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Demand Concepts: Kinked Demand Curve = - Step 1: Get each demand function in terms of Q, solve constraints with Q=0 to determine ranges - Step 2: Set to Q(P): (add equations by Q not P) - Ex: Market demand : Qdm= 150-10P If 8P15 single and & Qdm = 350-35P if 0P8 (combined) - Step 3: Multiply each demand function by its respective quantity (if applicable) - Step 4: Add the demand functions together and invert to get price in terms of quantity - Step 4: Solve for the equilibrium price and quantity; check to make sure that your price is in the correct range. i.e. in the single range or combined range - Step 5: If the P does not correspond with the appropriate range solve using the other demand function 2. Market Equilibrium & Government interventions - Market Equilib: Intersection of supply demand curve. - Fixed Dollar Tax: Shifts supply curve evenly. Percentage: Pivots supply curve. When inelastic demand, consumers pay. When elastic, producers pay.

Follow steps 3 and 4 - Firm Decisions re: Production Function o Fixed Costs: If the P > Average Cost (AC), pay the fixed cost to produce o Outsourcing: Per unit P to outsource (AC) ie. per unit costfor in house o Incremental Production: If P>MC, produce one more unit o Inputs if MPX/PX > MPY/PY if input X is always better than Y over range. 5. Perfect Competition (PC) - PC assumptions: Price takers, free entry and exit P = MC - There is no deadweight loss (only applies to monopolies) - Economic Profit: Revenue Opportunity Cost (different from accounting profit) - Profits are maximized at Q* that sets P=MC (p is just a number not a function of q) - ATC = TC/q = FC/q + VC/q; AVC = VC/q - P > min (ATC) Firm will produce and earn a profit; P* is above avg cost - Min (AVC) < P < min (ATC) Firm will produce in short run and earn a loss - P < min (AVC) shut down production immediately - Short-run: (Q*) < (0) which equals P - Short-run: shutdown if AVC (Q*) > MC (Q*) which equals P - Long-run: shutdown if AVC = ATC(Q*) > MC(Q*) which = P; Supply curve is FLAT - Long run: Price = min (ATC) -> solve for Q* and P*; fixed costs are zero - Long run: profit =0 (q) = pq LRTC (q) = 0 solve for q & plug to solve for p Type of Cost Short-Run Total Cost SR Total Avg. Cost (ATC/unit) Marginal Cost (MC) Formula TC(q)=TFC+TVC(q) ATC(q)=TC(q)/q=TFC/q+TVC(q)/q MC=TVC/q(q)

6. 3. Elasticity of Demand=

- Demand: Flatter = more elastic, steeper = more inelastic (for fixed P,Q) - Pricing: Use elasticity to determine whether a product is priced correctly (do not price in the inelastic region). Where losing more Q per change in P lose $$

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Unit elasticity: e=1 Elasticity of demandalways negative Own price elasticity: always Note: multiply by old Q & P negative Cross price elasticity: The % in Q for a % in P of a different product - Income Elasticity: % in Q for a % I. Inferior= neg. Normal= Substitutes: e>0; pos. Luxury>1 Complements: e<0
Production Function - Marginal Product of Labor and Capital:

Firms with Market Power: Monopoly - A Monopoly is the only supplier of a good with no close substitute - Marginal Revenue: If demand is downward sloping, then dP(Q)/dQ is negative; for positive Q the MR curve will be below the demand curve - Inverse inelasticity pricing rule allows firms set an optimal price that produces maximum profit but this method is inefficient because it creates a deadweight loss - MR = Same y-intercept of demand curve and 2 times slope (if the demand curve is P = a bQ, then MR is P = a 2bQ) - To create maximum profit MR = MC - If a monopolist wants to sell an additional unit, he has to lower the price - Marginal revenue in terms of elasticity: - A monopolist will always produce in the elastic region (<-1); Price is set above MC; Monopolies create a dead weight loss 6.1. Calculating Profits Under Monopoly - Step 1: Set Demand function with P(Q) = (inverse demand function) P(Q) - Step 2: Calculate total revenue TR = P(Q) x Q - Step 3: Calculate marginal revenue by taking derivative of TR - Step 4: Calculate Marginal cost by taking the derivative of TC - Step 5: Set MR = MC to determine maximum profit; solve for Q* and sub Q* into demand function to solve for P* - Step 6: Calculate = TR TC

1 MR = P ( Q) 1 +

To solve for cost-minimizing optimal input levels: 1. Take partial derivative of production function to determine MP 2. Calculate MPI for each input; set MPIs equal to each other to determine optimal production ratio (OPR) ie. If c = 2.5e, optimal mix is 2.5c per e 3. Plug the ratio Y* into the production function or budget function to find X*; Plug X* into optimal production ratio to find Y* 4. Solve for total costs with X* and Y*: Note: if 3 set MPI1=MPI2, MPI1=MPI3, MPI2=MPI3 or look for fixed or less productive inputs ie. inequality dont use 1 input. A coefficient (ie. 2A but A is > 2x price) Example: Production Function: Marginal Productivities: Set MPI equal to get OPR

6.2. Calculating Profits Under Monopoly w/ Multiple Plants - Step 1: Set Demand function with P in terms of Q (inverse demand function) P(Q); Note that Q = q1 + q2 - Step 2: Calculate total revenue TR = P(Q) x Q TR = P(Q) x (q1 + q2) - Step 3: Calculate marginal revenue by taking derivative of TR - Step 4: Calculate Marginal cost by taking the derivative of each TC function to get MC1 & MC2 - Step 5: Set MR = MC1 = MC2 to get two equations in terms of q1 & q2 - Step 6: Solve the system of equations for q1 & q2 to get optimal quantities and an optimal price (sub Q total into original demand function). - Step 7: If one quantity is negative, set MR = MC (for optimal plant) and solve for q* and p* - Step 8: Calculate = TR (optimal plant) TC (optimal plant) 6.3. Calculating the Selling Price of a Plant - Step 1: Calculate with both plants in production = TR TC1 TC2 - Step 2: Find MR based plant not for sale and set equal to MC of plant not for sale to find q* and calculate profit

- Step 3: Calculate profit of plant for sale by subtracting profit from step 1 profit from step 2 6.4. Monopoly to Perfect Competition - Monopoly: MR = MC - Perfect Competition: P = MC1 + MC2 (assuming both plants have optimal outputs) - When you are switching from monopoly to perfect competition make sure you have the correct MC - Note: Monopolies ONLY have deadweight loss and have higher producer surplus and lower consumer surplus than perfect competition 7. Pricing with Market Power: Personalized Pricing and Quant Discounting - The necessary conditions to use price discriminations are: market power; consumers valuations differ and resale is not possible - Price Discrimination is used to reduce Dead-Weight Loss; - Types of Price Discrimination: perfect, demographic, self-selecting 8. Price Discrimination - PD (Lecture 8) - Companies capture additional surplus by employing price discrimination. Examples include: 1. 1st Degree PD: If a monopolist can sell different units on the demand schedule for different prices, we say it is engaging in first-degree price discrimination 2. 3rd Degree PD: Price discrimination by geography e.g. Pharmaceutical prices in the US versus other countries 8.1. 1st Degree Price Discrimination - In price discrimination MR = P (similar to how a price taking firm operates in a perfectly competitive environment) - Market is segmented in two ways: 1. Across people as well as 2. Over quantities within people - Deadweight loss is zero (firm extracts all consumer surplus) - To calculate = Consumer Surplus + Producer Surplus Total Fixed Cost. 8.2. 3rd Degree Price Discrimination (setting two different prices) - In order to engage in 3rd degree price discrimination you will have two markets with their own demand curves. - Example: 1. Step 1: Convert the 2 demand functions into inverse demand function format and graph the two demand functions. 2. Get the Marginal Cost of the market by taking FOC of TC with Q =(q1 + q2) 3. Get the TR of each group P*Q1 and then take FOC to get MR for each group 4. Set MR1 = MR2 this will give Q1 in terms of Q2 5. Set the MR1=MC for each group and then solve q1*. Then plug in q1* into MR2 function to get q2*. 6. Plug q1* and q2* into the original demand functions to get p* for both groups. 7. Compute the profits for the firm plugging into TR-TC. If there is no price discrimination: 1. = P* x Q1 + P* x Q2 TC (Q1 + Q2) 2. = P (Q1 + Q2) TC (Q1 + Q2) 3. = PQ TC(Q) 4. Q = Q1 + Q2 = (80-P)/5 + (180 P)/20 5. Q = 25 P P =4 x (25 Q) 6. P = 100 4Q for P$80 7. = (100-4Q) x Q 50 20Q 8. Set derivative of profit function equal to zero and solve for Q and P. Make sure P 80 9. Two Part Tariff (Lecture 9) - The terminology two-part tariff simply means charging two distinct prices (allows firm to capture DWL and consumer surplus): o Access Fee/Membership Fee and Usage Fee/Visit Fee 9.1. Case 1: Single Type of Consumer - In these cases, there is a single customer type and we are provided with a single demand curve and marginal cost. Therefore, Access Fee = CS and Usage Fee = MC - P*u = MC (Q*u) Usage fee such that MR = MC. - Profit = CS 9.2. Case 2: Two Customer Types (can distinguish between two groups) - Since we can distinguish between the two groups we can charge each group an access fee specific for each group. Therefore: o Access Fee (Group 1) = CSGroup1; Access Fee (Group 2) = CSGroup2 o Usage Fee = Marginal Cost = MC o total profit = Q group 1 X Access Fee (Group 1) + Q group 2 X Access Fee (Group 2) o *Similar to price discrimination (firm extracts all CS) 9.3. Case 3: Two Customer Types (cant distinguish between two groups) - Since we cant distinguish between the two groups, we have to charge one access fee and one usage fee. We have to decide which access fee and usage fee generates the maximum profit based on the following options:

- There will be two groups (Weak and Strong) with two demand curves. The weak group has a lower demand than the strong group Option 1: Focus on non-frequent guys strong will get surplus; weak surplus = 0 - Set Access Fee = CSWeak; Set Usage Fee = MC - Calculate total profit ( ) = QTotal x (Access Fee) Option 2: Focus on the strong guys Firm captures all surplus, strong surplus = 0 - Set Access Fee = CSStrong (This will eliminate the weak grp); Set Usage Fee = MC - Calculate total profit ( ) = QStrong x (Access Fee) Option 3: Focus on both groups at price P - Solve for optimal usage fee where P* > MC - Set Access Fee = Remaining CSWeak; Calculate total profit ( ) = - QTotal(Access Fee) + QWeak(P* MC) x Q(P*)Weak + QStrong(P* MC) x Q(P*)Strong - Take derivative of and set equal to 0 to solve for P* (P* is usage fee). Plug P* into access fee equation to get Access Fee

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Pricing with Market Power IV Bundling Goods (Lecture 10)

- Companies capture additional surplus by bundling/tying goods together. It can be a useful strategy when the firm cannot charge different prices to different groups of consumers. Examples include: Pure Bundling: two or more products can only be bought together; none can be bought individually (i.e. cable channels) NOTE: only successful if one consumer values something less than oanother Mixed Bundling: two or more products can be bought together, but they can also be bought individually (i.e. Microsoft Office Word, Excel)

10.1. Pure Bundling - Negative correlations in prices is necessary for bundling to be profitable, but negative correlation in prices does not imply bundling is profitable - Steps to solve Individual & Bundling Problems: - Step1: Individual prices (no bundle) Different combinations of individual prices, add up revenue, subtract costs. Select most profitable option - Step 2: Pure bundle: sum up each persons willingness to pay across all items; check profit at each sum price. Select most profitable combination 10.2. Mixed Bundling The candy company estimates that three different types of household buyers of their candy exist. Each type has an equal number of households (for simplicity, assume one). Each household will demand at most one of each bar or bundle. It costs the candy company 5 cents to make either bar. The table below shows the reservation prices (in cents) of each household type for each candy bar. Step # 1 Price out consumer with lowest Consumer surplus and try to sell them whatever they desire most individually. Step # 2 Try and sell the product that is most desired to whomever has the highest want Household Type A B C individually. Step # 3 - Pick the most profitable combination. OR
CS from Bund le 1 0 -15 Potentia l Profit the Bundle 47 47 47 Potenti al Profit Good 1 49 4849 4849 48Potenti al Profit Good 2 23 23 23

Almond Joy 54 cents 30 cents 14 cents

Mound s 4 cents 27 cents 28 cents

Pricing Scheme Pbundle = 57 Pgood1 = 54 53Pgood2 = 28

Type A B C

CS Good 1 0 1+ -24 23+ -40 39+

CS Goo d2 -24 -1 0

11. Vertical Integration

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