Types, characteristics, pricing strategies

⇐ Назад

This section on product market, and this introductory chapter relate to the production of goods and services and their costs and prices in differently structured markets ranging from the theoretical model of perfect competition through there imperfectly competitive real-world models of monopolistic competition and oligopoly to monopoly. For each of these products markets, there is a set of characteristics that provide guidance in explaining different costs, efficiencies and pricing strategies.

Product markets: definitions

Perfect competition

Perfect competition is characterized by a large number of sellers so that no one seller or group of sellers can have a significant effect on the terms of exchange or transaction terms. These terms include prices, quantity, share of market, type of product, distribution, innovation, service/warranty/guarantee, etc. prices for each firm in this perfectly competitive environment are determined in the market where all firms (sellers) compete for the buyers of the same (homogeneous) product. That is, the price is said in this market and each firm must charge the "going price"; to charge more would result in loss of sales to other firms that produce the identical product. As a result, these firms are price-takers; it's from cells at the price set in the market or at the intersection of demand and supply.

To illustrate, under perfect competition, there are no barriers to entry for firms that want to enter the market - no technological secrets, no financial barriers, no legal or regulatory constraints, etc. Also, there are no barriers to exit, such as government subsidies, tax relief, import quotas, or high tariffs. In other words, efficiency is maintained or rewarded and inefficiency is reduced by new entrants. Perfect competition is also characterized by homogeneous or identical products; firms must use the currently available technology and fully utilize plant and equipment to maintain the competitive norm of costs and hence, be efficient. Since the products produced under perfect competition are identical they are perfect substitutes and have to be priced at the market. This would also mean that price (P) = marginal revenue (MR) seems each unit sells for the same price regardless of the quantity produced.

Under perfect competition there is no pricing strategy. The price elasticity of demand for each firm is perfectly elastic, horizontal function indicating that the products are perfect substitutes. Each firm must produce and price at minimum cost or a lose sales to the other firms. Each customer buys a product at its minimum average cost. Thus, the more substitutes available, the more competitive the industry structure and the more elastic the response to price changes. The perfectly competitive model is one of price- takers with no pricing strategy or power independent of the market.

Monopoly

There are many forms that monopoly can take. This is important to note that we are on the opposite end of market structures than that of perfect competition. That is, monopolies are characterised as one seller of a product for which there are no close substitutes; therefore, we would expect the demand of the consumer to be less elastic then in a perfectly competitive market. However, the monopoly demand curve will not be perfectly inelastic since the buyers can be influenced by price changes, or, as the price decreases, they may also wish to buy more. This, in turn, explains why the marginal revenue function will differ from the demand function as the price is lowered; in addition to total revenue becomes less and less.

Thus, under monopoly, the downward sloping demand curve implies the pricing strategy, even pricing power. The strategy is to change prices and outputs (to have a significant effect on the terms of exchange or transaction terms) in order to maximize revenue and profit. Barriers to entry allow monopolists to increase prices and limit output; hence, no a valuable close substitutes lead to a lack of competition and the demand curve is less elastic than that of perfect competition. There are several types of monopolies and pricing strategies that will review in later chapters.

Monopolistic competition

This market structure is the setting for many firms in the United States and other western countries. It is characterized by many medium-sized firms that need to be innovative and differentiate their products in ways other than price. This is to say, a firm in monopolistic competition can take sales away from a rival with a variety of "price-distracting" products and services. For example, a Ford supermarket might develop the future store complete with bakery, sandwich shop, restaurant, dry cleaner, specialty and take-home meals, film processing, drugstore, magazine and newspaper section, bulk foods, etc. this story could then price it's regular and stable goods higher than its rival stores; thus, a strategy that is based on product differentiation and innovation that reduces competition. With few substitutes, the competition is reduced, and the demand curve becomes less elastic. The firms charge above marginal costs and above minimum average cost, in the long run. The firms are less efficient than perfect competition since they tend to have zero economic profit but tries above minimum average cost. There will be a full explanation about this later.

Oligopoly

There are a relatively few sellers who act in through interdependently and/or collusively to be price -makers in order to control markets and the terms of exchange, for example, price, quantity sold, geographic markets, specialized markets, service terms, etc.

There are very strong barriers to entry. The good produced can be both homogeneous and heterogeneous, in other words, similar as in the product specialization such as structural steel where firms compete with each other in the same product market. In heterogeneous competition, firms differentiate their products to gain in revenue; for example, one firm may provide a complete line of hardware products, including some products that sell at the loss, in order to compete against firms that sell only those lines that produce profits. In the latter case, firms can increase their prices to the extent that there are fewer substitutes reflected in lower price elasticity of demand. Again, fewer substitutes, lower price elasticity of demand, and more pricing power are highly interrelated. There are more price-makers.

Perfect competition

Note the following:

1. Demand curve of the market (or industry - all firms selling some product) is downward sloping to the right but the demand curve over the firm is horizontal (implies perfectly elastic demand function).

2. Since the demand curve of the individual firm is horizontal, P=MR for the firm.

3. It would take this figure to be that of the long run (LR) equilibrium, each field will take its price from the market (price-taker). Thus, regardless of the quantity produced and sold, the price for the firm remains constant with the only decision being the optimal quantity to produce given a price.

4. Also, if the graph represents LR equilibrium, you may note that P=MR, P=MC and P= minimum average cost. P=MR implies that there is no pricing strategy (firms are price-takers); the demand function in horizontal. P=MC implies that the price of the product (the "value" to the consumer) is equal to the extra cost incurred by the seller in producing the marginal or extra unit of production. P= minimum average cost implies that firms are operating at zero economic profits. This also means that efficiency has been attained; in other words, each increase in the cost of an extra unit of production equals the price that the consumer is willing to pay. We will discover later that, in contrast, monopolistic competition has a large degree of inefficiency due largely to excess capacity my producing at average cost but not at minimum cost.

5. If we refer to the short run (SR), price is reflected by the demand function remains horizontal but can increase or decrease in the short run; therefore, there can be profits or losses in the short run. The firm wants to maximize profits or minimize losses by producing the optimal output, the level of output at the which MR=MC ( with perfect competition, MR=P). Thus, if you are given a graph, a table, or a set of output and price levels, you need to find the location of the optimizing output in the short run. For example, if price is $14, find the optimal output in the diagram below.

If P=MR, then the optimal output would be at the level at which MC=MR. follow the horizontal demand function over to where the price of $14 (MR) = MC ( intersection of the MC function with Price or Demand). Drop a line perpendicular to the horizontal axis and the output of 400 would be the optimal output, the output level at which profits will be maximized or the level at which MR=MC.

6. ATC=MC when ATC is at its minimum point. That is, MC always intersects ATC and AVC at the minimum points. When MC > ATC, ATC must be rising since the additions to total cost (marginal costs) are greater than average costs. This converse holds with MC > ATC.

7. The following are conditions that are correct about firms operating under perfect competition:

At the long run equilibrium,

A) P=MR. No pricing strategy. Firms are price-takers.

B) P=MC. Price at which product sells (at "market") equals the extra cost incurred.

C) P= minimum average cost.

D) firms realize zero economic profit or normal profit.

E) Firms have no incentive to price their goods and services below the market price.

F) The demand function for each firm is horizontal.

G) Products are homogeneous; therefore, no purpose for advertising.

8. Profits and competition. LR equilibrium under perfect competition leads to normal profits (zero economic profits). Profits less than normal = economic losses. Economic profits > zero or normal profits.

9. The conditions for a continuing production, shut-down, profits, loss is in the short run under perfect competition. For each price (P=MR), in the short run:

A) If P > AVC, firm should shut down and it is total loss is equal to its total fixed cost (TFC). If P > or = AVC, firm should continue production.

B) If P > AVC, firm continues to produce as long as MR > MC up to the level of output profits are maximized or losses minimized - level at which MR=MC.

10. Under perfect competition, price elasticity of supply is greater in the long run then in the short run since there are more opportunities for substitution of inputs.

Expanded concepts

1. The individual firm as a price-taker.

This is a price-taker, that is, the price for the homogeneous product is determined in the market, where all buyers and sellers meet, and "dictate" to each individual firm. Since there is a sufficiently large number of firms under perfect competition, no one firm on group of friends can determine its own price. The firms must sell at the market-determined price for two basic reasons:

A) If a firm increases its price above the market price, customers will buy the identical product from another seller at the market price (full information principle)

B) If a firm law as it is priced below the market price it will incur losses and not increase its sales significantly, if at all, since each room has a very small share of a very large number of sellers.

2. Criteria and output strategies for profit-maximizing films in the short run under perfect competition:

- For the appropriate context, firms may encourage some losses in the short run as long as the are covering average variable costs with the market price. Unless a firm can cover average variable cost with its price, it is more economical to shut down production and simply incur fixed costs; rather than incurring the fixed costs plus the variable costs, the latter is not covered by the price. The context here is the short run only.

- The decision-making process to determine best output, that is, the output level that maximizes total profits or minimizes total losses.

a. The firm should produce if P > average variable cost (AVC). It should continue to produce as long as marginal revenue (MR) > marginal cost (MC).

This means that the firm is adding more to it is revenue then it is adding to its costs at the margin of producing one additional unit. Therefore, as long as MR>MC, the firm would be adding more to his profits or reducing more of its losses. At the level of output at which MR = MC, profits would be maximized or a losses minimized, so it is the optimal output level.

If in the certain cases, there is no equality between MR and MC, we should select the highest level of output at which MR > MC.

b. To determine the total profits or total losses at the optimal level of output, use the following:

Optimal level of output X * ( P - ATC)

Total profits = Q*( P - ATC)

Where Q is the optimal level of output.

The long run adjustment process.

1. We assume that the only adjustment made, as demand changes, is the new firms enter (as demand increases leading to short run profits). The other type of adjustment is that the present firms increase production. Why not using this adjustment in order to simplify the process.

2. We also assume that the firms' average cost curve is identical and that these cost curves are unaffected by the adjustment process.

3. We assume that new firms enter with the same cost curves as the present firms and that the new firms are attracted by the short run profits in the industry. Also, we assume that firms will exit from the industry when demand decreases, leading to short run losses.

To illustrate this adjustment process, to the rats are provided below; the one on the left represents the individual firms, and the one on the right represents the industry or market where are all buyers and sellers of the same product meet.

We start at an equilibrium position with the price at Pa and quantity at Xa. (Mind the scale).

Step1.

The demand for the industry's product increases

Step2.

The demand for an individual firm increases

Step3.

New firms enter the market.

Note: it is the least likely case that, while new films entering the market, number of that firms are such that the profits straightly go to Zero. Usually, at a certain moment, firms experience losses because of the excessive number of firms in the industry.

Step 4.

Number of firms is going down until the economic profits reach zero.

This process of adjustment means the deficiency is produced in the long run under conditions of perfect competition. With P = minimum average cost, the firm has zero economic profits with just the return on investment that it could receive elsewhere at the similar level of risk.

Supply curve for the firm is more elastic in the long run then in the short run. The basis for this is that the firm has more possibilities for substituting among input choices.

Consumer and producer surplus

The consumer surplus and the producer surplus provide benefits that result directly from a perfectly competitive market. Consider an example: the consumer is willing to pay $100 for a pair of shoes if he buys two of them, $80 a pair for four pairs, and the market price is $60 a pair. Again in utility or satisfaction over costs is the consumer surplus.

It can be measured by the area ABC.

The producer surplus is demonstrated on the supply curve. The supplier or producer is willing to accept $20 a pair each of the first two pairs of shorts and $40 for each of four pairs. However, the market equilibrium price based on the suppliers $60 a pair. In other words, the market is willing to pay the supplier more than he is willing to accept. The producer surplus is the area OBC.

Monopoly

It is important to know monopoly in terms of a definition - a market structure where one from constitutes an industry and were not close substitutes exist for customers, it is also important to know that a potential monopoly power can be found under oligopoly of monopolistic competition. Thus, friends can acquire power in in perfectly competitive market if they can consistently priced goods in excess of marginal costs. Indeed, the Lerner index (P-MC)/ P is one method of the Economist used to a certain this pricing power, in particular, the greater the value of the index, the greater the market power, including its duration and how the ratio compares among firms we distinguish as "price-takers" in perfect competition from the "price-makers" in imperfect competition who are exemplified by monopoly pricing power. Alternatively, economists use the Herfindabl Index, the sum of the squares of the market shares of firms in particular market or industry, to measure the concentrated power or power generated by shares of the market.

Important concepts:

1. The monopolist faces a downward sloping demand function that implies that price is greater than marginal revenue, which implies a pricing policy that could actually lead to a lorry of price by the monopolist in order to induce more sales in the relatively elastic market.

2. What follows from number one above is the notion that the monopolist maximizes profits at the optimal level of output (MR=MC). By definition, the monopolist does control the supply of a product for which there are no close substitutes. However, the monopolist does not control the demand for the product but can exercise some influence on the amounts demanded by lowering of raising the price relative to price elasticity of demand. Also, the consumer can decide not to buy any of the monopolist's products.

3. Unregulated monopoly may lead to

a. Higher than competitive prices

b. Lower than competitive output

c. Misallocation of resources, inefficiency, and dead-weight loss

d. Rent seeking

4. Regulated monopoly can lead to

a. Move towards outputs that are more efficient through subsidies that rise as output rises.

b. "Fair" rate of return (P=ATC)

c. A socially optimal price and output, P=MC, which would require subsidies

The nature of monopoly and its types

Well hopefully can be identified by its definition and, more importantly, by its power. By definition, a monopoly is both in industry and the firm; a single firm sells a product for which there are no close substitutes. Thus, the firm is the industry. Is the finish is significant in theory and also in practice as one end of the market structure spectrum.

As we all know the perfectly competitive firm as the most competitive market structure, with no monopoly as the other end of the market structure spectrum.

In policy settings, we know that a potential merger between two large firms move the industry to be "less competitive" or to have a "tendency towards monopoly" with perfect competition and monopoly serving as the other end of market structure. A purely structural approach to such policy would suggest that above-cited merger be prevented. More importantly, monopoly can exert itself as a pricing power and/or as a determinant of output restrictions. This monopoly power and need not exist only a definitional monopoly, monopoly pricing power can and does take place in other imperfectly competitive structures such as oligopoly and monopolistic competition. Two forms of monopoly power, pricing and market share, are measured in the Lerner Index and the Herfindahl Index, respectively, as identified in the beginning of this chapter.

The demand curve facing the monopolist is the worst sloping to the right implying that P > MR and the pricing strategy ensues. The monopolist determines price and output at the intersection of MR and MC.

Is a vertical line is drawn at the intersection of MR and MC and extended up to the demand function and then horizontally to the vertical or price axis, we find the price and output.

Profits are maximized at that price and quantity and are measured as the rectangular area. The per-unit profit at the optimal output is.. Or their per unit price minus the per unit cost. Total profits would be price per unit minus average total cost times the number of units of output.

In contrast to perfect competition, the monopolist is likely to realize economic profits and be able to set the price where MC = MR and P > MC, the latter being symptomatic of monopoly pricing power. Also, output is restricted as compared to perfect competition. The price is higher and output is lower than the competitive counterpart leading to a misallocation of resources; the monopolist extracts a profit and restricts output that leads to a reduction of consumer surplus. Consumers receive fewer goods at higher prices and the monopolist receives a rent; he receives more than she contributes to production at the margin of the effort of the monopolist. Part of the reduction of consumer surplus accrues not to the monopolist as profits but the other part of the reduction accrues to no one or to a dead-weight loss, which is another form of resourcing misallocation in which resources could have been utilized to produce goods and services and are, instead, totally wasted. We measure this loss in terms of the loss of those goods and services that could have been produced.

On the graph:

1. The original consumer surplus is formed by the amount of total utility area under the demand curve after the amount of output consumed. This would occur in competitive markets.

2. Enter the monopolist for seeks economic profits. The monopolist will maximise profits with the optimal output ......where MR=MC.

.... This area is taken from consumer surplus

.... This area is new producer surplus

.... This area is a dead-weight loss

3. Adverse effects of monopolist.

... Price on perfectly competitive market

... Price of monopolist

... Quantity on perfectly competitive market

... Quantity of monopolist

Thus, monopolies are likely to show some inefficiency relative to the efficient model of perfect competition.

Price discrimination

If a monopoly or any in perfectly competitive firm had its way, it would charge each customer exactly the maximum price that each customer would be willing to pay. As a practical matter, this would be very difficult or impossible to do since the firm would not know the maximum price for each customer (the cost of identifying these differences would be high relative to any information revealed) and the policy would likely fall victim to some customers discovering the had paid more than others for the same product. Perhaps, you should not ask other passengers of an airline what they paid for the tickets unless you got a very good price.

Since the above suggests perfect price discrimination with perfect information about each customer, we can still find many examples of price discrimination. For example, movie theaters may charge less for an afternoon movie then for a movie in a more popular time such as evening or night. Senior citizens may be charged lower prices for a lodging, museum attendance, and transportation. Some discounts simply promote better allocation of scarce commodities such as space on highways at commuter rush hours. Price discrimination works best if the following conditions are operative:

1. Separate markets for consumers based on different price elasticities of demand. This really means that customers with higher price elasticity of demand have more choices of substitute products. Customers with Gloria Price elasticities have less sensitivity to price of a particular product since they have fewer substitute choices.

2. There must not be opportunities for the resale of the product.

3. The price differences are not based on the cost differences.

4. The firm is a price-maker - it has a pricing strategy that looks to charge a higher price and realize more profits.

Types of monopolies and their potential regulation

1. Natural monopoly

2. Unregulated monopoly

3. Regulated monopoly

a. "Fair" rate of return

b. Optimal pricing

c. Subsidized

Natural monopoly

Their original theory was that certain industries good best operate as monopolies, since to require or allow competition would negate the major economies of scale inherent in the nature of this industries. For example, the lick three coal industry requires massive generating plant and the complex network of transmitting and distributing electrical energy. Therefore, smaller competitive firms would be less efficient and more costly. There would be unnecessary duplication of terminal facilities, electrical lines causing inefficiency.

The traditional public policy for these nature monopolies was to create a power authority and or a public service commission in each state that would approve the creation of a monopoly to an electrical generating private company for a particular region or city, but the company would yield the right to price it services without public utility commission approval. Recently, states have been experimenting with regulation of the electric industry with respect to the generating function. The transmission and distribution functions would remain under control of the power or public authority.

Regulated monopoly

The traditional regulation of a natural monopoly would be to allow prices that offer a "fair rate of return", which would allow a price to be only at the intersection of average cost curve will demand function curve. This price would be approximately the price of the perfectly competitive firm; it would cover average costs, including implicit costs that represent what would have been earned elsewhere with the same resources; so, the notion of a "fair return" follows. The utility firm needs to get a return on its investment at least equal to what investors could receive elsewhere at the same level of risk.

You will observe that as a result of this regulation the final price of regulated monopoly is lower than the price of and regulated monopoly but higher than that of a competitive firm. The output of the regulated monopolist is less than that of the competitive firm but greater than that of the unregulated monopolist. Thus, the regulation of the nature on monopoly increases output and reduces price. However, in practice, the costs of the regulated electric utility were higher than expected with all sorts of inefficiencies present waiting to calls for deregulation of the electrical generation function.

Unregulated monopoly

Again we can see the different price and output effects of the unregulated monopolist. This monopolist is a profit maximizer.A profit maximizer prices and determines out at the level of output where MC=MR. this produces a price higher than the competitive price and an output which is lower than that of the perfect competition.

Other regulated monopolies

Another possibility, at least in theory, would be to price at the level, of which the price that is equal to MC. This would be the socially optimal price. When P=MC, as it does under perfect competition, the producer is having the extra cost incurred in producing one more unit "valued" at that cost by the consumer who is able to buy this extra unit from the producer or supplier. This represents efficiency at the margin of providing an additional unit of a good. Sometimes the question is asked about the ability of the firm to consistently price goes above marginal cost as an indication of monopoly power. Since normal profit seeking firm would price at the level of losses the government should provide subsidies for increasing units of output until the desired level of output is obtained.

General speaking, there is a tendency for last efficiency under monopoly since output is lower and prices higher as compared to perfect competition. Also, monopoly leads to dead-weight loss and resource misallocation.

Oligopoly

Perfect competition, as we have seen previously, provides a theoretical model, it sets the standard for efficiency, so oligopoly and monopolistic competition are inefficient since they are imperfect competitors. Monopolistic competition develops and fosters excess capacity in which there is underutilization of resources or inefficiency. Oligopolies, collusive and non-collusive, tend to set prices in such a way that P > MC, which is the standard identification and measure of monopoly pricing and rent seeking. There are many more monopolistic competitors in the real world then there are oligopolies but oligopolies represent the most dominant industries in terms of market share, assets and control over prices, output and allocation of resources. They are the best examples of "price-makers" and "rent seekers".

There are several basic concepts in this topic:

1. In the long run, monopolistic competition will be inefficient mainly due to excess capacity.

2. There is a long run tendency under monopolistic competition for zero economic profits. However, zero economic profits do not imply the efficiency of perfect competition in the long run. The monopolistic competitor has zero economic profits when average total cost equals price at the profit maximizing level of output but not at minimum average total cost, implying the inefficiency due to excess capacity as identified in number one above.

3. Allocative inefficiency of monopolistic competition is also identified by the price > marginal cost. Unlike perfect competition, there is a tendency to price goods and services at a higher level than the costs to produce additional units.

4. Monopolistic competition is also inefficient compared to perfect competition since then monopolistically competitive firm restrict output level in order to maximise profit. In other words, optimal output is at the level at which MR = MC, which results in a higher price and less output is compare to perfect competition in the long run.

5. Well the barriers to entry in the industry are not as formidable under monopolistic competition as under oligopoly, barriers to entry become a device for some monopolistic competitors to our economic profits in the long run.

6. Monopolistic competition is characterised by non-price competition (advertising, unique products, warranties, coupons, appeal to brand or store name, etc.), differentiated products, innovation, batch number of buyers and sellers, few barriers to entry and exit.

7. The profit-maximizing output and price for a firm and monopolistic competition is not level at which MR=MC. Also, unique to monopolistic competition is the long run tendency for Zero economic profits but with the ATC curve tangent to the demand function at the level of output at which MR=MC. However, ATC is higher than the minimum average cost.

8. Under oligopoly, there is more likely to be interdependence of the firms as contrasted to the price-takers of perfectly competitive market and the price-makers of monopoly power. This, at least, holds for the non-collusive model of oligopoly. It maintains itself by rivals matching decreases in prices but not watching price increases. Even the collusive oligopolists are somewhat constrained in price-making by the interdependence of the market.

9. Oligopolists, like other imperfect competitors, may charge had prices than needed to maximize profits. This is often reflected in monopoly pricing power.

10. When merger activity increases, the structure, behavior, and performance of oligopolists comes into play on policy decisions.

11. Oligopolists can be non-collusive or collusive.

Monopolistic competition

There are many sellers and buyers under monopolistic competition; thus, it is difficult for any firms to emerge as price-makers or to seek rents. In order for a firm to gain an advantage in the market, it is often necessary to innovate or otherwise find a niche in the market. In other words, if a monopolistic competitor is able to distinguish its products or services from rivals, the firm will be successful. Most of any success for monopolistic competitors derives from non-price competition, such as brand name, store name, shoppers' cards, rewards for frequent customers, special amenities in lodging, etc. the customers are not interested only in prices but almost everything else. Since the barriers to entry are relatively weak, rivals must continuously innovate to survive. There is a highly competitive atmosphere with customers quite sensitive to prices since there are many good substitutes available and a relative ease of entry into the industry. Thus, each of these foreign competitors has to find ways to distract the customers from prices and attract down to specially features such as in-store brands of high-quality, in-store bakery, etc.

These firms have downward sloping demand curves and they are characterized, as in monopolies, by price > marginal revenue and price > marginal cost.

In the short run, there are dynamic shifts in demand in an intense competitive environment. Thus, we can expect that some firms will realize profits as demand for their products increases, sometimes at the expense of rival firms, some of which will incur a loss is even to the extent of leaving the industry. Thus, in the short run, we can illustrate both situations with the following graphs:

Monopolistic competition is very dynamic. An example would be the many competitive e-commerce firms in recent years. Initially, the firms and their stockholders were reaping enormous profits. More recently, a number of those funds were forced to leave the industry; they were simply crowded out by other firms. Also, I understand that the normal or traditional way of illustrating these situations does not fully apply to e-commerce. Many e-commerce firms, except for those with exciting initial public offering, were not realising profits or had a very high price/earnings ratio, yet investors were interested in their stocks because of their potential or the sense that their stock prices would continue to soar to new highs.

Long run equilibrium monopolistic competition

Same is the nature of monopolistic competition is one of constant change, it's quite difficult to attain the status of long run equilibrium in practice, not also in theory. However, a long run tendency emerges that allows some of you to have a standard against which we can compare and contrast monopolistic competition with other forms of market structure, particularly perfect competition, which is the definable in theory. We can then say that there is some inefficiency in monopolistic competition when compared to efficiency in perfect competition. This comparison has many applications in practice, such as antitrust, market concentration, and innovation versus barriers to entry, etc.

There is a long run tendency from the poster competition to produce zero or normal economic profits but not at minimum average total cost. This is an indication of some inefficiency in monopolistic competition as compared to perfect competition where long run equilibrium is at the efficient level - price equals minimum average total cost. The basic difference is that producing at less than minimum average total cost reveals and efficiency mainly in the form of excess capacity or underutilization of resources. One might visualise for gasoline stations on the four corners of a busy highway, an intersection. The total demand, on average, for a gasoline is considerably less than the available supply; therefore, each station is not able to utilize all of its pump capacity. Which station does not sell enough gasoline to spread it fixed cost over the gallons of gasoline sold, so the stations quickly exhaust in economies of scale and do not reach minimum average total costs. This is a classic case of underutilization or a excess capacity. Suppose two gasoline stations would have the right capacity to handle the demand. They could then spend the fixed costs over a greater number of gallons and achieve some efficiency. With easy entry, there tends to be too many competitors given a certain demand.

Oligopoly: the non-collusive model

The key to understanding oligopoly is the "interdependence" of rival oligopolists. This defining characteristic of oligopoly can be manifest in collusive as well as in non-collusive if markets. In non-collusive markets rivals may base their strategies,in part, on their anticipated reactions of other firms. For example, one for my you want to raise its prices in order to increase profits. However, if a second firm is expected to lower its prices to undercut the sales of the first firm, than the first firm may not raise its prices in the first place. The second firm may employ a similar strategy depending on their anticipated reactions of the first firm. This is nonconclusive interdependence may actually lead to lower prices or, at least, no increases in prices. It may be apparent to the reader that the firms would want to have an understanding that both firms would increase prices to maximize their profits. However, one firm could cheat on the agreement and corner more profits for itself. The firms would have a "price war" in which there would be the possibility of all firms being worse off, even to the extent of substantial losses. However, if one firm raises its prices, the rival firm may not match the price increase so that it would capture market share from the other firm. Thus, it is assumed for noncollusive oligopolists that rivals will follow price decreases by a firm but not follow price increases.

Other oligopoly models

Theoretically, business may be defined as Nobel prize economist George Singler described it "as the whole set of activities designed to overcome barriers to profit."

The following are examples of other models of oligopoly that are evidenced by structure and behaviour of oligopolistic markets:

1. Priced leadership. If there is a price leader or dominant firm among other oligopolists the leader can set price to maximise profits and the other firms simply priced at the same level since they are virtually unable to gain market share by maintaining their previous prices. The other firms in the oligopoly market face smaller profits given their lower volume of production.

2. Cooperative non-collusive activities. Here there are tacit understandings about the value of limited advertising, promotion, etc. matches this is based on the interdependence of oligopolists.

3. Collusive oligopolies.

This oligopolist may decide that if "you can't beat them competitively, you can join them." That is, rivals may divide markets among themselves according to regional areas or product specializations. Collusive activities also include agreements to charge the same or higher prices. An airline may enter a contract with an aeroplane producer is their aeroplane producer agrees not to produce aeroplanes for other airlines or to charge them a higher price. Many such colours of activities are illegal in most countries. Cartels, such as OPEC may have production limits or price agreements among its members in an effort to set or control prices. This agreement can be maintained most easily if there are few members and if the cartel controls a major share of the supply of the product. Cartels are clearly price-makers and not price-takers.

Oligopoly: game theory

The interdependence of allocable lists can be illustrated in the context of a game in which the rivals attempt to maximise their profits. However, any particular strategy employed by one of the players may result in lower profits depending upon the strategy used by the other player. On the other hand, one firm find that it can develop a dominant strategy that will increase their profits regardless of what the competitive firm does. For example, in the competition between the top two European automobile firms, BMW and Mercedes. Each of down make special offers to sell it is vehicles to the general public at a special discount prices employed by its employees for a limited time. Will the strategy become dominant? That is, will BMW profits be increased regardless of whatever the Mercedes company follows suit? Orwill BMW's strategy be successful only if Mercedes does not offer similar discounts? This is not an empirically determined solution. The following are hypothetical numbers which represent profit in a playoff matrix.

The dominant strategy for BMW is to offer the discount. If BMW gives the discount and Mercedes also offers a similar discount, BMW has a profit ... And Mercedes has a profit ...

Other cases analogically.

If all of the above is analysed correctly, it becomes clear that BMW would use the strategy of a discount whether or not Mercedes provides the same discount. BMW has a dominant strategy, that of providing the employee discount to all its employers. This is called a dominant strategy. A similar outcome would be realized if Mercedes also provided the employee discount for buyers of its cars. So in this game both firms have dominant strategies.

In the matrix below the situation changes. If Mercedes chooses to discount, then BMW will also choose to discount. And if Mercedes chooses not to discount, then BMW again chooses to discount. So BMW has a dominant strategy.

The situation where neither of companies have an incentive to change their decision is called Nash equilibrium. A Nash equilibrium represents a different kind of game theory in which the strategy of each player is the best choice based on the strategy of the other player.

In this game we can see that is both companies chooses to discount the best choice for the other company will be to discount, and we know that no one has intensive to change their decision as their profits will lower. So this is the Nash equilibrium in this game (...,...)

Now, after all the information covered, you are able to try yourself in the the hardest exam in the world. This exam is designed in Kings college of Oxford.It seems to be pretty simple: you are given one word only and you have 3 hours to write about that word. Originally the word can be on any topic, for example, water, but we will make it a bit more simplistic and tight the variety of topics to economics.

The word will be:

Rationality.

Note: you can use your general knowledge and theory, which is not covered in this book.

Resource markets

It is obvious that there is a connection between product market and resource market, in particular, resource market is derived from the product market. In other words, the quantity of resources depend on how much will be the quantity of the final product demanded. This relationship is significant since it ties together the elasticity of products markets with that of resource markets. Moreover, salaries paid to labour depends on Labour's contribution to increases in productivity. This is not the only factor that influences the wage but one of the most important ones, there are many others, for example, discrimination, the amount of human capital of the worker, imperfect markets, skills and knowledge of the worker, etc.

The resource markets topic is quite technical, in other words, it can be easily explained via graphs and equations.The following are the most important concepts on resource markets topic:

1. Marginal revenue product (MRP) of a resource represents the demand for labour, it is downward sloping curve, similar to usual demand curve, that tells the firm what contribution to revenue of the firm each additional unit of labour brings. Thus, MRPL = MPL * MR ( of the final product)

Note: If we consider a perfectly competitive market we can conclude that products price is constant at all levels of output so marginal revenue of it is also constant.

2. Marginal factor cost (MFC) is the cost of each additional unit of labour hired by the firm.

Note: it can be constant if we talk about perfectly competitive labour markets.

3. Is the marginal factor cost of labour is the cost of hiring additional units of labour and demand for labour is the marginal revenue productivity of labour, then the firm will hire more labour as long as MRP > MFC in order to maximize its profits, until there will be an equality: MRP = MFC.

4. If there are more than one resource and a firm wants to maximize its profits, the equation will be as follows:

MRPL / MFCL = MRPK / MFCK = ...= 1

We can substitute marginal factor cost for wage rate if there is a perfectly competitive resource market.

If the firm wants to minimize its costs for more than one resource, then:

MPPL / MFCL = MPPk / MFCk = ... = MPPn / MFCn

5. If the firm wants to minimize its costs for more than one resource, then:

MPPL / MFCL = MPPk / MFCk = ... = MPPn / MFCn

6. The demand for a final product is crucial in deriving the demand for a resource. This connection is also helpful in computing wage elasticity of demand for labour.

7. Market imperfections and the government interference with resource markets. This include price ceilings, price floors, effects of trade unions, monopsonies, etc.

Derived demand, wage elasticity of demand

% change in Quantity demanded of labour / % change in wage rate

There are three laws of derived demand:

1. The price elasticity of demand for the final product significantly influences the way to elasticity of demand for labour. There is a positive correlation between them.

2. The wage elasticity of demand is higher if the proportion of labour costs relative to the total cost of production is higher.

3. The wage elasticity of demand from labour will be higher if there is a huge number of substitutes resources available on the market. Also, the easier it is to substitute their resource the higher will be the wage elasticity of demand.

Derived demand, wage elasticity of demand

% change in Quantity demanded of labour / % change in wage rate

There are three laws of derived demand:

1. The price elasticity of demand for the final product significantly influences the way to elasticity of demand for labour. There is a positive correlation between them.

2. The wage elasticity of demand is higher if the proportion of labour costs relative to the total cost of production is higher.

The demand for a resource

The demand for a certain resource for example labour can be derived from the demand for the final product. But the wage rate is not only determined by a Labour's physical contribution to the final product (MPPL), but also on the price of that product on its market. Thus, if the price of the final product increases the worker might be not that productive or actually decrease his marginal product, still the wage will increase.

Graph

Perfectly competitive labour market

The situation here will be the same as on a perfectly competitive market of a product. The wage rate is determined on their markets where all sellers and buyers of labour service meet. The firm is a price taker, in other words, there is no reason to said a higher wage rate down the market determines wage is, and he has a firm wants to lower the wage rate potential workers would simply moved to another company who is able to pay the market determined wage rate. The firm can only influence the number of units of labour hired in order to maximize its profits.

Graphs

Consider the case is a firm hires only one worker.

It has a marginal revenue product of 10 as well as the firm has to pay him only five so MRP > MFC.

So it becomes obvious that in the intersection between the demand for labour and the line of the ways determined on the general market is the equilibrium for a certain firm. The equilibrium wage will be WE and the number of workers will be 10. The profit of a certain firm will be the triangle S(WE)E

And the labour costs in this case will be 0WEE 10

Note: if you are given a table with MRP of different number of units of labour hired and a wage rate, and there is no equilibrium ( in no case MRPL = MFCL), you should choose such a number of labour units, at which MRPL > MFCL.

Imperfectly competitive resource market (monopsony)

Consider an alternative case: in a small town there is the only enterprise, which hire labour and there are little or no sources of other jobs outside this enterprise. In other words, there is only one buyer of labour in this particular city. Each time it wants to buy an additional unit of labour, it needs to pay a higher wage rate to attract more workers. Furthermore, it has to pay a higher wage to all of these existing workers in order to maintain their services.

So, MFCL here is an upward sloping curve. Marginal factor cost at a level of labour hired is more than the wage rate.

As far as the believer is to be fine at the intersection between marginal revenue product of labour and marginal factor cost than the equilibrium will be in the point E and the wage rate is to be find on the wage rate curve. The monopsonist here will pay only WM wage rate ( which is the lower than the competitive wage rate ) and will hire the XM units of labour ( which is lower than the competitive number of units of labour hired).

Graph

Cost minimization or the least cost combination

Profit maximization in the hire of more than one resource

1. The basic equation in least cost combination is:

MPPL / MFCL = MPPK / MFCK

Special case: is more resource markets are perfectly competitive than the equation transforms into:

MPPL / PL = MPPk / Pk

2. Profit maximization problem is solved by an equation:

MRPL / MFCL = MRPK / MFCK = 1

Remember, for perfectly competitive resource markets we can substitute marginal factor costs for prices of resources.

Shifts in demand for a resource

The crucial equation here is:

MRPL = MPPL * MRx

Where X is a product.

So any reasons for changes in MPPL or MRx will shift the demand curve. Mathematically, MRPL will increase if MRx or MPPL will increase. This will lead to the right shift of the demand curve. The same situation will be if any of these decreases, this, in turn, will lead to the left shift of the demand curve.Also, changes in the number of firms on the market which form the demand for labour may also cause shifts of the demand for labour. If a new company enters the market, it creates new workplaces, so the demand for labour increases, hence the demand curve shifts to the right.

Supply of resources

Let us start with standard market graph. Again, the situation is the same as the way the usual supply curve. The high is the prize for you work, the more "quantity of labour" people are willing to supply. We can conclude that labour supply curve is upward sloping. Note: the labour supply curve represents the minimum wage for each quantity of labour supplied, but the term "minimal wage" here is not related to the legal minimum wage.

Now let's think about an individual, who supplies he is working hours to a firm. For this working hours he earns a wage, which is spent on consumption of several goods.

Graph

This is a labour-leisure trade-off. As the number of hours in the week is limited (the resource is scarce), we need to distribute it between labour and leisure. For a labour we earn money during the leisure time we earn nothing, as well as caring opportunity costs of wage, which could have been earned for our stand on leisure. Obviously, if the wage increases, the opportunity cost of each additional hour of leisure time increases.

At first, one is willing to supply more labour hours though his wage does not increase that significantly. This happens because consumption of goods is more preferable for him at this time then leisure time.

Then, at a certain point, he starts to realize that if he is the wage increases, he will not be able to supply more quantity of labour then before.

Shortly after, leisure for him becomes even more preferable, so that if he is wage increases, he will supply less quantity of labour than before.

Substitution effect

The labour leisure trade-off varies for different groups of people. The young, discriminated people (race, gender), unskilled workers are more likely to have the usual or upward sloping labour supply curve because the cannot "afford" more leisure, they are more likely to increase the number of working hours as their wage increase. However, the "backward bending" part of the labour supply curve would most likely apply to older, experienced workers. These can "afford" themselves more leisure as leisure for them is a preferable good.

Then if their wage increases, they are expected to supply less labour hours.

Shifts in supply

There are several factors that can cause shifts in the supply curve of resources:

1. The number of suppliers. The more people are willing and able to supply their labour hours to the market, the more labour each company may hire at every level of wage as we assume that at any wage rate there are some people who are willing to supply their labour services.

2. Attractiveness of the job. Nowadays in many countries the political situation is such, so it is quite easy to start a new business.For example, if a country wants to increase the number of farmers , it creates better facilities for starting a business. This, in turn, creates an incentive for people to move to that countries. This will shift the labour supply curve to the right.

3. The relative prices of similar uses of labour resource. It is a common fact that personal drivers are generally paid more than drivers of buses. So we expect the supply of personal drivers to increase (shift to the right) and the supply of drivers of buses will fall (shift to the left).

The basis of wage differentials

Inequality in income distribution is widening over the overtime so as is basis will be helpful in any discussion of the topic:

1. Specialization. No one can possess all the skills which are necessary for all jobs. So it becomes obvious that certain combinations of skills and knowledge are necessary for some high-paying jobs and some are not, so this creates wage differentials.

2. Attractiveness of jobs. Jobs are usually unattractive so the wages are to be relatively high to cover the unattractive nature of that job. (Miners, underground drivers, etc)

3. Compensating wage differentials. Several jobs have some special characteristics such as risk, for example, washers of windows. Washers of skyscraper scrapers are paid significantly more than the washers of the ground floor windows.

4. Human capital. Workers with higher level of education experience hell are generally paid more than workers without such characteristics.

5. Physic income.

A certain job may have other benefits apart from monetary income. For example, a farmer may earn more if he decides to work on the factory but he prefers to enjoy landscapes and working on his homeland so he is ready to sacrifice part of his monetary income for this benefits.

6. Discrimination. It is not a secret that certain groups of people are discriminated on the basis of age, gender race, etc.

7. Immobility. There is a deficit of miners in the Alaska, but we cannot imagine the situation that all minors from all over the world with immediately move to the Alaska. They have families homes so they are not so mobile to move to the best opportunity.

8. Labour market imperfections. Perfectly competitive labour market are generally provide higher wages down the monopolistic market. Also, during a certain period of time, the wage can be influenced by unions.

9. Government interference. Subsidies minimum wage laws licence can create income inequality between workers.

Costs, production, supply

In this chapter will discuss the basic concepts of costs and production and there in their interdependence upon the price and output decisions made by certain firm. Appropriate revenue data and the market structure in which the firm is operating is crucial in this decision making process.

These are the basic concepts in this topic:

1. The law of diminishing marginal productivity or returns. The rate at which production increases varies because in short run several imports are considered to be fixed.

3. The area is an inter relationships between all cost curves. We'll discuss them later in this chapter.

4. Economies of scale. As production increases there are several reductions in average cost per unit. There are constant, increasing, and decreasing returns to scale. Consider the case if we double our inputs, then if the output doubles, it is constant returns to scale, is it increases but less than doubles, it is decreasing returns to scale, and if it increases even more then than doubles it is increasing returns to scale.

4. Short run an long run cost curves.

As it was described earlier in the chapter 1 there are four types of resources: land, labour, capital, and entrepreneurial ability. The latter suggest the task to create a firm and start production process, but before a firm can organize resources in any manner, it needs to have a technology, a function Q = f(L, K) where Q is output, L and K is labour and capital respectively. There around might be more resources than just labour and capital, but this is the usual case.

The distinction between short run and long run

This distinction is crucial role in the economic theory. It is generally thought that in the short run, has several inputs are fixed, supply cannot "totally adjust" to demand changes while in the long run, as now all inputs are variable, it is possible for supply to "fully adjust" to demand changes. The law of diminishing marginal returns is applicable only in the short run. The law of diminishing returns explains the shape of marginal physical products curve (MPP): in the beginning it increases at an increasing rate, then, at some point, production increases at a decreasing rate. Consequently, there will be a decrease in total production. Efficiency will only be experienced. There is a lot of quantity of fixed resources for a variable inputs to work with. In other words, there is no reason to hire more workers in each of them will not have a workplace.

Relation of production to cost

Efficiency will only be experienced. There is a lot of quantity of fixed resources for a variable inputs to work with. In other words, there is no reason to hire more workers in each of them will not have a workplace.

Relation of production to cost

In order to fully understand this relation it is needed to define what the total physical product is.

Total physical product ( TPP) is the amount of final product produced by a certain firm. Generally, it has positive correlation with the number of inputs or resources. Average physical product (APP) is defined as the total product for each unit of variable input. In other words, if we talk about labour, the number of units of total product per worker.

APP = total output / variable input

Marginal physical product (MPP) is the derivative of total product by the certain input or the number of final product for each additional worker hired.

MPP = change in output / change in input

Note:

When APP is at its peak, it intersects MPP.

When MPP reaches zero, total physical product is at its peak.

Graph

Costs

1. Fixed costs. (Rent of the building, lump-sum taxes, depreciation)

They are defined as costs, that are constant regardless of changes in output. Total fixed costs are equal to total costs if the output is zero.

Average fixed costs and the amount of total fixed costs per unit of output.

AFC = TFC/Q

Obviously, Average fixed cost curve is downward sloping. If the quantity goes to infinity, the average fixed cost curve will decline approaching zero.

2. Variable costs. ( Material expenses, which relate to production, travel expenses, etc)

Total variable costs (TVC) depend on the output changes, in particular, there is a positive correlation between them.

Average variable cost (AVC) years the amount of total variable for each unit of output.

AVC = TVC / Q

3. Total costs

Total cost is the sum of total variable costs and total fixed costs.

TC = TVC+TFC

Average total cost (ATC) is the amount of total costs per each unit of output.

ATC = AVC+AFC

(This can be easily derived from the first equation).

4. Marginal costs

Marginal cost is the amount of total cost pretty each additional unit of output. In other words it is a derivative from total cost function.

MC = change in total costs / change in output

Note: marginal cost curve intersects both average variable cost curve and the average total cost curve at their minimums.

⇐ Назад