Previous drugs: Tagamet (1977); Zantac (1983); Pepcid ...yamamoto/files/Jun_27-1.pdf · ©2005...
Transcript of Previous drugs: Tagamet (1977); Zantac (1983); Pepcid ...yamamoto/files/Jun_27-1.pdf · ©2005...
Chapter 10 1©2005 Pearson Education, Inc.
A Rule of Thumb for Pricing: Example 10-1 Market for antiulcer drugs
Previous drugs: Tagamet (1977); Zantac(1983); Pepcid (1986); Axid (1988) By1996, Prilosec it had become the best-selling drug in the world.
�Recent introduction: Prilosec (1995)
� The producer of Prilosec, Astra-Merck,was pricing the drug at about $3.50 perdaily dose.
Chapter 10 2©2005 Pearson Education, Inc.
A Rule of Thumb for Pricing: Example 10-1 Market for antiulcer drugs
� The marginal cost of producing &packaging Prilosec is only about 30 - 40cents.
3.5 =.3
1+ (1/Ed )
or3.5 − .3
3.5= −
1
Ed
Ed ≅ −1.09
Chapter 10 3©2005 Pearson Education, Inc.
Prilosec
�Read the FT articles on your handouts onLosec. Note that �������������� ����� ������������������������������������������������ �����������������������������������������������������������������������
Chapter 10 4©2005 Pearson Education, Inc.
Monopoly Power
� Pure monopoly is rare
� However, a market with several firms, eachfacing a downward sloping demand curve, willproduce so that price exceeds marginal cost
� Firms often product similar goods that havesome differences (product differentiation),thereby differentiating themselves from otherfirms (monopolistic competition (Ch. 12))
Chapter 10 5©2005 Pearson Education, Inc.
Monopoly Power: Example
� Four firms share a market for 20,000toothbrushes at a price of $1.50
�Profits maximizing quantity for each firmis where MR = MC
� In our example that is 5000 units for FirmA, with a price of $1.50, which is greaterthan marginal cost
�Although Firm A is not a pure monopolist,they have monopoly power
At a market priceof $1.50, elasticity of
demand is -1.5. 2.00
$/Q
1.50
1.00
Quantity10,000 QA20,000 30,000 3,000 5,000 7,000
$/Q
2.00
1.50
1.00
1.40
1.60
DA
MRA
Market Demand
Firm A has some monopolypower and charges a pricewhich exceeds MC where
MR=MC.
MCA
The Demand for Toothbrushes
Chapter 10 7©2005 Pearson Education, Inc.
Measuring Monopoly Power
� Our firm would have more monopolypower, of course, if it could get rid of theother firms�But the firm’s monopoly power might
still be substantial� How can we measure monopoly power to
compare firms?� What are the sources of monopoly power?
�Why do some firms have more thanothers?
Chapter 10 8©2005 Pearson Education, Inc.
Measuring Monopoly Power� Could measure monopoly power by the extent to which
price is greater than MC for each firm
� Lerner’s Index of Monopoly Power� L = (P - MC)/P
�The larger the value of L (between 0 and1) the greater the monopoly power
� L is expressed in terms of Ed
�L = (P - MC)/P = -1/Ed
�Ed is elasticity of demand for a firm, notthe market
Chapter 10 9©2005 Pearson Education, Inc.
Monopoly Power
�Monopoly power, however, does notguarantee profits
�Profit depends on average cost relativeto price: π=Q(P - AC)
�One firm may have more monopolypower but lower profits due to highaverage costs
Chapter 10 10©2005 Pearson Education, Inc.
Rule of Thumb for Pricing
�Pricing for any firm with monopoly power:�If Ed is large, markup is small
�If Ed is small, markup is large
( )dEMC
P11+
=
Elasticity of Demand and PriceMarkup
P*
MR
D
$/Q
Quantity
MC
Q*
P*-MC
The more elastic isdemand, the less the
markup.
D
MR
$/Q
Quantity
MC
Q*
P*P*-MC
Chapter 10 12©2005 Pearson Education, Inc.
� Is it possible for a monopolist to keep itsmarket for a long period?
�Can a firm with monopoly power continueto exercise the power for a long period?
Questions
Chapter 10 13©2005 Pearson Education, Inc.
Markup Pricing: Supermarkets &Convenience Stores (Ex. 10.2)
�Supermarkets
1. Several firms
2. Similar product
3. Ed = −10 for individual stores
4.P =MC
1+ 1 −10( )=MC
0.9=1.11(MC)
5. Prices set about 10 -11% above MC.
Chapter 10 14©2005 Pearson Education, Inc.
Markup Pricing: Supermarkets &Convenience Stores (Ex. 10.2)
�Convenience stores have moremonopoly power
�Convenience stores do have higherprofits than supermarkets, however�Volume is far smaller and average fixed
costs are larger
Chapter 10 15©2005 Pearson Education, Inc.
Markup Pricing: Supermarkets &Convenience Stores (Ex. 10.2)
�Convenience Stores
1.Several stores
2Similar products
3Ed ≅ −5
4P =MC
1+ (−1/5)=MC
.8=1.25MC
5 Pr icesset about25%aboveMC
Chapter 10 16©2005 Pearson Education, Inc.
Sources of Monopoly Power
�Why do some firms have considerablemonopoly power, and others have little ornone?
�Monopoly power is determined by abilityto set price higher than marginal cost
�A firm’s monopoly power, therefore, isdetermined by the firm’s elasticity ofdemand
Chapter 10 17©2005 Pearson Education, Inc.
Sources of Monopoly Power
� The less elastic the demand curve, themore monopoly power a firm has
� The firm’s elasticity of demand isdetermined by:
1) Elasticity of market demand
2) Number of firms in market
3) The interaction among firms
Chapter 10 18©2005 Pearson Education, Inc.
Elasticity of Market Demand
�With one firm, their demand curve ismarket demand curve�Degree of monopoly power is determined
completely by elasticity of market demand
�With more firms, individual demand maydiffer from market demand�Demand for a firm’s product is more elastic
than the market elasticity
Chapter 10 19©2005 Pearson Education, Inc.
Number of Firms
� The monopoly power of a firm falls as thenumber of firms increases; all else equal�More important are the number of firms with
significant market share�Market is highly concentrated if only a few
firms account for most of the sales
� Firms would like to create barriers toentry to keep new firms out of market�Patent, copyrights, licenses, economies of
scale
Chapter 10 20©2005 Pearson Education, Inc.
The Social Costs of MonopolyPower
�Monopoly power results in higher pricesand lower quantities
�However, does monopoly power makeconsumers and producers in theaggregate better or worse off?
�We can compare producer and consumersurplus when in a competitive market andin a monopolistic market
Chapter 10 21©2005 Pearson Education, Inc.
The Social Costs of Monopoly
� Perfectly competitive firm will produce where MC= D � PC and QC
� Monopoly produces where MR = MC, getting theirprice from the demand curve � PM and QM
� There is a loss in consumer surplus when goingfrom perfect competition to monopoly
� A deadweight loss is also created with monopoly
Chapter 10 22©2005 Pearson Education, Inc.
BA
Lost Consumer Surplus Because of thehigher price,
consumers loseA+B and
producer gainsA-C.
C
Deadweight Loss fromMonopoly Power
Quantity
AR=D
MR
MC
QC
PC
Pm
Qm
$/Q
Deadweight Loss
Chapter 10 23©2005 Pearson Education, Inc.
Chapter 10 24©2005 Pearson Education, Inc.