Market structures and pricing
Revenues
Consumers
* Inverse demand curve gives willingness-to-pay
* Benefit consumer(s) derive(s) from additional good;
* Area under inverse demand curve measures total willingness-to-pay, total benefit or total surplus. * Maximum price I can charge as producer determined by inverse demand function * Marginal revenues; revenue of next unit I sell
Strategies
* Profit maximization
* Marginal profits equal to 0 (MR=MC)
* Classic economic theory; entrepreneurial capitalism
* Owner makes strategic decisions
* Managerial capitalism;
* Ownership changed
* Control changed
* Potential conflicts between shareholders and management * Firms got bigger: coordinate difficulties
* Revenues maximization
* Decreasing revenues bad for image
* Financial institutions want certainty
* Low revenues mean relatively high risk for suppliers * Low revenues may lead to budget cuts, including management * Bonus
* MR=0
* Marketing effort
* Managerial utility maximization
* Managers maximize own satisfaction
* Growth maximization
* Long term strategy
* Behavioral theories
* Different groups, satisfy all groups to survive: satisfying * Altruistic objectives: public interest
* Welfare maximization
* What strategy is relevant?
* Autonomy and income advancement
The Term Paper on The Alltel Pavilion Case: Strategy and Cvp Analysis
Based on an actual entertainment pavilion, the case develops many factors unique to a service business and illustrates how pavilion management can use CVP analysis to determine which artists to attract and what kinds of contracts to have with these performers. The Pavilion has two types of customers (paying ticket holders and free ticket holders) and earns profits from three types of revenues ( ...
* Successful business is most important personal objective * Growth objective
* Profit maximization
* Model
* Economic profit ≠ accounting profit
Market structures
* Perfect competition
* Monopolistic competition
* Oligopoly
* Monopoly
Perfect competition
* Many (small) suppliers and buyers: ‘price takes’
* Demand function for individual company
* Products are perfect substitutes
* Free entry and exit
* Information is perfect (available to all no cost)
* Free movement of products: supply responsive to market forces * Innovation exogenous: producers reactive rather than proactive.
* Benchmark: Welfare is maximized (p=mc)
* Efficiency
* Productive efficiency: AC cannot be lower
* MC curve passes though minimum of AC
* Allocative efficiency: resources are distributed and used as preferred by consumers: P=MC * Pareto efficiency: no one can be made better off without making anyone else worse off.
Monopoly
One seller; can influence price (output)
Price > marginal cost: economic inefficiency (although the firm itself may be
efficient) * Barriers to entry
* Initial costs
* Sunk costs
* Brand loyalty
* Economies of scale
* Patents and licenses
* Anti-competitive behavior
Revenues
* Demand: Q
* Inverse demand: P=a/b-1/b*Q
* Revenues: R = P*Q = Q*a/b-1/b*Q₂
* Marginal revenue: ∂R/∂Q
* Additional revenues from next unit sold
* ∂R/∂Q = a/b-2/b*Q
* Twice as steep as inverse demand
* Positive if εр < -1
* Demand is elastic (point-elastic)
Natural monopoly
* Market can only sustain 1 producer
* Competition (P=MC): all competitors make a loss
* P>MC: loss when P help to sustain monopoly or oligopoly * Government; policy regulation
* Spatial pre-emption; new entrants do not have access to necessary inputs * Cost barriers
* Reputation: customer loyalty, safety
* Exit barriers: shrinking a firm is expensive (labor, capacity) * Entry-deterring strategies; pricing, spare-capacity, corporate deals (price discrimination)
Oligopoly: non-corporate behavior
The Essay on Individual Rights Competition One Market
Tondaleria Marcus Economics November 13, 2003 Competition is the freedom to produce and the freedom to trade what one has produced for one's own self interest, in the pursuit of one's own happiness. Politically speaking, competition is a consequence of the political right to life, liberty, and the pursuit of happiness; especially when it is applied to the economic sphere of production and trade. ...
* Competition based on output (quantity) or price.
* Two basic oligopoly models:
* Cournot (quantity competition)
* Bertrand (price competition)
* Cournot: firms determine output simultaneously, and the bring this to the market; * Bertrand: firms announce prices. Demand is allocated to low-price firm(s), who then produce(s) demand
Cournot competition
* Assumes that firms produce identical products
* Demand: Q=a-b*P
* Inverse demand: P=a/b-1/b*Q
* Now we have 2 producers (duopoly): P=a/b-1/b*(Q1+Q2)
* Profits maximized when MR=MC (Equivalent to monopolists), taking the competitors action as given. * Inverse demand: P=a/b-1/b*(Q1+Q2)
* Revenues firm 1: R1=Q1*[a/b-1/b*(Q1+Q2)]
* Marginal revenues: MR1=a/b-1/b*(2*Q1+Q2)
* Equilibrium: MR1=MC1
* Expression in Q1 and Q2
* Similar expression for company 2
* MR1: ∂R1/∂Q1 =
* P*∂Q1/∂Q1 + Q1*∂P/∂Q1
* P + ∂P/∂Q1*Q1
* 1 + (∂P/∂Q1*Q1/P)*P
* (1+1/εp)*P
* MR1=MC1: (1+1/εp)*P=MC1
* P=MC1/(1+1/εp)
* Cournot oligopolist sets price above MC!
* –Same for monopoly
Bertrand oligopoly
* Price competition (again assume identical goods)
* Firms announce prices. Demand is allocated to low-price firm(s), who then produces demand. * If a firm sets above its competitor’s price, clients will prefer the competitors (identical goods).
* Bertrand equilibrium is therefore equivalent to competitive equilibrium: price equals marginal cost.
Price discrimination
* Conditions:
* Market power
* Different groups of consumers (based on willingness-to-pay, demand elasticity etc.) -> segmentation * Resale is not possible
* Cost of discrimination may not exceed additional profits * Market should be transparent.
* Charge different (groups of) consumers different prices to maximize profits -> price discrimination * First, second and third degree
The Essay on Disposable Income Price Demand Supply
Explain what is meant by the term "an economic model" and outline a model of price and output determination in a free market. Examine the effect of a change in real disposable income on equilibrium price and output. An economic model or theory is a simplified explanation and analysis of economic behaviour. It allows us to predict, and therefore intervene, if we do not like the outcome of a ...
First degree pricing discrimination
* Perfect discrimination: each unit of output sold at different price; * Price determined by inverse demand curve;
* What is the optimal output?
Second degree price discrimination
* Non-linear pricing: price depends on how much you buy;
* Fundamentals;
* Application;
* Consumer decides on how much to buy;
* Self selection constraints
* 2 consumers each spends Ri to receive Xi
* Buy Xi if benefitsi (Xi)-Ri >0
* Benefits 1 (X1)-R1> benefits1 (X2)-r2
* Benefits 2 (X2)-R2> benefits2 (X2)-r1
* Consider an individual demand function (for convenience, marginal costs are 0) * Monopolists want to supply X1 at a total price of A
* Consider two individual demand functions
* Monopolist would like to supply X1 at A+B+C and X2 at A
* But: if consumer 1 also purchase X2 at a price of A, he/she will get surplus B (self selection) * If the monopolists would charge A+C for X1, consumer 1 gets surplus B and the monopolist higher profits. Can the
monopolist get higher profits? * Make X2 unattractive for consumer 1`
* Offering less of X2 (loss of monopolist) allows for higher profits from X1.
Third degree price discrimination
* Set prices for different groups of consumers: examples?
Summary
* Profit maximization
* Monopoly, perfect competition: two extremes.
* Regulation of monopoly: incentives.
* Cournot oligopoly:
* decide on production, then price determined in market * Cournot ologipolist has monopoly power (p>mc)
* Bertrand:
* decide on price, then output determined in market; p = mc * Price discrimination
* Higher profits
* Market power
