- Good morning, good
afternoon, good evening.
The topic for tonight's
discussion is to focus in on
the other models of the
degrees of competition
that a firm could be in
fact associated with.
We talk about it as the monopoly model,
and that's the, remember
all the way at the end
of the spectrum, that's
like there's only one firm
in the industry.
But this applies to every firm
that has a downward sloping demand curve.
So with the exception of
those firms that are in
perfect competition,
what we did last time,
that have a horizontal demand curve,
all other companies are
gonna have a downward sloping
demand curve.
So basically this model applies
to almost any business firm,
whether it's monopolistic
competition, oligopoly
or monopoly, as long as the
demand's downward sloping,
this analysis is in fact correct.
And that's why I like to call
it not the monopoly model
but the price searcher
model, it's the same chapter
and the same information, but
it applies to all those firms
not just to the monopoly model.
So as we said, the firm
now faces, and remember
this is about the firm
now, not the industry,
but the individual firm.
And the firm faces a downward
sloping demand curve.
And we know that traces out the quantities
that they're able to sell at each price.
But for them it means
in order to sell more,
they have to lower the per
unit price in doing them.
And we can calculate total
revenue on the diagram
as we have done before.
If in fact the price is
10, I only sell 1 shirt
and I take in $10 of total revenue.
If I lower my price to
nine, I sell a second shirt,
and that's the only way I can do it
based on the data we've been given.
So I lower my price to nine,
but I have to have the
same price for everybody,
at least in this initial analysis,
and so at $9 I sell an additional shirt,
that's an additional
$9, but I lose a dollar
that I was receiving...
That I was receiving from
the first individual.
So total revenue goes from $9 to $18,
and that's the change that takes place.
If I lower it again to $8,
I sell an additional shirt,
three eights are 24,
lower it to 7, I sell an additional shirt,
total revenue is still going up,
and I get to $6 and total revenue is 30,
$6 times five units being sold.
But now notice something
about moving from $6 to $5.
At $6 I sell 5 shirts, so
there's my total revenue,
if I lower my price to
five, I sell six shirts,
so I take in an additional $5.
But I've given up $5 of
revenue from the previous items
I was selling in $6, everybody see it?
I'm gaining this area over here,
but I'm losing this area right here.
I'm gaining this area, but
I'm losing in that area.
So at that point total
revenue is the same,
5 times 6 is 30, 6 times 5 is also 30.
So I can then calculate
the additional revenue,
which is what marginal revenue is,
associated with each additional unit sold.
And for the first unit, marginal revenue
is the same as price.
If I charge a price above
$10, I don't sell any.
So the first shirt that I sell,
marginal revenue is the
$10 that I in fact receive.
At $9 we noted that the
change in total revenue
is only $8.
It's an additional nine minus one,
so the change in total revenue,
or marginal revenue, is $8.
For the third shirt it
is in fact $6, 'scuse me.
Three eights are 24
and four sevens are 28.
And then it's $4, and
then for the fifth shirt
it's at $2, and then the sixth
shirt, as we said, is zero
because that last shirt doesn't bring any
additional revenue coming in.
In fact if you look at selling
for $5, and selling 6 shirts,
so I get $30 in, if I
lower the price to $4,
I sell an additional shirt.
But four sevens are 28.
So beyond that sixth unit,
marginal revenue's actually negative,
the additional revenue is
not positive, it's negative,
it goes from $30 down to $28.
And so marginal revenue as
we said, is below the line,
it's negative in that area.
So I can draw the marginal
revenue function as a line graph.
And the way to see how you
can draw that correctly
has to do with the geometry of
a straight line demand curve.
At the midpoint of a
straight line demand curve
is where marginal revenue is zero.
Think back to my example
between $6 and $5,
we said that's where
marginal revenue is zero.
So the upper half of the curve,
marginal revenue's positive,
it's above the axis.
And that is the elastic
portion of the demand curve,
if you remember back to doing elasticity,
the upper half of the curve is elastic.
What does that mean?
It means when I lower price,
total revenue goes up.
Remember from elasticity?
If demand's elastic, I lower
price, total revenue increases.
If total revenue increases,
then marginal revenue's positive,
because as I sell the next
unit I'm getting additional
amounts of revenue in.
At the midpoint of the straight line,
marginal revenue is zero.
And then beyond that, you're
in the inelastic range,
and remember in that range raising price
increases total revenue.
Meaning that the additional
revenue associated
with selling those units
is in fact negative,
total revenue is going down.
So you can always accurately
draw this diagram,
which you wanna be able to do
to solve certain kinds
of problems graphically,
by number one, setting
marginal revenue equal to price
at the intersection of the vertical axis,
find the midpoint of demand,
which is also the midpoint
of that line segment because
it's a right triangle,
and that's where it's zero,
and then just draw your line
right through those two points.
And whatever slope you have,
that'll be an accurate
representation of marginal revenue
for that particular demand curve.
I wanted, I thought there was a chart,
I guess there's not.
I thought that I had a chart
showing marginal revenue
but I guess I don't have it.
Okay, so we now know
what demand looks like.
From that the seller can
calculate his marginal revenue,
the anticipated additional revenue
for selling different units,
and then the question is
what's the right rate of output
to maximize profit?
Same question we asked before.
Well we know mathematically
that I wanna produce every unit
that adds more to revenue
than it adds to cost.
Just think about it, if
it adds more to revenue
than it adds to cost,
it's contributing towards
a positive profit.
So I wanna produce all those units.
I don't wanna produce anything
that has an additional cost
greater than the additional revenue.
And so the optimal point is
the same as it was before,
the optimal rate of production,
and therefore price for this firm,
is the quantity where
marginal cost just equals
marginal revenue.
You've produced all the units
that add more to revenue
than they add to cost,
you haven't produced any units over here
that would add more to cost
than they add to revenue,
- [Student] Excuse me,
could you repeat please
what the optimal rate of production is?
- Yes, where marginal
revenue equals marginal cost.
- Thank you.
- And in the abbreviations,
it's MR equals MC.
- Thank you.
- Sure.
So that's the best the firm can do.
Once you've solved for that in the graph,
once you've drawn that in,
the rest of the diagram
doesn't mean anything,
the rest of the diagram
doesn't mean anything
'cause you know that's the
best you can possibly do
for this single price seller.
The price would be the price
up on the demand curve,
'cause that's the price
from which you calculated
marginal revenue,
and that's also the price that will sell
the quantity that you wanna produce.
QM's the best quantity to maximize profit,
PM is the price that will sell
just in fact that quantity.
So that's the monopoly price,
that's what the M stands for.
But we notice something that's different
from the perfect competition model.
And that is that the price is above
the marginal cost of production.
Price is bigger than
marginal cost of production.
Now, yeah, yeah, Leanne.
- [Leanne] Price is only
bigger than cost in monopoly?
- Yeah, and it's because,
let me go back to perfect competition.
Demand was horizontal, and that
meant that marginal revenue
was the same as price.
Remember every unit you could
get an additional dollar
when you produced and sold it.
So when demand is horizontal,
perfect competition,
price is the same as
marginal revenue, right?
Good, now once we get to
this downward sloping curve,
we can see that here marginal
revenue is less than price.
Right, as we talked about, right?
Well, the best rate of production
is to compare each unit
and how much it adds to cost,
how much it adds to revenue.
So that's what you did when
you moved out and decided
that was the best rate of production.
For all the units before
that, marginal revenue,
remember it's measured as
a heighth above each unit,
is bigger than the additional costs,
so you'd wanna produce those,
you wouldn't wanna produce
beyond that as I said,
'cause there marginal cost is...
Marginal cost is...
(chuckling)
I'm sorry, I was looking
at the wrong thing,
marginal cost is higher
than marginal revenue.
Marginal cost is bigger
than marginal revenue,
so I don't wanna produce out there,
I wanna produce all of these
so that's why that's the solution.
- [Leanne] And the price unit
(speaking out of mic range)
- No, no, no, it's the price
that you're charging on
to the customer, it's the
price on the demand function.
- [Leanne] It'll always be
more than the marginal revenue?
- Yes, as long as
demand's downward sloping.
And the reason is because if
demand's downward sloping,
marginal revenue is less than price.
And you produce where marginal
revenue equals marginal cost.
Right? Okay?
Okay, good.
And I went through this quickly,
but the reason marginal
revenue is less than price,
remember is, when I lower the
price to sell that next unit,
I lose revenue from the previous people.
Because they were all paying me $8 before,
now if I'm charging seven,
I'm losing all those dollars
from them, I'm gaining the new
dollars that I'm getting in
when I sell the additional unit, right?
But because it's what I'm gaining
minus what I'm losing, it's
gonna be less than price.
Okay, good.
So we know, as I said for this curve,
price is above marginal cost.
Now, the term market power means,
and you need to write this down,
'cause I don't think it's in the slides
and I think it's in the class
notes but I'm not positive.
The term market power,
and sometimes it's called monopoly power,
it's the same thing,
refers to the ability
to charge a price
that is above marginal cost.
Market power by itself just means
the ability to charge a
price that's greater than
marginal cost of production.
Consequently the higher the price is,
relative to marginal cost,
the greater the market power of the firm,
the more power that firm
has in the marketplace
with respect to competitors, Carol?
- [Carol] The ability to
charge a price above what?
- Above marginal cost.
So let's say, let's think
of the product as being
Microsoft's operating system, Windows 10,
I think isn't that the
latest one for the PCs?
Think about what price
do they charge for that?
It's like 90 just for an upgrade, right?
If you have Windows 9 I
think it's 90 to move up.
If you are building your
own computer though,
and you go to Microsoft
and say I wanna buy
the operating system from you,
I think it's like $230,
but either one of the prices
works for my analysis.
Okay, so price is somewhere,
100 to $200, right, good.
Now think about the
marginal cost to Microsoft
of producing and selling one more CD
that has the operating system on it.
We're thinking about marginal cost, right?
Well there's the cost of the
CD, let's say that's two cents,
there's a cost of burning
the data onto the CD,
let's say that's two cents,
it comes in a plastic box,
let's say that's two cents,
so we're up to six cents now.
And they have a tri-colored picture on it,
let's say that's an additional two cents.
So the marginal cost to
Microsoft is like eight cents,
and the price is like 90 or $200.
They clearly have a lot of market power,
and they clearly would
be called a monopolist.
But remember, there
are always substitutes,
that's one of those phrases you
wanna carry around with you.
The monopoly model says
it's only one firm,
but that's like a benchmark,
that's like a make believe model,
every firm faces competition.
They might not face a lot of competition,
like the case of Microsoft,
but there are always
substitutes available.
Substitutes for Windows or what?
(student speaking off mic)
Yeah, OSX or whatever
it is now for the Mac
and then there's Unix which is the,
the open source system
that's on the internet.
And so there are always competitors,
but they have a lot of market power,
so price is way above marginal cost.
My girlfriend's birthday
was not too long ago,
and she wanted a new purse.
And I think I told this story, didn't I?
- [Students] No.
- No, when I was doing, oh good.
She wanted a new purse for her birthday
so of course we went to what store?
Who has the best purses?
(students speaking off mic)
No, no.
- Neiman Marcus.
- Gucci.
- What?
- Neiman Marcus.
- No, no, those are
the brands, what store?
- Macy's or Bloomingdale's.
- Bloomingdale's?
- Irma's, isn't it Hermes?
I know, but Hermes is a brand, right?
- Yeah.
- Yeah, good,
so we go to Hermes.
I'd forgotten it.
- Well that's
a nice boyfriend.
Well we just went, I didn't
say I bought anything.
(students laughing)
So we went in, and they had
this really beautiful bag,
it was like a little
log and it was leather,
and it had big stitching on it,
and then it had a gold clasp and handle,
and it was really very attractive.
And I turned the price
tag over and it was $800.
And it was like, oh geeze.
And so I said to her, "Honey,
Macy's carries handbags."
"Macy's is a good store,
they carry handbags."
So we went to Macy's and they had a bag,
and by the way, the color at Hermes was
- [Student] Orange.
- No, no, no, was rouge,
it was a red bag, rouge.
We went to Macy's and they had a bag,
it was very similar, and it had stitching
and it had a gold handle,
and I turned the price
tag over and it was $400.
Well clearly the other bag was
better than this bag, right?
It was, it was a better bag.
But it wasn't better by
$400 in terms of cost.
So I estimated, and that's why
I have this relationship up,
I estimated that for them,
maybe their cost was 400
and they were selling it for 800.
So they clearly have market power,
they have a really great
reputation in the marketplace.
And they do, they have
really quality stuff
and quality people who really know stuff
and they're all attractive
and the store's attractive,
and all that kinda stuff.
And it's $800, right?
So I said to her, "You
know Target has handbags."
(students laughing)
And by the way, the
color there, it was rouge
and then it was, what was it?
I can't think what the name it was there.
So we went to Target and
sure enough there's a bag
that's very similar, right?
(laughing)
It's the same size, and
it's made out of pleather
as opposed to actual leather.
And it was like $74, right?
So which one did I give her?
- [Student] The $74 one.
- Oh, come on.
That's minus two points right there.
No, she got the $800 bag.
I'm not stupid, people, right?
- [Student] My boyfriend
would've given me the 74.
- Well and you should change boyfriends.
(students laughing)
That's why you're taking this course,
so you can get better quality people.
You can tell him this story.
Clearly they have market power, because,
and it's not Hermes, it's Coach
is what I was thinking
about, Coach handbags.
They clearly have market power
'cause the price looks like
it's about twice marginal cost
in that situation.
If you think about the demand
for Scott paper towels,
and I must've done this
when I did elasticity,
there are a lotta close substitutes,
remember that is a case of
monopolistic competition.
Lots of differentiated
products that are similar
but not identical.
Some are more absorbent, some are colored,
some are these kinds of things.
But there's a whole lot
of close substitutes.
So in fact you can see
that price is very close
to marginal cost.
There's not much market power there
because demand is downward
sloping to that degree.
If you went to the price taker model,
the one we did last time,
the most competitive case.
Remember the assumptions,
the economist assumes
there are thousands and
thousands of buyers and sellers,
the products are identical between them,
you can't even tell who produced it
when it's at market.
There's perfect information,
zero information cost,
everybody knows everything,
you know the price,
you know the quality,
you know where it is,
and there's zero cost
of entering or exiting,
those are the conditions
for perfect competition.
In that case, as we just said in review,
the price is the same as marginal revenue,
you produce where marginal
cost equals marginal revenue,
same thing we're doing now,
but this firm has no market power
because price is the
same as marginal cost,
y'all with me?
Good, so as you look at those diagrams
you can see the changing
nature of competition
and the changing amounts of market power.
Monopoly has that really big upcharge,
then you have still pretty good size,
then you have a very small one,
and then you have zero at
the most competitive model.
Yeah, Leanne.
- [Leanne] Where the
marginal cost and the demand,
that the box that it makes,
that's the total revenue, right?
- Price times quantity.
- Yeah.
- Right.
And then marginal cost,
in fact that's great
because you're thinking
about exactly the point
that I wanted to make.
If you go back to this model of Microsoft
that has all this market power,
and we said, the price is 200,
and the marginal cost is like six cents,
and so you might be, the
average person on the street
would tell you, well
they're making profits,
they're making monopoly profits,
I mean they're a monopoly,
they have to make
monopoly profits, right,
they're a monopoly.
The answer is wrong.
Because remember, profit is
total revenue minus what?
Total cost, and total
cost includes not only
variable cost, but fixed cost.
Now, think about Microsoft.
To develop that product, they
have thousands of engineers,
they work on it for years,
they get really high salaries,
they're up in wherever their
park is for their property.
And they have all kinds of
equipment and they test things
and so forth.
So they spend millions
and millions of dollars
in fixed cost to develop that system.
So the summary point I'm
trying to make to you is
even though a firm may
be called a monopoly
it is not guaranteed to be making profits.
Y'all with me?
There's no guarantee of
profits, you could say wow,
look at that now.
In fact you guys have seen
this in your own lifetime,
you've seen stores where there
was a really big upcharge,
right, like really fancy
stores and they had
a really big upcharge, and
they went bankrupt, why?
Well because they had a big ratio here
but they weren't making
enough money to cover
their fixed costs.
And so there's no guarantee,
of being a monopoly
or having lots of market power,
there's no guarantee
of profits whatsoever.
In fact I wanna look
at that now in terms of
firms potentially
entering into competition
and what is the effect on
the firm's profitability.
So profit as we said, is price
relative to average cost.
And we recall from our cost curve diagram
we know marginal cost is
gonna intersect average cost
at the minimum of the bowl,
at the minimum of the bowl.
But the cost curve is totally separate
from the demand curve.
That's two different data sets,
demand is what you buyers
are willing to buy from me
at different prices,
cost comes from the back room.
That depends on the
technique of production
and all those kinds of things.
So average cost could be,
okay this one's working,
average cost could be up here,
could be intersecting marginal cost there.
It could be here, it could be down here,
it's totally independent of demand,
of what demand looks like.
So we don't know if the
firm's making a profit
'til I bring in average cost
from which I can calculate
total cost, it was the
point Leanne was addressing.
So I bring in my average cost curve,
I can draw it in the same space,
and let's say suppose
it is where it is now.
So I'm producing QM, so my per unit cost
is the heighth of average cost
at that rate of production.
To get total cost I would take the average
and then multiply by quantity.
The same way I did to get total revenue,
I took the price multiplied
by the number of units.
So to get total cost I take average cost,
multiply by the units that
I'm in fact producing.
So the bottom area, the total revenue,
would be PM QM, the whole rectangle,
the bottom area would be total cost,
average cost times quantity,
and so profit would be the
difference between those two,
in fact it is price minus
average cost times quantity
is another way of thinking about it.
Price that I sell it for,
minus my per unit cost
of production, times
how many units I've sold
would give me the profit
that I'm making for the firm.
Now if a firm is making positive profits,
what can you expect in the marketplace?
Anybody?
If a firm is making a lotta profits,
what can you predict would happen?
- [Student] High revenues?
- Huh?
- High revenues?
- Well revenue above cost, we know that,
I know what high means, but we know that,
but what response would
you see in the marketplace?
People spot somebody making profits,
people who have similar
resources are gonna do what?
Come into competition,
right, come into competition.
The story I like to tell is...
Years ago, there was a firm that produced
microwave transmitters.
Raytheon was the firm.
And, this is back in the 50's,
and if you go downtown
and go up on the buildings
you'll see a big rectangle that
looks like a stereo speaker
and if you look five miles
over you'll see another one
facing it, so you'll see
these throughout downtown.
Those are microwave relays,
and this one is broadcasting
10,000 signals to that one,
and it's carrying 10,000 data streams,
and that one is broadcasting
back to this one
and it's carrying some
unbelievable number.
I'm very good at visualizing things
but I'll tell ya, I can't
visualize how this invisible wave
carries information.
I don't know that much about physics, but,
my guy said well you just take the wave
and then you put the data
on it, or, I don't know.
But they do, that's how all
your internet stuff goes,
how all the telephone calls
have gone for a long time,
through these microwave transmitters.
At that time, the transmitter was easily
as big as this room.
The transmitter machine
was as big as this room
and it was run on vacuum tubes,
and it was very expensive, it
cost like a million dollars,
which means in today's
dollars it would be like
50 million, something like that.
So the chief engineer,
and this is a true story,
chief engineer went down
to his guys in the lab
who were developing a new
microwave creating tube,
vacuum tube, and so the guy turned it on,
and then he started talking
to him about what it does
and how much it costs to make
and all those kinds of things,
so he was evaluating
this new potential input.
And he went up to his office afterwards
and he was wearing a jacket,
and he had a Hershey bar
in the inside pocket.
And so he took out the Hershey bar
and it was partially melted.
It was partially melted, and he was like,
he's a scientist, an engineer, so he said,
I've worn this jacket lots of times
in hotter weather than this
and I've never had it melt,
so something else is going on.
So where was I, I was down in the lab
standing next to a
microwave, a vacuum tube.
So he thought, okay,
maybe that's the source,
although they didn't
know this at the time,
and he went out and
bought a little tiny bag
of popping corn, unpopped popping corn.
And he went back to the lab
and he leaned it up against
the tube and then he told the technician,
okay turn it on again.
Well think if you were
the technician, right?
The guy comes in with a bag of popcorn?
Like, oh, he's lost it, right?
This is crazy, right?
So they turn it on, nothing
happens, nothing happens,
and then, a couple kernels pop.
And he realizes that
somehow the microwaves
are causing the food to cook,
or causing the food to cook.
Now we know today what goes on,
microwaves cause the molecules to jiggle
and jiggling the
molecules causes the heat,
and the food cooks from the inside out,
it heats up on the
inside and then outward.
So the next board
meeting, this is Raytheon,
you know, microwave stuff.
The next board meeting he goes to report
and he said, you know it might be possible
to make a microwave oven.
Now if you were on the board of directors
you'd think this guy's lost his mind.
It costs millions of dollars
to build the transmitter,
what are you talking about, right?
So obviously it was not possible then
but as science continued,
we moved from vacuum tubes
to chips, I'm sorry, we
moved from vacuum tubes
to transistors, that made
it smaller and cheaper.
Then we moved to chips, that
made it smaller and cheaper.
Eventually it became possible
to think about building
a transmitter and a receptacle
and perhaps get it down
to what you could actually sell it for.
So they invested in all this research
and they didn't know if
it was gonna work or not.
And the first ones they
developed were much larger,
they were for restaurants,
they were the size of a refrigerator
and they sold for like $4,000.
And restaurants would do it
'cause I can cook food quickly
to serve to my customers.
And the real problem they had then was
how to convince the general
public that it was safe
to use these things.
I mean you're cooking with
invisible rays, right,
like X-rays and stuff.
And they put demonstration
units out at various areas,
one was the north campus of UCLA,
and they put it up and
it was next to a standard
thing where you put the money
in and take the food out,
vending machine.
And they had croissants and
ham and cheese sandwiches
and a couple other items.
So you'd buy the food there
and then you'd open the door,
and it had a handle like
a giant freezer, right,
like this gigantic handle
that you had to open.
And then you place it
in and then you close it
and lock this handle,
and then you push buttons
that had pictures on 'em,
so here's a picture of a croissant
or a ham and cheese sandwich,
so you press the button.
Even then it hummed, it
made a humming sound.
And the handle locked,
so you couldn't possibly
get it open while it was
generating microwaves.
And then when it was
through it actually dinged
much like they still do today.
And then you'd open it and you'd reach in
and the sandwich would be hot
and the whole inside of the oven was cold.
Now you talk about
science and stuff, right?
People were really scared of it,
people were really scared of it.
They thought it would make you go blind,
people would say, oh, you'll go blind,
microwaves make you go blind and so forth.
But eventually, eventually
they managed to get
enough advertising out, enough
informational discussions,
and they started to make
positive economic profits.
The branch was called Amana,
they were the first ones
to come out with one for the home,
and it was still very expensive,
but they actually started
making positive profits.
As soon as they made those
profits, what happened?
Anybody.
(students speaking off mic)
Good, who came in against them?
Who would you predict
would come into competition
to produce a kitchen appliance?
(students mumbling off mic)
Someone who has similar resources, right,
someone who knows how to
produce kitchen equipment.
General Electric, KitchenAid, Samsung.
Samsung knew more about
the microwave transmission
than they did about the appliances
but they came in as well.
So over time the response is new firms
are going to enter the industry.
As they do, the result is
that demand will decline
for your product, will decline
and become more elastic,
but as long as there's positive
profits being reported,
there's an incentive for more
firms to enter that industry.
So now it is a commodity.
If you want a microwave go to Best Buy,
there is a wall to choose from.
There's a little tiny one
for $49 for sandwiches,
then there's the regular size,
then there's one that has
the blade that rotates.
Then there's one that
has presets for popcorn
and other stuff.
And then there's a big
one for cooking turkeys,
this gigantic microwave.
The rate of return on those
is approximately 7% right now,
small appliance rate of
return, about six to 7%.
Which means zero economic profits.
Once again, remember
economic profits mean what?
Above and beyond the normal
rate of return, right?
Remember economic profits
are above and beyond
the normal rate because
the normal rate is included
in economic total cost.
'Member opportunity cost
was part of that total cost
that you are subtracting
from total revenue.
So over time, competition
will drive the price down,
reducing demand, reducing price,
until you reach this situation.
Here, price is the same as average cost,
including opportunity cost,
and so now the firm is
making zero economic profits.
They're still making a rate of return,
normal rate of return, 7%
for that degree of risk
in the marketplace, but they're
not making economic profits
as a result of the new firms entering.
Yeah.
- [Student] On the test
there was a question about
economic profits and is
it beneficial to society?
Or, you know what I'm trying to say?
- There was a question
about why is the market
efficient or something,
and the answer was,
because it maximizes the gains from trade.
There was a question like that.
Now I don't know what, I don't know...
But I think there was a question on there,
going back to our
discussion about the firm,
'cause that was before the second midterm,
was our discussion about the
fact that because the owner
receives profits,
employees make more money.
There was a question like that,
or if you make them pay for healthcare
wages will go down,
those were two questions
that were in that particular area.
But it's really important
to understand that,
if you ask the average guy in the street,
if this guy's making a profit,
is that better for the employees?
And they'll say no.
No, no, if he's making a profit
he must be buying them cheap
or something, right?
But we know from our understanding
about my running a co-op,
when the owner gets to keep the profit,
number one the employees
can get a guaranteed salary
whether you're successful or not
as long as you're still in business.
And then secondly, productivity goes up
because the owner's gonna
monitor the employees,
they're gonna work to their potential,
which means they're more
valuable to the employer.
Remember this employer's in competition
with all the other employers out there
to bid for your services, so wages go up
as a result of that kind of organization.
Now, we talked about
efficiency for the marketplace
when we were doing perfect competition.
And there's market demand,
means demand facing the firm,
but that's the demand for it.
And then there's marginal cost.
So it looks like this
would be the equilibrium
in the marketplace.
It's demand and supply
intersecting, remember,
supply was the sum of
marginal cost to the firms,
this is the demand facing the firms.
So it looks like the market
would lead us to this point
of efficiency.
But we know the firm is gonna operate
where marginal revenue
just equals marginal cost,
they're gonna operate at this QM,
they're not gonna operate out there.
So there is a potential efficiency loss
because these units that are right here,
are valued by the buyers more
than the cost of production.
And so they're not being produced,
so this is a potential gain from trade
that's in fact not taking place.
It looks like there's this efficiency loss
relative to the marketplace.
In some countries of the world,
there are absolute monopolies,
and they are usually in dictatorships.
And they're usually protected by tariffs
to keep competition out.
And they do make monopoly profits.
Like Indonesia, it was
Jakarta, that's the city.
I can't remember the guy's name.
But he gave the monopoly
to manufacture automobiles
to his brother.
Indonesians don't know anything about
how to manufacture automobiles,
they never manufactured automobiles.
So he hired people and brought 'em in,
and then they built a plant
and they started producing
domestic automobiles that were terrible.
And then he put a tariff of like $30,000
on a $30,000 car.
So if you wanted to
buy a Ford or something
you had to pay $60,000
or the equivalent of it.
So clearly there's a problem
with an efficiency loss
in some cases, in some situations
where there are monopolies.
But it's not always the case.
And next week I'm gonna talk about
some alternative pricing techniques
which allows you to produce those units,
it's called, 'scuse me,
price discrimination.
And if you can price discriminate,
which means different
prices to different buyers,
then you can produce those
units and make a positive profit
eliminating the quote efficiency loss.
But that is the area that's talked about.
And by the way, this goes back to what
I was talking to you about.
The market takes you all the way out
to the intersection of demand and supply.
That means it maximizes
gains from trade, right?
The gains from trade are
the difference between
the value to buyer and
the cost to society.
The price line splits it up,
so the consumers get the area above that,
consumer surplus value.
The producer gets the area of the price
minus his marginal cost, that
is producer surplus value.
So the market would take us out,
if this were the right marginal cost curve
the market would take
us out to that level.
However, that marginal
cost curve comes from
the way this firm is currently producing.
How big a plant they've
decided on and so forth.
And one of the solutions
under the Anti-Trust Laws
when a firm is monopolizing and charging
quote, monopoly prices,
is to break the firm up
into smaller firms.
Make them compete and then we'd get closer
to the competitive result.
Everybody with me, right?
The idea was, in fact,
Microsoft was sued by Sun
and a couple other firms
for monopolizing the market
for browsers on the computer.
Microsoft clearly had monopoly power
in the operating systems,
but Microsoft was saying to its customers,
which are all the PC manufacturers, right?
I'll sell you the operating system
which you can then load on your computer,
and you pay me a price for
each unit that you sell
that has it on there,
only if you agree not to
put an icon on the screen
for any browser other
than Internet Explorer.
Everybody know what I'm saying?
When you buy a machine
there's all kinds of icons
of things you can get,
and they were saying, no,
only if you don't put any
competitor's icons on the screen.
Well that's called
extending monopoly power
and that's illegal under
the Anti-Trust Laws
if you have the size of
market that they did.
So they were sued for violation of that
and it went to court, and
the judge was considering
breaking them up into two firms.
That is an operating system firm
and an applications firm.
And that can be done, and all transactions
have to be arm's length like
it was in the marketplace,
and communication stops except
for communication that's
monitored and so forth.
So they actually were
considering breaking it up.
Well if you break it up they
don't have the same cost curve.
They don't have the same cost curve.
Let me give you an example,
say you have one firm
making and selling a
thousand cars per month.
And let's say it's
Toyota and that's out of
the Maryville, Ohio plant,
which is this gigantic plant,
it's as big as three city blocks.
So they're now producing with that
so the marginal cost
curve is from that plant
that they have, the really big plant.
You come along, you say, well,
you're charging monopoly prices,
so we're gonna break you
up into 10 separate firms.
Well now think about it,
if you create 10 firms
to replace this firm,
and the market will support
a total of a thousand cars
purchased per month, then,
and these guys produce
very similar cars, so each
firm would end up producing
a hundred cars a month.
Which means they'd have to produce
with a much smaller plant,
they don't need this gigantic plant.
But a much smaller plant,
we know is more expensive.
And the reason I know it is,
if the small plant were better,
then Toyota would have
a bunch of small plants.
But they don't, they
have a really big plant,
economies of scale in production.
So breaking it up is not the right answer
because if you break it up,
they will not have that
marginal cost curve.
You could get an industry supply,
that's the sum of their marginal costs,
but it could easily
intersect demand up here.
Meaning prices much higher
than they all are right now.
So that's the second
reason why there may not be
an efficiency loss.
Leanne?
- [Leanne] I don't really
know how to ask this, but,
for efficiency loss is
that a company's profit?
- No.
- Like not exactly, but
company's?
- No, it's totally different.
It's a welfare analysis
of the society's loss.
It's not profit that they're getting,
profit would be average cost, right,
and then price and so forth.
But that is being done
from this welfare analysis,
that the heighth of demand
is the value to the buyers,
the heighth of the supply,
cost curve, is marginal cost.
And so those units, if you produce them,
would generate this much value to somebody
if you could do it and
they'd pay this price for it.
And the cost is only this much,
so that's the gain from trade
that is not happening now
because you're restricting output to here.
With me?
It's a gains from trade
that you're not getting
because they're restricting output.
When you hear people talk about monopolies
they will often say to you,
monopolies restrict
output and raise price.
Monopolies, and they do,
from what would appear to be
the competitive result.
But it doesn't guarantee
profitability as I said before.
Good.
So we might then look at why
some firms have monopoly power,
what are the sources of a
firm having market power,
or having monopoly power?
Well the first example's
called a natural monopoly.
And that is,
there's some markets that will not support
more than one firm.
If you think about the
local power company,
there's only one local power company.
If you think about the local gas company,
there's only one gas company.
And the reason is that they have,
and the same thing with the water company.
They each have what's
called a natural monopoly.
And that is the market
will only support one firm.
Think about the example, Thousand
Oaks is about to be built,
they're gonna build 10,000 homes,
and they want somebody to come
in and provide power to them.
So there's PG&E in L.A., and then there's
Southern California
Edison down in San Diego,
they're both separate power companies.
So they would go in and look at it,
and number one, think of the
cost of setting up your system.
Number one, you have to
wire the entire city.
And in Thousand Oaks they
said it has to go underground.
So you had to dig trenches
and cable your electric wires
to the entire city,
you had to build transformers
to step down the power
from the high tension
lines down to residential,
you had to run individual
lines from your grid
out to each house,
you had to install meters
on each house, right?
So the fixed cost is really big
to start out in business, right?
Once you have done that, and by the way,
the way you'd figure out
whether it's worthwhile
doing or not, you'd figure
out what is the average income
gonna be for the kind of
houses you're building
for the sales price that you're gonna get,
then what is the average electrical usage
of houses like that, and
most of 'em have kids,
and so you can project the
annual usage by the city.
And then you'd think about
what's the revenue stream
if I charge a standard competitive price,
which I'm being regulated
by the state to charge,
and then if the stream
of money coming back in
is more valuable when we
measure the value today
than the cost of putting
up the wiring today,
then it's worth going into, right,
then it's semi-profitable in that way.
But here's the point, once
one company has done that,
another company's not gonna come along
and rewire the whole city
and offer electricity,
because think about it.
Electricity's totally fungible, right,
it comes from one guy or another,
it doesn't matter to
you, it's electricity.
Perfect substitutes.
And let's say they would
split the market in half,
so each one would get 500
houses as opposed to 1,000.
But at 500 houses neither one
of 'em can make any money,
they're not making profits.
Everybody see it?
Good, so that's called a natural monopoly,
the market will only support one firm.
Another firm will not come in and compete.
Because those are, those firms
have a lot of market power.
All of them are regulated
within the state,
and there is what's called the
Public Utilities Commission,
the PUC, and all of their
rates have to be approved
by the PUC.
And so the company has to go and present
their cost of information
and then try and justify
why they should be able
to raise the rates.
When nuclear power was not being insured
by the federal government,
and so the producer of nuclear power had
ultimate responsibility for
anything that went wrong
at the plant, they had to
put aside money to do that.
And in doing that, they
had to raise their rates.
And so the companies,
the electric companies
can pass that on to the
consumers as a real cost.
If I buy power from,
what's the one down south?
Between here and San Diego.
- [Student] San Onofre?
- Yeah, San Onofre's
plant, then I go to the PUC
and I say, look, the energy's
costing me this much,
12 cents per kilowatt, and
so I can raise my price
in that particular way.
So that's a natural monopoly.
A second source of monopoly
power is owning a patent
over your product, and
you all are familiar
with the term patent, you
know basically what it is.
A patent is an agreement by the government
to protect your specially
invented idea or product,
for 20 years, from being
duplicated by somebody else.
It's very easy to copy what you've done.
If you bring on a microwave oven
I can take it back to the
shop and I'd buy 10 of 'em,
I have my engineers take 'em apart,
they make the drawings up,
they measure all the parts,
and then maybe one of 'em I'm
having trouble figuring out,
but I'll figure it out pretty quickly.
And then I can come back on the market
with a substitute in that way.
So patents were granted to firms
to protect them from competition.
So that doesn't sound good, right,
'cause they'd charge monopoly prices.
So why would they do that?
Well the answer is because
the patent gives firms
an incentive to go out and find new things
that are valuable to people,
to invent things that are valuable.
Now when you're producing new products
it's very risky, right?
The more different it
is from other products
the more risky it's
going to be to produce.
Drug companies have patents
on their new medicines,
it's not 20 years, it depends,
it's 7 years or 9 years
depending upon certain conditions.
But to get a patent, you
have to demonstrate this
at the patent office.
Number one that what
you're producing is unique,
which means nobody else
is producing it right now,
it's unique.
Number two, it's non-obvious.
You can't patent something
that anybody would see
and say, yeah, let's do it that way.
Draftsmen know to draw a
line, when we used to draw a,
when we used to draw diagrams,
that you pull the pencil
and you rotate it,
and it gives you an even
graphite line in doing that.
We can't patent that
'cause it's obvious, right?
Plus the third thing is,
it's not state-of-the-art.
And that already is state-of-the-art,
so you can't patent something
everybody knows about,
you can't patent it if it's obvious,
you can't patent it if it's unique.
You also have to demonstrate
that it creates value
for the buyers, that your
product is doing something
for the buyers that they would
in fact value having done.
If you meet all those criteria,
then in fact you can get this
protection from competition.
Yeah.
- So what does it mean,
when you buy some products,
I'd seen in the back it says,
product pending, what
is that supposed to--
- Patent pending.
- It's just pending?
- Yeah, when you apply for a patent,
it takes like two and
a half to three years
to get that protection,
and so what you do on the
product is say patent pending,
which means to all other
people who are thinking
about trying to copy your product
that you've already filed
a patent for this design.
So don't try and copy it
because it'll be a violation,
so that's what that means.
It's tragic that the government
actually has cut back
in that overall budget
scheme where they reduce
10% of everybody's expenditures,
all the departments,
they cut back the Department of Patents.
So there are fewer patent reviewers
so it takes longer to get
these new products to market.
And if they were brought to market,
they would be producing
value to the buyers.
So it's another thing government's stupid,
I've been teaching you
that all semester, yeah.
- [Student] What's the
difference between a patent
and a copyright?
- I'm gonna come to that next, right.
Patents are on actual products, okay.
And by the way you can't patent an idea,
you can't patent an idea, it
has to be an actual thing.
Copyright is on things that are written,
which is music and literature.
And it's the same as a patent and that is
that it's a guarantee that
people can't copy your book
and sell it without paying
you a royalty for it.
So it's the same kind of
protection on those two things.
Trademarks are also patentable,
you know, the Exon symbol,
or whatever your symbol is,
can be protected from somebody copying it
to give you an identity of your own.
We had a case when I
was doing the consulting
where there was a firm in South Korea,
well let me back up.
In plumbing there's a
firm called Price Pfister,
and it's P-H-I-S-T-E-R, Price Pfister.
And it has a very unique
scroll on the products,
on the packaging, it says Price Pfister
but it's the really nice
scroll work in the way
the name is presented.
A company is South Korea came out
and the name of their price was,
it was something really
similar, it was like,
Price Pfixer or it was
something that was so similar
that it was clear that they were doing it
in order to confuse to consumer, right,
'cause you think you're
getting Price Pfister
and it wasn't.
So Price Pfister brought
an action of a violation of
trademark and we won, we represented them
in the economic analysis
of the amount of damages
that had been done by the firm.
So that's patents and copyrights, thanks.
The third is actions the firm might take.
And one of them is to have a reputation
that if you even come close to my product,
I'm going to sue you.
Now the way it works is
this, I bring an Anti-Trust
case against you for patent violation,
if I can convince one federal judge,
that's all I need is one judge,
to say this case has merit,
then you have to cease and
desist what you're doing
until such time as it's proven in court
that you're not violating the patent.
Everybody see it?
All I have to do is get one judge to say,
yeah, that's a valid
claim, I think consumers
are probably confused by that.
Then you have to stop selling
until it can go to court.
Well hell, it doesn't go
to court for three years,
so you're really protected
for that period of time
in doing that.
So some firms have a reputation
of just being really
aggressive with suing people,
and that itself prohibits other
firms from entering, right,
'cause if you know, oh
no, he's gonna sue me.
If you sue and win, you
win your attorney's fees,
if you sue and lose you
don't get compensated
for your attorney's fees.
So it's a real risk to sue somebody
because if you don't win then
you're out a lot of money
most likely.
Good.
There is what's called
exclusive licensing,
and that is that, as you know for example,
if you wanna open a liquor store
you have to go to the
state and get a license
for that particular location.
The state has a geographic rule
depending upon the
density of the population,
that if they already have liquor stores
that are 20 miles apart or 10 miles apart,
you can't get a license
in that area, right?
So the license gives you monopoly power
in that local market.
'Cause the exclusive license
prohibits other firms
from entering into competition
in your particular area.
A third is called bundling, and that is
tying together two products,
as in the case I mentioned with Microsoft,
and only selling them as a bundle,
only selling them as one product.
So if you wanna get A you have to get B,
and if you wanna get B you have to buy A.
And that is a way of
extending monopoly power
into an area by requiring
that if you buy my product
in the big area where I
have the market power,
then you can buy the other product,
otherwise you're not able to.
So those are all actions
the firms might take
to generate the ability to
create a monopoly power.
Doesn't mean profits, but
it does mean market power.
So what are some of the
solutions to this problem?
The first is, the government
has lots of regulations
on prices.
If you're charging a single price,
well you're not allowed
to charge different prices
to different people just at whim.
Now if you have different
costs of servicing them,
you can charge different prices.
But you can't just see you
come in in a coat and tie
and say well here's your menu, right,
and then you come in in shorts and,
I don't let you in in
shorts, but here's your menu.
You can't just price discriminate
based on stuff like that.
So there are regulations about pricing.
In 1890 we passed the
Sherman Anti-Trust Act,
that broke up these major trusts of firms.
Like all the railroads
were in one big trust
and so they were able to fix
prices on rail transportation.
That's illegal after that law.
And then in 1936 we passed
the Robinson-Patman Act,
and that again had specific behaviors
depending upon your size in the market,
of what you're allowed to do
and what you're not allowed to do.
- [Student] Excuse me, that was 1936,
and which act was that?
- Robinson dash Patman.
- Thank you.
- Right.
Suppose you have 35% market power
and a new firm comes in in competition.
If you have above 35% market share,
new firm comes in in competition with you,
you're not allowed to lower your price
below your own cost of production.
You're not allowed to drive this guy out
by just selling it at a loss
to get him out of the market
and then raise the prices back up.
If you only have 5% market
share, I don't care what you do,
right, it doesn't matter.
Sara Lee was sued by a guy in San Diego
who came up with some
new frozen fruit pies.
And they had, it was apple
but he had cinnamon on 'em
and some other really good stuff,
and Sara Lee's a big maker in
the dessert section, right,
they make all these frozen
cherries and apple pies,
all that kinda stuff.
So this guy opened up and
then they lowered their prices
below their own cost of production.
The guy sued 'em and won the suit.
No, you're not allowed to do that,
so there are laws that protect people
from these kinds of activities,
and that is the Anti-Trust Laws.
And the final solution is
what we're gonna talk about
next week, it's called
price discrimination.
If I'm able to charge different prices
to different customers,
and do it in a manner that still
meets the fair requirement,
then I can avoid the efficiency loss,
'cause as I was saying to you,
I can sell those units
without lowering the price
to these guys,
if I can lower the price to you guys,
then the efficiency loss is wiped out
and the firm does not have...
And it's a way, it doesn't eliminate
the market power of the firm,
but it eliminates the efficiency loss
because those units can
be produced and sold.
So as we said, price discrimination,
the general definition simply says
different prices for different units sold.
We'll talk about three kinds next week.
First degree is different
prices to different buyers.
Second degree is different
prices for different units
that you buy.
So your soft drinks right?
$1.10 for 10 ounces,
and then for 10 cents more
you can get another 10 ounces,
and that's second degree.
It's also called quantity
forcing, quantity forcing,
lowering the price to the same buyer
on additional units purchased
to move down that buyer's demand curve.
Third degree is different prices
to different groups of buyers
based on different elasticities of demand.
And I'll just give you
a real quick example.
Airlines, airlines charge
tremendously different prices
as you know to different customers.
How do you get the low price?
How do you get the low price on airlines?
- [Student] I use Google search.
- What?
- I use Google search.
- Okay, right, and you can
do that now in comparison.
But who gets lower prices?
When you book when?
- [Student] Early.
- When you book early, good.
Well if you think about it,
if I'm lowering the price
to people who book early
and raising the price to
people who don't book early,
I must believe that this group is elastic
and this group is more inelastic.
Well who are the two types of,
what are the two reasons why people fly?
One is for vacation or
personal travel, right?
Or going home, but I mean
personal travel, right?
What's the other one?
- Business.
- Businesses, good.
Personal travel is much
more elastic, right?
You can fly anytime in August, right?
And you can book well ahead
of time to get a lower price.
Business travel, number one,
is paid for by the company,
and so consequently the
person making the flight
is not gonna have to pay for it, right,
that makes it more inelastic.
But secondly, in business,
you have to be there
when the meeting is called.
And you may not know about it
until two days ahead of time.
You're on the west
coast, regional manager,
they call this meeting in
Chicago for two days from now,
you have to fly two days from now.
So the airlines change the
prices based on which group
they think you're in.
If you're the inelastic demander,
I wanna raise the price to you.
Elastic demander, lower the price.
They even do it, again,
the isolation is the same
one we talked about, but
if you fly and come back
during the week without
a weekend in between,
you'll pay a higher round trip
than if you book and
then stay over a weekend.
The reason is the business
man is not, or person,
is not gonna stay over the weekend, right?
It's not fun for them,
they wanna get home.
If you're going to stay over a weekend
then you're at least
partly probably mostly
a personal flier.
So they lower the price
for you in that way.
Hotels charge higher rates during the week
and lower rates on weekends in general,
same thing, because people
who are staying there
during the week are probably
doing it for business,
and people on the weekends
are doing it for fun.
So we'll cover all
three of those next week
with lots of examples.
And it's one of the areas I
think is the most interesting
in the course because it really is
these really clever techniques
that firms have employed.
Hotels have like 12 different
rates for the same room
on the same night.
