Chapter 10

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Chapter 10Chapter 10

Price Searcher Markets with Price Searcher Markets with Low Entry BarriersLow Entry Barriers

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OverviewOverview

How a price searcher is different How a price searcher is different from a price taker.from a price taker.

Analyze the price searcher graphAnalyze the price searcher graph Long run equilibrium in a price Long run equilibrium in a price

searcher market searcher market Contestable marketsContestable markets EntrepreneurshipEntrepreneurship Price discriminationPrice discrimination

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Competitive Price SearcherCompetitive Price Searcher

Competitive Price Searcher: A firm thatCompetitive Price Searcher: A firm that

1.1. Has low barriers to entryHas low barriers to entry

2.2. Faces a downward sloping demand Faces a downward sloping demand curve (because they produce curve (because they produce differentiated products)differentiated products)

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Differentiated Products: Products that Differentiated Products: Products that are distinguished from similar are distinguished from similar products by characteristics like products by characteristics like quality, design, and method of quality, design, and method of productionproduction

Ex. Nike Shoes vs. other shoesEx. Nike Shoes vs. other shoes

Ex. Miller Beer vs. Natural LightEx. Miller Beer vs. Natural Light

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Because good substitutes are Because good substitutes are available, the demand curve faced available, the demand curve faced by competitive price searchers is by competitive price searchers is highly elastichighly elastic

An decrease in price will increase the An decrease in price will increase the quantity sold.quantity sold.

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The Price Searcher GraphThe Price Searcher Graph

In order to sell a higher quantity, a In order to sell a higher quantity, a price searcher will have to lower price searcher will have to lower price.price.

Marginal Revenue will always be less Marginal Revenue will always be less then price for a price searcherthen price for a price searcher

MR < PMR < P

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Maximizing profitsMaximizing profits

A price searcher maximizes profits by A price searcher maximizes profits by producing where MR=MC.producing where MR=MC.

1.1. If price > ATC, then firm makes an If price > ATC, then firm makes an economic profiteconomic profit

2.2. If price < ATC, then firm makes an If price < ATC, then firm makes an economic losseconomic loss

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Long-run equilibriumLong-run equilibrium

When firms in a price searcher market When firms in a price searcher market make an economic profit (loss), new make an economic profit (loss), new firms will enter (exit) and drive price firms will enter (exit) and drive price down (up).down (up).

In the Long-run, firms will make zero In the Long-run, firms will make zero economic profit.economic profit.

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Economics of Business FailureEconomics of Business Failure

Competition will drive failing firms out Competition will drive failing firms out of business and free up the resources of business and free up the resources used by that firm for more productive used by that firm for more productive use.use.

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Price Takers vs. Price SearchersPrice Takers vs. Price Searchers

In Long-run equilibrium, both price takers In Long-run equilibrium, both price takers and price searchers:and price searchers:

1.1. Have price equal to average total cost Have price equal to average total cost (ATC)(ATC)

2.2. Make zero economic profitMake zero economic profit

However,However,

price taker: P = MR = MCprice taker: P = MR = MC

competitive price searcher: P > MR = MCcompetitive price searcher: P > MR = MC

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Contestable MarketsContestable Markets

Contestable markets are markets in Contestable markets are markets in which firms can enter and exit with which firms can enter and exit with minimal riskminimal risk

Ex. an airline routeEx. an airline route

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Contestable MarketsContestable Markets

A contestable market has 2 important A contestable market has 2 important conditionsconditions

1.1. Prices above the level necessary to Prices above the level necessary to achieve zero economic profits will achieve zero economic profits will not be maintainednot be maintained

2.2. The costs of production will be kept The costs of production will be kept to a minimumto a minimum

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EntrepreneurshipEntrepreneurship

An Entrepreneur is a person who An Entrepreneur is a person who introduces new products or improved introduces new products or improved technologies.technologies.

Successful entrepreneurs will increase the Successful entrepreneurs will increase the value of resources value of resources

Ex. Henry FordEx. Henry Ford

Ex. Ray KrocEx. Ray Kroc

Ex. Bill GatesEx. Bill Gates

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Entrepreneurship: Who Knew?Entrepreneurship: Who Knew?

Ken Olson, chairman/founder of Digital Equipment Corp., 1977: "There is no reason anyone would want a computer in their home."

Fred Smith’s (FedEx) Yale University Senior Project Grade Remark: "The concept is interesting and well-formed, but in order to earn better than a 'C,' the idea must be feasible."

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#2 Be Entrepreneurial#2 Be Entrepreneurial

Who would have thought….Who would have thought….

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EntrepreneurshipEntrepreneurship

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Entrepreneurship and Economic Entrepreneurship and Economic GrowthGrowth

Creative Destruction:Creative Destruction: The replacement of The replacement of old products and production methods by old products and production methods by innovative new ones that consumers judge innovative new ones that consumers judge to be superior.to be superior.

This process generates economic growth This process generates economic growth and higher standards of livingand higher standards of living

Think of life today compared to life 100, 50, Think of life today compared to life 100, 50, or even 20 years ago!or even 20 years ago!

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Entrepreneurship and Economic Entrepreneurship and Economic GrowthGrowth

Our medicineOur medicine

Our EntertainmentOur Entertainment

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Price DiscriminationPrice Discrimination

A practice whereby a seller charges A practice whereby a seller charges different consumers different prices different consumers different prices for the same product or service.for the same product or service.

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Effective use of price discrimination Effective use of price discrimination requires 2 things:requires 2 things:

1. Identify and separate at least two 1. Identify and separate at least two groups with different elasticities of groups with different elasticities of demanddemand

2. Prevent those who buy at the low 2. Prevent those who buy at the low price from reselling to those who buy price from reselling to those who buy at the high price.at the high price.

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Examples of price discrimination:Examples of price discrimination:

Ex. Movie theatre tickets (adult vs. Ex. Movie theatre tickets (adult vs. children)children)

Ex. Airline tickets (Saturday night stay)Ex. Airline tickets (Saturday night stay)

Ex. Books (paperback vs. hardback)Ex. Books (paperback vs. hardback)

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BundlingBundling

BundlingBundling: the sale of two or more : the sale of two or more goods and services together.goods and services together.

Ex. extra value mealEx. extra value meal

TyingTying: the act of making the : the act of making the purchase of one good conditional on purchase of one good conditional on the purchase of a second goodthe purchase of a second good

Ex. hospital room Ex. hospital room

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ReviewReview

1.1. Understand the concept of a price Understand the concept of a price searcher and differentiated products.searcher and differentiated products.

2.2. Be able to analyze the price searcher Be able to analyze the price searcher graph.graph.

3.3. Understand the concept of long-run Understand the concept of long-run equilibrium (comparing price equilibrium (comparing price searchers and price takers).searchers and price takers).

4.4. Understand the concept of Understand the concept of contestable markets.contestable markets.

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ReviewReview

5. Understand the concept of creative 5. Understand the concept of creative destruction and how destruction and how entrepreneurship leads to economic entrepreneurship leads to economic growth.growth.

6. Understand the idea and process of 6. Understand the idea and process of price discrimination and bundling.price discrimination and bundling.

Chapter 10

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Transcript of Chapter 10