A2 U3 Markets

Video overview - http://www.economicspro.eu/vid.php?user=EconomicsPro&video_id=5

Perfect competition - http://www.economicspro.eu/vid.php?user=EconomicsPro&video_id=20

Monopolistic competition - http://www.economicspro.eu/vid.php?user=EconomicsPro&video_id=22

Oligopoly - http://www.economicspro.eu/vid.php?user=EconomicsPro&video_id=23

Monopoly - http://www.economicspro.eu/vid.php?user=EconomicsPro&video_id=21

Consumer and Producer Surplus

http://www.youtube.com/watch?v=qTxniCLYgok&feature=related

http://www.youtube.com/watch?v=MinxczZXtKA&feature=related

Outline possible approaches to the problem of monopoly.

Possible approaches that could be used to deal with the problems posed by monopoly include:

- compulsory breaking up of all monopolies (monopoly busting)
- use of price controls to restrict monopoly abuse
- taxing monopoly profits
- rate of return regulation
- nationalising or taking into public ownership previously privately-owned monopolies
- privatising previously state-owned monopolies
- removing barriers to entry and regulations that previously protected monopolies

Not all these possible approaches have been used by the UK competition policy authorities and some of the policies — notably nationalisation and privatisation — are the opposites of each other and could hardly be used at the same time. Questions in the Unit 3 examination paper may well ask for analysis and evaluation of policies the authorities might use.

It is extremely unlikely, however, that questions will ask for a history of UK policy or for a description of the roles of the Competition Commission and the OFT. Although the roles of the competition authorities have been described here, this should be treated as useful background knowledge, rather than as information for students to learn in depth.

Evaluate the view that, because price discrimination (PD) enables firms to make more profit, firms, but not consumers, benefit from PD. (25)

Price discrimination enables firms to increase their profits by setting a profit maximising price for different groups of consumers and therefore increase total profits. Customers with inelastic demand, who buy peak priced tickets may have reduced consumer surplus as firms increase prices to them. These customers will lose welfare as they pay a price higher than marginal cost, which is allocatively inefficient.

With price discrimination, the demand curve is divided into the elastic range down to D1 and the inelastic range down to D2. A higher price (P1) is charged to the low elasticity segment, and a lower price (P2) is charged to the high elasticity segment. The total revenue from the first segment is equal to the area P1,B,Q1,O.

The total revenue from the second segment is equal to the area E,C,Q2,Q1. The sum of these areas is always greater than the area without discrimination (see the upper diagram). Where more prices are introduced the value of the revenue area rises, and more of the consumer surplus is captured by the producer.

This profit can benefit consumers too; firms may use it to fund R&D. This enables dynamic efficiency and consumers benefit from better quality products and services in the long term; very important in industries like pharmaceuticals where a lot of investment is needed.

Another potential benefit of profit is that it might enable a firm to stay in business. By gaining more revenue as a price discriminator the firm is able to make sufficient profits to stay in the industry which might not have be the case had they only been able to charge one price. Although some customers pay a higher price they have a service where otherwise there might be none, a clear improvement.

Some customers may benefit if the higher prices paid by inelastic customers subsidise lower prices for other groups of consumer e.g. so the high prices paid by business people travelling at peak time could subsidise lower prices for pensioners say. However, people with inelastic demand (adults travelling at peak time) may have no greater ability to pay (an unemployed person travelling to an interview) than people with elastic demand (e.g. rich pensioners). So whilst price discrimination could enable a fairer distribution of resources in society, it doesn’t seem likely that it would!

So it can be seen that price discrimination provides benefits to some consumers, even those who pay the higher prices. The indirect benefits associated with dynamic efficiency gains are perhaps limited in scope, where supermarkets might deliver such improvements might be more difficult to determine than for a drug company. What seems quite clear is that firms benefit most from the ability to target customers by price.

Producer Surplus

http://www.youtube.com/watch?v=i-z_RmiTNoM&feature=player_embedded

Identify the producer and consumer surplus.

The relationship between AR and MR in monopoly

The relationship between the average and MR curves in monopoly is shown in diagram. Aa a monopolist’s demand curve slopes downward to the right (the market demand curve), an extra unit of output can only be sold by reducing the price at which all units of output are sold.

Total sales revenue increases by the area k in the diagram, but decreases by the area h. Areas k and h respectively show the revenue gain (namely the extra unit sold multiplied by its price) and the revenue lost resulting from the sale of an extra unit of output.

The revenue lost results from the fact that in order to sell one more unit of output, the price has to be reduced for all units of output, not just the extra unit sold. MR, which is the revenue gain minus the revenue loss (k − h), must be less than price or AR (area k).

Now in the top half (elastic section) of the AR curve, the area k is always larger than the area h, diagram illustrates. This means that MR is always positive under the top half of the AR curve.

However, the reverse is true under the bottom half of the demand curve. In this situation, demand is inelastic, with the result that the equivalent area k is always smaller than the equivalent area h. MR is now negative.

The final point to note is that provided the monopolist’s MR curve is linear (i.e. a straight line), the curve is twice as steep as the monopolist’s AR curve. MR falls to zero at the point where the MR curve cuts through the horizontal (output) axis of the diagram.

Dynamic efficiency.

Dynamic efficiency occurs over time, as technology provides the chance to produce more and/or better products that improve welfare.

Improvements in dynamic efficiency result from the introduction of better methods of producing existing products and also from developing and marketing completely new products. In both cases, invention, innovation and research and development (R & D) improve dynamic efficiency.

The rip-off world of monopoly power

www.bbc.co.uk/news/business-11549150

Can you analyse what Gavascon did wrong and relay it in a succinct way?

The best win Luxury Chocolate from Green and Blacks!

Distinguish between normal and supernormal profit.

The concepts of normal and supernormal profit enable economists to get round a significant theoretical problem. Figure 5.1 below shows a perfectly competitive firm in long-run equilibrium.

The firm’s total sales revenue and also total cost of production are shown by the rectangle bounded by the points OP1XQ1. Because total cost = total revenue, the firm apparently makes no profit.

But why should a firm stay in the market if in the long run profit is zero?

The answer lies in the difference between normal and supernormal profit.

Normal profit is the minimum profit necessary to keep incumbent firms in the market. However, the normal profit made by firms already in the market is insufficient to attract new firms into the market. Because a firm must make normal profit to stay in production, economists treat normal profit as a cost of production, which is included in a firm’s average cost curve. In the long run, firms that cannot make normal profit have to leave the market.

Supernormal profit (which is also called above-normal profit and abnormal profit) is any extra profit over and above normal profit. In the long run, and in the absence of entry barriers, supernormal profit performs the important economic function of attracting new firms into the market.

Source unknown.