Download ECON 1001 AB Introduction to Economics I Dr. Ka

ECON 1001 AB
Introduction to Economics I
Dr. Ka-fu WONG
Ninth week of tutorial sessions
KKL 925, KKL 1010, K812, KKL 106
Clifford CHAN
KKL 1109
[email protected]
Covered and to be covered
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Covered the week before the break
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Dr. Wong finished up to slides of 24 of kf011.ppt
You should have at least read up to Chapter 10 Monopoly and
Other Forms of Imperfect Competition
Midterm 2 will be held on this Saturday; it covers everything up to
Chapter 10. Focus on materials covered after the first midterm
If not, please press hard on it. Start reading Chapter 11 Strategic
Choice in Oligopoly, Monopolistic Competition, and Everyday
Life
To be covered in the tutorial sessions this week
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Problems in chapter 10: #1, #3, #5, #7, #8 and #9
You are advised to work on the even ones as well
Problem #1, Chapter 10
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Two car manufacturers, Saab and Volvo, have fixed
costs of $1 billion and marginal costs of $10,000 per car.
If Saab produces 50,000 cars per year and Volvo
produces 200,000, calculate the average production cost
for each company. On the basis of these costs, which
company’s market share do you think will grow in relative
terms?
Solution to Problem #1 (1)
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Given in the question, both manufacturers have a fixed
cost of $1 billion and a marginal cost of $10,000 per car
Marginal cost = Variable cost
Total variable cost (TVC)= Marginal cost * quantity
Saab
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TVCSaab = 10,000 * 50,000 = $500,000,000
Total cost (TC) = Total variable cost + Total fixed cost
TCSaab = $500,000,000 + $1,000,000,000 = $1.5 billion
ACSaab= $1.5 billion / 50,000 = $30,000
Solution to Problem #1 (2)
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Volvo
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TVCVolvo = 10,000 * 200,000 = $2,000,000,000
Total cost (TC) = Total variable cost + Total fixed cost
TCVolvo = $2,000,000,000 + $1,000,000,000 = $3 billion
ACVolvo= $3.0 billion / 200,000 = $15,000
Why Volvo’s average cost is only half of Saab’s even if
they actually face the same fixed and marginal costs?
Volvo’s annual production is 4 times larger than Saab’s
This reveals that Volvo has a much higher market share
than Saab, and thus it has a higher potential for growth
relative to Saab
Problem #3, Chapter 10
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Multiple-choice question
A single-price, profit maximizing monopolist:
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Causes excess demand, or shortages, by selling too few units of
a good or service
Choose the output level at which marginal revenue begin to
increase
Always charge a price above the marginal cost of production
Also maximizes marginal revenue
None of the above statements is true
Solution to Problem #3, (1)
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A) False
Even if a monopoly produces less than the perfectly
competitive quantity, it will not produce any excess
demand or shortage
At the chosen output, demand and supply coincide
B) False
A monopoly maximizes the total profit instead
Similar to a perfectly competitive firm, a monopoly
produces at a level where marginal revenue is equal to
marginal cost
Solution to Problem #3 (2)
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C) True
A monopoly determines an output level by equating
marginal revenue and marginal cost, but it charges a
price according to the demand
Demand function is always higher than the marginal
revenue function
Thus, a monopoly always charges a price is greater than
the marginal revenue (marginal cost)
Solution to Problem #3 (3)
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D) False
A monopoly maximizes the total profit instead
It actually produces at a level where marginal revenue is
equal to marginal cost
E) False, as only C is proven to be a true statement
Problem #5, Chapter 10
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Explain why price discrimination and the existence of
slightly different variants of the same product tend to go
hand in hand. Give an example from your own
experience.
Solution to Problem #5 (1)
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To capture a higher profit for itself, a monopoly produces
less than the perfectly competitively output
If it is legal, a monopoly will set a number of prices for a
number of slightly differentiated products
A monopoly can earn a higher monopoly rent by setting
a pricing strategy that is able to identify different types of
customer
This pricing strategy requires so much information,
particularly the distinctive characteristics and reservation
price of the customers
Solution to Problem #5 (2)
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When customers’ reservation prices are identified, a
monopoly can then produce products that are slightly
different from each other
The differentiation should reveal the distinctive
characteristics of the types of customer so that
customers can self-select to the differentiated products
As a result, price discrimination and existence of slightly
different variants of the same product always come hand
in hand
Solution to Problem #5 (3)
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Example
Automobile
A typical automobile often comes in three options
available to choose from
The options are very similar to each other, but they are
sold in three level of prices
The cheapest option- a basic vehicle with manual
transmission and no stereo system and air conditioner
The moderate option- a basic vehicle with auto
transmission, stereo system, air conditioner and other
automotive features, such as power seats and power
locks
Solution to Problem #5 (4)
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The most expensive option- a basic vehicle with all the
features available on the moderate option plus some
luxurious touches like sunroof and leather seats
Low-income drivers tend to choose the cheapest option
Average-income drivers tend to choose the moderate
option
High-income drivers tend to choose the most expensive
option
The monopoly is thus able to earning a monopoly rent by
serving three types of customer with a differentiated
product
Problem #7, Chapter 10 (1)
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TotsPoses, Inc., a profit maximizing business, is the only
photography business in town that specializes in
portraits of a small children. George, who owns and runs
TotsPoses, expects to encounter an average of eight
customers per day, each with a reservation price shown
in the following table.
Problem #7, Chapter 10 (2)
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A) If the total cost of each
photo portrait is $12, how
much should George
charge? At this price, how
many portraits will
George produce each
day? What will be his
economic profit?
Customer
Reservation price
($ per photo)
A
50
B
46
C
42
D
38
E
34
F
30
G
26
H
22
Solution to Problem #7 (1)
Customer (A)
Reservation
price ($/photo)
(B)
Total revenue
($/day)
(# of A) * (B)
Marginal
revenue
($/photo)
A
50
50
50
B
46
92
42
C
42
126
34
D
38
152
26
E
34
170
18
F
30
180
10
G
26
182
2
H
22
176
-6
Solution to Problem #7 (2)
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As a monopoly, George will produce at a level where
marginal revenue = marginal cost
Given that the total (marginal) cost of each portrait is $12
Based on the above table, George will set a price that is
consistent with serving only the first five customers
That is the reservation price of the fifth customer, $34
At $34, George earns an economic profit as follows
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= Total revenue – total cost
= ($34 * 5) – ($12 * 5) = $170 - $60
= $110 per day
Solution to Problem #7 (3)
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B) How much consumer surplus is generated each day
at this price?
At $34, the consumer surplus:
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Difference between sum of reservation prices and total revenue
($50 + $46 + $42 + $38 + $34) – ($34 * 5)
$40 per day
Solution to Problem #7 (4)
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C) What is the socially efficient number of portraits?
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If there is no positive or negative externality, the socially efficient
output is the perfectly competitive output
That is P = MC = MR
Since the marginal cost is less than all of the reservation prices,
George should serve all the customers
8 portraits are the socially efficient output
Solution to Problem #7 (5)
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D) George is very experienced in the business and
knows the reservation price of each of his customers. If
he is allowed to charge any price he likes to any
consumer, how many portraits will he produce each day,
and what will his economic profit be?
First degree price discrimination
George will serve all the customers as the marginal cost
is less than all the reservation prices
Solution to Problem #7 (6)
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George should charge a price according to each
customer’s reservation price
As long as price is less than or equal to the customer’s
reservation price, the customer is still willing to buy the
portrait
Monopolistic profit
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= Sum of reservation prices – total cost
= ($50 + $46 + $42 + $38 + $34 + $30 + $26 + $22) – ($12 * 8)
= $192 per day
Solution to Problem #7 (7)
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E) In this case, how much consumer surplus is
generated each day?
If George charges a price according to the reservation
price, he will capture all the consumer surpluses as
monopolistic profit
Thus, there will be no consumer surplus
Solution to Problem #7 (8)
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F) Suppose George is permitted to charge two prices.
He knows that customers with a reservation price above
$30 never bother with coupons, whereas those with a
reservation price of $30 or less always use them. At what
level should George set the list price of a portrait? At
what level should he set the discount price? How many
photo portraits will he sell at each price?
Solution to Problem #7 (9)
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Second degree price discrimination
There are two markets
Again, since the marginal cost is lower than all the
reservation prices, serving all customers is profitable!
George should charge a list price for which the
reservation price is slightly more than $30
By setting the list price at $34, George will have 5
customers willing to purchase a portrait
For the discounted market, George should set the
discount price that is equal to the lowest reservation
price
Solution to Problem #7 (10)
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By setting the discount price at $22, George will have 3
customers willing to use the coupon and purchase a
portrait
Charging at these two particular prices, George will be
able to serve all the customers profitably
The value of the coupon should be
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list price ($34) - lowest reservation price ($22) = $12
Solution to Problem #7 (11)
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In this case, what is George’s economic profit, and how
much consumer surplus is generated each day?
Economic profit
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=($34 * 5) + ($22 * 3) – ($12 * 8)
$140 per day
Consumer surplus
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Consumer surplus from customers using and not using coupons
Sum of reservation prices – total revenue
($50 + $46 + $42 + $38 + $34) – ($34 * 5) + ($30 + $26 + $22) –
($22 * 3)
$52 per day
Problem #8, Chapter 10 (1)
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Serena is a single-price, profit maximizing monopolist in
the sale of her own patented perfume whose demand
and marginal cost curves are as shown. Relative to the
consumer surplus that would result at the socially
optimal quantity and price, how much consumer surplus
is lost from her selling at the monopolistic profitmaximizing quantity and price?
Problem #8, Chapter 10 (2)
MC
$ per ounce
60
40
30
20
10
MR
0
8
12
Ounces/day
D
24
Solution to Problem #8 (1)
P
$ per ounce
60
Net Loss in
consumer surplus
MC
40
Perfectly
competitive output:
P=MC
30
20
Loss in producer surplus
10
Monopolistic
output: P>MR=MC
Transfer from
CS to
0
monopoly
rent
MR
8
12
Ounces/day
D
24
Q
Solution to Problem #8 (2)
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Perfectly competitive output: P=MR=MC
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Monopolistic output: P > MR=MC
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12 ounces, $30 each ounce
The firm still produce at MR=MC, but it charges a price higher
than MC
8 ounces, $40 each ounce
Serena produces less than the perfectly competitive output
Consumers loss due to the monopolistic price
Loss in consumer surplus
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= the area of the trapezoid between $30 and $40
= (8 +12) * ($40 - $30) *1/2 = $100
Solution to Problem #8 (3)
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However, part of loss in consumer surplus is actually
transferred to the monopoly rent
That is the area of rectangle between $30 and $40
Transfer from consumer surplus to monopoly rent
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= ($40 - $30) * 8 * = $80
Net loss in consumer surplus (shown in green)
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= $100 - $80 = $20
Problem #9, Chapter 10
MC
60
$ per ounce
In the preceding
question, how much total
surplus would result if
Serena could act as a
perfectly price
discriminating
monopolist?
40
30
20
10
MR
0
8
12
Ounces/day
D
24
Solution to Problem #9 (1)
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A perfectly discriminating monopolist would sell
according to each buyer’s reservation price (Similar to
part E of Problem #7)
The marginal revenue curve and the demand curve
become the same
Serena would then produce at the perfectly competitive
level, which is 12 ounces per week
Serena completely captures the consumer surplus by
targeting each buyer’s reservation price; there will be no
consumer surplus
The consumer surplus will be transferred and contributed
to the monopoly rent
Solution to Problem #9 (2)
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The total surplus is
thus the area under
the demand curve
but above the supply
curve at 12 ounces
per day
= ($60 - $0) * 12
ounces * 1/2
= $360 per day
MC
60
$ per ounce
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40
30
20
10
MR
0
8
12
Ounces/day
D
24
The end
Thanks for coming!
See you next week!!!