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Market Dynamics and Pricing

Market Dynamics and Pricing. Entry and Exit in Perfect Competition and Monopoly; Monopsony ; Price Discrimination; Monopolistic Competition. Perfect Competition vs. Monopoly. Perfect Competition. Monopoly. Many sellers Homogeneous products (perfect substitutes) Easy entry and exit

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Market Dynamics and Pricing

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  1. Market Dynamics and Pricing Entry and Exit in Perfect Competition and Monopoly; Monopsony; Price Discrimination; Monopolistic Competition

  2. Perfect Competition vs. Monopoly Perfect Competition Monopoly • Many sellers • Homogeneous products (perfect substitutes) • Easy entry and exit • Perfect Information • Many sellers and homogeneous products imply that firms are price takers • One seller • One product - no close substitutes • Entry is blocked • Firm faces no competition and acts as a price “maker”

  3. Dynamics of Perfect Competition • Long run • Positive profits attract entry • Negative profits (losses) cause exit • Equilibrium occurs when there are no incentives for entry or exit • P=LMC=LAC • Zero Economic Profit • Short Run • Firms set P = MC • May result in profits or losses • Shutdown if P < AVC or operating losses > fixed cost

  4. Dynamics of Monopoly • Long Run • Firm may earn profits or losses at MR=MC • Positive Profits will not attract entry • Negative Profits (losses) cause exit (P < LAC) • Short Run • MR = MC • Firm may earn profits or losses • Shutdown if P < AVC or operating losses > Fixed Cost

  5. Monopsony: One Buyer • Single buyer, many sellers • No competition among buyers • Buyer chooses quantity where Marginal Expenditure = Marginal Value (Demand) • ME is analogous to MR for a seller • ME has twice the slope of the supply curve • Buyer restricts quantity and reduces price • Leads to dead weight loss similar to monopoly • Labor Unions may have been a reaction to monopsony behavior by firms in some labor markets

  6. Price Discrimination: Market Power • First Degree: Perfect Price Discrimination • Efficient; No DWL • Second Degree: Volume Discounts • Economics of Scale: MC < AC (P= MC is not profitable) • “Declining Block” Pricing: Lower DWL than MR = MC • Third Degree • Groups of Buyers (Markets) differ in price elasticitiesof demand • Identify these groups • Separate buyers into two or more groups • Charge different prices to each group • Prevent arbitrage • Profit Max: MR1 = MR2 = MC • P1(1 + 1/E1) = P2(1 + 1/E2) = MC • DWL ambiguous

  7. Monopolistic Competition • Many Sellers • Differentiated Products (not perfect substitutes) • Easy Entry and Exit • Short Run • Just Like Monopoly: MR = MC • May earn profits or losses • Shutdown if P < AVC or operating losses > Fixed Cost • Long Run • Positive profits attract entry • Losses cause exit • Equilibrium when there is no incentive for entry or exit • MR = MC => P = LAC; AC tangent to demand curve • DWL - ambiguous

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