Firms and customers III MPA 612: Public Management Economics February 20, 2018 Fill out your reading report on Learning Suite!
Current events Now expanded to take advantage of your new vocabulary!
Plan for today ϵlasticitiϵs of dϵmand Market power
ϵlasticitiϵs of dϵmand What happens to quantities as prices change?
<latexit sha1_base64="xfgnsxqj6yrtyipxczp/+xf4v5u=">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</latexit> <latexit sha1_base64="yi1u1ciet4n66jzb8tehjz/jsxq=">aaacjxicbvbns8nafnzu7/pv9ehlsqhelkki6keq9eaxbwufpptn9kwxbjzh90uoib/gi3/fi4cqgif/its2glohfoazebx9eyrsghtdd6c0mzs3v7c4vf5ewv1br2xs3pg41ryapjaxvg2yaskunfgghntea4scca2gfzhyww+gjyjvnq4s6etstolqcizw6lzo/qemitfcxoqe0n3qh5rxzl8eiyw28m/m5drheyepal6enfjyt1j1a+4ydjruc1ilbbxuzej3yp5gojblzky77ibyyzhgwsxkzt81kddez3fqtlqxu7gtjc/m6a5vejsmtx0k6vj9ozgxyjhbfnhkxpde/pvg4n9eo8xwujmjlaqiik8whamkgnnrz7qnnhcua0sy18l+lfj7zmta2+yohprfk6dj86b2unmbh9wz86knrbjndsgeqzmjckauieeahjnh8kyg5nv5cl6cn+d9ei05xcww+qxn8wu/jatv</latexit> Responsiveness to price changes " = % % " = Q P P Q % change in demand that follows a 1% change in price Q P or Q P ϵ = 2: If price increases by 10%, quantity decreases by 20% ϵ = 0.5: If price increases by 10%, quantity decreases by 5%
ϵ = = Perfectly elastic Any change in price moves quantity to 0 Identical goods Two vending machines ϵ > 1 = Elastic Changes in price change the quantity a lot Goods with substitutes Diet Coke ϵ = 1 = Unit elastic Changes in price change the quantity the same ϵ < 1 = Inelastic Changes in price change the quantity a little Goods with few substitutes AIDS medicine ϵ = 0 = Perfectly inelastic Changes in price do nothing to the quantity Survival goods Water in the desert
ϵ = = Perfectly elastic ϵ > 1 = Elastic ϵ = 1 = Unit elastic ϵ < 1 = Inelastic ϵ = 0 = Perfectly inelastic
Warning though! Elasticities are not the same as the demand curve A linear demand curve has lots of elasticities!
$60.00 $50.00 $40.00 $30.00 $20.00 $10.00 Elastic Demand Unit elastic Inelastic $0.00 $160.00 $140.00 $120.00 $100.00 $80.00 $60.00 $40.00 $20.00 $0.00 0 2 4 6 8 10 12 Revenue 0 2 4 6 8 10 12
Excel time! Go back to the Raspberry Cordial worksheet
Why do elasticities matter in public policy? Taxing things changes their prices Changing prices changes quantities Taxing elastic goods will make quantities go down a lot and decrease tax revenues Taxing inelastic goods will make quantities go down slightly and not hurt revenues
If P by 10%, Q 8.3% 2.7% 19.72%
General guidance Tax products with inelastic demand unless you're trying to change consumption Soda? Cigarettes? Alcohol? Property?
Market power Who gets to set the price?
Max π MC = MR Best Q Demand = MC Normal competition Demand = MC = MR = P
Where does price come from in perfect competition?
Price discrimination With perfect information, firms can set individualized demand curves for customers Price = WTP Lyft/Uber Airplane tickets Amazon
Price taking Firm decisions have no impact on the price of a good Perfect competition You re stuck with whatever the prevailing market price is
But what if you could affect the price? Would you want to? Why or why not? Costs matter. Set price to your MC, maximize your profit.
Market power Ability to influence market prices This is why people get MBAs; move market away from perfect competition
Monopolies Switching costs Branding and differentiation Cost or input controls Government regulation Price discrimination
Monopolies Market = 1 firm Monopolists will naturally produce less quantity at higher prices than firms in competitive markets Creates deadweight loss
<latexit sha1_base64="ic38cl1jyxanfugksep3n+neqvm=">aaacb3icbzdlssnafiyn9vbjlershynfecsslik6eirdugyhsyumlsl00g6dxjizccv06czxcencxa2v4m63cdjmoa0/dpx85xzonn+lgrxsnl+1wtlyyupacv3f2nza3jf29+5elhbmbbyxihc8jaijibellyx0yk5q4dhs9kb1rn5+ifzqkgzjcuzcaa1c6lompei947abt67heroewaojhudv1tpqvk8oylxnnleyy+zucnfyusmbxi2e8ex0i5wejjsyisg6lhlln0vcuszirhcsqwker2hausqgkcdctaehtocxin3or1y9umip/t2rokcicecpzgdjozivzfc/wjer/qwb0jbojanxbjgfmcgjmkuc+5qtlnlygyq5vx+feig4wljlp6sqrpmtf41dkv+vzwa1vlvj0yica3aetoeflkan3iigsaegj+azvii37ul70d61j1lrqctn9sefaz8/ovet8q==</latexit> Math time! P = Q + 40 TC = Q 2 + 140
What they ll charge P = MC = best Q under competition MR = MC = max(π)
Consumer surplus WTP price paid Producer surplus Price sold WTS Deadweight loss Loss of surplus from Paretoefficient point
Natural monopolies Big expensive things with large capital outlays and low marginal cost Generally more efficient to just have one firm handle it Utilities Public transportation
How do you fix monopolies? State ownership Pro: Better Q Con: Waste (x-inefficiency) Regulated monopolies Pro: Incentive to be efficient Con: Incentive to maximize capital (gold-plated water coolers)
How do you fix monopolies? Competitive bids Pro: Incentive to be efficient Con: Incomplete contracts Antitrust laws Pro: Increases competition Con: Bad for natural monopolies
How do you fix monopolies? Let the market go wild Pro: If monopolist can price discriminate, probably okay Con: Perfect price discrimination not possible + raises equity concerns
Switching costs Make it harder for consumers to switch away from you Brand-exclusive benefits Technology constraints Search costs Network costs
Branding and differentiation Make your stuff nonsubstitutable Advertising Brand loyalty
<latexit sha1_base64="o2/skqh4h3etfs3/pr38vpbdwuq=">aaacehicbvbns8naen34wetx1koxxsl0ykleua9csrcvqgrjc00pm+2mxbrzdbubqgn5c178k148qhj16m1/47bnqvsfddzem2fmxpgwqrtjfftlyyura+uljflm1vborr23/6bekjhxswbctkkkckoc+jpqrlqjjcgogwmgw8beb46ivftwez1oscdgfu4jipe2uteubpfeoppgcbxt5jmxwys4k9w8c0zikkrrjnjetstozzkclhk3ibvqwovax0fp4dqmxgoglgq7tqi7gzkaykbycpaqkia8rh3snpsjmkhonv0oh8dg6cfisfncw6n6eyjdsvljodsdmdidne9nxp+8dqqji05gezjqwvfsuzqyqawcxan7vbks2dgqhcu1t0i8qcypbuismxdc+zcxix9au6w5d2ev+nwrrgkcginqbs44b3vwazzgawwewtn4bw/wk/vivvsfs9ylq5g5ah9gff4aedccya==</latexit> If people are stuck with you (or like you a lot, or believe in your product, or if your stuff generally isn t substitutable) you can charge them more How much more? Markup depends on elasticity P MC P = 1 "
Elastic demand
Inelastic demand
Cost and input controls Own the means of production Control scarce inputs Control cheap supply chains
Government regulation Make the government stop others from competing with you Patents and intellectual property Licensing Prohibition of competition