Download Ch 10 Price-searching model

Chapter 10
Price-searching Model
© Pilot Publishing Company Ltd. 2005
Contents:
• Price-searching
• Monopoly
• Monopolistic Competition
• Oligopoly
• Advanced Material 10.1
• Advanced Material 10.2
• Advanced Material 10.3
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Price-searching
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A price-searcher (尋價者) is a participant of
a market who
1. can ___________
the market price of
affect
the good sold in the market and hence
2. it has to __________
search for the wealthmaximizing price.
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not allowing entry
A closed market is a market ________________,
monopolistic
e.g., a _________________
market.
An open market is a market ________________,
allowing entry
e.g., a _________________
market.
price-taking
(Options: allowing entry / not allowing entry /
monopolistic / price-taking)
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Monopoly
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What is a monopoly?
Monopoly (壟斷) is the kind of markets with
one
• only ____________
seller and its goods
close substitutes.
• have no _________
The only seller is called a _______________.
monopolist
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Reasons for the existence of a monopolist
-- existence of entry barriers
1. Sole ownership of essential resources or skills
2. Patents or copyrights
3. Natural monopoly
4. Government franchise (專營權)
5. Formation of cartel (同業聯盟)
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Demand and revenue curves of a monopolist
$
downward sloping
A monopolist faces a ____________
market demand curve.
Note: A firm facing a
downward sloping
demand curve must be
a price-searcher. Why?
D
0
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Q
Derivation of AR curve:
coincides with
AR curve ____________
demand curve.
$
TR  P  Q
TR P  Q
AR 

P
Q
Q
(Options: lies above / coincides with / lies below)
D = AR
0
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Q
Derivation of MR curve
$
-ΔP
Gain from selling
MR=
an additional unit

MR < P
P
D
0
-
Loss from
lowering price
Q
+ΔQ
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Q
Gain from selling
an additional unit
Loss from lowering
price of preceding units
Derivation of MR -- Graphical illustration
$
For each unit, as MR < P, MR curve
lies below
______________
demand curve.
(Options: lies above / lies below /
coincides with)
P*
MR*
MR
0
Q*
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D
Q
Derivation of the equation of a linear demand curve
P
A
• A = the price at or above which Qd drops to zero
• To sell each additional unit of X, P has to be cut by B.
 Equation of this linear demand curve : P = A – BQ
+1
-B
Demand Curve (DC)
A
•_________
is the y-intercept
•_________
is the slope
-B
0
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Q
Derivation of the corresponding MR curve of a linear DC:
MR 
( P  P )  Q  P  Q
Q
i.e., MR  ( P  0 ) 
P
Q

Q
P
 ( P  P ) 
P  P
1
P
Q
Q
 P  P  (1 
pEd
or, MR  ( P  0 )  slope  Q  ( A  BQ)  BQ  A  2 BQ
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1
)
| pEd |
Demand curve:
P = A – BQ
MR curve:
MR = A - 2BQ
MR curve bisects any horizontal lines
between the y-axis and the demand curve.
P
A
Demand Curve
P=A-BQ
MR curve
MR=A-2BQ
0
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A
2B
A
B
Q
Relation between pEd and MR MR  P  (1 
)
| pEd |
$
| pEd | >1

0
1
| pEd | =
1
| pEd | < 1
Q
MR=0
MR
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D=AR
When D is
MR is
elastic
+ve
unitarily
elastic
0
inelastic
-ve
Equilibrium of a monopolist
--derived from MR and MC curves
Equilibrium conditions:
1. MR = MC
2. MC curves cuts MR curve from below
3. In the SR, AR  AVC
In the LR, AR  LRAC
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Short-run equilibrium
MR=MC
MC cut MR
from below
P*
ar
Wealth-max. output = Q*
AR  AVC
avc
mc = mr
Worth producing Q*
and charging P*
Q*
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Long-run equilibrium
MR=MC
MC cut MR
from below
P*
ar
Wealth-max. output = Q*
AR  LRAC
ac
mc = mr
Worth producing Q*
and charging P*
Q*
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LR cost curves are lower than SR cost curves
since in the LR, a monopolist can adjust the production scale
to adopt the cost-minimizing production method.
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Special features of a monopolist
Wealth-max. output:

MR = MC
If MC  0  MR  0
| pEd | >1
|pEd| = 1
Q*
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
Demand = elastic or unit. el.
 inelastic
at the wealth-maxi. Output
Special features of a monopolist (con’t)
If MR1 & MR2 cut the MC
curve at the same point,
MR=MC  wealth-max. Q
Q1 & Q2 are produced
 Charge P1 for D1
 Charge P2 for D2
P1
P2
 No definite relationship
between Q and P
 No supply curve for
a monopolist
Q1=Q2
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Monopoly and efficiency
Conditions:
Production efficiency
firms use the cost-mini. production methods; and
MCs of firms producing the same goods are equal
Consumption efficiency
 MUVs of individuals consuming the same good
are equal
Allocative efficiency
 MUV of each good is equal to its MC
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Situation of a monopoly
To maximize wealth  Minimize cost
Achieving production efficiency
To maximize utility  Consumers buy at MUV = P
 MUVA = P = MUVB = ….
Achieving consumption efficiency
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Situation of a monopoly
P
Production: MR=MC
Deadweight Loss
Consumption: P=MUV
P > MR

MUV = P > MR = MC
i.e., MUV > MC
Pm
MC curve

P = MUV
Ppt
Allocative
inefficiency
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
MR=MC
MR
0
Qm Qpt
Market
Demand
(MUV)
Q
MUV > MC  Under-production
Monopolistic Competition
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What is a monopolistic competition?
Monopolistic competition is the kind of markets with
the following characteristics:
 A large no.of sellers who are small and not associated
 Heterogeneous products
 Imperfect information
 Free entry and exit
Example: The retailing industry of VCD
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Why is a monopolistic competition a price-searching market?
Supplying heterogeneous product or
having imperfect information
 a monopolistically competitive firm can
raise price without losing all its sellers &
lower price without seizing all the buyers from other sellers.
Why?
 it is a price-searcher facing a downward sloping DC
 with many substitutes, its DC is highly elastic
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Features of a monopolistically competitive firm
Common features between a
monopolist and a monopolistically
competitive firm
D curve
Downward sloping
AR curve
Coincides with the demand curve
( AR = P)
MR curve
Lower than the demand curve
[ MR = P x (1 - 1/|pEd|) ]
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Net receipt
= TR - TC
Output
range
The output must not lie on the inelastic
range of the linear demand curve
Supply
curve
No supply curve
(or no definite relation between P & Qs)
Efficiency
Allocative inefficiency (under-production)
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Wealthmaximizing
output
Where MR = MC and MC curve cuts
MR curve from below, provided that
AR  AVC in the short run or
AR  LRAC in the long run
Wealthmaximizing
price
Determined by the demand curve,
corresponding to the wealthmaximizing output
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Special features in the long run
Monopoly
Monopolistic competition
Openness of
the market
No. of firms
Closed
(no entry)
One only
Net receipt
in the LR
May be +ve
Open
(free entry)
Indeterminate
(since different sellers
charge different Ps and
produce different Qs)
=0
(due to free entry and exit)
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Q10.5:
“In the long run, a monopolistically competitive firm
earns zero net receipt and so the demand curve
it faces must be tangential to its LRAC curve.” Discuss.
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Oligopoly
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What is an oligopoly?
Oligopoly (寡頭) is the kind of markets with
a few large sellers, oligopolists,
dominating the market.
Examples: Soft drink industry, television
broadcasting industry and banking industry.
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Why is an oligopoly a price-searching market?
 With a significant market share, an oligopolist can
affect the market price through quantity adjustment.
 By the law of demand, P , Qd  , and vice versa.

Facing a downward sloping demand curve

An oligopolist is a price-searcher
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Features of an oligopolist
 Facing a downward sloping DC.
 An oligopolist shares all the common features of
a price-searching market.
In LR, an oligopolist in
 a closed-market may enjoy +ve net receipt;
 an open-market will enjoy zero net receipt.
Special features:
Interdependence, price war Vs. price rigidity,
and non-price competition. Why?
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Advanced Material 10.1
Equilibrium derived from TR and TC curves
Slope =MR
Net receipt
Slope =MR
Net receipt
Slope =MC
Short
run
Q*(MR=MC)
Q*(MR=MC)
Wealth-maximizing output
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Slope =LRMC
Long
run
Advanced Material 10.2
Misconception: Not producing at
the optimum scale is inefficient
Allocative efficiency  produce Q at which MUV=MC
Production efficiency  these worth-producing units are
produced at the minimum cost
 To achieve efficiency, a firm is not required to
produce Q at which AC is the lowest since they may not
be worth producing (e.g., with MUV < MC).
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Advanced Material 10.3
Comparison between a price-taking industry
and a monopolistic industry
P
Deadweight Loss
MC curve
Pm
A monopolistic
Price-taking
industry
industry
Ppt
MR
0
Qm
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Qpt
MUV
Q
Price-taking
industry
Monopolistic
industry
Horizontal
Downward sloping
Horizontal
(coincides with the
demand curve)
Downward sloping
(coincides with the
demand curve)
Horizontal
MR curve of
a firm
(coincides with the
Downward sloping
(lower than the
demand curve,
∵ MR < P)
D curve
faced by
a firm
AR curve of
a firm
demand curve,
∵ MR = P)
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Price-taking
industry
Monopolistic
industry
Market
quantity
supplied
Larger output
(Qpt where
the  MC curve cuts
the market D curve)
Smaller output
(Qm where
the  MC curve cuts
the MR curve)
Market price
Lower price at Ppt Higher price at Pm
Output range
on the market
D curve
No restriction
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Where the demand
is elastic or
unitarily elastic
Price-taking
Monopolistic
industry
industry
With a supply
Without a supply
Market supply
curve
curve
curve
(a definite relation (no definite relation
between P and Qs) between P and Qs)
Net receipt of
firms in the
long run
No. of firms in
the long run
0
Net receipt  0
No restriction
One only
(free entry and exit)
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Price-taking
industry
Production
scale of firms in Produce at the
optimum scale
the long run
 Production
Efficiency
attained
 Consumption
 Allocative
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Monopolistic
industry
No restriction
 Production
 Consumption
 Allocative
(under-production)
Q10.4:
“A price-taker cannot determine the market price
but it can determine the quantity supplied.
A monopolist can determine both.”
Do you agree? Explain.
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Correcting Misconceptions:
1. If a price-searcher sells an additional unit of its
output at P, its marginal revenue should also be P.
2. Under uniform pricing, MR is always equal to AR.
3. If the marginal cost of production is equal to zero,
a price-searcher would produce an infinite amount
of output.
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Correcting Misconceptions:
4. A monopolist is the sole supplier of a good without
close substitutes. Without close substitutes,
the good must be price inelastic in demand.
5. A price-searcher must charge a certain price
in supplying its output. It must have a supply
curve relating its price to its output.
6. A price-searcher is inefficient because
it usually does not produce at the optimum scale.
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Correcting Misconceptions:
7. A price-searcher is inefficient because
it cuts output to raise price.
8. The imposition of a tax on a price-searcher
will lower its output level.
9. A price-searcher makes a larger profit than a
price-taker.
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Survival Kit in Exam:
Question 10.1:
(a) If the marginal cost is equal to zero, what would be
the output level of a price-searcher?
(b) If the marginal cost is equal to a constant, how does
the price change when the demand of a price-searcher
increases from D1 to D2 as shown in the diagram?
$
MC
D1
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D2
Q