cost of the resources needed to produce that unit (MC).
The monopoly Q is too low; total surplus could be increased by increasing Q.
Grey triangle is dwl, as between qm and qc, the demand curve which represents the buyers value of good,is above the producer cost of producing good, if these units are transacted, either producer, consumer or both would have realized gains from trade, but cause monopolywant to maximise profit, and single market price, monopolist produces at qm, grey triangle means gains of trade in competitive market, but they wont be realized in monopoly
What is price discrimination?
selling the same good at different prices to different buyers
What characteristic of consumers is used in price discrimination?
willingness to pay.
A firm can increase profit by charging a higher price to buyers with higher WTP.
How does producer surplus and consumer surplus arise from perfect price discrimination
D=MR
To maximise profit, would want to price each buyer willingness to pay, mr of 2nd unit is the price charged to 2nd buyer, and 3rd buyer and son on . MR curve is the same curve as the dd curve, as willingness to pay is depicted by dd curve. Produce where buyer willingness to pay is at least as gbreat as the marginal cost of that unit. Produce at mr=mc
Cpnsumer surplus is the differnece between the price they pay (charged according to what each buyer willing and able to apy along demand curve) and the amount they are willing to pay
BOTH ARE THE SAME, HENCE CONSUMER SURPLUS IS 0
Producer surplus is area above the mc curve, below the demand curve, paid by each byer from 0 to q. Firms are able to charge exactly what the marginal buyers wtp. Producer captire all consumer surplus as profit, BUT NO DWL
Why is perfect price discrimination not possible?
No firm knows every buyer’s WTP.
Buyers do not announce their WTP to sellers.
How do firms get around not having perfect price discrimination?
firms divide customers into groups based on some observable trait (e.g., age) that is likely related to WTP.
