1 MECO 6303 My name is Stan Liebowitz Pronounced: Lee – bow –wits Reading list: Web Page...
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1 MECO 6303 • My name is Stan Liebowitz • Pronounced: Lee – bow –wits • Reading list: • Web Page http://www.utdallas.edu/~liebowit / Course Syllabus for Business E conomics ME CO 6303 ProfessorStan Liebow itz;Office:SM3.801;Telephone: 972-883-2807 email:liebowit@ utdallas.edu ; hom epage: ww w .utdallas.edu/~liebow it/ ; O ffice H ours:T 3pm orbyappointment Main Text: Business Econom ics Landsburg/M ankiw.U TD Edition,2006. Notes forthecourse, old exams, and so forth can be found on m y hom epage. A pproxim ateschedule: Weeks1-2 (August22,29):Chapter14 (477-498), C hapter1 (1-32),4.4 (86-91). Topics: A ssum ptions,O pportunity Cost,Scarcity,Econom ic G oods,Production Possibility curves,Demand and Supply, equilibrium ,Elasticiticity. Illustrations:When Should a firmraiseitsprice? Elasticity forfirm and industry. Weeks 3-4 (Septem ber 5,12):Chapter 8.1,8.2 (229-249), the meaning of price and value,Economic Efficiency,consumer and producersurplus;maxim izing behavior of firm s. Illustrations: Diam ond-water paradox, costs of theft, and Comparable Worth Week 5-6 (Sept19,26):Chapter 8.3 (249-263) w ho pays for a tax?, im pactof price controls.. Illustrations:Laborunions;farm price supports Week 7 (October 3):Midterm , Week 8-9 (October 10,17). Chapters 5, 6.1 (121-155) Topic: Production, Costs, equim arginalprincipal, Competition and Monopoly.Illustrations: Impactof Sunk costson firm behavior;Long run and shortrun effectsofprice changes.
1 MECO 6303 My name is Stan Liebowitz Pronounced: Lee – bow –wits Reading list: Web Page liebowit/liebowit
1 MECO 6303 My name is Stan Liebowitz Pronounced: Lee bow wits
Reading list: Web Page
http://www.utdallas.edu/~liebowit/http://www.utdallas.edu/~liebowit/
Slide 2
2 Basics of Course What is economics about? Micro economics.?
Current def: whatever economists study - not a very useful
definition of a discipline. Historical and more useful definition:
allocation of scarce goods for competing ends. In reality, it
focuses mainly on how free markets, consisting of voluntary
participants, operate. It can also be used to analyze other
non-market forms of production and distribution.
Slide 3
3 What Types Of Questions Do Micro- economists Try To Answer?
What pricing strategies allow firms to maximize profits? When
should a firm produce a product in house, and when should it
purchase from outside vendors? Can a firm pass on a tax? What is
the effect of taxes on the profit maximizing behavior of firms?
What is the impact of airline deregulation? What is the optimal
amount of pollution? Do women get paid less then men? Why?
Slide 4
4 Economic actors are rational: voluntary actions are only
undertaken when they are expected to make people better off.
Assumptions In Economics Major actors: consumers and producers.
Economics as Science- abstract model simplifies, requires
simplifying assumptions. Consumers try to maximize happiness
(utility) Our wants are greater than our abilities to fulfill them
(scarcity) Producers try to maximize profits
Slide 5
5 Assumptions: Economic Actors Are Rational 1.Voluntary actions
are only undertaken when they are expected to make people better
off. 2.Even people in asylums act economically rationally in most
instances, according to experiments.
Slide 6
6 Assumptions: People Try to Maximize Happiness (Utility) 1.
This does not imply selfish behavior. 2.If giving to others is what
makes you happy, that is what maximizes your utility. 3.Rationality
in this case implies that you wish to maximize your giving to
others, not to just have the money wasted.
Slide 7
7 Assumptions: Firms Try to Maximize Profits 1.Private
for-profit firms are supposed to work for their shareholders, who
usually are interested in stock price appreciation, which results
from profit maximization. 2.But, many organizations are not
for-profit firms clubs, government, charities, and so forth. But
even if they dont maximize profits, they still should be interested
in efficiency, and also in what happens to the demand for their
product when conditions change. 3.This assumption leads to good
predictions about firms behavior, so it doesnt need to be always
true.
Slide 8
8 Assumptions: Scarcity 1.Our wants are greater than our
abilities to fulfill them (scarcity). Factually correct throughout
history. 2.If we do not have scarcity, then everyone has as much of
all products as they want. There would be no trading, no markets,
and no prices. 3.The problem of scarcity could in principle be
solved either by increasing output or decreasing wants. Some
religious or philosophical movements work on decreasing wants;
Capitalism tends to go the increasing output route. Problem will
never be solved.
Slide 9
9 Some Basic Definitions Goods: things people want : Economic
goods: goods that are scarce. Question- must goods have a positive
price? Are all positive priced items economic goods? Opportunity
cost: what you give up when you engage in an activity. Measured as
the value of your next best activity (the activity you would have
engaged in if you didnt choose the first activity). Example:
opportunity cost of going to college.
Slide 10
10 Illustrates concepts of efficiency, scarcity, opportunity
cost. Assumes society with two goods (perhaps Robinson Crusoe with
fish and fruit). Indicates combinations of each good that can be
produced. Example for farmer: amount of two possible commodities he
might grow. Production Possibility Curves.
Slide 11
11 Two questions A financial analyst on TV said the impacts of
the hurricane on the country wouldnt be so bad since most of the
damaged property was insured. Is this a correct statement? Oil
prices rise when a hurricane is predicted to impact oil rigs and
refineries. What is that about? Is it profiteering?
Slide 12
12 Production Possibility Curve Fish Fruit slope of line
indicates tradeoff in ability to produce different types of goods A
BB1
Slide 13
13 No Specialized Resources-PPC Straight 2 Production
Possibility Curves under 2 scenarios Fish Fruit slope of line
indicates tradeoff in ability to produce different types of goods A
BB1
Slide 14
14 Specialized Resources- PPC Curved Line Production
Possibility Curve Fish Fruit B A
Slide 15
15 Demand Defined for a single market particular product and
particular consumers. Each unit of the good is identical to all
other units. Represents highest price consumers are willing to pay,
and quantity they want at a given price. Time dimensions Holds
everything but price and quantity constant (income, tastes, price
of other goods, gravity, Y2k problems.) law of demand demand slopes
down based on empirical observation. movement along versus movement
on
Slide 16
16 D P Q Demand
Slide 17
17 Demand Defined for a single market particular product and
particular consumers. Each unit of the good is identical to all
other units. represents highest price consumers are willing to pay.
Holds everything but price and quantity constant (income, price of
other goods, gravity, Y2k problems.) time dimensions law of demand
demand slopes down based on empirical observation. movement along
versus movement on
Slide 18
18 P1P1 P WLM QEQE Q2Q2 D Demand for RNE* Q1Q1 P2P2 *Rethinking
the Network Economy
Slide 19
19 D D1 P Q Perhaps a positive review in the Economist leads to
an increase in demand curve Shift in Demand for RNE
Slide 20
20 Price Elasticity Of Demand def: percentage change in
quantity divided by percentage change in price (Q/Q)/(P/P) or (Q/P)
(P/Q) measure of responsiveness 1. If Elasticity is >1 known as
elastic (responsive customers) 2. If Elasticity is =1 ; unit
elastic 3. If Elasticity is
24 Implications of Elasticity If Elasticity is 1 firm can not
necessarily increase its profits by a change in price. Thus firms
that maximize profits must have elasticities >1. Example of
VideoTape Pricing History Demonstrates Importance of knowing
elasticity.
Slide 25
25 Long Run and Short Run Elasticities Elasticity is greater in
the long run consumers have more time to react to price changes For
example, if the price of gasoline goes up, consumers at first can
try to reduce the amount they drive, but this is often difficult.
Over time, they can by more fuel efficient cars or move closer to
their work.
Slide 26
26 D before consumers have much time to adjust P Q original
price D after consumers have time to adjust to price change amount
consumed after short period of adjustment\ amount consumed after
longer period of adjustment\ new higher price
Slide 27
27 Supply: Represents minimum price sellers require to
voluntarily provide the product. assume it slopes up for now. In
reality it depends on the cost conditions of the firm. Same
assumptions as with demand: everything else is held constant.
Slide 28
28 P2P2 P1P1 Q2Q2 Q1Q1 S minimum price firm is willing to
accept. Should be equal to the cost of producing the additional
output Meaning of Supply
Slide 29
29 P1P1 P2P2 Q1Q1 Q 2007 SLSL Long Run/Short Run Oil? SsSs Q
2011
Slide 30
30 Meaning of (Stable) Equilibrium A situation such that the
variables of interest remain at rest until disturbed by some
outside force. For stability, the variables must return to the
equilibrium after being disturbed by some force. Gravity and the
resting place of tennis balls. We assume many producers and
consumers to start the analysis. Surplus and shortages take the
place of gravity in these markets.
Slide 31
31 P1P1 PePe QeQe Q1Q1 S D Surplus Shortage P2P2 Q2Q2
Illustration of Supply Demand Equilibrium
Slide 32
32 Examples of changes in Equilibrium Supply and Demand
analysis assumes that market moves from one equilibrium position to
another. Shifts in D or S alter equilibrium. For example, how would
you expect the price and quantity of Pepsi Cola to change when:
Price of Coca Cola falls. Price of fructose goes up Surgeon general
warns of soda threat to health. Winter changes to summer. TV ads
for cola banned 1.Answers on next slide.
34 Lesson 3 1.The Meaning of Price, Value, and Economic
Efficiency. 2.Consumer and Producer Surplus. 3.Diamond Water
Paradox. 4.Efficiency of Competitive Market equilibrium
5.Efficiency Implications of Price Controls and Taxes.
Slide 35
35 Area under demand = total value of that output Total Value
of Q 1 Units= 1+2+4 Total Value of Q e Units= 1+2+3+4+5 QeQe Q1Q1
P1P1 PePe 1 2 3 4 5 D
Slide 36
36 Area under supply = total cost (net of fixed costs) P1P1
PePe 1 2 Increase in Total Cost when output increases from Q 1 to Q
e =1+2 QeQe Q1Q1
Slide 37
37 What about Comparable Worth An issue in J Roberts Supreme
Court nominationhe suggested it was anti- capitalist. Was he
correct? What is comparable worth? What arguments are given by its
defenders? What are the arguments if its detractors?
Slide 38
38 Role of Price Mechanism for Allocating Goods in Markets:
willingness to pay. What are alternative mechanisms? First come,
first served Strongest and most Powerful Random Selection Friends
and relatives
Slide 39
39 Meaning of Price What is the meaning of price when it is
used to allocate goods? What does a high, or a low, price tell us
about the product? Diamond-Water paradox: why are diamonds
expensive when water is so cheap?
Slide 40
40 PwPw S water QwQw Total Value of Water is entire area D
water Average Value Water Average value of water is mid value of
water used. So what does price measure? Meaning of Price
(diamond-water Paradox PAPA
Slide 41
41 PdPd value of diamonds Average Value Diamonds Q Diamonds S
diamonds D diamonds Meaning of Price (continued)
Slide 42
42 PdPd PwPw S water QwQw Total Value of Water is greater than
value of diamonds Average Value Diamonds Q Diamonds D water S
diamonds D diamonds Average Value Water Average value of water is
also greater. So what does price measure? Meaning of Price
(continued)
Slide 43
43 Meaning of Price in Markets Price Measures the value of the
last unit sold, or marginal unit. Price, therefore, is unrelated to
average or total value of a product. Salary, which is the price of
labor, need not be related to the value of the worker or the work.
How can one group of workers generate higher wages for
themselves?
Slide 44
44 What about Comparable Worth What can we say about it
now?
Slide 45
45 WSJ on Economics Wage Market economics job market.pdf
Slide 46
46
Slide 47
47
Slide 48
48 Consumer and Producer Surplus Consumer surplus is the
difference between the price paid and the higher price that
consumers would have been willing to pay for the product. Producer
surplus is the difference between the payment received and the
minimum payment that producers would have accepted.
50 Price Controls Artificial Government Restraint of Price Can
be a floor, or a ceiling Popular during wars, or in non-market
economies Simple view: distortion in output More complete view:
wrong consumers get product.
Slide 51
51 P1P1 PePe 1 2 3 4 5 6 7 8 CS Before Price Control= 1+2+3 Ps
Before Price Control = 4+5+6 CS After Price Control = 1 PS After
Price Control = 2+4+6 QeQe Q1Q1 Price Floor at P 1 P2P2 Q2
Slide 52
52 P1P1 PePe 1 2 3 4 5 6 7 8 CS Before Price Control= 1+2+3+8
Ps Before Price Control = 4+5+6 CS After Price Control = 1 PS After
Price Control = 2 QeQe Q1Q1 Price Floor at P 1 AND wrong producers
Q2Q2 Q0Q0
Slide 53
53 P rc PePe 1 2 3 4 5 6 CS Before Price Control= 1+2+3 Ps
Before Price Control = 4+5+6 CS After Price Control = 1+2+4 PS
After Price Control = 6 QeQe Q1Q1 transfer Rent Control (Price
Ceiling) 7 Q2
Slide 54
54 Revenue from Consumers P1P1 PePe 1 2 3 4 5 6 7 8 CS Before
Price Control= 1+2+3 Ps Before Price Control = 4+5+9 Taxpayers =
2+3+4+5+6+7+8+10 QeQe Q1Q1 9 10 P clearing Government guarantees
price at P 1 and and sells output at market clearing price Q2Q2 S D
CS After Price Control = 1+2+3+4+5+6+10 PS After Price Control =
2+3+4+5+7+9
Slide 55
55 P1P1 PePe 1 2 3 4 5 6 7 8 CS Before Price Control= 1+2+3 Ps
Before Price Control = 4+5+9 CS After Price Control = 1 PS After
Price Control = 2+3+4+5+7+9 Taxpayers = 3+5+6+7+8+10+11+12 QeQe
Q1Q1 9 10 P clearing Government guarantees price at P 1 and burns
any output it can not sell at that price Q2Q2 11 12
Slide 56
56 Price Gouging How would it be defined? Should it be illegal?
What are the plusses and minuses? What are the two roles that price
plays in the economy? What impact does it have on distant future
behavior? Which is better: windfall profits tax, or price gouging
law?
Slide 57
57 Who Pays For A Tax? Terminology in Book is not exactly
correct. Two forms of analysis: decreasing supply or decreasing
demand. Tax burden is shared depending on slope of both
curves.
Slide 58
58 P1P1 PePe QeQe Q1Q1 Price Paid by Consumer } amount of tax D
S StSt Tax from consumers vantage
Slide 59
59 P1P1 PePe QeQe Q1Q1 Price received by Producer } amount of
tax D S DtDt Tax from producers vantage P0P0
Slide 60
60 P1P1 PePe QeQe Q1Q1 Price Paid by Consumer } amount of tax D
S StSt Distortion from Tax P0P0
Slide 61
61 D with infinite elasticity P Q Instance of Tax borne by
Producer Q1Q1 Q2Q2 S1S1 S P1P1 Price Paid by Consumer
Slide 62
62 D with zero elasticity P Q Instance of Tax borne by Consumer
Price Paid by Consumer S S1S1 P0P0 P1P1 Q0Q0
Slide 63
63 S with infinite elasticity P Q Instance of Tax borne by
Consumer Price Received by Producer P0P0 Q1Q1 Q0Q0 DtDt D
Slide 64
64 S with zero elasticityP Q Instances of Tax borne by producer
Price Received by Producer P0P0 P1P1 DtDt D Q0Q0
Slide 65
65 Corporation and Proprietorships. Corporations which use
stock have two advantages: limited liability and transferability of
ownership. Disadvantages: the corporate income tax and costs of
incorporation. Proprietorships have unlimited liability and can not
be transferred. They do not have to pay corporate income tax,
however. (New hybrid forms). Firms in our theory produce output in
order to maximize profit. Marginal Analysis will help us understand
profit maximization. Firms: Legal Forms
Slide 66
66 Marginal Analysis Relationship between Total, Average, and
Marginal Magnitudes? You already have experience you have been
calculating your average since elementary school. Each test is a
marginal score. Useful in Understanding Profit Maximization. Total
Revenue is defined as Price multiplied by Quantity. MR is the
change in TR when another unit is sold.
Slide 67
67 Marginal Analysis - Demand 1. Note Relationship between
elasticity and Marginal Revenue.
Slide 68
68 More Marginal Analysis
Slide 69
69 Marginal Costs and Profit
Slide 70
70 Profit Maximization Marginal Analysis TR= PxQ Calculus leads
to MR=MC conclusion; Alternatives to Calculus AR = demand curve;
marginal revenue curve must lie below demand curve Profit maximized
when TR-TC is greatest (vertical difference) this implies slope of
TR = slope of TC which means that MR=MC
Slide 71
demandofelasticitywhere P Q P P Q P Q P Q Q Q P Q TR QP Also
MCMRso Q Max MCMR Q TC Q TR Q TCTR ) 1 1()1( 0 Some simple
Calculus
Slide 72
The Intuition demandofelasticity wherePMRor are ) 1 1() PQ QP
-P(1=MR 1=Q whereQ)P(-P= MRSo effect. P thisof because P thanless
is MR price. in down go whichunits Qfor QP +unitlast of
price=revenues bringsLast Unit units. Q of instead sold units 1+Q
when Revenuein RevenueMarginal
Slide 73
73 D MR $ q* Max Profit TR TC max Rev Profit Maximization
Output
Slide 74
74 AC MC D MR Profits P* q* Another Angle
Slide 75
75 The Firm's Inputs And Costs Fixed And Variable Costs. Fixed
Costs: Costs that do not change when output changes. Variable
costs: Costs that do change when output changes. Long Run and Short
run. Long Run: A long enough period of Time such that all costs are
variable Short Run: A period of time such that at least one input
(cost) is fixed.
Slide 76
76 TC=FC+VC; TC/Q = FC/Q +VC/Q which is ATC= AFC +AVC AVC AC
Fixed and Variable Costs AFC Total Fixed P Q q1
Slide 77
77 Irrelevance of Fixed Costs if you stay in Business Changes
in Fixed costs don't alter profit maximizing P and Q because fixed
Costs dont impact Marginal Costs. Fixed Costs do impact profits,
and may cause firm to decide the leave industry. Same with lump sum
taxes.
Slide 78
78 AC 1 MC D MR Profits2 P* q* AC 2 Impact of Fixed Costs on
Profit Profits1 AC* AC**
Slide 79
79 Economies and Diseconomies of Scale What does this imply
about the AC curve? defined simply as whether or not AC rises or
falls long run AC Vs. short run AC Distinguishing between economies
of scale and improvements in technology very important. Can firms
have diseconomies of scale but industries have economies of
scale?
Slide 80
80 AC Economies of Scale Diseconomies of Scale
Slide 81
81 Long Run AC LRAC SRAC1 SRAC3 SRAC2 MC2 MC3 MC1 Q1
Slide 82
82 Do average costs fall over time, or is average cost downward
sloping? AC1990 P* q* AC1991 AC1992 AC1993 AC1994
Slide 83
83 Can firms have diseconomies of scale but industries have
economies of scale? External Effects Industry output effects the
costs of individual firms. Positive External Effects can cause AC
for industry to fall even though each firm has upward sloping AC
curve. Used to explain apparent decreasing costs but multiple firms
in industry.
Slide 84
84 Midterm goes only up to this point
Slide 85
85 perfect competition Many participants, buyers and sellers.
Sellers are infinitesimally small. Homogeneous products. Free entry
and exit. Perfect information.
Slide 86
86 1. Competitive Firms a. In the short run almost horizontal
demand. b. supply curve of firm is the MC above AVC. c. Industry
supply horizontal sum of firms mcs (the sum of their output at a
price).
Slide 87
87 AC 1 MC D = MR P* q* Short Run Profit Maximizing solution
for a competitive firm; MC seems to be the supply curve. AC q*
Profits
Slide 88
88 AVC AC supply curve of firm is the mc above avc AFC P Q q1
q2 q3 p3 p2 p1 S MC
Slide 89
89 supply curve of industry is the horizontal sum of each
individual firms supply. Firm A Firm B Firm C Industry qaqa qbqb
qcqc Q a+b+c p1 s s s S q a1 Q = q a1 p2
Slide 90
90 Competitive Equilibrium a. fixed number of firms in SR!! no
entry or exit allowed; therefore, industry supply can not change b.
for firm: d=mr=p=mc c. In longer run, profits draw entry of firms,
increasing industry supply, lowering price and profits down to
zero; negative profits cause exit, decreasing supply, raising price
and bring profit back to zero.
Slide 91
91 AC P "Representative" Firm in Industry P Competitive
Industry This represents a competitive industry in a short run
equilibrium. Meaning that until entry or exit can occur, nothing
will change since the price equalizes quantity demanded and
supplied. But the typical firm earns profits (right hand picture)
and entry will increase industry supply in long run, lowering
price. p1 qQ1Q1
Slide 92
92 AC P "Representative" Firm in Industry P Competitive
Industry This represents a competitive industry in a long run
equilibrium (price P 3 ). Once achieved, nothing will change since
the price equalizes quantity demanded and supplied. Since the
typical firm earns no profits (right hand picture) no further entry
or exit will occur. S1 S3 p1 p2 S2 p3 Q1Q1 Q2Q2 Q3Q3 q q1q1
Slide 93
93 Efficiency of Competition a. no deadweight losses-- i.e. on
prod poss frontier b. each firm at bottom of ac--- seems good, but
actually irrelevant for economic efficiency c. consumers vote with
dollars. Popular products make money, drawing entry until enough of
the product is produced. The drive for profits makes firms
efficient and efficient firms drive out inefficient firms (Darwin
and Economics).
Slide 94
94 AC P "Representative" Firm in Industry P Competitive
Industry The right hand diagram represents the typical firm in long
run equilibrium. The firm is at the bottom of the AC, meaning that
costs are minimized. Industry has zero deadweight loss. q 1 2 CS=1
PS=2
Slide 95
95 Efficiency of Competition (rpt) a. no deadweight losses--
i.e. on prod poss frontier b. each firm at bottom of ac--- seems
good, but actually irrelevant for economic efficiency c. consumers
vote with dollars. Popular products make money, drawing entry until
enough of the product is produced. The drive for profits makes
firms efficient and efficient firms drive out inefficient firms
(Darwin and Economics).
Slide 96
96 Competitive Markets that arent Example of taxi-cab
medallions Television station licenses. Medical doctors Many, many,
more.
Slide 97
97 Long Run Supply: No External Effects Competitive industry
must have constant costs in this case. Long run industry supply
must be horizontal at the bottom of the AC of representative firm.
Long run industry output changes only through entry and exit of new
firms.
Slide 98
98 AC P "Representative" Firm in Industry P Competitive
Industry The typical firm in long run equilibrium at the bottom of
its AC, meaning that costs are minimized. With no external effects,
each firm always produces q and long run industry output only
changes when the number of firms changes. q LRS SRS P1P1
Slide 99
99 Long Run Supply with External Effects Competitive industry
may have increasing or decreasing costs in this case. Long run
industry supply changes only as the bottom of the AC of
representative firm changes.
Slide 100
100 P Q AC for representative firm as industry output Q
increases. AC (Q1) AC (Q2) AC (Q3)
Slide 101
101 P Q Q1 Q2 Q3 Long run supply in decreasing cost competitive
industry AC (Q1) AC (Q2) AC (Q3) LRS
Slide 102
102 Monopoly Vs. Competition Monopoly versus competition
(smaller q, higher p) Imposing a tax on a monopolist similar to
competition in that producer still bears part of it. Price controls
and monopoly...a case where controls may increase efficiency. Price
discrimination. The tradeoff associated with patents and copyright
- deadweight loss in consumption versus possible new products.
Slide 103
103 S MR D PcPc QcQc PmPm QmQm 1 2 3 4 Monopoly charges higher
price, produces smaller quantity. Monopoly causes Deadweight Loss
1+2. Area 3+4 is transfer to producer from consumer MC
Slide 104
104 MR D P1P1 MC+t P2P2 taxtax Q1Q1 MC Q2Q2 Tax on Monopoly:
price goes up by less than tax, so burden of tax is still shared.
Monopolist tends to pay bigger share than would competitors.
Deadweight loss grows.
Slide 105
105 MR D P1P1 P control Q1Q1 MC Q2Q2 A Price Control on a
monopolist. Since p cannot go above P control the MR is equal to P
control, output may increase (if price control is not too low, and
deadweight loss may decrease.
Slide 106
106 MR D P1P1 P control Q1Q1 MC Q2Q2 A Price Control on a
monopolist. Since p cannot go above P control the MR is equal to P
control, output may increase (if price control is not too low, and
deadweight loss may decrease. Q3Q3
Slide 107
107
Slide 108
108 Perfect Price Discrimination Theoretical ideal. Cannot be
fully achieved. Find maximum price that every consumer is willing
to pay and charge them that price. Requires more information than
any firm has, and the prevention of arbitrage. Demand Curve becomes
MR curve. No Deadweight Loss. Approximate examples: automobile
dealers, doctors in the old days.
Slide 109
109 Perfect Price Discrimination. S P6 P3 P1 D
Slide 110
110 Price Discrimination If markets for a single product have
different MRs, profits can be increased by shifting output from low
MR markets to high MR markets. Raise price in low MR market and
lower price in high MR market. High MR market is high elasticity
market. Need to Prevent Arbitrage. Examples: Airlines with business
travelers and vacationers. Coupons.
Slide 111
111 price before discrimination mr1 mr2 MR D mr Market 1Market
2 Q1Q2 P1 P2 D MR
Slide 112
112 Price Discrimination Rules Raise price in market with lower
elasticity (lower responsiveness) Lower price in market with higher
elasticity. Do this until MRs are equalized. But prices will not be
equalized. Examples: Airlines with business travelers and
vacationers.
Slide 113
113 Monopsony Single buyer instead of single seller. Price paid
is less than competitive level. Quantity purchased is also less.
Deadweight loss, similar but inverted compared to monopoly.
Slide 114
114 MR D PcPc QcQc PmPm QmQm 1 2 3 4 Monopsony pays lower
price, consumes smaller quantity. Deadweight Loss 1+2. Area 5+4 is
transfer to consumer from producer. S MFC 5 6 7 8
Slide 115
115
Slide 116
116 The Causes of Monopoly Natural Monopoly and Network effects
Government grant (U.S. postal service, electric company), Patents
and Copyright. Control of scarce resource. Technical Superiority.
Attempts to Cartelize Industry
Slide 117
117 Natural Monopoly Downward sloping AC curve. More efficient
to have 1 large firm than many small firms. Rate of return
regulation is how we regulate these firms. Removes incentive to
keep costs down.
Slide 118
118 AC PrPr QrQr MC QEQE D MR PEPE Losses with efficient output
PmPm Qm Unregulated Profit Natural Monopoly
Slide 119
119 Network Effects Increased market size makes product more
valuable to consumers. This is just like an economy of scale in
that it benefits large firms relative to small ones. Leads to
natural monopoly. It implies that demand increases for large
networks, and that prices should rise. In Microsoft case, judge
decided that they are a barrier to entry.
Slide 120
120 Patent (copyright) tradeoff With no protection, creators do
not reap much of the rewards of their creations. They are given
monopoly protection, which increases their revenues, but raises
price to consumers. This increases the number of inventions, but
decreases the use of each invention? We do not know the optimal
tradeoff.
122 Monopolization If earned through better performance is not
illegal. Agreements to restrain trade are per se illegal.
Definition of market is often crucial here.
Slide 123
123 Cartels 1.Firms try to collectively act like a monopolist.
This means restricting output to raise price. 2.What are the
impediments? 1.KEY POINT: FIRMS HAVE AN INCENTIVE TO CHEAT because
their elasticity is greater than the industry as a whole. 3. Even
if firms can reach an agreement, how can it be enforced?
Slide 124
124 Cartels 1.Enforcement is the crucial problem for a cartel.
Since every firm individually has an incentive to cheat, some
impediment to cheating is required if the cartel is to succeed. The
usual impediments to rule breaking are detection and punishment.
Cartels need to implement the same impediments. 2. Detection: How
can the cartel determine when someone has violated the agreement?
3. (1) Can it use police power of the state? 4.(2) Can it use its
own enforcement agency? Mafia, etc.
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125 Cartels 1.Can the Cartel punish one firm without hurting
member firms to the same extent? 2.Can they all target their
punishment to harm only the one cheating firm? 3.Is OPEC a cartel?
4.It is unclear whether OPEC is a classic cartel. Did everyone in
the organization have to cut output?
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126 Price Discrimination Illegal if it gives some firm an
advantage over other firms. If individuals are consumers, is not
illegal. Price Discrimination is not likely to harm efficiency.
Perfect Price discrimination is perfectly efficient. Intention of
this rule was to protect mom-and- pop stores and grocers from
department stores and supermarkets. It was intended to reduce
competition.
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127 Public Goods 1. Definition: Goods that do not get used up
when consumed. In other words, one persons consumption of a good
doesnt reduce anyone elses potential consumption of the same good.
2. Obviously, these are not physical items that get used up.
Instead they are usually ideas and artistic expressions. 3. They
are at the core of the Information Age Economy, since information
is a public good. 4. The Demand for Public Goods is the vertical
sum of individual demands.
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128 Vertical Addition of Demands Q Q1 D D3D3 D2D2 D1D1 P1P1
P3P3 P2P2 P4P4
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129 Public Goods 1. Think of book titles as public goods, but
physical copies of single book title are private goods that embody
a public good. 2. Several questions arise: how many titles are
optimal to publish? How many copies of each title would be optimal?
How do competitive markets work? Monopolies? Finally, is it
possible to produce public goods efficiently?
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130 Q Q1 Q2 D P1P1 P3P3 P2P2 P4P4 In principle, a perfectly
discriminating monopolist can produce efficient amount of public
good. S
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131 number of copies of a title MC of printing 1 2 3 4 5 6 7 8
Pm Qm Production of a Single book title MR D
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132 number of titles written MC of writing another title Pm Qm
Perf Discrimination Demand for titles Q* Market Demand for Titles
Attainable Demand for titles Q**
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133 Copyright Tradeoffs Underconsumption- too little
consumption of a particular title. Underproduction- too few titles.
Due to public goods nature of books. Question: is this model
actually the appropriate model? Does copyright raise price in the
consumption market?
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134 Copyright without higher prices How would copyright benefit
owner if it doesnt raise price? Increasing the quantity might be
beneficial even at non monopoly price. Restricted entry prevents
profits from being driven down and that is the benefit of
copyright.
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135 Predatory Pricing Current court-created definition (known
as Areeda-Turner rule) : price below average variable cost. Also
requires that there be a serious likelihood of driving prey out of
business and of recouping losses. Likely to lose money for the
predator, and unlikely to remove the prey. Can only succeed if prey
is removed. Few real world examples. Standard Oil cases are largely
fictional.
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136 AVC AC AFC P Q p3 p2 p1 S MC Predatory Pricing
Slide 137
137 Resale Price Maintenance 1.These are laws (also called fair
trade laws), at the state level, that forbid retailers from
charging less than a price specified by a manufacturer. 2.Puzzle:
why would manufacturers not be happy to have retailers selling
their product at low prices, since that would seem to increase
sales and profits?
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138 Resale Price Maintenance 1.Answer: Two possible answers
a.Firms are colluding and Resale Price Maintenance removes the
incentives to cheat since if they lower their price to retailers it
wont get passed on to consumers and it will not increase their
profits. b.Goods need special treatment from retailer, and free
riding by some retailers will force others to stop providing the
treatment. RPM stops some retailers from free riding off of other
retailers.
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139 Tie-In sales. Generally considered to be an extension of
monopoly by courts. In other words, courts believed it was an
attempt to use one monopoly to create a second. Tie-In sales are
poorly understood by courts, imperfectly understood by most
economists. Frequently, tying good is sold very cheaply, while tied
good is very expensive. Famous cases: IBM and computer cards, Xerox
and toner, Canning machines and tin plate. Two monopolies are not
better than one if products are used together (in fixed
proportions).
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140 P Q Tie In Sale when products used together PLPL Q1Q1 MR D
pairs of shoes MC=AC left or right shoes MC=AC pairs of shoes 2P L
P P -P L
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141 PD version of Tie-In Story 1.Seller is thought to have two
types of customers heavy versus light users. 2.Tied good is thought
to meter the use of the tying good, to separate heavy from light
users. 3.By lowering price of tying good, and raising price of
tied-good, producer increases payments made by heavy user relative
to light user. 4.Problems: heavy users likely to use up machines
faster tie-in may have no impact on relative payments.
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142 Risk Reduction version of Tie-In 1.Consumers are unsure how
much use they will get from the tying good (machine). 2.This
riskiness causes them not to be willing to pay the full expected
(predicted) value of the product. 3.Seller has many such customers
and can provide insurance since the large numbers makes overall
results predictable. 4.By lowering price of tying good, and raising
price of tied-good, producer provides insurance for consumers
afraid they might not have much use for machine.
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156 Economics in the Real World Should the Record Industry
worry about file-sharing? First you use economic theory. Then you
perform empirical analysis based upon economic understanding.
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157 4 Possible Impacts of Copying on the Producer Substitution
Effect: Copies replace the purchase of a work. This is most basic
intuition. Clearly decreases sales. Not a problem for videotaping.
Hard to imagine that it isnt important for many forms of copying.
Particularly counterfeiting.
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158 Indirect Appropriability Producers capture value of copies
( Liebowitz, J. Political Economy, 1985) Requires: Large
variability in copies made per original inability to identify which
originals are turned into copies This is the reason photocopying
did not appear to harm publishers.
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159 Try out before purchase Defense in the Napster Case If cost
of sampling low, it is efficiency enhancing. But not necessarily
revenue enhancing! Drunken Sailors Example Empirical evidence that
sampling doesnt increase sales. Superior choices of Cable TV
generally doesnt increase viewing hours Radio doesnt appear to
increase record sales. Sampling (Exposure Effect)
Slide 160
160 Users have higher value because there are more other users.
It is not clear which products this might apply to, perhaps
business software. Users of Copies Increase Value to Purchasers
Could in theory increase sales. Seems unlikely to be important in
most instances of copying. Network Effects
Slide 161
161 More Measurement Problems Inspires confidence, doesnt
it?
Slide 162
162 Filesharing
Slide 163
163 What Did Napster Victory Do?
Slide 164
164 The blip in 2004 and Measurement Issues
Slide 165
165 No Change in Substitute Markets in the Period around
1999
Slide 166
166 DVD growth was close, but no cigar.
Slide 167
167 DVD Sales Rose, but Rentals Fell Overall, it cant explain
the CD decline
Slide 168
168 Additional Evidence It has been claimed (Oberholzer/Strumpf
Grokster Amici brief) that genres of music least likely to have
been downloaded have shared in sales decline (in particular Country
Music), which would be inconsistent with downloading causing the
harm.
Slide 169
169 The RIAA Law Suits had some Initial Success Sales increased
as well during first six months, consistent with assumption of
file-sharings harm. File-sharing declined in the first six months,
consistent with timing of RIAA lawsuits.
Slide 170
170 Statistical Study Compare sales change in cities based on
change in file-sharing, proxied by Internet usage. 1998 to 2003.
Control for as many other variables as possible: income,
demographics, etc. By taking differences over a short time
interval, you control for characteristics of cities that do not
change over short intervals.
Slide 171
171 Result File-sharing has caused the entire decline in sales,
and prevented a robust period of growth.
Slide 172
172 Tragedy of the Commons Common Property Resource lake,
forest, any productive resource that allows free use. The tragedy
is that the resource is overused. Greater tragedy is that it is
overused to the point where its entire value might be
dissipated.
Slide 173
173 Fishermen on Lake
Slide 174
174 Illustrating Overuse
Slide 175
175 Business Applications Should a firm have internal charges
when one division helps another (e.g. technical support)? Network
Effects (again).