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Cournot Model
Assume P = 30 Q MC1 = MC2 = 0 Firm 1s reaction curve Q1 = 15 Q2 Firm 2s reaction curve Q2 = 15 Q1 Equlilibrium : Q1 = Q2 =10
Cournot equilibrium
Stackleberg model
One firm sets its output before other firms do Leader Firm 2s reaction curve Q2 =15 Q1 Firm 1s revenue: R1= 30Q1 Q1^2 Q1Q2 And MR1 = R1/Q1 = 15 Q1 Equilibrium : Q1 = 15 , Q2 = 7.5
FC $20 and VC $0 Firm 1' s demand : Q 12 2 P 1P 2 Firm 2' s demand : Q 12 2 P2 P 1 Nash Equilibrium : P $4 Collusion : P $6
$12 $16
$6
$4
Firm 1s Reaction Curve
Nash Equilibrium
$4
$6
P2
Charge $4
$12, $12
$20, $4
Firm 1 Charge $6
$4, $20
$16, $16
Few Problems
MC MC
Price cut unmatched
P*
Q* MR
Quantity
P1 P* DD P2
MCD
At this price, fringe firms sell QF, so that total sales are QT.
QF QD
QT
MRD
Quantity
Implications
No dead weight loss Competitive output level achieved Each unit sold at different price CS mopped-up by the professional
MC P* PC
Additional profit from perfect price discrimination, i.e., Deadweight loss being converted into monopoly profit.
D = AR
MR
Q* Q** Quantity
In case of first-degree price discrimination, MR coincides with AR, so that MR would have no separate existence.
Consumer Surplus
MC
AC
P2 P3
P1
D=AR
Q1
Q2
Q3
Q MR
MC = MR1 = P1(1+1/E1) = MR2 = P2(1+1/E2) => P1/P2 = (1+1/E2)/(1+1/E1) => Pricing: Charge higher price to
P2
MC
MR1
Q1
Q2
Qt Quantity
External Benefits
Value MSB
When there are positive externalities (the benefits of repairs to neighbors), marginal social benefits MSB are higher than marginal benefits D. A self-interested home owner invests q1 in repairs. The efficient level of repairs q* is higher. The higher price P1 discourages repair.
D
DWL P1 P* MEB
MC
q1
q*
Repair Level
External Costs
Price
When there are negative externalities, the marginal social cost MSC is higher than the marginal cost. The differences is the marginal external cost MEC. The profit maximizing firm produces at q1 while the efficient output level is q*.
MSC MC =MEC
Price
MSCI S = MCI
Aggregate social cost of negative externality
P* P1 P1
MECI MEC D
q* q1
Firm output
Q* Q1
Industry output
MSC
Assume: 1) Competitive market 2) Output and emissions decisions are independent 3) Profit maximizing output chosen
6
At Eo the marginal cost of abating emissions is greater than the marginal social cost.
At E1 the marginal social cost is greater than the marginal cost of abatement. The efficient level of emissions is 12 (E*) where MCA = MSC.
MCA
E0 0 2 4 6 8 10
E* 12 14
16
E1 18 20
22
24
26
Level of Emissions
Acme, US Electric each emit 40 tons SO2, total of 80 tons. Goal: reduce emissions 25% (to 60 tons/month) Suppose cost of reducing emissions is $100/ton for Acme, $200/ton for US Electric. If regulation requires each firm to reduce 10 tons,
cost to Acme: (10 tons) x ($100/ton) = $1,000 cost to USE: (10 tons) x ($200/ton) = $2,000 total cost of achieving goal = $3,000
Alternative: issue 60 permits, each allows its bearer one ton of SO2 emissions (so total emissions = 60 tons) give 30 permits to each firm establish market for trading permits Each firm can choose among these options: emit 30 tons of SO2, using all its permits emit < 30 tons, sell unused permits buy additional permits so it can emit > 30 tons
Acme spends $2,000 to cut emissions by 20 tons has 10 unused permits, sells them for $1,500 net cost to Acme: $500
US Electric emissions remain at 40 tons buys 10 permits from Acme for $1,500 net cost to USE: $1,500 Total cost of achieving goal: $2,000
Typology of Goods
Characteristics
Rival Excludable
Nonexcludable
Common Property Resource Public Good
Private Good
Non-rival
Club Good
When a good is non-rival, the social marginal benefit of consumption (D) , is determined by vertically summing the individual demand curves for the good.
Marginal Cost
D1 0 1 2 3 4 5 6 7 8 9 10 Output
Private Cost
Demand
F*
FC
Problems
If the market is captured by a first degree discriminating monopolist, the total quantity in the market would be __, while consumer surplus would be ___. Deadweight loss would be ___.
If the market is captured by a second degree monopolist, who charges P1 price for first block of quantity = Q1, and P2 for the block of quantity: Q2 Q1 the consumer surplus would be ___ and deadweight loss would be ___. The second degree monopolists super normal profit would be ___ (>, < or = write the most appropriate option) that of first degree discriminating monopolist, but > _____ (>, <, or = write the most appropriate option) when compared to non-discriminating monopolist charging a uniform price.
There is a vibrant cross-border trade between India and China for Sneezys medicine. How much would Sneezy charge for the medicine in India and China? a. b. c. d. Rs. 10 Rs. 30 Rs. 40 Rs. 50
During a recent visit by the Chinese foreign minister, Sneezy made a deal with him whereby, Sneezy would be the only authorized entity to deal with the cold medicine between India and China. That is, Sneezy would manufacture the drug in India and export to China. No other entity can export/import the drug between India and China. How much would Sneezy charge for the drug in India and China respectively? a. b. c. d. Rs. 30 and Rs. 50 and Rs. 40 and Rs. 60 and Rs. 50 Rs. 50 Rs. 60 Rs. 40
Bundling
Pricing Normal Pricing Bundling
Pure Bundling
Mixed Bundling
Question- Bundling
The overall objective is to allow the firm to earn its targeted rate of return If the return requires $X of total profit, then the per unit markup will be $X/Q Hence, the price is given by the formula:
X P AVC AFC Q
MC
PA
MCE PE AR MCA
MR
QA = Q E
Quantity
PA
PE,M
QE,1 QE,2
= QE
Quantity
Question- cont