In each case: fixed firms in the market, then entry/exit

Transcription

1 Main structure Firms are price-takers (Perfect competition) Firms have market power (Imperfect competition) (Sessions 1 6) (Firms decisions &equilibrium) Firms decisions Equilibrium (Sessions 7 11) (Sessions 12 15) In each case: fixed firms in the market, then entry/exit Review Session Slide 1

2 Key ideas on imperfect competition Imperfect competition Fixed firms in market Entry & exit Firms decisions Equilibrium Firms decisions Equilibrium MC = MR P, Q Nash eqm. VΠ > FC? Each active firm has economic profit 0. No potential entrant could make economic profit > 0 by entering. Review Session Slide 2

3 And their analogues for perfect competition Perfect competition Fixed firms in market Entry & exit Firms decisions Equilibrium Firms decisions Equilibrium MC = MR = P s i (P) s(p) = d(p) VΠ > FC? P > AC u? Each active firm has economic profit 0. No potential entrant could make economic profit > 0 by entering. Review Session Slide 3

4 Prices with imperfect competition $ 25 P π MC 10 5 d(p) Q π MR Q Pricing reflects both marginal cost and a markup. Review Session Slide 4

5 Advantage of the model of perfect competition? There are no mark-ups, so we can isolate the effects of cost on prices. with a remarkably simple 2-dimensional picture: supply=demand. Review Session Slide 5

6 Price after a shift in demand: perfect competition s(p) d(p) d new (P) Q Review Session Slide 6

7 Reasons for the upward sloping supply curve? 1. Increasing marginal cost of firms in the market. Particularly pronounced in the short-run, hence the lower elasticity of short-run supply and the greater short-run volatility of prices. 2. Increasing minimum average cost of subsequent entrants (entry by heterogeneous firms). 3. Increasing cost of key inputs $ (example: cranberry bogs) s(p) 40 P Producer surplus Total cost d(p) Q Q Review Session Slide 7

8 Price after a shift in demand: perfect competition s(p) d(p) d new (P) Q Change in price is due entirely to increasing marginal costs (of existing firms, of new entrants, or of scarce inputs). Review Session Slide 8

9 Session 8: Pricing with Market Power 1. The firm s pricing problem: MC = MR. 2. Profit-maximization versus social efficiency. 3. Exit and entry. 4. Social efficiency with a LR fixed cost. Review Session Slide 9

10 Once upon a time, on some exam You manage the Zenith, a venue for concerts in Paris. You have signed a contract with a band called Tool for a concert on December 10. The contract specifies that the band receives 60,000 plus 12 per ticket sold. Assume that you have additional (constant) marginal costs of 8 per ticket sold and that you are not capacity constrained. The demand curve for the concert is Q = 8, P. a. What price should you charge? Review Session Slide 10

11 b. Suppose that Trent Reznor, a musician, has offered to join the concert to perform together with Tool. His presence would cause demand at any price to double. Reznor wants a fixed payment that does not depend on the number of tickets sold. What is the maximum amount you would be willing to pay him? Review Session Slide 11

12 Session 9: How pricing depends on demand 1. Useful formula: ( MR = P 1 1 ) E 2. Price-sensitivity effect: (Assuming constant marginal cost ) If demand becomes less price sensitive, then the firm should raise its price. 3. Volume effect: (Keeping price-sensitivity constant ) If a firm has increasing marginal cost and the volume of demand goes up, then the firm should raise its price. Review Session Slide 12

13 Session 10: Explicit price discrimination Bottom line: Equate MR across market segments. Charge higher price to segment with less elastic demand. Review Session Slide 13

14 Once upon a time, on some exam A pharmaceutical firm sells a patented drug in Hong Kong and Taiwan. It produces the drug with constant marginal cost in a plant in Singapore and transportation costs for delivering the drug to Hong Kong and Taiwan are thesame.thedrugsellsfor30inhongkongand20intaiwan(pricesin $US). Recent estimates have shown that the elasticity of demand is 2 for the Hong Kong market and 5 for the Taiwanese market. You are told that the price is set correctly (i.e., maximizes profit) for the Taiwanese market. Show that the price is not correct for the Hong Kong market. In which direction should the firm adjust its price? Review Session Slide 14

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16 Session 11: Implicit price discrimination (Screening) 1. Perfect price discrimination (benchmark) 2. Screening via differentiated products 3. Bundling Review Session Slide 15

17 FPM Ex Zahra sells a good with unit demand. She has constant MC = 5. Zahra has perfect information about her customers valuations. But she is initially prohibited by law from price discrimination. She chooses to charge $10, which results in sales to 10,000 customers. She calculates that these customers obtain a total of $50,000 in consumer surplus. Then the regulation is lifted and she engages in perfect price discrimination. Based on this limited information, what can you say about (a) how many customers she will sell to? > 10,000 (all her old customers plus more) (b) what range of prices she will charge? 5andup (down to her MC) (c) how much her profit will go up by? > 50,000 (prior consumer surplus + deadweight loss) Review Session Slide 16

18 Sample Exam 3, Problem 17 (Bundling) You are a monopolist selling two different types of concert tickets. You have zero marginal cost and hence your objective is to maximize revenue. You face three groups of potential customers, with an equal number of customers in each group. The following table summarizes the valuation of each group for each concert. (Each customer s valuation of going to both concerts is just the sum of his individual valuations.) Valuation Type Rock World A 5 60 B C Review Session Slide 17

19 Sample Exam 3, Problem 17 (Bundling) (Continued) Valuation Type Rock World Bundle A B C (a) Pure bundling: What is the optimal price for the bundle of both tickets? What is your profit? See valuations of bundle above. Possible price points are 65, 100, and 110, yielding revenue (profit) 195, 200, and 110. So optimal bundle price is 100 for a profit of 200. (b) Mixed bundling: Find one mixed bundle pricing strategy that gives you higher profit than your answer with pure bundling. Offer World ticket alone for 60; sell this to A. Offer bundle for 95; sell this to B and C. (Price has to leave surplus of at least5fortypeband10fortypec,sothattheydonot prefer the single ticket. Total profit is = 240. Review Session Slide 18

20 With 4 sessions on game theory Tools/concepts that go beyond our applications to pricing and competition Session 12: Static Games and NE Basic and universal tools. Session 13: Imperfect Competition Price and quantity competition: static games. Core session vis-à-vis the framework. Session 14: Explicit and Implicit Cooperation How and why to explicitly or implicitly cooperate. Session 15: Strategic Commitment How timing and commitment matter. Review Session Slide 19

21 Session 12: Static Games and Nash Equilibrium 1. Players, actions, payoffs. 2. Best responses. 3. Dominant strategies. 4. Nash equilibrium. Review Session Slide 20

22 Session 13: Price competition with fixed firms 1. Each firm s decision is same as pricing with market power: Topics 8&9 2. Goods are substitutes prices are strategic complements (Always with linear demand; almost always in real life.) 3. Interaction captured by Nash equilibrium Each firm s price maximizes its own profit given price of the other firm. Review Session Slide 21

23 Scenario Product category: Passenger jets. Dominated by two firms: Airbus (A) and Boeing (B). (For simplicity, imagine that each firm produces one kind of jet, and these two jets make up the entire product category.) Hypothetical demand functions: Q A = 60 3P A + 2P B Q B = 60 3P B + 2P A Constant marginal cost, same for both firms: MC A = MC B = 12. Review Session Slide 22

24 Now the exercise Q A = 60 3P A + 2P B, MC A = 12 Q B = 60 3P B + 2P A, MC B = 12 I tell you: Nash equilibrium prices are P A = 24 and P B = 24. Now you tell me: If you calculate Airbus marginal revenue at these prices, what value will you find? Now do it, using the formula for MR as function of price and elasticity. Review Session Slide 23

25 Session 13: Imperfect competition with entry/exit 1. Entry has two effects on profit: smaller market shares greater competitive pressure on prices 2. Higher FC less entry less intense competition higher prices (Even though no firm bases pricing on its fixed cost.) 3. Increase in market volume more entry lower prices Review Session Slide 24

26 Exercise Consider the model of imperfect competition with free entry as studied in class (with constant MC). Which of the following statements are valid? (Circle any that apply. Give no explanations.) a. There is no deadweight loss. b. If the fixed cost falls enough, then entry will take place and the price will fall. c. An increase in market depth (increase in volume) is likely to lead to entry but overall the price will rise. d. The number of firms in the market is such that no firm makes a loss but if one more firm entered then it would not earn a profit. Review Session Slide 25

27 Session 14: Explicit and Implicit Cooperation 1. Nash equilibria are typically not efficient. 2. Cooperation (collective action) can be achieved by: Contracts. Repeated interaction. Merger between firms. 3. In price competition with substitute goods, cooperative solution means raising prices above the NE prices. 4. With complementary goods, the opposite. Review Session Slide 26

28 Go back to our Airbus-Boeing example Firms demand functions: Q A = 60 3P A + 2P B Q B = 60 3P B + 2P A Demand of merged firm: Use hint that prices should be the same: Common value P. Total demand Q = Q A + Q B as a function of P : Q = 120 2P. Elasticity of demand at the NE prices? What does this illustrate? Review Session Slide 27

29 Session 15: Strategic Commitment 1. Sequential games and backward induction. Life must be understood backward, but it must be lived forward. Soren Kierkegaard 2. When you have the chance to commit, think about: In what way you want to influence the other players actions. How you can achieve this. Review Session Slide 28

30 Exercise Consider the game payoffs shown below: Player A Up Down 9 7 Player B Left Right a. What is the Nash equilibrium of this game? (No explanation is needed.) b. What is the backward-induction solution of the Stackelberg game if player B moves first? (Show using a game tree.) Review Session Slide 29