competitve info

7/26/2019 Competitve info

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Economics of the Firm

Competitive Pricing

Techniques


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Market Structure Spectrum

Perfect Competition Monopoly

One Producer With 100%market share

The market is supplied by manyproducers each with zero marketshare

Firm Leel !emand !O"#$OT eual industry demand

Firm Leel !emand"&'(L# industry

demand

When makin) pricin) decisions* you need to be aware o+ what your marketstructure is


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,ecall the characteristics we laid out +or a competitie market

-1. /any buyers and sellers

no indiidual buyer+irm hasany real market power

-. 2omo)eneous products

no ariation in productacross +irms

-3. $o barriers to entry it4scostless +or new +irms to

enter the marketplace

-5. Per+ect in+ormation prices and uality o+ products

are assumed to be known toall producersconsumers

-6. $o "7ternalities (LLcostsbene+its o+ the productare absorbed by the

consumer

-8. Transactions are costless buyers and sellers incur no

costs in an e7chan)e

9an you think o+ situations where all these assumptions hold:


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/easurin) /arket #tructure 9oncentration ,atios

#uppose that we take all the +irms in an industry and ranked them bysize. Then calculate the cumulatie market share o+ the n lar)est +irms.

# ofFirms

Cumulative MarketShare

100

80

40

20

01 32 4 !0 " 2010

$C


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/easurin) /arket #tructure 9oncentration ,atios

# ofFirms


100

80

40

20

01 32 4 !0 " 2010

$

C

/easures the cumulatie market share o+ the top +our+irms

4CR


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9oncentration ,atios in '# manu+acturin); 1 1


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/easurin) /arket #tructure. The 2er+indahl>2irschmanAnde7 B22AC

% Market share of firm i

&ank Market Share

1 2 !22 2 !2

3 2 !2

4 2

2

! 2

" 2

8 2''( % 2)000

==

N

i

isHHI1

2

is2

is


8/75


100

80

40

20

01 32 4 !0 " 2010

$ ''( % 00

''( % 1)000

*he ''( in+e, penali-es a small num.er of total firms


9/75


100

80

40

20

01 32 4 !0 " 2010

$

''( % 00

''( %

*he ''( in+e, also penali-es an une/ual +istri.ution of firms


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9oncentration ,atios in For #elected Andustries

(n+ustry C&4 ''($reakfast Cereals 83 244!

utomo.iles 80 28!2

ircraft 80 2!2

*elephone /uipment 10!1omens Foot5ear 0 "6

Soft 7rinks 4" 800

Computers Peripherals 3" 4!4

Pharmaceuticals 32 44!Petroleum &efineries 28 422

*e,tile Mills 13 64


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,ecall that in a per+ectly competitie world* price euals mar)inalreenue

The market determines theeuilibrium price o+ D1E55 and500*000 +ish sold by the 1*000

+ishermen

/arket

!ollars

0

D1E55

!emand

#upply

500*000

!ollars

0

1E55

Andiidual

(t the preailin) market price o+D1E55* each +isherman supplies 500+ish

/9

/,

500


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An a monopolized market* the sin)le +irm in the market +aces the industrydemand cure

500*000 +ish are sold at a marketprice o+ D1E55

/arket

!ollars

0

D1E55

!emand

500*000

!ollars

0

1E55

Andiidual

The sin)le +irm in the market haschosen that price o+ D1E55 based o++o+ industry demand

/9

500*000

!emand


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We will be assumin) that pricin) decisions are bein) made to ma7imizecurrent period pro+its

Total ,eenueseual price timesuantity

Total 9osts Bnote that total costshere are economic costsE That is*we hae already included areasonable rate o+ return oninested capital )ien the risk in

the industryC

Pro+its TCPQ =


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(s with any economic decision* pro+it ma7imization inoles ealuatin) eerypotential sale at the mar)in

2ow do my pro+itschan)e i+ Aincrease my sales

by 1:

2ow do myreenues chan)e i+

A increase my salesby 1: B/ar)inal,eenuesC

2ow do my costschan)e i+ Aincrease my salesby 1: B/ar)inal9ostsC

TCPQ =


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An a world where +irms hae market power* they control their leel o+ sales by settin) their priceE#uppose that you hae the +ollowin) demand cure B( relationship between price and uantityC.

Total#ales

?our listed price

For e7ample. A+ you were to set aprice o+ D0* you can e7pect 80sales

PQ 2100=

Q

P

60=Q

20$=P

D

( ) 60202100 ==Q


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We could also talk about inerse demand Ba relationship between uantity and priceC.

For e7ample. A+ you wanted to

make 50 sales* you could set a D30price

( pricethat will hitthat tar)et

?our tar)et +or sales

PQ 2100=

Q

P

40=Q

30$=P

D

30

260

210040

=

=

=

P

P

P

QP 5.50=


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"ither way* i+ we know price and total sales* we can calculate reenues

Total ,eenues

GBD30CB50CG D100

Total ,eenues G Price&uantity

9an we increase reenues pastD100 and* i+ so* how:

Q

P

40=Q

30$=P

D

QP 5.50=


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"ither way* i+ we know price and total sales* we can calculate reenues

Turns out lowerin) price was the ri)htthin) to do to raise reenuesE

Total ,eenues GBD36CB30C G D1060

Total ,eenues GBD6CB60C G D160

Q

P

40=Q

30$=P

D

QP 5.50=

50=Q30=Q

35$=P

25$

=P


19/75

7

Anitially* you hae chosen a price BPCto char)e and are makin) & salesE

Total ,eenues G P&

#uppose that you want to increase your salesE

What do you need to do:

Q

p

Q

p


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7

?our demand cure will tell you how much you need to lower your price to reachone more customer

This area represents the reenuesthat you lose because you hae tolower your price to e7istin) customers

This area representsthe reenues that you

)ain +rom attractin) anew customer

Q

p

p

Q


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7

?our demand cure will tell you how much you need to lower your price to reachone more customer

,eenues GBD30CB50C G D100

BDE60CB50C GD0

BD


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Demand curves slope downwards this reects the negativerelationship between price and quantity Elasticity of Demand measuresthis e!ect quantitatively

"uantit

y

Price

#$%&

%

#$'%

(

( )000,50$=ID

%20100*5

54=

%10100*

50.2

50.275.2=

210

20

%

%=

=

=

P

QDD


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)ote that elasticities vary along a linear demand curve

"uantity

Price

#*%

*& +& ,&

#$&

P Q % Changein Q

%Changein P

Elasticity

#*% *&

#*( *$ +' -$. -$*

#$& +&

#/. +$ ** -% -+/

#/& ,&

#. ,$ $% -/& -$%%

-/&

-.

-,

-'

-+

-%

-(

-*

-$

-/

&

D

3.2=D

61.=D

PQ 2100=


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Let4s calculate the elasticity o+ demand at a uantity o+ 50 BaEkEaE a price o+ D30C

(t a uantity o+ 50* theelasticity o+ demand isbi))er that 1 in absolutealue

Q

P

40=Q

30$=P

D

QP 5.50=

41=Q

50.29$=P7.1% =P

5.2% =Q

47.17.1

5.2

%

%=

=

=

P

Q


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Let4s calculate the elasticity o+ demand at a uantity o+ 50 BaEkEaE a price o+ D30C

A+ A want to increase my salestar)et* A need to lower my priceto all my e7istin) customers

Total ,eenues GBD


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(n elasticity o+ demand that is )reaterthan 1 in absolute alue indicates thatlowerin) price will increase reenues

Total ,eenues GBD


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(n elasticity o+ demand that is less than1 in absolute alue indicates that raisin)price will increase reenues

Total ,eenues GBD10CB@0CG D@00

Total ,eenues GBD10E60CB=


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-/&

-.

-,

-'

-+-%

-(

-*

-$

-/

&

Elasticity

&

$&&

(&&

+&&

,&&

/&&&

/$&&

/(&&

Total Revenues

,eenues are ma7imized when the elasticity o+ demand euals >1

/a7 ,eenues&uantity G 60Price GD6,eenues G D1*60

&uantity G 60Price GD6"lasticity G >1

"lasticity is lessthan >1. raise price

"lasticity is )reaterthan >1. lower price


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-+&

-(&

-$&

&

$&

(&

+&

P

/,

P G D30

/, G D


30/75

-+&

-(&

-$&

&

$&

(&

+&

&

$&&

(&&

+&&

,&&

/&&&

/$&&

/(&&

P

/,

P G D6

/, G /9 G D0

$ote that because we hae i)nored the cost side* we are assumin) mar)inalcosts are eual to zeroI

,eenues G D160


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$ow* let4s brin) in the cost sideE For simplicity* lets assume that you +ace aconstant mar)inal cost eual to D0 per unitE

Quanti

ty

Price Total

Revenue

Margi

nalRevenue

Total

Cost

Margi

nalCost

Proft

/ #(.%& #(.%& #(.%& #$& #$& #$.%&

$ #(. #., #(,%& #(& #$& #%,

* #(,%& #/(%%&

#('%& #+& #$& #,%%&

( #(, #/.$ #(+%& #,& #$& #//$

% #('%& #$*'%&

#(%%& #/&& #$& #/*'%&

+ #(' #$,$ #((%& #/$& #$& #/+$

' #(+%& #*$%%

&

#(*%& #/(& #$& #/,%%

&9ontinuin) on downJ

$. #*%%& #/&$.%&

#$/%& #%,& #$& #((.%&

30 $35 $1050 $2050 $!00 $20 $"50

*/ #*(%& #/&+.%&

#/.%& #+$& #$& #((.%&


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-%&&

&

%&&

/&&&

/%&&

Total 0evenue Total Cost

Pro1t

#lope G 0

Pro+its G D560

( pro+it ma7imizin) price sets mar)inal reenue eual to mar)inal costE /ar)inalreenue is the chan)e in total reenue BiEeE the slopeC


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-*&

-$&

-/&

&

/&

$&

*&

(&

%&

+&

Price 2arginal Cost

2arginal 0evenue

P G D36

Pro+it G BD36>D0C30G D560

Price G D36&uantity G 30"lasticity G >E38

( pro+it ma7imizin) price setsmar)inal reenue eual to mar)inalcost

This is not a coincidenceE (

monopoly sets a markupthat is inersely proportionalto the elasticity o+ demandI

42.35$

20$35$=

=

P

MCP

42.36.2

11==


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/arkups +or #elected Andustries

(n+ustry 9(

Communication :6"2Paper llie+ Pro+ucts :630

lectric) ;as Sanitary Services :621

Foo+ Pro+ucts :880

;eneral Manufacturin< :"""Furniture :"31

*o.acco :!38

pparel :444

Motor =ehicles :433Machinery :300

#uppose that weassumed theautomobileindustry weremonopolizedJ

#o* a 1% increase in automobile prices will lower sales by E3%

433.=

P

MCP

3.2433.

1==

( it i.l t tt t t ith t l i i t


35/75

7

9oss from char

Q

p

Q

p


36/75

!ollars

0

D50

50*000

Let4s suppose that $otre dame has identi+ied three di++erentconsumer types +or $otre !ame +ootball ticketsE Further*assume that $otre !ame has a mar)inal cost o+ D0 per ticketE

D10

D@0

=0*000 @0*000

(lumni

Faculty

#tudents

A+ $otre !ame had toset one uni+orm price toeerybody* what price

would it set:


37/75

!ollars

0

D50

50*000

Let4s suppose that $otre dame has identi+ied three di++erentconsumer types +or $otre !ame +ootball ticketsE Further*assume that $otre !ame has a mar)inal cost o+ D0 per ticketE

D10

D@0

=0*000 @0*000

(lumni

Faculty

#tudents

Price Quantity TotalRevenue

Total Cost Proft

#/$& (&3&&& #(,2 #,&&3&&& #(&2

$#0 0000 $5!M $1"M $"2M

#(& ,&3&&& #*$2 #/+2 #/+2

D0 /9


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!ollars

0

D50

50*000

$ow* suppose that $otre !ame can set up di++erential pricin)E

D10

D@0

=0*000 @0*000

(lumni

Faculty

#tudents

Price Quantity

TotalRevenue

TotalCost

Proft

#/$& (&3&&& #(,2 #(&&3&&&

#((2

#,& *&3&&& #$(2 #*&&3&&& #$/2

#(& /&3&&& #(&&3&&&

#$&&3&&&

#$&&3&&&

Total ,&3&&& #'+2 #.&&3&&&

#+'2

D0 /9

Pricin) #cheduleK ,e)ular Price. D10

K Faculty#ta++. D@0K #tudent. D50

What would $otre !ameneed to do to accomplishthis:

"7ample. !! codes are a di)ital ri)hts mana)ement techniue that allows +ilm


39/75

"7ample. !! codes are a di)ital ri)hts mana)ement techniue that allows +ilmdistributors to control content* release date* and price accordin) to re)ionE

!! codin) allows +or distributors to price discriminate by re)ionE


40/75

Why is moie theatre popcorn so e7pensie:

!ollars

0 00

D16

300

Meneral

Public

#enior9itizens

D@

This would be an easy pricediscrimination problemJ

Pricin) #cheduleK ,e)ular Price. D16K #enior 9itizens. D@


41/75

$ow* suppose that the identities are unknown: 2owcan the theatre e7tract more money out o+ the aidmoie)oer:

!ollars

0 00

D16

300

(id

/oie)oer

Occasional/oie)oer

D@

Tic&etPrice

Po'cornPrice

Total

4ption 5/ #/( #/ #/%

4ption 5$ #, #' #/%

4ption 5* #$ #/* #/%

(s lon) as the totalprice Bpopcorn N

ticketC is D16 or less*aid moie)oers willstill )o

Which pricin) option would you choose:

# h !i ld k hi b h


42/75

#uppose that !isneyworld knows somethin) about the aera)econsumer4s demand +or amusement park ridesE !isneyworld hasa constant mar)inal cost o+ DE0per ride

!ollars

0

E60

!emand

60

Price ('er ri)e* Quantity (ri)es*

#/ .. /

#., $

#& /&&

PQ 100100=

(s a +irst pass we could sole +or a pro+it ma7imizin) price per


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(s a +irst pass* we could sole +or a pro+it ma7imizin) price perride

!ollars

0

E61

!emand

5E0C&

D1 Fee G B1CBD1>PC&

Price('erri)e*

Quantity(ri)es*

Ri)eRevenue

,eeRevenue

TotalRevenues

MarginalRevenues

Marginal Cost

#/ & #& #& #& --- ---

#.. / #.. #&&% #..% #..% #&$

#., $ #/.+ #&$ #/., #.,% #&$

#&* .' #$./ #('&%

#(..+

#&* #&$

$02

+# $1+! $"#02

$"++#

$02 $02

#&/ .. #.. #(. #(...

#&/ #&$

Total Pro+it G D5@E0

We are still lookin) to wheremar)inal reenues eualmar)inal costsE

PQ 100100=

The optimal pricin) scheme here is to set a price per ride eual


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The optimal pricin) scheme here is to set a price per ride eualto mar)inal costE We then set the entry +ee eual to theconsumer surplus )eneratedE

!ollars

0

!emand

E0C


47/75

!ollars

0

E61

!emand

5seniorsE We could discriminate based on price per ride Bassume there is oneo+ each typeC

$on>#eniors

!ollars

0

E51

!emand

3D00

P & T, Pro+it

D560 1 D560 D300

D=6 D660 D60D0 3 D880 D10

D60 5 D00 >D500

Pro+uct 1 MC % ?100C Pro+uct 2 MC % ?10C

Profits % ?40 B ?300 % ?"0

P H dli d t ll th d t t b ld t l


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9onsumer Product 1 Product #um

( D60 D560 D600

H D60 D=6 D66

9 D300 D0 D60

! D560 D60 D600

Pure Hundlin) does not allow the products to be sold separately

Pro+uct 2 MC % ?10C

Pro+uct 1 MC % ?100C

With a bundled price o+ D600* all +our consumers buy

both )oods.Profits % 4?00 A?100 A ?10 % ?1)000

/i7ed Hundlin) allows the products to be sold separately


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( D60 D560 D600

H D60 D=6 D66

9 D300 D0 D60

! D560 D60 D600

) p p y


Pro+uct 2 MC % ?10C

Price 1 % ?20

Price 2 % ?40

$un+le % ?00

9onsumer (. Huys Product BPro+it G D300C or HundleBPro+it G D60C9onsumer H. Huys Hundle BPro+it G D60C

9onsumer 9. Huys Product 1 BPro+it G D160C

9onsumer !. Huys Only Product 1 BPro+it G D160C

Pro+it G D@60

or D@00

/i7ed Hundlin) allows the products to be sold separately


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( D60 D560 D600

H D60 D=6 D66

9 D300 D0 D60

! D560 D60 D600

) p p y


Pro+uct 2 MC % ?10C

Price 1 % ?40

Price 2 % ?40

$un+le % ?20

9onsumer (. Huys Only Product BPro+it G D300C

9onsumer H. Huys Hundle BPro+it G D=0C

9onsumer 9. Huys Hundle BPro+it G D=0C

9onsumer !. Huys Only Product 1 BPro+it G D360C

Pro+it G D1*1


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( D300 D00 D600

H D300 D00 D600

9 D300 D00 D600

! D300 D00 D600


Pro+uct 2 MC % ?10C

) ywith respect to the indiidual )oods* but little ariation with respect to thesumI:

Andiidually Priced. P1 G D300* P G D00* Pro+it G D1*000

Pure Hundlin). PH G D600* Pro+it G D1*000

/i7ed Hundlin). P1 G D300* P G D00* PH G D600* Pro+it G D1*000

#uppose that you sell laser printersE To create printed pa)es* you need both a printer


59/75

and an ink cartrid)eE For now* assume that the toner cartrid)es are sold in acompetitie market and sell +or D eachE (n ink cartrid)e is )ood +or 1*000 printedpa)esE

!ollars

0

D

!emand

15

D18&uantity o+printed pa)es

B000sC

Toner cartrid)eprice

What price would yousell the printer +or:

9# G QBD18 > DCB15C G D


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only you produceE What would you do i+ you could choose a printer priceand a cartrid)e price:

!ollars

0

D DCB=C G D5E60

/,

/9D

Q P TR TC MR MC Proft

/ #/% #/% #$ #/% #$ #/*

$ #/( #$, #( #/* #$ #$(

* #/* #*. #+ #// #$ #**

( #/$ #(, #, #. #$ #(&

% #// #%% #/& #' #$ #(%

+ #/& #+& #/$ #% #$ #(,

$+ $!3 $1" $3 $2 $"+

, #, #+( #/+ #/ #$ #(,

We could make our money on thecartrid)es and sell the printerscheapJ

PQ =16

(lternatiely* we could do somethin) like the amusement parkE We


61/75

ma7imize pro+its combinin) cartrid)e reenue ($! printer reenue

!ollars

0

!emand

15

D18&uantity o+printed pa)esB000sC

Toner cartrid)eprice

9# G QBD18 > DCB15C G D


62/75

#uppose that you can easily identi+y them and preent resaleE We coulddiscriminate on both the printer price and the cartrid)e priceE

!ollars

0

D D DCB6C G D1E60

/,

/9D

Pro+it G BDDC= ND5E60 G D=3E60 Pro+it G BD=>DC6 ND1E60 G D3=E60

Total Pro+it G D111

PQ =12PQ =

16

(lternatiely* we could essentially )ie the cartrid)es away and discriminate on


63/75

the printer Blike !isneyworldCE

!ollars

0

!emand

15

D189# G QBD18 > DCB15C G D DCB10C G D60

/9D

Pro+it G D


64/75

you hae a hi)h alue and low alue demander* but you don4t know who is whoELet4s +irst try and do this like the amusement park

!ollars

0

!emand

15

D189# G QBD18 > DCB15C G D DCB10C G D60

/9D

15 9artrid)e Packa)e G D


65/75

you hae a hi)h alue and low alue demander* but you don4t know who is whoELet4s +irst try and do this like the amusement park

!ollars

0

!emand

10

D189# G QBD18 > D 10 9artrid)e Packa)e G D=0

Total Willin)ness to Pay G D110

9onsumer #urplus G D50

15 9artrid)e Packa)e G D18

> reuired consumer surplus G D50

!iscounted Price G D@8

15 9artrid)e Packa)e G D@810 9artrid)e Packa)e G D=0

Pro+it G D@8 N D=0 > D5 G D10@

PQ =16

Let4s try a di++erent strate)yE #uppose that you char)e a markup on the cartrid)esd th h i + th i t t h W ld t th i


66/75

and then char)e a common price +or the printer to eachE We would set the priceo+ the printer eual to the consumer surplus o+ the lower alue demander o+ insurethat both )roups buy the printerE

!ollars

0

!emand

1>P

D19# G QBD1 > DPCB1>PC

D80

DP

"7ample.

9artrid)e Price. D39onsumer #urplus G QBD1 > D3CBDCB1C G D103

PQ =12

We need to +ind the best cartrid)e priceJ


67/75

Price Quantity1

Quantity 2

TotalRevenue

Consu.er-ur'lus

PrinterRevenue

TotalRevenue

TotalCost

Proft

#& /+ /$ #& #'$ #/(( #/(( #%+ #,,

#$% /%'% //'% #+,'% #+.&* #/*,&+ #/((.* #%% #,..*

#%& /%% //% #/*%& #++/*% #/*$$% #/(%'% #%( #./'%

#* /* . #++ #(&% #,/ #/(' #(( #/&*

$" 12 # $#0 $32 $!" $1"" $"0 $10"

#($% //'% ''% #,$,'%

#*&&* #+&&+ #/($.* #*. #/&*.*

PQ =16PQ =12

( )21

QQP +

( ) 2

125. QP CS*2 ( )212$ QQ +

Let4s try a di++erent strate)yE #uppose that you char)e a market on the cartrid)esd th h i + th i t t h W ld t th i


68/75

and then char)e a common price +or the printer to eachE We would set the priceo+ the printer eual to the consumer surplus o+ the lower alue demander o+ insurethat both )roups buy the printerE

!ollars

0

!emand

@

D19# G QBD1 > D5CB@C G D3

D80

D5

Hest 9hoice.

9har)e D3 +or the printerBHoth customers will buyC

9har)e D5 +or cartrid)esLow alue customers buy @

cartrid)es2i)h alue customers buy 1

cartrid)es

Pro+it G D3 N BD5>DCB0C G D105

PQ =12

One last e7ampleE 9onsider the market +or hot do)sE


69/75

p )/ost people reuire a bun +or each hot do) they eatBwith the e7ception o+ the (tkins diet peopleIC

Price of a 'ot 7o< Price of a 'ot 7o< $un

2ot !o)s and Huns are made by separate companies eachhas a monopoly in its own industryE For simplicity* assumethat the mar)inal cost o+ production +or each euals zeroE

( )BH PPQ +=12

For simplicity A will assume that mar)inal costs are zero


70/75

BiEeE we are ma7imizin) reenuesC

#uppose that you knew that the buns were sellin) +or D*

what should you char)e:

Quantity Price TotalRevenue

MarginalRevenue

/ #. #. #.

$ #, #/+ #'

* #' #$/ #%

( #+ #$( #*

5 $5 $25 $1

+ #( #$( -#/

?ouchar)e D6

( ) PPQ H =+= 102$12

Hut* i+ the bun )uy sees you char)in) D6* he needs to


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react to thatJ


MarginalRevenue

/ #+ #+ #+

$ #% #/& #(

* #( #/$ #$

" $3 $12 $0

% #$ #/& -#$

+ #/ #+ -#(

Hun Muychar)e D5

( ) PPQ B =+= 75$12

Hut* i+ the bun )uy is char)in) D5* you need to react to thatJ


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MarginalRevenue

/ #' #' #'

$ #+ #/$ #%

* #% #/% #*

" $" $1! $1

% #* #/% -#/

+ #$ #/$ -#*

?ouchar)e D5

( ) PPQ B =+= 84$12

$ th t th i d i t


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$ow* suppose that these companies mer)ed intoone monopoly

Quantity Co./ine)Price

TotalRevenue

MarginalRevenue

/ #// #// #//$ #/& #$& #.

* #. #$' #'

( #, #*$ #%

% #' #*% -#*

! $! $3! $1

' #% #*% -#/

, #( #*$ -#*

. #* #$' -#%

?ouchar)e D8+or hotdo)bun

( ) PPPQ HB =+= 812

Look at what happened hereJ


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#eparate 2ot !o)Hun #uppliers

9onsumer Pays D@ +or a

hot do)bun pair

#in)le 2ot !o)Hun #uppliers

9onsumer Pays D8 +or a

hot do)bun pair

"liminatin) a company bene+its consumersIII

( )HB PPQ +=12

4$4$

=

=

B

H

PP 6$=+ BH PP

"7ample. /icroso+t s $etscape


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"7ample. /icroso+t sE $etscape

The ar)ument a)ainst /icroso+t was usin) its monopoly power in

the operatin) system market to +orce its way into the browsermarket by bundlin) Anternet "7plorer with Windows

competitve info

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