Micro Chapter 10

Price-Searcher Markets With Low Entry Barriers

4 Learning Goals

1) Characterize and explain the output decisions of competitive price-searcher markets.

2) Determine the costs and benefits of this market structure

3) Justify the practice of price discrimination

4) Bring out the role of the entrepreneur in decision making and firm organization.

Competitive Price-Searcher Markets

These markets are also called monopolistic competition because they have characteristics similar to other types of markets:

Many sellers

Low entry barriers

Sell differentiated but similar products

These firms have to work very hard to convince you to buy their products

Watch video: You’ve Got Mail-monopolistic competition

The same decision rules apply:

(1) Close if:MR < AVC, or

TR < TVC

(2) Keep producing as long as MR > MC

But now the firm has some control over price

Output in the Short Run:

If profit exists, new firms will enter and “steal” some of your customers– Your demand curve will shift left

If losses exist, some existing firms will exit and you will gain customers– Your demand curve will shift right

Graph of SR profits:

Watch content video: Short run profits

Graph of SR losses:

Watch content video: Short run losses

Another example of fighting over customers:

Watch video: Pixar-one man band

Q10.1 If firms in a competitive price-searcher market are currently experiencing economic profits, then over time,

1. new firms will enter the market, and the current firms will experience a decrease in demand for their products.

2. new firms will enter the market, and the current firms will experience an increase in demand for their products.

3. some existing firms will exit the market, and the remaining firms will experience an increase in demand for their products.

4. some existing firms will exit the market, and the remaining firms will experience a decrease in demand for their products.

Q10.2 The fact that barriers to entry are low in competitive price-searcher markets means that if current firms are making economic losses,

1. these losses will remain in the long run because no firms can exit the market.

2. current firms will exit the market, causing the demand curves that face the remaining firms to increase.

3. new firms will enter the market, causing the demand curves that face the existing firms to decrease.

4. new firms will enter the market, causing no change in the demand curves that face the existing firms in the market.

Output in the Long Run:

As firms exit and enter the industry, the firm demand curve shifts until zero profit exists

At zero profit – no more entry or exit

Graph of LR:

Watch content video: long run

Key Point:

Since each firm produces a differentiated product, we don’t speak of a market supply or demand curve but only of a firm supply and demand curve

A local grocery store has a truly immense array of famous brands of beer from all over the world, with lots of examples of microbrews from all regions on the United States. How can a small brand stand out from the shelves against all this competition? In other words, how can the manufacturer practice product differentiation and get the customer’s attention? These companies have no national advertising budgets; they are not sponsoring the Super Bowl. The trick appears to be some clever eye-catching name. Years ago we saw Black Dog and Pete’s Wicked Ale. Today we have Arrogant Bastard Ale, a fairly heavy brew whose label tells the customer that he or she probably isn’t tough enough to drink this bottle and should instead buy one of the wimpy standard brands with a multi-million-dollar advertising budget. That is a clever name and a clever challenge. While I didn’t buy a bottle, it has stuck in my mind and probably will win me over the next time I shop.Q: Think up a name for a brand of beer that you will create. The only requirements are that your brand name cannot be unprintable in a family newspaper and must be the best possible name to sell more of the beer.

Q10.3 When a competitive price-searcher market is in long-run equilibrium, the firms will

1. earn economic profit.

2. operate at an output level that minimizes long-run average total cost.

3. charge a price that is equal to average total cost.

4. operate at an output level where price is equal to marginal cost.

Q10.4 If a price searcher is producing at a level of output such that its marginal cost is $5 and its marginal revenue is $3, the firm should

1. increase output in order to reduce per-unit costs.

2. decrease the price of its product and expand output.

3. increase price and reduce its rate of output.

4. reduce both price and output.

Examples of Monopolistic Competition:

Network television, Fox enters the market

SUVs

Reality TV shows

Evaluating Competitive Price-Searcher Markets

Q10.5 (MA) Compared to the outcome when the firms are price takers, competitive price-searcher markets will result in

1. a wider variety of products.

2. less product variety.

3. lower prices.

4. higher prices.

What’s good and bad about this kind of market structure?

A tradeoff exists – – with fewer firms the ATC is lower (good) but

product variety is also lower (bad)– with more firms the ATC is higher (bad) but

variety is also higher (good)

ATC is higher mainly due to brand promotion

Q10.6 Some economists argue that competitive price-searcher markets are inefficient because

1. the firms earn economic profits in the long run.

2. the firms' marginal costs and marginal revenues are not always equal.

3. firms do not produce the output rate that would minimize their average total costs.

4. barriers to entry are high.

Evaluating these kinds of markets & economic progressHere are two different interpretations:

1) Recall the short-run dynamics: positive profits, new firms enter, existing firms lose customers

What if new firms expand the size of the market so that existing firms also grow?

Why do similar stores and restaurants open close to each other?

Evaluating these kinds of markets & economic progressAlternative analysis: positive profits, new firms enter, new and existing firms attract customers, both demand curves shift right

Evaluating these kinds of markets & economic progress

2) Recall the long-run equilibrium: zero profit, no entry or exit

No entrepreneur will want to settle for this

As the market conditions begin to reach this point, the entrepreneur must then get creative to keep positive profits

Innovation and invention will keep markets away from long-run equilibrium

Driven by the profit motive, entrepreneurs continually drive economic progress

A Special Case: Price Discrimination

What is price discrimination?

The practice of selling the same good to two or more groups of people at different prices

Disney World offers tourists a three-day pass that costs several hundred dollars. But Floridians can obtain the same pass for a bit more than $100. This is a great example of demand-based price discrimination. The cost to Disney of letting a Floridian or an out-of-stater into the park is the same. But the out-of-staters, having traveled to Florida, often with the sole purpose of visiting Disney World, have a very inelastic demand, while the Floridians have lots of other ways they can spend time while at home. Their demand is more elastic. It is easy for Disney to separate the two markets. All it needs to do is to ask those people seeking to purchase the cheap tickets to show a Florida driver’s license.Q: Is there any way you can get around Disney’s clever way of separating the markets for these discount passes?

Who can price discriminate?

Any firm that – (1) has a downward-sloping demand curve – (2) can separate its customers into at least

two groups– (3) can prevent customers from re-trading the

product

Why do firms price discriminate?

To increase profits

How do firms price discriminate?

By setting a relatively high price for those customers with inelastic demand and a relatively low price for those customers with elastic demand

Graph:

See handout “discrimgraphs.pdf”

As you approach Los Angeles International Airport by car, the price of regular gasoline changes dramatically. The stations near the freeway exit charge about 30 cents a gallon less than does the last gas station before the car rental return offices. If you go farther beyond the airport, prices again drop off quickly. The stations are price discriminating to take advantage of the customers’ different price elasticities of demand. Customers who have waited until just before the rental office face the choice of gassing up for $2.35 or of letting the rental company charge them over $5 per gallon to fill up. The station’s only competition is the rental company; and the $5 price limits what the nearby station can charge. Markets are neatly separated- you won’t drive back to a cheaper station once you’re near the rental office, and you can’t buy gasoline from some sidewalk peddler who has gotten it cheaper.Q: If this is true, why doesn’t the gas station nearest the car rental offices charge $5 per gallon?

Examples:

Airlines – Saturday night stay usually indicates vacation traveler (more elastic) while non-Saturday indicates business traveler (more inelastic)Grocery stores – coupons and saver cards; those who cut coupons and have saver cards are usually more elastic demandersUniversities – in-state versus out-of-state tuition; in-state students are usually more elastic demanders

Q10.7 If a movie theater is going to gain by charging students a dollar less than other customers,

1. the demand of students must be more elastic than that of other customers

2. the demand of students must be less elastic than that of other customers

3. students must have higher incomes than other customers.

4. other customers must enjoy movies more than students.

Q10.8 (MA) Which of the following are necessary conditions for effective price discrimination?

1. The firm must face a downward-sloping demand curve.

2. There must be at least two distinguishable groups of consumers.

3. The producer must be a pure monopolist.

4. The seller must be able to prohibit buyers from easily reselling the product to other potential buyers.

Entrepreneurship and Economic Progress

(1) An entrepreneur is someone who makes decisions based upon uncertainty, discovery, and business judgment.

(2) These decisions cannot be graphed or modeled

Q10.9 In order to be successful in a competitive market economy, an entrepreneur must

1. provide buyers at least as much satisfaction per dollar spent as the buyer could get elsewhere.

2. supply consumers with goods and services valued less highly than the resources necessary to produce them.

3. take resources from other producers, thus reallocating wealth but not creating new wealth.

4. gain government grants and subsidies.

Main Points:

Entrepreneurs play a vital role in economic progress by discovering new products and services that create wealth

Market forces provide incentives (and signals) for entrepreneurs to try new ideas

Watch video: Pirates of Silicon Valley-start of Apple

Here’s the critical piece of the Microsoft story:

Watch video: Pirates of Silicon Valley-license DOS to IBM

Q10.10 Economic analysis suggest that in a competitive market economy, when an entrepreneur has made a large profit,

1. consumer benefits must have been reduced by at least the amount of the profit.

2. other producers have lost profits of the same size.

3. economic progress for society as a whole has normally been enhanced.

4. luck or chance, rather than productive activity, has nearly always been the largest factor.

Question Answers:10.0 = 1

10.2 = 2

10.3 = 3

10.4 = 3

10.5 = 1 & 4

10.6 = 3

10.7 = 1

10.8 = 1, 2 & 4

10.9 = 1

10.10 = 3