Quantitative Demand Analysis and Production Costs, Quiz 4 econ, Chapter 7 & 8 Market Structures and Economic Concepts

Elasticity Formula

%ΔG/%ΔS. Greater than 1 is highly responsive, smaller than is slightly 1 responsive.

elasticity = 1

unitary

elasticity < 1

inelastic (not responsive)

Elasticity > 1

price is elastic

Total Revenue (TR)

P×Q.

Average Product of Labor (APL)

Q/L.

Average Product of Capital (APK)

Q/K.

Marginal Product of Labor (MPL)

ΔQ/ΔL or dQ/dL.

How to solve marginal product and capital questions

you just take the derivative in respect to k (capital) or L labor)

Value of Marginal Product (VMPL)

MPL×P.

Marginal Rate of Technical Substitution (MRTS)

MPL/MPK.

Total Cost (TC)

FC+VC(Q).

Marginal Cost (MC)

ΔTC/ΔQ.

Average Fixed Cost (AFC)

FC/Q.

Average Variable Cost (AVC)

VC/Q.

Average Total Cost (ATC)

TC/Q.

Total Variable Cost

Use AVC formula which is AVC=TC/Q plug in what you know.

Cost Function

Mathematical relationship that relates cost to the cost minimizing output associated with an isoquant.

determinants of Elasticity

1) Availability of substitutes

2) Time

3) Budget large ticket item or small ticket item

Short run

One factor held constant

Long run

everything is variable

Sunk Cost

-cost that is forever lost after it has been paid (like paying for a super bowl commercial)

VMPL(profit max input) must equal

wage

next best option for VMPL

≥ wage

Oligopoly

Few Firms, Interdependent

Sweezy

o The firms produce differentiated products

o Each firm believes its rivals will cut their prices in response to a price reduction but will not raise their prices in response to a price increase

Cournot (quantity battle)

o The firms produce differentiated products or homogenous(identical) products

o Each firm believes rivals will hold their output constant if it charges its output

-Each firms marginal revenue is impacted by the other. firms output decision

Stackelberg (price leadership)

o The firms produce differentiated products or homogenous products

o A single firm (the leader) chooses an output before all other firms choose their outputs

o All other firms (the followers) take as given the output of the leader and choose output that maximize profits given the leaders output

Betrand (price war)

o The firms produce identical products at a constant marginal cost

o Firms engage in price competition and react optimally to prices charged by competitors

o Consumers have perfect information and there are no transaction costs

-This war would come to an end when the price each firm charges equals the marginal cost

Collusion/Collusive(cartel)

o When firms openly and formally get together at united and set price and quantity

-They are illegal in the us

-Cheating: part of the agreement is for you and I to reduce and quantity and charge higher price, if one cheats and decides to increase qunaity and decrease price without telling it collapses. (this happens all the time)

Oligopoly solutions in terms of profit:

Profit of collusion >Profit of Cournot > Profit of stackleberg

> Betrand is the lowest

1st degree price discrimination

the practice of charging each consumer the maximum price he or she would be willing to pay for each unit of the good purchased

Implication and problem of 1st degree price discrimination

o the firm extracts all surplus from consumers and earns the highest possible profit

o managers rarely know each consumers maximum willingness to pay for each unit of the product (they need a lot of information)

Second degree price discrimination

posting a discrete schedule (2 or 3 different prices) of declining prices for different ranges of quantity. Available for everyone

Implication of Second degree price discrimination

firm extracts some surplus from consumers without needing to know the identity of various consumers' demand

Third degree price discrimination

1. charging different prices based on systematic differences in demand across demographic consumer groups

-Have to have two distinct group of customers (old vs young, male vs female)

-Have to have two different elasticities

-They should be separable

-No possibility of resale

Implications of Third degree price discrimination

o Marginal revenue will be different for each group. That is, if there are two groups MR1 > MR2 for example

Two Part Pricing

o A pricing strategy whereby a firm with market power charges a per unit price equal to marginal cost plus a fixed fee equal to the consumer surplus each consumer receives at this per unit price

o Like a membership thing, or an entrance fee and then buying this at the place

Block Pricing

a pricing strategy in which identical products are packaged together in order to enhance profits by forcing customers to make an all or none decision to purchase

-Ex) we will just have one price at 24 dollars

Which pricing strategy extracts all the consumer surplus

- 1st degree

- Two part pricing

- Block pricing

Cross subsidies:

a pricing strategy in which profits gained from the sale of one product are used to subsidize sales of a related product

Ex) wanting to ski but not having the equipment so you rent it. you spend 100 dollars on the ticket but 200 dollars on the equipment, they make money on the rent equipment rather than the ticket

Transfer Pricing

A pricing strategy in whihc a firm sets the internal price at which an upstream divison sells an input to a downstream divison

Ex) a parent company manufacturing goods in a high-tax country and selling them to a subsidiary in a low-tax country

Four-firm concentration ratio

Measures market share of top four firms.

C4(four firm) Ratio

(S1+S2+S3+S4)/Sr.

Highly concentrated market for C4

ratio close to 1

Herfindahl-Hirschman Index (HHI)

Square the market shares; ranges 0-10,000. 3450 means it needs to be watched closely (not comeptitive) the further away you are from 0 you are the more concentrated the market

Rothschild Index

Measures market concentration based on elasticities. Elasticity of total or Market / Elasticity of 1 firm

Lerner Index

= (P - MC) / P. o Closer to one you are concentrated, closer to 0 less concentrated

Markup formula

= 1 / (1 - L); indicates that the Lerner Index is (5) times the margina cost

Deadweight Loss (DW) Index

Measures social welfare changes with output increase. If you are closer to 1 firm expands its output and social welfare will improve, if DW is closer to 0 social welfare does not change

Barriers to Entry

- Capital Requirement: requires an enormous a lot of capital so companies cant come in

- Economy of Scale

- Patent: legal barrier that stops a firm

Vertical Merger

beginning and end of the production process all carried out by a single firm.

Example: Like a farmer growing wheat going all the way to the bakers.

Horizontal Merger

merging 2 or more similar final productions into a single firm:

Example: Like 20 lawyers forming a law firm

Conglomerate Merger

- Integration of 2 or more different product lines into a single firm. These companies don't have no relation.

Example: Warren buffet: buying anything and everything doesn't have to do with each other

Reasons For mergers

-Decrease cost,

- Recap the benefits of Economies of scale: will lead to less Competition but benefit them as they can share things

-Increase market power, HHI will go up

Perfect Competition

- : consumers are king, and firms are the servant, and markets are the agent. consumers are doing very good(farmers a good example)

Perfect Competition Must satisfy the following conditions:

- Must be identical( no difference among the products)

-Many buyers and many sellers

-Free Entry, Free exit (no barriers of entry/exit) most important characteristic, makes each buyer large or small

- Perfect information (both buyers and sellers know all the information)

- No transaction cost (you don't need a 3rd party to buy)

Monopoly

Single firm dominates market, sets prices and cannot charge any price Example: Souther california of Edison

Why do we have monopoly:

- Technology: Like Microsoft

- Geographical: if you are the only one in the area (like southern California Edison)

- Resource ownership (Like the diamond company debeers owning 70% of the diamonds)

- Economies of Scale: (like GMC they produce so many cars as they are very big)

- Patent: Legal barriers

- Cost complentarity:

- Economies of scope: the monopoly is so big they can make multiple products. (Like car compaies making trucks sedans vans)

Monopolistic Competition

- Products are not Identical

-Many buyers and many sellers

-Free Entry, Free exit (no barriers of entry/exit) most important characteristic, makes each buyer large or small

- Perfect information (both buyers and sellers know all the information)

- No transaction cost (you don't need a 3rd party to buy)

Monopolistic competition; reinvention:

Create a new product or new concept, to make profit positive again

Profit Maximizing Output

Where MR equals MC for maximum profit.

Perfect Competition to Monpoly will lead to:

- Higher prices

- Lower quantities

- Lower Consumer surplus

- Dead weight Loss

Consumer Surplus

Difference between willingness to pay and market price.

Law of demand

Price and quantity move in the opposite direction

Price goes up demand goes down, price goes down demand goes up

Consumer Surplus:

: willingness to pay-what consumer actually pays

Law of supply

As the price of a good rises, the quantity supplied of the good rises, holding other factors affecting supply constant. Price down, Supply down. It moves the same way

Changing only price leads to changes in quantity supplied

Producer Surplus:

the amount of producers receive in excess of the amount necessary to induce them to produce the good. (profit basically)

Market Equilibirum

: A place there is no tendency for movement, the market will clear, and quantity demanded = quantity supplied

Below the equilibrium is a shortage, above the equilibrium is a surplus, at the equilibrium quantiy demanded=quantitysupplied

Price ceiling

: Maximum legal price that can be charged in a market (shown below the equilbrium on the graph because of a shortage)

Price floor

Minimum legal price that can be charged in a market (shown above the equilbrium as there is a surplus)

Social Welfare

Consumer surplus + producer surplus

What is Market failure?

where private market fails to come up with an appropriate solution.

Exists because of a lack of clearly defined property rights(right to use, right to exclude, right to resell)  which leads to market failure

Resolve by assigning property rights

Five faces of Market Failure

Market power(monopoly), externality, public good, incomplete information, common resources.

MB >MC

Q goes up so continue what you are doing

MB < MC

Q goes down, cut back

MB = MC

Optimal point

Demand Shifters

1.        Income

a.        Normal good: Income goes up you buy more, if income goes down you buy less of it. Ex)steak

b.       Inferior good: Your income goes up and you buy less of it. Ex) A in n out burger

2.        Prices of related goods:

a.        Substitute goods:

b.       Complement goods:

3.        Advertising and consumer tastes

a.   Informative advertising: something new, new ideas new concepts

b. Persuasive advertising(Brand wash): keep advertising that you basically stop thinking and end up buying the product.

4.        Population: Population increases = D1 demand will go up

Less people: D2 demand will go down

5.        Consumer Expectations

-              If you think an hamburger will make you look bad, D2, demand will go down

-              If you think an hamburger will make you look good, D1, demand will go up

Supply Shifters

1.        Input prices: If input prices (like minimum wage) goes up Supply goes up, S2

2.        Technology: Better technology = S1

3.        government regulation: Gonna cost you money, S2

4.        Number of firms:

a.        Entry: more firms come in, S1

b.       Exit: start to shut down, S2

5.        Substitutes in production: many elements are shared(substitutable) like some parts of cars. More substitutes in production, S1

6.        Taxes: S2

a.        Excise tax: a tax on each unit of output sold(per pack of cigarettes, a cup of coffee), where tax revenue is collected from the supplier

7.        Producer expectations: If you expect a lot of traveling in may, gas will go up: S1

   If you expect in the winter less people will eat ice cream: S2

Thanksgiving turkey: S1

Conditon 1 (Celler-Kefavuer)

Merger that increases HHI by less than 100 or leads to an unconcentrated market (post-merger HHI <1500) is typically permitted

2nd condition(Celler-Kefavuer)

Markets are considered modertaely concentrated when the post merger results in: 1500<HHi<2500, mergers with an HHI in this range and increase the HHI by more than 100 points potentially raise antitrust concerns

3rd condition (Celler-Kefavuer)

Markets are considereed highly concentrated when the post merger HHI > 2500. mergers with an HHI in this range and increase the HHI between 100-200 points potentially raise antitrust concerns

4th condition (Celler-Kefavuer)

If a merger increases the HHI by more than 200 points and leads to a highly concentrate market, it is presumed to enhance market power