Lecture 18: Market Power

Production functions are critical economic models that can be represented in three precise ways:
1. As an Equation: Y = f(X) - where $Y$ is a function of $X$.
2. As a Table: data structured in rows and columns reflecting the relationship between input and output.
3. As a Figure: graphical representation showing various combinations of inputs leading to output.

Setting the price of beautiful cars can be described by:
- Given the equation: P = 80,000 + 14,400Q
- Details consist of:
- Price ($P$) at a fixed base amount with variable charge related to the quantity sold ($Q$).
- The derived equations show relationships between different variables leading up to total revenue.
Deadweight Loss (DWL) arises from inefficiencies from pricing strategies.

Cost functions include:
1. C(Q) = 100
2. C(Q) = 2,000 - 100Q
3. C(Q) = 1,000 + 100Q
4. C(Q) = 1000 + rac{100}{Q}
Equilibrium price possibilities include:
- a. $100
- b. $1,000 (firm profit analysis indicated differential pricing strategies)
- c. $1,500
- d. $1,900
Efficiency observation: Equilibrium is inefficient when setting prices above marginal costs (MC).
DWL calculation example:
- DWL = ($900 - $100) + … + ($200 - $100) = $3,600
- Alternative representation, DWL = rac{(900 - 100) imes 9}{2} = $3,600

A firm exhibiting market power can:
- Set prices above marginal cost.
- Offer products that are differentiated.
- Ensure profit margins are enhanced, generating potential deadweight loss (DWL).
Deadweight loss detail:
- Increases with demand elasticity; the steeper the demand, the larger the DWL.

Firm with few close substitutes:
- Demand curve becomes more inelastic
- Higher market power translates to greater profits
- Less efficient equilibrium outcomes.
Firms with elastic demand curves:
- Experience lower market power, reduced profit margins, and smaller DWL.
- Perfect competition: firms face horizontal demand and lack market power.

Characteristics include:
- High fixed costs and low marginal costs lead to decreasing average costs.
- Such conditions often limit competition as it favors transitioning towards winner-take-all outcomes.
- If a single firm can maintain lower average costs than multiple producers, it forms a natural monopoly.

Firms pursue market power through:
- Establishing intellectual property rights,
- Limiting market entry,
- Raising switching costs,
- Mergers or acquisitions,
- Collusion or combination as a cartel.
Antitrust Policy Functions:
- Prosecute anticompetitive practices,
- Regulate natural monopoly pricing,
- Facilitate public utilities.
Historical case: Standard Oil's significant market power led to its dissolution in 1911 under the Sherman Antitrust Act.

Price-setting by firms leads to inefficiencies in resource allocation. Conditions can be defined as follows:
- For potential buyers: MC < WTP < P
- Results in under-consumption of goods.
Cause of market failure includes:
- Differentiation of products, restricting competition,
- Average cost decreases resulting in monopolistic outcomes.
- Antitrust regulation can address these failures.

Scheduled for Thursday, 10/30:
- 15 MCQs covering sections Q2.1-2.4 (counting for 30%)
- 2 SAQs from homework sections HW 2.1-2.4 (counting for 70%)
- Review and work on practice exams prior to exam date.
- Supplies required: calculator, single page of handwritten notes.

Data on labor discipline and implications of income distribution:
- Related curves such as Lorenz and Gini indicating cumulative income shares against wages.
Example scenario (Johann as a farmer) involves:
- Reservation options, indifference curves indicating economic choices and feasible frontiers based on hourly work commitment.

In classes to follow, students will engage in practice multiple choice questions aimed at consolidation of learned concepts, including market power conditions and pricing strategies.