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  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”

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 fixed cost

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 Fixed Cost

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

Price Discrimination: Market Power  First Degree: Perfect Price Discrimination  Efficient; No DWL  Second Degree: Volume Discounts  Economies 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 elasticities of demand  Identify these groups  Separate buyers into two or more groups  Charge different prices to each group  Prevent arbitrage  Profit Max: MR 1 = MR 2 = MC  P 1 (1 + 1/E 1 ) = P 2 (1 + 1/E 2 ) = MC  DWL ambiguous

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 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