Praxeology with Dr. T

1. First, press the F5 key (or the “Slide Show” button) to view this slide in the presentation mode. And then with the sound on your computer system turned on and turned up, please Click on theGoldenSpeaker on the right to hear an important preliminary message: Praxeology with Dr. T

2. Chapter 6 The Best Quantity and Price

3. Two Types of Firms • Price Takers • Price Searchers -------------------------------------- • We will dispense with the price takers rather quickly, and then focus on price searchers.

4. Price Takers • Price is determined in the market. • Each firm is so small, it can’t affect price.

5. Price Takers • Each firm faces a horizontal demand curve. • There is perfect substitutability. • There is nothing at all unique about any particular seller’s product and/or service. • There is no conceivable reason to buy from Jones rather than Smith.

6. Price Takers • Marginal revenue is the same as price. • Because the firm can sell all it wants at the going price. • Firms does not have to reduce price to get more customers.

7. Price Takers • Price is given, so the only decision is quantity. • Best quantity is the point at which marginal revenue equals marginal cost.

8. Is “Price Taker” Assumption Realistic? • Probably not. • The assumption is that there is no difference at all in the entire purchasing experience that is different between one firm and another. --------------------------------- • At least, the “price taker” assumption should never be used as a standard by which real-world markets are judged.

9. Price Searchers • Each firm’s product (broadly defined) is at least somewhat different. • Each firm faces a downward sloping demand curve. • They must reduce price if they want to sell more units.

10. Price Searchers • Assuming no price discrimination, as price is decreased, two things happen: • Previous customers get a lower price. (This reduces revenue.) • The firm picks up new customers. (This increases revenue.) ---------------------------------- • The marginal revenue is the net effect of these two things.

11. Marginal Revenue for the Price Searcher • Because the price searcher has to lower prices in order to sell more, his marginal revenue will be inside the demand curve.

12. The Best Quantity for the Price Searcher • The best quantity to produce is the point at which the marginal revenue equals the marginal cost. • 20 Units.

13. The Best Price for the Price Searcher • The best price is the price that corresponds to the best quantity. • First, find the best quantity, then go up to the demand curve to find the price that is charged when that quantity is produced. • Notice that price ($15) is higher than marginal cost.

14. An Interesting “Problem” • Consider Frank. He is willing to pay a price higher than the marginal cost, but yet the firm is NOT willing to sell to him. Why? • Because if the firm wants to sell more than 20 units, it must lower the price to the previous 20 customers as well. This makes the marginal revenue less than the height of the demand curve.

15. The “Deadweight Loss” Triangle • The yellow area is sometimes called a “deadweight loss triangle.” • Some say that the firm “should” produce 30 units instead of 20.

16. “Price Discrimination” to the Rescue • If the firm could charge each customer on the demand curve the price that each of them is willing to pay, then the marginal revenue curve would be the same as the demand curve. • In such a case, the firm would be willing to produce 30 units instead of 20.

17. Price Discrimination • But price discrimination is difficult. • It is impossible to know the demand prices of all the customers. • What if some enterprising customers buy from us at the lower price and then sell to our own customers at a higher price? • So, “perfect” price discrimination is not usually feasible for a firm.

18. “Partial” Price Discrimination • But it is sometimes possible to group customers into categories depending on the firm’s perception of the relative demands of its various customers. • This “partial” price discrimination is quite common. • From a property rights perspective, there is nothing morally wrong with price discrimination, because there is no violation of rights.

19. More on the Deadweight Loss Triangle • The price-taker “standard” suggests that a firm should produce where “price equals marginal cost.” • The perfect price discrimination standard would cause the firm to produce where “price equals marginal cost.”

20. More on the Deadweight Loss Triangle • Neither of these standards (on the previous slide) is even remotely feasible in the real world. • The deadweight loss triangle is a “loss” only when compared to situations which cannot exist.

21. Thanks for Viewing Dr. T 775-727-2009