Indorg - Class 2 - Appunti 2 PDF

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Class 2 - INDORG HOW DO FIRMS BEHAVE IN A PERFECTLY COMPETITIVE MARKET? Concept of profit: when talking about profit, we must include all costs, including the cost of capital.! Profit = revenues – costs Extra profit: additional remuneration that goes to the firm which has some market power.! Output = f( L , K ) Output is a function of labour and capital.! Usually the cost function is written using cost of labour (w) and cost of capital (r):! C=(w*L)+(r*K) Another way to write the cost function is:! Costs = fixed costs (FC) + ( 2 * output (y))" (why the number 2? It’s an e.g.)! C = FC + ( 2 * y ) A firm that produces a single output, has price p which is the price of the single output.! The firm is price-taker, so p is external, it can’t be modified.! The firm maximizes profit.! 𝞹 = ( p * y ) – C( y ) Firm has to choose y in order to maximize the difference between ( p * y ) – C( y )! In order to do this we take the derivative.! 𝟃𝞹 / 𝟃y = p – ( dC / dy ) = 0 So, p = ( dC / dy ), with ( dC / dy ) that is the marginal cost MC, so p = MC.! The firm chooses y in order to equalize p and MC. (*)! In the long run, 𝞹 = 0.! In order to survive, the firm must have a non-negative profit, so it should set ( p * y ) ≥ C( y ).! So we have p ≥ [ C( y ) ] / y The price set must be greater than the quantity given by total costs divided by output, the average costs.! p ≥ AC (price should be at least as large as average costs). In the long run, the marginal cost curve equals the supply curve. (**)! ANTITRUST Imperfectly competitive markets show inefficiencies.! The state tries to solve these inefficiencies.! How can the state intervene? 2 ways:! - Europe: the state acts as a player. There is no need for antitrust as there are public enterprises that are an integrant part of the market.! - USA: the state acts as a referent. It aims at limiting market power of the companies, especially the abuse of it.! European states introduce in the market public enterprises/firms, in particular in the so called key sectors.! In the US, the state doesn’t enter the market, it acts as a referent, who sets the rules and forces them. The best example is the “antitrust legislation” of 1890.! Sherman act, made of 2 articles:! - any attempt to limit trade is illegal.! - any attempt to monopolize market is illegal.!

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What is the difference between profits and producer surplus?! The difference is given by the presence of fixed costs.! Profits = Producer surplus + Fixed costs! Producer surplus = Profits – Fixed costs Social welfare = Consumer surplus + Producer surplus So, Social welfare = Consumer surplus + ( Profits – Fixed costs)! The goal of antitrust authorities is to maximize social welfare. Social welfare is maximized when deadweight loss is reduced/minimized.! Monopoly: the supplier has maximum market power as there is no competition.! The monopolistic maximization problem is the opposite of the perfect competition one.! In a monopolistic setting, the supplier can choose either the price or the quantity supplied. He can’t choose both. The demand curve has downward slope.! In a perfectly competitive market, 𝞹 [ = ( p * y ) – C( y ) ] is maximized when p = MC( y ) Now, p is no longer a parameter, as it is affected by y. The new equation for profit is:! 𝞹 = [ p( y ) * y ] – C( y ), taking the derivative of 𝞹, we get that [ ( dp / dy ) * y ] + p( y ) = MC( y ) So, we get that the marginal cost is equal to the marginal revenue (which is lower than p, because the derivative of p with respect to y multiplied by y [ ( dp / dy ) * y ] is negative).! A monopolist has to choose his best point along the demand curve, which is given.! p( y ) = MC( y ) + markup The price is above marginal cost, so there is an extra profit, the markup.! PRICE DISCRIMINATION (Ch. 5 and 6) - Pigou, 1920: “Price discrimination means giving different prices to different consumers”.! pa ≠ pb! Anyway, to have a clear idea about price discrimination, we should have a look at costs as well.! - Stigler: “The difference should not be in prices, but in the ratio between prices and costs across consumers”.! ( pa / ca ) ≠ ( pb / cb )! When does price discrimination occurs? Three prerequisites must occur/happen/be present:! 1. The seller must have price making power/market power.! 2. The seller must have information about consumers.! 3. There mustn’t be no resale conditions, buyers must be last buyers.! How does price discrimination occurs? Classification of price discriminations (Pigou):! 1st degree price discrimination: ideal/perfect price discrimination. The seller has full information about each individual demand. He knows the reservation price each consumer has, which means that he knows which is the willingness to pay of each customer. Because of this, the seller can charge to each customer its reservation price. In this way he absorbs consumer surplus, which is taken away from consumers. There is only producer surplus.' This type of price discrimination is both interpersonal (it can be done between different people) and intrapersonal (it can be done with the same person).! 2nd degree price discrimination: non-linear pricing. The unit price depends on the quantity.! Price discrimination

Output (y)

Price (p)

R / Ex

Unit price ( r / y )

No

y

p

p*y

p

Yes (3X2)

1

p

p

p

Yes (3X2)

2

p

2p

p

Yes (3X2)

3

p

2p

2/3 p

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E.g. of 2nd degree price discrimination/non-linear pricing: 2 parts tariff system (TPT)! There are two parts: a fixed part and a variable part that depends on consumption.! The example is a tennis club, where you pay an annual subscription fee in order to be a member of the club, but when you play and reserve a tennis court for an hour you have to pay a reservation fee.! TPT = FC + VC( y ) ( TPT / y ) = ( FC / y ) + [ VC( y) / y ] This is an interpersonal type of price discrimination! 3rd degree price discrimination: group pricing. This price discrimination is based on observable features that act as discriminatory factors. These features must be proven.! A customer is treated differently, whether he belongs or not to a specific group.! The seller should have an estimate of the group demand function.! A group of customers that has high elasticity of demand, is flexible and reacts to changes in prices.! A group of customers that has low elasticity of demand, is rigid and doesn’t react to changes in price. It is nor sensible to price changes.! What is the impact of price discrimination on social welfare?! What happens to consumer surplus?! We compare social welfare under price discrimination versus social welfare under uniform pricing.! SWpd vs SWu! - 1st pd: social welfare under 1st degree price discrimination equals consumer surplus under perfect competition. The difference is that under 1st pd, the producer absorbs the consumer surplus. Social welfare goes up with respect to the uniform pricing (even if only one player takes advantage from it).! - 2nd pd: a condition for SW to go up is that total output sold under price discrimination is greater than total output that would be sold under uniform pricing.! - 3rd pd: a condition for SW to go up is that total output sold under price discrimination is greater than total output that would be sold under uniform pricing.

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