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Economics 2023-02

Economics 2023-02. Class 18. Today’s class. Aplia Report: Two homeworks this week, Chapters 10 and 11 76% of you did the Chapter 9 homework 28% of you have done every homework On average, you have done 82% of the homeworks Best 10 weekly homeworks count 14% of final grade.

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Economics 2023-02

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  1. Economics 2023-02 Class 18

  2. Today’s class • Aplia Report: • Two homeworks this week, Chapters 10 and 11 • 76% of you did the Chapter 9 homework • 28% of you have done every homework • On average, you have done 82% of the homeworks • Best 10 weekly homeworks count 14% of final grade. • We will finish chapter 10, on monopoly. • Then we will start talking about the key issue of oligopoly, and how economics now approaches it, namely interaction and thus ‘game theory.’

  3. How does Aplia affect your final grade? • It doesn’t • Best 10 weekly grades count 14% • Average weekly grade counts 14% • Best 10 weekly grades count 18% • 120% of average weekly grade counts 12%

  4. Recap: Efficiency and Monopoly • Perfect competition is efficient because P = MC and surplus is maximized • Monopoly is inefficient because P > MC and surplus is NOT maximized – there is always a potential buyer who would be willing to pay more than the cost of producing another unit.

  5. Does the fact that perfect competition is socially efficient and monopoly is not mean that we should outlaw monopoly? Suppose the monopoly in question is the result of a patent that prevents all but one firm from manufacturing a highly valued product. Would we be better off without patents?

  6. Survey: Suppose without patents, there would be no new medicines. Patents result in [temporary] monopoly. Should monopoly be • Outlawed • Outlawed except for drug companies • Allowed for patents • Allowed whatever its cause

  7. Consider another case: suppose the monopolist is a natural monopolist. For the natural monopolist, MC < AC

  8. Efficiency requires P=MC But if MC<AC, if P=MC the firm loses money

  9. If society wants what she produces, it is better for the natural monopolist to maximize profit and stay in business than to charge MC and go out of business.

  10. The efficiency loss from single-price natural monopoly stems from the fact that the profit-maximizing price is above marginal cost, thereby excluding many buyers who "should" be in the market (because they are willing to pay a price greater than or equal to marginal cost).

  11. Recall that the monopolist would gladly expand output if it could do so without having to sell the current output at a lower price.

  12. Can a monopolist find ways of lowering prices to some buyers while keeping price high for others? [Whether a natural monopoly or just some other kind of monopoly] Jargon: Price discrimination: charging different buyers different prices for the same good or service.

  13. Example 18.1. Ram is a monopolist in the market for carved sisalwood bowls in his village, a minor tourist stop in Northern India

  14. Each day 8 tourists visit his shop, and each has a different reservation price for Ram's standard bowl. [Remember: ‘reservation price’ for a buyer is the highest price the buyer is willing to pay -- jargon] If these reservation prices are as listed in the table on the next slide, draw the demand curve Ram faces each day.

  15. Visitor Reservation price A $16 B $14 C $12 D $10 E $8 F $6 G $4 H $2

  16. The demand curve always shows at each point on it the reservation price of the buyer of that unit.

  17. Example 18.2. Ram has to charge the same price to all buyers. He can produce as many bowls as he chooses at a cost of $3 each (and only whole bowls can be sold). How many bowls should he sell each day if his goal is to maximize profit?

  18. Expand if MR > MC = 3. MR from 3rd bowl = 8; MR from 4th bowl = 4; MR from 5th bowl = 0; So keep expanding until Q = 4.

  19. Example 18.3. In the preceding example, how much profit does Ram make? Total revenue = 10x4 = $40/day Total cost = 3x4 = $12/day Profit = $40 - $12 = $28/day

  20. Example 18.4. In the preceding example, is 4 bowls per day a socially efficient level of output? No, because there are buyers (F, G) willing to pay more ($6, $4) for additional bowls than their $3 marginal cost.

  21. Visitor Reservation price A* $16 B* $14 C* $12 D* $10 E* $8 F* $6 G* $4 H $2

  22. Visitors A-G are willing to pay more for a bowl than the cost of producing one, and thus it would be efficient for each to get one. Visitor H is not willing to pay the cost of producing a bowl and so should not have one. Thus the socially efficient number for Ram to make and sell is 7 bowls/day.

  23. Example 18.5. Now suppose that Ram is a very shrewd judge of human nature. After a moment's conversation with a visitor, he is able to discover the visitor's reservation price for a bowl. If Ram then charges each visitor his respective reservation price, how many bowls will he sell and how much profit will he make?

  24. Ram will sell bowls to visitors A-G and each will pay his reservation price. He will not sell to visitor H. Visitor Res. price Visitor Res. price A* $16 E* $8 B* $14 F* $6 C* $12 G* $4 D* $10 H $2 Total rev = 16+14+12+10+8+6+4 = $70/day Total cost = 7x3 = $21/day Profit = 70-21 = $49/day

  25. A monopolist who is able to charge each buyer his or her reservation price is called a perfectly discriminating monopolist. For a perfectly discriminating monopolist, there is no efficiency loss [but the monopolist captures all the potential consumers’ surplus]. All buyers are served who are willing to pay a price high enough to cover marginal cost.

  26. In flea markets and tourist markets overseas, bargaining between buyers and sellers is common. • Bargaining can produce an outcome closer to social efficiency than fixed prices can • Bargaining rather than fixed prices shifts some surplus from buyers to sellers • Bargaining is a way tourists can exploit sellers in poor countries • 1 and 2 are both likely

  27. In practice, however, there are virtually no sellers who know each buyer's reservation price – and bargaining takes time and effort, so destroying surplus [for most people – maybe not some tourists]. Price discrimination does occur, but in reality it is usually imperfect price discrimination.

  28. More examples of price discrimination – time-of-day-pricing and toll-free HOV lanes

  29. The Hurdle Method of Discrimination

  30. Example 18.6. Ram's 8 visitors again have the same reservation prices for carved wooden bowls as before. Ram does not know each buyer's reservation price. But suppose he does know that no buyer with a reservation price above $9/bowl ever uses discount coupons. Those with reservation prices below $9 use them whenever they are available.

  31. If Ram makes coupons available in the government tourist magazine, those buyers who clip and present them get to pay a discount price for bowls. Others pay the regular list price for bowls. To maximize profit, at what levels should Ram set the list price of a bowl and the discount price?

  32. In each submarket, the monopolist should expand output as long as MR>MC. List Price SubmarketDiscount Price Submarket Visitor Res. price Visitor Res. price A $16 E $8 B $14 F $6 C $12 G $4 D $10 H $2

  33. List-Price Submarket Visitor Reservation price MR $16 A $16 $12 B $14 $6 C $12 $4 D $10

  34. For the list price submarket, MR from sale of fourth bowl is 4 > MC =3. To sell 4 bowls in the list price submarket, Ram will choose a list price of $10. At that price, all non-coupon clippers buy a bowl.

  35. Discount-Price Submarket Visitor Reservation price MR $8 E $8 $4 F $6 $0 G $4 -$4 H $2

  36. For the discount price submarket, the MR from the sale of the 2nd discount bowl is 4; the MR from the 3rd discount bowl is 0. So Ram should choose a discount price of $6/bowl and sell 2 bowls in the discount market.

  37. MRs in the discount price sub-market MR from the 2nd bowl is 4 MR from the 3rd bowl is 0

  38. Example 18.7. At a list price of $10/bowl and a discount price of $6/bowl in the preceding example, how many bowls does Ram sell and how much profit does he make? Is this outcome socially efficient?

  39. Total revenue = 10x4 + 6x2 = $52/day Total cost = 6x3 = $18/day Profit = 52-18 = $34/day The outcome is not socially efficient because visitor G doesn’t get a bowl even though he is willing to pay more ($4) than marginal cost ($3). But it is closer to efficiency than the single-price case.

  40. The discount coupon case is said to be closer to social efficiency than the single-price case. Why? • P = MC • More bowls are produced • Total surplus is larger • P = ATC • It is not really.

  41. Examples of the hurdle method of price discrimination: Rebate coupons: hurdle = having to mail the coupon to the manufacturer

  42. Temporary sales: hurdle = having to find out when & where the sale occurs

  43. Hardback books and paperbacks: hurdle = having to wait for the paperback Hardback: $25.00 Paperback: $16.47

  44. Evening shows and matinees: hurdle = having to go at a less desirable time Our Prices

  45. Note the hurdle it is hard to jump over … • Another form of price discrimination is discounts for students, children, and the old – hard to jump. • This kind of price discrimination is appealing to the monopolists. Why? • It works if different groups are mostly on different parts of the demand curve – i.e. have different price elasticities of demand.

  46. Coach fares and Super-Saver fares: hurdle = having to book a month in advance Los Angeles-Honolulu round trip: NW Flight 91 Depart Wed Mar 30 Return Fri Apr 1 $1467 NW Flight 91 Depart Thu Jun 16 Return Thu Jun 23 $570

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