Econs Test 2

Market Power

• A pharmaceutical firm discovers a compound with cancer treatment potential in a remote location owned by a single family.
• Both the pharmaceutical firm (due to the patent) and the landowners (due to control of the compound's source) possess market power.

Demand Curve and Consumer Choice Model

• The consumer choice model reveals the quantity a consumer will buy at any given price, which informs the demand curve.
• The consumer choice model cannot determine the most profitable price for a firm because it contains no data on costs.
• The consumer choice model does not show how consumer decisions affect total revenue, this is derived from the demand curve.

Total Welfare in a Market with Market Power

• Total welfare in a market is usually the sum of consumer surplus and producer surplus.
• Total welfare represents the sum of all of the economic rents from the market.
• Total welfare is the difference between what a consumer is willing to pay and the seller's costs.

Countering a Rival Firm Selling Identical Goods at a Lower Price

• One way to counter rival firms is product differentiation, making a product seem different from another to consumers.

Average Revenue Curve for a Firm with Market Power

• For a firm with market power, the average revenue curve is the same as the demand curve.
• The average revenue curve for a firm with market power is downward sloping.

Producer Surplus

• Producer surplus is the area below the price the seller receives to the left of the quantity the seller sells, and above the marginal cost curve.
• Producer surplus represents the difference between the price the firm receives and the firm's costs.

Consumer Choice Model

• When firms sell perfect substitutes, the indifference curves are straight lines, but when firms sell differentiated products, indifference curves are curves.

Profit-Maximizing Firm with Market Power

• Demand (D) = Average Revenue (AR)
• Total Cost (TC) = Average Cost (AC) * Quantity (Q)
• Marginal Revenue (MR) = Marginal Cost (MC)

Barriers to Entry

• Patents, economies of scale, and single-firm ownership of a key resource can all create barriers to entry.

Profit vs. Revenue Maximization

• A profit-maximizing firm will have a higher price and sell a lower quantity.

Consumer Surplus and Price Increases

• If the price increases, then consumer surplus will decrease.

Demand Curve Slope

• The demand curve is downward sloping because as price increases, consumers are willing and able to buy less of the good.

Production Quantity

• The quantity of production that maximizes total revenue is greater than the quantity that maximizes profit.

Consumer Choices

• If someone is willing to pay $60 for something but it costs $70, they will not buy the item and their consumer surplus is zero.

Marginal Revenue and Marginal Cost

• If marginal revenue exceeds marginal cost, a firm should decrease the price.
• If marginal revenue is less than marginal cost, a firm should increase the price.

Game Theory

• In a simultaneous game, players A and B have dominant strategies (J and Z respectively).
• The Nash equilibrium, also a dominant strategy equilibrium, occurs where Player A chooses Strategy J and Player B chooses Strategy Z.
• The total payoff to both players in equilibrium is 16.8.

Consumer Surplus

• Consumer surplus is the difference between the price the consumer is willing to pay and the price that they actually pay.

Price Changes

• If price decreases, consumer surplus increases, producer surplus may increase or decrease, and total welfare will increase.

Elasticities

• Elasticities indicate the direction and magnitude of change in one variable when another changes.

Elasticity of Demand

• Demand for high-quality housing is relatively elastic because it constitutes a significant portion of consumer income.
• If the price elasticity of demand is equal to zero, we can say that demand is perfectly inelastic.
• If demand is unitary elastic, then the (own) price elasticity of demand must be equal to negative one.

Firm Mark Up

• A firm with market power will have a smaller mark-up for goods with demand that is relatively more elastic.

Price Discrimination

• A firm engaging in price discrimination charges higher prices to consumers with relatively more inelastic demand.

Demand Curves

• A demand curve that is relatively elastic is flat.

Total Revenue

• If a firm with market power has elastic demand, it should decrease its price to increase total revenue.

Factors that create more elastic demand

• Higher significance of price in the total cost to the consumer.

Straight Line Demand Curve

• At the top of the straight-line demand curve, demand is elastic because the percentage change in price is small and the percentage change in quantity demanded is large.

Bundling

• Bundling involves selling two or more items together as a single package.
• Bundling increases total revenue for the firm if demand for multiple products is heterogeneous.
• Bundling is less restrictive for consumers than ‘tying’.

Income Elasticities

• Income elasticity measures the responsiveness of the quantity of Good X demanded to a change in consumers' income.

Price Elasticity for Rugby

• If the price elasticity of demand for green fees is -0.8, the golf club should increase the green fees.

Cross Price Elasticity

• When the price of XBox consoles increased by 12%, the quantity of Playstation consoles demanded was observed to increase by 9%, the cross-price elasticity of demand between XBox and Playstation consoles is equal to 0.75, and they are substitutes.

Profit

• A combo meal is an example of bundling, where the firm is trying to extract additional profits from selling multiple goods that have heterogeneous demand.

Types of Goods

• If the income elasticity of demand is a positive number (less than one), we can say that the good is a normal good.
• If a good is an luxury good, then the income elasticity of demand must be positive and greater than one.
• If two goods are substitutes, then the cross-price elasticity of demand between the two goods must be positive.
• If the cross-price elasticity of demand is equal to zero, we can say that the two goods are unrelated to each other.

Manager Actions

• When evaluating whether to execute a change in price, a manager should consider the (own) price elasticity of demand for their product.

Price Setting

• Managers might rely on past experience to set the price.
• Managers might use cost-plus pricing.
• Managers might use heuristics to price their product.

Profit Schemes

• Under an optimal two-part pricing scheme, a firm's profits come from the up-front fee only.
• Multi-period pricing is when the firm initially sets a low price, and then increases the price later.

Firms

• It is costly for the Waikato Rugby Union to change the price of tickets every week.
• Block pricing occurs when a firm sells its product at a price that decreases if a consumer buys more of the product.
• When bank customers in New Zealand want to change banks, they will receive a new bank account number, this creates a switching cost for bank customers.