1. ECON 202: Principles of Microeconomics Review Session for Exam 3 Chapters 11-15

2. Review Session 32 ECON 202: Princ. of Microeconomics Review Session 3 1. Perfect Competition. 2. Monopolistic Competition. 3. Oligopoly. 4. Monopoly. 5. Pricing Strategy.

3. Review Session 33 ECON 202: Princ. of Microeconomics Review Session 3

4. 4 ECON 202: Princ. of Microeconomics 1. Perfect Competition Conditions for perfect competitive market:  Many buyers and sellers, small relative to the market.  Products are identical.  No barriers to new firms entering the market. Prices are determined by the interaction of aggregate demand and aggregate supply. Firms are so small that cannot affect the price in the market.  If raise prices, consumers switch to another firm.  Price takers.  Example: wheat farmers. Firms face perfectly elastic demand.

5. Review Session 35 ECON 202: Princ. of Microeconomics 1. Perfect Competition

6. Review Session 36 ECON 202: Princ. of Microeconomics 1. Perfect Competition In order to maximize profits is equivalent:  To produce where difference between total revenue and total cost is the greatest.  To produce where marginal revenue is equal to marginal cost. In the case of firms in perfectly competitive markets, marginal revenue is equal to the price in the market. Condition for maximizing profit:  Price = Marginal Cost

7. Review Session 37 ECON 202: Princ. of Microeconomics 1. Perfect Competition Remember that:  Total Revenue = Price x Quantity  Total Cost = Average Total Cost x Quantity Price and cost (dollars per bushel) Quantity P Marginal Cost Q Profit Maximizing level of output Total Revenue Average Total Cost Total Cost Profit

8. Review Session 38 ECON 202: Princ. of Microeconomics 1. Perfect Competition Shut-down decision in the short run. Price and cost (dollars per bushel) Quantity Marginal Cost Average Total Cost Average Variable Cost P1P1 Q1Q1 P2P2 Q2Q2 P MIN Q SD Supply Curve for the firm in the short run

9. Review Session 39 ECON 202: Princ. of Microeconomics 1. Perfect Competition In the long-run  With economic profit, entry of new firms make price decrease until firms are breaking even.  With economic losses, exit of firms make price increase until firms are breaking even.  Resulting situation is Long-run competitive equilibrium. Long run competitive equilibrium price is at minimum point of the Average Total Cost curve. Economic profits disappear in the long run.

10. Review Session 310 ECON 202: Princ. of Microeconomics 1. Perfect Competition According to the slope of long-run supply curve  Horizontal: constant-cost industries.  Upward sloping: increasing-cost industries.  Downward sloping: decreasing-cost industries. In the long-run, perfect competition results in productive efficiency.  When a good is produced at the lowest possible cost. Also, perfect competition achieves allocative efficiency.  A state of the economy in which production represents consumer preferences  Every good is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it.

11. Review Session 311 ECON 202: Princ. of Microeconomics 2. Monopolistic Competition Monopolistic Competition is market structure where:  Many firms.  Barriers to entry are low.  Products are similar, but not identical.

12. Review Session 312 ECON 202: Princ. of Microeconomics 2. Monopolistic Competition

13. Review Session 313 ECON 202: Princ. of Microeconomics 2. Monopolistic Competition Economic profits attract more firms:  Shifts demand to the left.  Makes demand more elastic.

14. Review Session 314 ECON 202: Princ. of Microeconomics 2. Monopolistic Competition Monopolistic Competitive firms have excess capacity.  By increasing output, average cost can be reduced. In monopolistic competition:  Productive efficiency is not reached: products are not produced at the lowest cost.  Allocative efficiency is not reached: firms charge a price different than marginal cost. However, consumers benefit from differentiated products and more closed suited to their tastes.

15. Review Session 315 ECON 202: Princ. of Microeconomics 3. Oligopoly Oligopoly is market structure where:  Few competitors.  Identical or differentiated products.  Restrictions to entry. In case of oligopolistic markets, revenues of the firms depend on actions of other competitors. Approach to analyze oligopolies: game theory.

16. Review Session 316 ECON 202: Princ. of Microeconomics 3. Oligopoly More than 40% indicates 4-firm concentration ratios per industry oligopolistic market. Herfindahl-Hirschman Index (HHI)  Sum of squared shares: 30 2 + 30 2 + 20 2 + 20 2 = 2,600  HHI > 1,800 : oligopolistic markets. Barriers to entry.  Economies of scale.  Ownership of a key input.  Government-imposed barriers.

17. Review Session 317 ECON 202: Princ. of Microeconomics 3. Oligopoly Duopoly: price competition between two firms. Firms would collude, but is against the law.

18. Review Session 318 ECON 202: Princ. of Microeconomics 3. Oligopoly Dominant strategy  The best strategy for a player, regardless of what the other players decide. Nash equilibrium.  A situation where each player is choosing its best strategy, given the others players’ strategies.  A situation where no player has an incentive to change of strategy. In most business situations games are played repeatedly.  Firms can collude implicitly to reach the cooperative equilibrium.  Example: “low price guaranteed”

19. Review Session 319 ECON 202: Princ. of Microeconomics 3. Oligopoly Sequential games to analyze business strategies. Best strategy for WalMart is to build the large store, deterring entry from Target.

20. Review Session 320 ECON 202: Princ. of Microeconomics 3. Oligopoly Forces that determine the level of competition in an industry.

21. Review Session 321 ECON 202: Princ. of Microeconomics 4. Monopoly A monopoly is a firm that sells a good that does not have close substitutes. In other words, a monopoly is a firm that can ignore the actions of all other firms.  If it can ignore them, they are not producing close enough substitutes. Reasons for monopolies  Entry Blocked by Government Action Patents and copyrights. Public franchises.  Control of a Key Resource  Network Externalities  Natural Monopoly

22. Review Session 322 ECON 202: Princ. of Microeconomics 4. Monopoly

23. Review Session 323 ECON 202: Princ. of Microeconomics 4. Monopoly Monopoly reduces economic efficiency.

24. Review Session 324 ECON 202: Princ. of Microeconomics 4. Monopoly At the present, mergers of large firms have to be approved by:  Antitrust Division of the US Department of Justice.  Federal Trade Commission. Mergers guidelines  Market definition Relevant market is the market where by rising the prices of all the firms, profits increase.  Measure of concentration: Herfindahl-Hirschman Index (HHI) 01,000 1,800 10,000 Not concentrated Moderately concentrated Highly concentrated Mergers not challenged by FTC & DoJ If HHI rises > 100: mergers MAY be challenged If HHI rises > 50: mergers MAY be challenged If HHI rises > 100: mergers WILL be challenged

25. Review Session 325 ECON 202: Princ. of Microeconomics 4. Monopoly Regulating Natural Monopolies

26. Review Session 326 ECON 202: Princ. of Microeconomics 5. Pricing Strategy Price discrimination:  Charging different prices to different customers for the same product.  Price differences are not explained by differences in cost. Requirements for successful price discrimination:  Market power.  Different types of customers (willingness to pay).  Ability to separate types of customers (no arbitrage).

27. Review Session 327 ECON 202: Princ. of Microeconomics 5. Pricing Strategy Less elastic demand pays a higher price. More elastic demand pays a lower price.

28. Review Session 328 ECON 202: Princ. of Microeconomics 5. Pricing Strategy Perfect price discrimination  If monopolist know the willingness to pay of all the customers, it can charge exactly this willingness to pay to them.

29. Review Session 329 ECON 202: Princ. of Microeconomics 5. Pricing Strategy Two-part tariffs  When consumers pay one price (or tariff) for the right to buy as much of a related good as they want at a second price.  Disneyland, Ipods.

30. Review Session 330 ECON 202: Princ. of Microeconomics 5. Pricing Strategy Different types of customers and asymmetric information  Firms know that customers have different willingness to pay for goods, but their identification is difficult.  They try to have customers reveal their type: High-value customers to order the higher priced pack. Low-value customers to order the lower priced pack.

31. Review Session 331 ECON 202: Princ. of Microeconomics 5. Pricing Strategy

32. Review Session 332 ECON 202: Princ. of Microeconomics 5. Pricing Strategy Because of difficulty to identify each type of customer, firm ends up:  Giving some extra benefit to high-value customer in order to make her reveal her identity.  Selling a lower than efficient level of quantity to low-value customer. Price per channel is higher for the low value customer ($14 / 4 = $3.5) than for the high value customer ($26 / 10 = $2.6). Quantity discounts are not only explained by differences in cost, but also by pricing strategies of firms.

33. Review Session 333 ECON 202: Princ. of Microeconomics Problems Given this information for a firm in a perfect competitive market: How much will produce at a price of $55? What will be its profit? The firm will have economic losses if the price goes below: If in the long-run equilibrium there are 100 identical firms in this market, what will be the quantity supplied in the market? If in the long-run equilibrium aggregate demand shifts to the left, will firms enter or leave this market?

34. Review Session 334 ECON 202: Princ. of Microeconomics Problems Given this information for a firm in a monopolistic competitive market: What price maximizes profits for the firm? Will its profit be above or below $700? What is the productively efficient level of production?

35. Review Session 335 ECON 202: Princ. of Microeconomics Problems Suppose that at initial point, they keep the level of tuition, do any school has incentives to change of strategy? What is the dominant strategy for Texas M&A? And for t.u.? What is the Nash equilibrium?

36. Review Session 336 ECON 202: Princ. of Microeconomics Problems What is the quantity produced by this monopolist? What is his profit? What is the Deadweight Loss? What is the productively efficient level of production? Suppose that there is only one consumer in this market and that price in the demand curve when quantity is 600 is $82. Would the monopolist make more profit by charging a two- part tariff? How much would be the entry fee and the price per unit.

37. Review Session 337 ECON 202: Princ. of Microeconomics Problems What is the price and quantity that this monopolist will choose? What is his profit? If a regulatory agency wants the monopoly to produce the productively efficient level of output, how much would the monopolist produce? What is the profit of the monopolist in this case? What price and quantity should impose the regulatory agency to make sustainable the monopolist? Suppose that the monopolist is again free to decide how much to charge and produce How much will the monopolist collect from entry fees if decides to charge a two- part tariff? How much will the monopolist charge per unit of product? How much is his total profit in this case?

38. ECON 202: Principles of Microeconomics Review Session for Exam 3 Chapters 11-15