BA 361- EXAM 1 Chloe Baker 5 determinants of market demand: Price Incomes (inability) Tastes Prices of complements/substitutes Expectations (prices?, future income?) market: collection of individual demanders (sellers) market demand equation: Qi=f(Pi, Y, T, Pj, E) i: good or service that we are talking about j: something else market demand question: if we change ____, how will quantity and price be affected? ?Qi/?Pi Hold everything constant except for price why do we use price elasticity of demand? Slope of the demand curve is vulnerable to units of measure price elasticity of demand equation: ?= %?Qi/ %?Pi how to avoid the problem with units of measure tells you: the percent change in quantity when we change the price cross-price elasticity of demand: ?ij= %?Qi/ %?Pj if the price of good A changes, how will it affect the quantity of good B If ?ij < 0 ( Goods are complements If ?ij > 0 ( Goods are substitutes If ?ij = 0 ( Goods are unrelated in consumption 3 determinants of market supply: Resource availability and prices Technology Market structure (level of competition) market supply curves reflect?. Underlying costs Supply costs complements: 2 markets/goods used together Ex. Beer and krystals complements( _____ move in the same direction: quantities substitutes( ___ move in the same direction: prices how do complements work together? When the supply of good A increases, the demand for good B will increase how do substitutes work together? If the demand for good A increases, the demand for good B will decrease production links? Goods used in the production of other goods Ex. Steel and ball bearings how do production links work together? If the price of good A (steel) increases, the price of good B (ball bearings) increases Because you use it to make them TC= FC + VC MC= ?TC/?Q AC= TC/Q AFC= FC/Q AVC= VC/Q AC= AFC + AVC ____ = _____ to maximize profits( MR = MC short run: a period of time sufficiently short for some costs to be FIXED long-run: a period of time sufficiently long for all costs to become VARIABLE the importance of distinguishing between the short run and the long run depends on? the managerial time horizon managers look 18 months into the future when making decisions( for most firms that is in the short run Asian managers( 60 months typical time horizons vary by?. Nation/culture AFC= Vertical distance between the ATC and AVC AFC=ATC-AVC As you product more, AFC becomes smaller and vice versa Why are AVC and ATC u-shaped? They are economies of scale( as you produce more, costs go down but as you continue to product more, it is harder to manage and costs go up if MC > AC( pulls the average up if MC < AC( pulls the average down 3 rules of the market game: Structure Conduct performance what questions should we ask when playing the market game? Who is playing? ( who is participating in the market? Given the rules, how will we play and what will be the outcome? market definition: product and geographic dimension product dimension-( what products are included in the market geographic dimension( what areas are included in the market **If you had a monopoly in the market, would you be able to impose a profitable and lasting monopoly price? IF NOT, expand definition the broader the region? the easier it is to be a monopoly seller problem( the internet how do you use the market definition? Start with the narrow definition and ask questions. If yes, use this definition. If not, lower it. 5 elements of the market structure: Market definition Market shares/concentration Conditions of entry Degree of vertical integration Demand conditions market shares/concentration: how much of the market is concentrated in the hands of how many sellers? conditions of entry: are there barriers to entry? degree of vertical integration: which stage of the production process occurs within your prim? Raw materials (top)( customers (bottom) demand conditions: what are the buyers like? Similar or different? How? Is the demand growing or declining? two ways of determining market share? CR4 and HHI concentration ratio CR4: sum of the market shares of the 4 largest firms in the market the bigger the number, the more concentrated the market, the smaller, the more competitive easy, fast, understandable problem when CR4? Fails to account for distribution what is a much better measure of market share? HHI (but a little less data intensive) HHI: (shares of all firms)^2, then sum up all the shares Write in formula the biggest HHI you can get is _ 1 : monopoly market smallest HHI you can get is __ 0: competitive market when do you shut down your firm in the short run? If price is below ATC( If I can cover all variable costs and still have some left to pay fixed costs( keep going If I cant cover variable costs( shut down 5 elements of market conduct: What to make How much to make Product differentiation How to respond to rivals Degree of vertical integration break even price: minimum average total cost shut down price: minimum average variable cost cease production if it is less than the average variable price MC curve becomes? The supply curve for the firm ? = total revenue-total cost MR= ?TR/?Q MC= ?TC/?Q profit maximization: MR=MC if MR>MC( want to keep producing more revenue produced from the last unit is greater than the cost of producing the last unit good thing: ? increases if MR AVC Eventually firms will exit what happens to the demand and supply curves as firms exit? Supply curve moves left, price increases, and other firms can survive Q: increased N: decreased q: decreased monopolist: single seller in the market for a monopoly, firm demand curve= market demand curve for a monopoly, how are $ and q linked? Sell more: lower price Sell less: raise price And vice versa when MR and AR become disconnected, what are the 2 different affects on revenue? Raise revenue to attract new customer Lower revenue by lowering price of existing customers how do you find price? Find where MC=MR and go town to q, then go up to the demand curve to find price profit= difference between price and ATC does a monopoly firm always earn profit? Not always( not guaranteed by most of the time barriers to entry: anything that raises the cost incurred by potential entrants above those incurred by incumbent producers 3 types of barriers to entry: Structural barriers to entry Institutional barriers to entry( laws, patents Behavioral barriers to entry 3 types of behavioral barriers to entry: Advertising R and D Other behaviors (predatory pricing, limit pricing, collusion, price discrimination) which of the behavioral barriers to entry is the most effective? Advertising Not collateral Bat their history of advertising But hard to borrow for Research and Development: Uncertain(don?t know if it will yield anything usable Have to have money you can lose predatory pricing( game: game: ?you get a dollar, and I get 9, otherwise he gets 10? barrier to entry( ?I will drive the market down, flood it with output if you enter?( I can survive, you cant predatory pricing: incur losses to run someone else out of the market people will eventually learn the pattern and wont enter limit pricing: don?t charge a full monopoly price to keep others from entering difference between limit and predatory pricing: limit pricing: below monopoly pricing, but still yields profits predatory pricing: price below AVC, actually losing money collusion: next best thing after monopolies getting together with rivals and act as a monopoly ?restraint of trade?- illegal but regular factors of collusion: price to emulate monopolist immediate incentive to cheat works best with homogeneous outputs, limited number of sellers, stable market demand conditions there are ways to dampen incentive to cheat anti trust treatment varies greatly across countries why doesn?t Collusion last? Once firms agree to set prices, instantly each firm has the incentive to cheat why aren?t monopolies sustainable? Competition Illegal two ways to detect cheaters of collusion? ?meet or release clause?- if you can find it for less, go buy it and we will release you from our contract ?most favorite customer clause?- if I sell product for less than I am charging you, I will refund you If P>MC in a monopoly outcome? Price is too high Output is too low efficiency outcomes: Are monopolies allocatively efficient? No( output is restricted and price is too high efficiency outcomes: are monopolies technically efficient? NO( costs are not minimized efficiency outcomes: are monopolies dynamically efficient? Maybe( murkier(does it have incentive to engage in R and D? only if it doesn?t have another way to keep out entrants price discrimination: charge different customers different prices( some people WOULD pay more as good as it gets( earning as much as possible 4 conditions of price discrimination: Must have market power Must have customers with observable differences in demand (know who will and wont pay) Must be a possibility of resale Price according to inverse elasticity rule Inverse elasticity rule: SHAPE \* MERGEFORMAT 1st part: price cost margin( how good is the price? ( charge higher price to people who are willing to pay more 2nd part: price elasticity i: particular class of customers example of price discrimination: airlines have market power( all charge similar prices 2 types of customers with different demands business: don?t stay long book flight last minute HAVE to go so will pay any price leisure: book flight way in advanced flexible, price sensitive, Want to go anti-trust laws: designed to protect competition because it yields efficiency looks like competition Number of firms: monopoly, perfect competition, oligopoly( Monopoly: one firm Perfect competition: many firms Oligopoly: few firms most markets in the world are ____ oligopolies in between monopolies and perfect competition key characteristic of oligopolies: few enough firms that the options available to any one firm depends on the behavior of other market participants firms are interdependent sufficiently few so that all the firms are interdependent my decision depends on yours other characteristics of oligopolies: can develop with or without product differentiation requires the development of EXPECTATIONS (as I?m planning, I have to GUESS what the rivals will do) market with only two firms is a duopoly point of oligopolies: there were industries where costs changed but prices didn?t why? :firms fearful about what rivals will do 3 oligopoly models: Kinked demand Game theory Dominant firm kinked demand: explains price inflexibility no explanation of beginning price and quantity values criticized( no starting or ending point behavior based on EXPECTATIONS 2 expectations of kinked demand: Firms assume rivals WILL NOT follow price increase If I raise price, rivals will NOT follow Characterized by extreme rivalry Assumes rivals WILL follow price decrease If I lower my price, other will follow why firms can be inflexible= because of the way firms treat their rivals what matters with kinked demand? What the seller BELIEVES demand looks like what causes the outcome of kinked demand? Expectation, fear firm has why is part of the demand curve steep and part of it flat in kinked demand? Current price is set Flat part: represents increasing prices above current price( if raise price: rivals don?t follow (flat) Steep part: represents decreasing prices below current price ( if lower price, rivals follow (steep) in game theory, why do both firms do the same thing and accept less money? (ex. Advertising) if both advertise, they don?t do as well as if they both didn?t BUT if one advertised and the other didn?t, the one who didn?t would be screwed both firms advertise (make less $ than possible), because they are scared of what the other firm will do market failure we depend on markets that allocate resources because we have a limited amount of stuff We depend on markets to move the resources to the place where they are most valuable But occasionally markets fail (don?t give us the right answer)( government should intervene 5 types of market failure: Public goods Un-natural, monopoly, and anti-trust Natural monopoly Informational asymmetries Externalities public goods: government has to produce them because no one else will because they don?t bring profit entry is motivated by profit and profit depends on the ability to exclude use (in order to impose a price)( a public good occurs when a private vender CANNOT exclude usage( cant charge a price so cant profit from it does not yield utility to users a good that would yield utility to users?. Will NOT be privately provided, so that the government must intervene, generally by providing the good directly example of a private good: streets( no way to charge the public for it national defense( everyone has to protect everyone components of un-natural, monopoly, and anti-trust: US antitrust statutes designed to protect competition, not competitors Anti-competitive behavior Merger evaluation/approval Third party enforcement/ triple damages Varies HUGELY by national boundaries US antitrust statutes designed to? Protect the PROCESS of competition anti-competitive behavior: want to be monopolists anti-trust works in 2 ways: way you compete with rivals( legal merger settlement 2 aspects of anti-competition: 3rd party enforcement( law depends on the person who is injured to enforce laws (bring a civil suit against the person) Triple damages( if someone does something illegal and hurts someone, that person could collect 3X the money natural monopoly equation: C(q1 + q2) < C(q1) + C(q2) If you have a single firm producing q1 and q2, can do it at a lower cost than more than one seller selling q1 and q2 natural monopoly: one firm can serve a market more efficiently than any market of two or more firms ___ define natural monopolies: Sunk costs sunk costs, ex. Fixed cost that is not recoverable (cant get it back or money back) Ex. Electric utilities, cable providers, sewage Represent natural monopolists how do you find profits? Same as other monopolists MC=MR Will be the only seller what happens to long-run average cost curve in a natural monopoly? Declines over relevant output range if the government intervenes with a natural monopoly( we want the same output was we would get from competition 4 government remedies of a natural monopoly: Direct ownership Regulation Establish standards Franchise agreements ** natural monopolists will behave as monopolists unless the government intervenes informational asymmetries: occur when one side of the market knows a whole lot more than the other side prohibitively expensive for individuals consumers to gather information why does government intervene with informational asymmetries: in order to provide information to the public example of informational asymmetry: airplanes( airline knows a lot more information about the planes than the customers government intervenes by establishing safety standards and making sure that they are met externalities: someone eternal to the transaction is affected costs of external people aren?t taken into account by the transaction unfettered market will not take into account full range of costs or benefits( benefits or costs fall on those outside the transaction can be positive or negative how does government intervene with externalities: through taxing negative externalities or subsidizing positive externalities examples of externalities: cigar paper mill smell of bakery education( subsidized( people will do things with education that will benefit the broad society tang( came out because of the space program and we benefit
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