Market Power, Price Discrimination, and Imperfect Competition

Market power

A Firm that is a price maker, influences the market price of its product.

Monopoly

A market dominated by one firm.

Sources of market power

Prevent further firms from easily entering.

Natural monopoly

Where one firm efficiently produces the entire industry output.

Switching costs

The costs that a consumer incurs due to changing products.

Differentiation

A strategy designed to differentiate company's products.

Absolute cost advantage in obtaining a key input

The Firm has absolute cost advantage over other firms.

Government regulation

A final import form of entry barrier.

Marginal revenue for a firm with market power

How this relates to price.

Profit maximization decision

Where cost = MR which equals MC, (C=MR=MC).

Lerner index

Computes how much a firm should mark up its price.

Inefficiency of market power

Consumer surplus, producer surplus, total surplus, transfer, deadweight loss.

Price caps

Government regulations to deal with market power.

Antitrust laws

Aimed to reduce market power.

Patents, licenses, copyrights

Forms of government regulation to protect the firm and promote innovation.

Pricing strategy

Uniform versus nonuniform pricing.

Requirements for nonuniform pricing

Has market power and can prevent resale.

Price discrimination

Has market power, prevent resale, consumers have different demand curves.

Direct price discrimination

This allows the firm to capture total market surplus.

Perfect price discrimination

Firm charges each consumer his willingness to pay.

Segmenting

This is how firms separate customers by charging different prices.

Indirect price discrimination

Firms offer a variety of pricing choices to the consumer.

Quantity discount

A decrease in price for consumers who purchase in large quantities, bulk.

Versioning

This is offered to the different types of consumers in a market.

Bundling

Pure Bundling is when a firm incorporates two or more products into a bundle and sells it at a single price.

Negatively Correlated Demand

When the willingness to pay for the 2 products is negatively correlated.

Block Pricing

This is a discounted price for the consumer for purchasing large quantities.

Two-Part Tariffs

This is where a firm charges two prices; a fixed upfront fee and then an additional price per unit on top of that.

Imperfect Competition

Market structure where firms have some market power and can influence prices.

Oligopoly

This is market competition among a small number of firms.

Nash Equilibrium

This is when both firms are best responding to each other, requiring each firm to do the best it can relative to other firms.

Collusion

This is an illegal business practice among firms who coordinate prices of their products sold.

Bertrand Competition

An extreme form of market competition where two firms compete on price until Price = MC.

Cournot Competition

Refers to an oligopoly with two firms producing identical goods, competing by choosing quantities simultaneously.

Residual Demand

Just the leftover demand after accounting for the quantities produced by other firms.

Residual Marginal Revenue

Same intercept and twice the slope of the residual demand curve.

Reaction Curves

Graphical curves that represent how firms will react to one another's actions.

Efficiency Implications of Collusion

The two firms would then split total market profit, which is found by (P-MC)xQ.

Efficiency Implications of Bertrand Competition

Prices will equal marginal costs, leading to no economic profit.

Efficiency Implications of Cournot Competition

Each country produces 20 barrels of oil.

Profit Calculation

Profit can be calculated as (P-MC)*Q when fixed costs are zero.

Producer Surplus

Equals profit if fixed costs are zero.

Market Power Requirements

To use advanced pricing strategies, a firm must have market power, can prevent resale, and consumers must have different or identical demand curves.

Optimal Strategy for Two-Part Tariffs

Determining the fixed fee and per-unit price to maximize profit.

Implications for Efficiency

Analyzing how different pricing strategies affect overall market efficiency.