Micro part 9- Price discriminating monopolies, Oligopoly

Question 1

What is Price discrimination

Answer 1

1. when a firm sells a different price to different customers for the same product

Question 2

What are the conditions of price discrimination

Answer 2

1. The seller must have some price making power e.g. barriers to entry to prevent competition
2. The seller must be able to separate the markets to prevent those buying the good at a lower price selling it on themselves at a higher price
3. Must face different PED in different markets

Question 3

What is First degree price discrimination

Answer 3

1. This is where each consumer is paying the maximum they would be willing to pay so consumer surplus is completely eroded and turned into producer surplus
2. P = MR because TR from previous units stays the same

Question 4

Why is First degree price discrimination Unlikely to happen in real world

Answer 4

1. firms need info on each consumer’s willingness to pay
2. hard to separate markets
3. need high levels of market power

Question 5

What is second degree price discrimination

Answer 5

1. Consumers receive different prices based on the volume purchased
2. If consumer buys Q2 then pays lowest price of P2 but if buys Q0 then pays higher price of P0

Question 6

What is third degree price discrimination

Answer 6

1. Charging different prices to different segments of the market based on: time, location etc.
2. Markets need to be segmented so consumers in lower priced market cannot buy from higher prices market
3. Charge higher prices where PED is more inelastic, lower price where PED is more elastic

Question 7

What are the advantages of price discrimination

Answer 7

1. Can benefit a group that may have not originally been able to afford a certain good.
2. greater access to merit goods leads to positive externalities
3. Make markets more contestable in l.r. e.g. low cost airlines use p.d. to fill their planes
4. An increase in output because of firms selling extra units at a lower price can help exploit EoS and therefore reduce LRAC

Question 8

why does price discrimination benefit a group that may have not originally been able to afford a certain good.

Answer 8

1. This occurs because they have a high degree of market power so can control prices as are price makers and if they can segment markets.
2. This benefits those in the lower price market and if they could not afford the good before discrimination then there is an increase in social welfare and equity.

Question 9

What are the Disadvantages of price discrimination

Answer 9

1. Lead to predatory pricing where firms cross-subsidise from the higher priced market so can set prices below cost which drives out competition and increases market power
2. It reduces consumer surplus/eqaulity in most cases. 3. Reduces consumer welfare, turns consumer surplus into producer surplus.
3. This can strengthen monopoly power and turn it into higher prices in l.r

Question 10

What are the Characteristics of monopolistic competition

Answer 10

1. Differentiated g/s, but close substitutes so XED is high. Presence of advertising.
2. There is independence, firms are not concerned with how rival firms react to price and output decisions
3. Low barriers to entry/exit
4. Many firms, each with low market power
5. There is a downwards sloping demand curve so firms have some degree of price setting
6. Imperfect information

Question 11

Short run price and output in respect to monopolistic competition

Answer 11

1. In the short run, profit maximise where MC=MR and can make ANP.
2. There are higher prices, creating a loss in consumer surplus and welfare in the short run

Question 12

Long run price and output in respect to monopolistic competition

Answer 12

1. In the long run, new firms are incentivised to join the market by profits, which they can due to low barriers to entry
2. This increases supply which decreases price, competing away abnormal profits
3. It also makes the demand more elastic since there are now more substitutes, and it shifts to the left
4. Firms may attempt to stay in the short run ANP by differentiating product and innovating

Question 13

Describe how choice is affected by monopolistic competition

Answer 13

1. Differentiated products in the market, means consumers can makes decisions over which goods may maximise their utility, leading to an increase in consumer welfare
2. Advertising by firms allows consumers to identify which g/s will maximise their utility, further maximising welfare

Question 14

Is monopolistic competition productively efficient or inefficient

Answer 14

1. productively inefficient
2. Achieved when operating at the lowest point on AC curve
   3 . On the diagram, operate where MC=MR, so price is P1, which is higher than P2
3. This is because many firms means firms cannot fully exploit their fixed factors because mass production is difficult
4. This causes them to produce at an output below the MES
5. This means that firms operate at a level of output below optimum capacity

Question 15

Is monopolistic competition allocatively efficient or inefficient

Answer 15

1. Allocatively inefficient
2. Diagram shows P < MC since firms operate where MC=MR
3. This means the value that consumers place on the last unit bought is greater than the cost of producing that unit (good is under-produced)
4. This means consumer welfare is reduced

Question 16

Describe the effect of monopolistic competition on innovation/dynamic efficiency

Answer 16

1. Consumers may see higher levels of innovation and higher quality goods
2. Occur because in the short run, there is the presence of ANP as seen by diagram
3. This means there are funds available to invest in product innovation, which can increase consumer welfare
4. Firms are incentivised to do so as it can further differentiate their product (non-price competition).
5. Due to lack of perfect information it can prevent other firms from benefiting from their innovations which can increase their profits in the long run
6. Means potential for higher profits and low price for consumers with better quality goods

Question 17

What is Non-price competition

Answer 17

1. Where firms use factors like packaging or advertising to increase demand for their products, over price.

Question 18

What are the characteristics of oligopoly

Answer 18

1. Small number of firms each with significant market share
2. Some product differentiation as a form of non-price competition
3. There are barriers to entry/exit but differ between industries
4. There’s interdependence between firms. They are mutually dependant since each firm is affected by its rival’s decisions
5. This interdependence may mean firms react unpredictably

Question 19

Describe the kinked demand curve

Answer 19

Kinked demand curve

1. An oligopoly can observe current prices but must anticipate rival reactions to changes in price
2. If the firm raises price then assumed rival firms are less likely to follow so demand is relatively elastic above P0 due to the substitution effect
3. If the firm lowers price then assumed rival firms are likely to follow so demand is relatively inelastic below P0

Question 20

What are the criticisms of the kinked demand curve

Answer 20

1. no explanation of how this ‘sticky’ price is achieved

2. cannot predict what happens to output if MC changes since there’s discontinuity in the MR curve

Question 21

What is the significance of product differentiation

Answer 21

1. It means firms face a downwards sloping demand curve.
2. This means firms can raise prices without losing all its demand since the product has close but not identical substitutes.
3. This means the firm is a price maker
4. It means consumers have a wider range of choice. 5. This may increase utility for some consumers which can increase consumer welfare
5. It means prices are more stable since firms can maintain or increase market share by non-price competition

Question 22

What is game theory

Answer 22

1. Used to predict the outcome of a firms’ decision when it has incomplete information about others

Question 23

What is duopoly

Answer 23

1. market structure in which there are two firms producing with each other

Question 24

What is Dominant strategy

Answer 24

1. the strategy a firm adopt irrespective of the strategy of other firms

Question 25

What is Nash equilibrium

Answer 25

1. Nash equilibrium – the optimal strategy for all firms

Question 26

What are payoffs

Answer 26

1. Payoffs – the possible outcomes associated with the various combinations of strategy

Question 27

What does game theory say about dominant strategy

Answer 27

1. Any equilibrium where firms are maximising collective profits is unstable since by lowering price then one firm can increase individual profits
2. This means the dominant strategy will be the one where they lower price and the equi. payoff is where joint profits are at their lowest

Question 28

How may firms be tempted to compete

Answer 28

1. Firms can either compete of collude
2. May be tempted to compete, outcome is Qpc and Ppc
3. either on price, output or non-price
4. most likely to be characterised by non-price competition

Question 29

Why might firms engage in collusion

Answer 29

1. Could engage in collusion where interdependence encourages firms to join together and act as if they were a collective monopoly
2. explicit where there’s an open agreement on price/output strategy (cartel)
3. implicit where there’s an unwritten agreement not to compete
4. needs a credible punishment strategy

Question 30

When is collusion in a oligopoly more likely

Answer 30

1. firms want to maximise l.r. profits
2. price reductions will be quickly matched by retaliating firms
3. when it’s more difficult to conceal a price reduction

Question 31

When is collusion in a oligopoly less likely

Answer 31

1. there are many firms in an industry with lower barriers to entry
2. Firms have surplus capacity
3. Effective legal frameworks to prevent/deter