I am trying to be more systematic and organized about how things are laid out. So I have laid out a general weekly schedule for the days going forward. We will be trying to keep to this schedule until we either go back to school, or the semester ends.
Monday: New notes. New work. I will be available via email for questions.
Tuesday: A day for you to work on your work. I will be available via email for questions.
Wednesday: Planning/Grading for me. You can work on your own.
Thursday: New notes. New work. I will be available via email for questions.
Friday: A day for you to work on your work. Zoom meeting for questions.
If we keep to that schedule, we should have more than enough time to cover the remaining topics and still have time left over to review.
As we get closer to the end of the semester we will hopefully have a bit more information about what's going on in school and what's up with the AP test.
Since today is Tuesday, you can use today to finish yesterday's work. If you have questions please send me an email.
Tuesday, March 31, 2020
Monday, March 30, 2020
March 30 - Monopoly Part 3 - Price Discrimination
[Note: Thanks to everyone that has joined the remind class. Unfortunately I am having issues with my access to Remind. Consequently, even though the class has been created I cannot access it as a teacher and thus cannot send you messages. I have a help request into the company. Hopefully it will get resolved shortly.]
Today and tomorrow we will be wrapping up our look at Monopolies. Tomorrow we will look at regulating monopolies and at monopolies in the long run. Today we will look at price discrimination, which is the first part of this power point.
Monopolies Part 3
We originally learned about Price Discrimination in one of the early chapters in the Undercover Economist. The idea of price discrimination is that a business is trying to figure out a way to charge different people different prices.
There are three types of price discrimination.
1) Charge each person the most they are willing to pay. The idea here is that somehow the store is able to determine this info and adjust the price accordingly. When Bob walks into the store the store somehow knows that he is willing to pay $5 and charges him $5. When Susan walks in, they know she will only pay $4 and they charge her $4. This type of price discrimination is very hard to achieve.
2) Charge everyone the same price for the first unit and then a different price for additional units. This works in one of two ways.
The more typical version is to charge a higher price for the first unit and then a lower price for additional units. A great example of this is Subway. Subway charges you a particular price for a 6" sandwich. If you want to make it 12", they charge you substantially less for the second 6". They are able to do this because the money you paid for the first half of the sandwich covers most of their costs: the food, wages for employees, electricity, maintenance, etc. If you are willing to buy the second half of the footlong sandwich, they really only need to charge you for the food. All of the other costs were already covered in the first half. Thus, they can charge you less and still make a profit on the second half.
The other way it works is when a business charges a lower price for the first unit and then higher prices for additional units. This only works if they get you "locked in" to their product. A good example of this is razor blades for shaving. The store sells you the handle for the razor and one or two blades at a relatively low cost per blade. If you want to keep using the handle you bought, you have to buy more of their blades. (The competitors blades won't work on their handle.) Thus, they can now charge more money per blade for the extra blades.
3) Charge one group one price and another group a different price. An example of this is charging different prices at a movie theater. For instance senior citizens, military personnel, or students get a different (usually lower) price.
In order for price discrimination to work, the store must have three things:
a) Monopoly Power: this doesn't mean that they have to be a monopoly. It just means that the store has to have a significant control of the market. So it could be an oligopoly.
b) Market Segregation: you can easily divide people into groups. For example it is easy for a theater to identify senior citizens, military personnel or students, by simply looking at their ID.
c) No Resale: if the product can be bought and resold, price discrimination doesn't work. Because you could just go ask someone who can get the lower price to buy it for you. The theater can offer lower prices to senior citizens because their customers can't take the movie home for others to enjoy (without breaking the law anyway.) That's why a bookstore doesn't offer a senior discount.
The power point then looks at two of the price discrimination strategies in more detail. First let's look at the third strategy. Different prices for different groups.
Why does the theater offer a lower price to senior citizens? Aren't they losing money?
The idea here is that the theater looks at its normal situation and sees how much money they will make. But then the theater asks itself, "Is there some way we can increase sales? Is there someone out there who isn't coming to the movies that we can get to show up?"
Retired senior citizens have a lot of free time, so they could come to the movie. But they also don't have a lot of extra money. So there are probably people who would go to the movie but they can't really afford it. What if we offered those people a discount?
If that entices more people to come to the movie then the theater is making additional money that they otherwise wouldn't have gotten. It's like they suddenly create a new market (the second graph in the power point) and any revenue earned in that market is bonus money. In particular because it didn't cost them anything to provide those movies.
Let's say that if they didn't offer a senior discount 20 people would go see the movie. With the senior discount 30 people come to the movie. How much more cost to the theater did the additional 10 people create?
The answer is effectively none. The theater was already showing the movie. They didn't have to hire any new employees. So it was essentially bonus revenue.
It is possible that some of the people in the original 20 movie watchers were senior citizens. So those people paid less than they would have originally. However, as long as the discount brings in enough new customers, the revenue lost by old customers getting the discount won't matter. If the discount doesn't bring in enough new customers, then you should stop offering the discount.
Finally let's look at the first type of price discrimination, charging each person the most they are willing to pay. As I said earlier this is very hard to achieve. But what would happen if you could do it?
If I have a store and every time a customer comes in I somehow know what they are willing to pay how does that affect our graph?
Here is a chart with two different scenarios. The cost to produce the product is $5. The left side is under a normal monopoly in which I charge everyone the same price. The right side is with price discrimination and I am charging everyone the most they are willing to pay.
Note that each row represents just 1 sale to 1 customer. In other words, on the left if I set the price at $7 I will sell four units all for $7. On the right I would still sell four units, but will charge each customer a different price.
First off notice that on both sides of the chart no sales are made for a price below $5. If it costs $5 to make, I am not going to sell for less than $5.
Looking at the left side, what is the Marginal Revenue for each line. (Figure this out on a scratch piece of paper.) To get you started, if the price is $10, I will make one sale for a TR of $10. If I am willing to lower the price to $9, I will make two sales for a total of $18. So the MR is $8. Do this all the way down to the last sale at $5.
Hopefully you saw that the MR goes down much faster than the price. Because in a monopoly MR is less than DARP.
Now think about the MR for the right side. The 1st customer comes in and is willing to pay $10. He gets charged $10.
Then a 2nd customer comes in. They are willing to pay $9. They get charged $9. But the key difference is that the first customer was still charged $10. So the marginal revenue for the first person was $10. The MR for the second was $9. The MR for the third will be $8. And so on.
In other words, the MR is now THE SAME as the Price. In other other words, the MR line has rejoined the DARP line. We now have a downward sloping MRDARP line.
Now lets think about the idea of Consumer Surplus. Here's another chart. It's similar to the first chart, but this time on the left the price doesn't change. We are looking at what happens when the price is $5 without price discrimination. On the right we still have price discrimination.
Remember that CS is the difference between what a person is willing to pay and what they actually paid.
On the left how much CS is there?
(10-5) + (9-5) + (8-5) + (7-5) + (6-5) + (5-5) = $15 of CS
On the right side how much CS is there?
(10-10) + (9-9) + (8-8) + (7-7) + (6-6) + (5-5) = $0
If we have this form of Price Discrimination. The CS disappears.
Worksheets:
This link will take you to an online copy of all the Monopoly Work Sheets. You need to scroll down and do the pages for Price Discrimination (Activity 3-13)
Monopoly Work Sheets
Today and tomorrow we will be wrapping up our look at Monopolies. Tomorrow we will look at regulating monopolies and at monopolies in the long run. Today we will look at price discrimination, which is the first part of this power point.
Monopolies Part 3
We originally learned about Price Discrimination in one of the early chapters in the Undercover Economist. The idea of price discrimination is that a business is trying to figure out a way to charge different people different prices.
There are three types of price discrimination.
1) Charge each person the most they are willing to pay. The idea here is that somehow the store is able to determine this info and adjust the price accordingly. When Bob walks into the store the store somehow knows that he is willing to pay $5 and charges him $5. When Susan walks in, they know she will only pay $4 and they charge her $4. This type of price discrimination is very hard to achieve.
2) Charge everyone the same price for the first unit and then a different price for additional units. This works in one of two ways.
The more typical version is to charge a higher price for the first unit and then a lower price for additional units. A great example of this is Subway. Subway charges you a particular price for a 6" sandwich. If you want to make it 12", they charge you substantially less for the second 6". They are able to do this because the money you paid for the first half of the sandwich covers most of their costs: the food, wages for employees, electricity, maintenance, etc. If you are willing to buy the second half of the footlong sandwich, they really only need to charge you for the food. All of the other costs were already covered in the first half. Thus, they can charge you less and still make a profit on the second half.
The other way it works is when a business charges a lower price for the first unit and then higher prices for additional units. This only works if they get you "locked in" to their product. A good example of this is razor blades for shaving. The store sells you the handle for the razor and one or two blades at a relatively low cost per blade. If you want to keep using the handle you bought, you have to buy more of their blades. (The competitors blades won't work on their handle.) Thus, they can now charge more money per blade for the extra blades.
3) Charge one group one price and another group a different price. An example of this is charging different prices at a movie theater. For instance senior citizens, military personnel, or students get a different (usually lower) price.
In order for price discrimination to work, the store must have three things:
a) Monopoly Power: this doesn't mean that they have to be a monopoly. It just means that the store has to have a significant control of the market. So it could be an oligopoly.
b) Market Segregation: you can easily divide people into groups. For example it is easy for a theater to identify senior citizens, military personnel or students, by simply looking at their ID.
c) No Resale: if the product can be bought and resold, price discrimination doesn't work. Because you could just go ask someone who can get the lower price to buy it for you. The theater can offer lower prices to senior citizens because their customers can't take the movie home for others to enjoy (without breaking the law anyway.) That's why a bookstore doesn't offer a senior discount.
The power point then looks at two of the price discrimination strategies in more detail. First let's look at the third strategy. Different prices for different groups.
Why does the theater offer a lower price to senior citizens? Aren't they losing money?
The idea here is that the theater looks at its normal situation and sees how much money they will make. But then the theater asks itself, "Is there some way we can increase sales? Is there someone out there who isn't coming to the movies that we can get to show up?"
Retired senior citizens have a lot of free time, so they could come to the movie. But they also don't have a lot of extra money. So there are probably people who would go to the movie but they can't really afford it. What if we offered those people a discount?
If that entices more people to come to the movie then the theater is making additional money that they otherwise wouldn't have gotten. It's like they suddenly create a new market (the second graph in the power point) and any revenue earned in that market is bonus money. In particular because it didn't cost them anything to provide those movies.
Let's say that if they didn't offer a senior discount 20 people would go see the movie. With the senior discount 30 people come to the movie. How much more cost to the theater did the additional 10 people create?
The answer is effectively none. The theater was already showing the movie. They didn't have to hire any new employees. So it was essentially bonus revenue.
It is possible that some of the people in the original 20 movie watchers were senior citizens. So those people paid less than they would have originally. However, as long as the discount brings in enough new customers, the revenue lost by old customers getting the discount won't matter. If the discount doesn't bring in enough new customers, then you should stop offering the discount.
Finally let's look at the first type of price discrimination, charging each person the most they are willing to pay. As I said earlier this is very hard to achieve. But what would happen if you could do it?
If I have a store and every time a customer comes in I somehow know what they are willing to pay how does that affect our graph?
Here is a chart with two different scenarios. The cost to produce the product is $5. The left side is under a normal monopoly in which I charge everyone the same price. The right side is with price discrimination and I am charging everyone the most they are willing to pay.
Note that each row represents just 1 sale to 1 customer. In other words, on the left if I set the price at $7 I will sell four units all for $7. On the right I would still sell four units, but will charge each customer a different price.
Normal Monopoly
|
Monopoly With Price Discrimination
|
||||
Number of Customers
|
Price Customer is Willing to Pay
|
Price All Customers Pay
|
Price Customer is Willing to Pay
|
Price Each Single Customer Actually
Pays
|
|
1
|
$10
|
$5
|
$10
|
$10
|
|
2
|
$9
|
$5
|
$9
|
$9
|
|
3
|
$8
|
$5
|
$8
|
$8
|
|
4
|
$7
|
$5
|
$7
|
$7
|
|
5
|
$6
|
$5
|
$6
|
$6
|
|
6
|
$5
|
$5
|
$5
|
$5
|
|
7
|
$4 or Less
|
-
|
$4 or Less
|
-
|
|
First off notice that on both sides of the chart no sales are made for a price below $5. If it costs $5 to make, I am not going to sell for less than $5.
Looking at the left side, what is the Marginal Revenue for each line. (Figure this out on a scratch piece of paper.) To get you started, if the price is $10, I will make one sale for a TR of $10. If I am willing to lower the price to $9, I will make two sales for a total of $18. So the MR is $8. Do this all the way down to the last sale at $5.
Hopefully you saw that the MR goes down much faster than the price. Because in a monopoly MR is less than DARP.
Now think about the MR for the right side. The 1st customer comes in and is willing to pay $10. He gets charged $10.
Then a 2nd customer comes in. They are willing to pay $9. They get charged $9. But the key difference is that the first customer was still charged $10. So the marginal revenue for the first person was $10. The MR for the second was $9. The MR for the third will be $8. And so on.
In other words, the MR is now THE SAME as the Price. In other other words, the MR line has rejoined the DARP line. We now have a downward sloping MRDARP line.
Now lets think about the idea of Consumer Surplus. Here's another chart. It's similar to the first chart, but this time on the left the price doesn't change. We are looking at what happens when the price is $5 without price discrimination. On the right we still have price discrimination.
Normal Monopoly
|
Monopoly With Price Discrimination
|
|||
Price Customer is Willing to Pay
|
Price Customer Actually Pays
|
Price Customer is Willing to Pay
|
Price Customer Actually Pays
|
|
$10
|
$5
|
$10
|
$10
|
|
$9
|
$5
|
$9
|
$9
|
|
$8
|
$5
|
$8
|
$8
|
|
$7
|
$5
|
$7
|
$7
|
|
$6
|
$5
|
$6
|
$6
|
|
$5
|
$5
|
$5
|
$5
|
|
$4 or Less
|
-
|
$4 or Less
|
-
|
|
Remember that CS is the difference between what a person is willing to pay and what they actually paid.
On the left how much CS is there?
(10-5) + (9-5) + (8-5) + (7-5) + (6-5) + (5-5) = $15 of CS
On the right side how much CS is there?
(10-10) + (9-9) + (8-8) + (7-7) + (6-6) + (5-5) = $0
If we have this form of Price Discrimination. The CS disappears.
Worksheets:
This link will take you to an online copy of all the Monopoly Work Sheets. You need to scroll down and do the pages for Price Discrimination (Activity 3-13)
Monopoly Work Sheets
Saturday, March 28, 2020
Remind - Sign Up
Though I probably should have done this earlier, better late than never.
I've set up a remind for the class. Please do so as soon as you can.
Here's how to join the class.
I've set up a remind for the class. Please do so as soon as you can.
Here's how to join the class.
Friday, March 27, 2020
March 27 - Monopoly Practice Sheets
[I have yet to hear from everyone in our class. So, if you could do me a favor and pass along the information that there is work that needs to be done and turned in, that would be great.]
Today there are no new concepts to learn. Instead you get to practice and show me that you understand what we've been doing so far. Particularly as it applies to filling out a Revenue and Cost Chart for a monopoly, and as to reading Monopoly Graphs.
Click the links below to download the files. Then save them to your computer with your name as the start of the file. (Ex: Baumann Monopoly Graph)
Fill them out and then email them back to me.
Here you go:
Monopoly Revenue and Cost Chart
Monopoly Graph Reading
Please have these back to me by Monday at the latest.
If you have questions be sure to ask!
Today there are no new concepts to learn. Instead you get to practice and show me that you understand what we've been doing so far. Particularly as it applies to filling out a Revenue and Cost Chart for a monopoly, and as to reading Monopoly Graphs.
Click the links below to download the files. Then save them to your computer with your name as the start of the file. (Ex: Baumann Monopoly Graph)
Fill them out and then email them back to me.
Here you go:
Monopoly Revenue and Cost Chart
Monopoly Graph Reading
Please have these back to me by Monday at the latest.
If you have questions be sure to ask!
Thursday, March 26, 2020
March 26 - Monopolies Day 4 - Efficiency and Deadweight Loss
Today we are still working with the Monopoly Day 2 notes. The second half of those notes talks about Monopolies, efficiency and deadweight loss.
Remember that a PC firm is both allocatively and productively efficient. Why?
They are allocatively efficient because they always produce where MR = MC = P. That isn't a problem for them because, like all businesses they are trying to maximize their profit. So they want to produce where MR = MC. Since the MR line and the Price line are the same, it all works out perfectly.
PC firms are also productively efficient. On our MACG graph, a firm is productively efficient if it is producing at the bottom of the ATC curve. Again this happens naturally in a PC firm because it is a price taker. And we know that the market has a long run equilibrium that is at the bottom of the ATC curve. The bottom of the ATC curve is also the point at which the MC line passes through. So once again the firm wants to produce at that location.
What about monopolies?
Because the MR line is no longer the same as the DARP line there is really no way for the monopoly to produce where MR = MC = P. Thus the Monopoly is inherently not allocatively efficient.
Monopolies are also not productively efficient. Because the DARP line is downward sloping, in order for the price line to pass through the bottom of the ATC, there would also have to be an area to the left of that in which the monopoly could earn a profit.
If you owned a monopoly and you had a choice between breaking even at the bottom of the ATC curve or reducing your quantity a little and making a profit, which would you choose? Remember that the monopoly is a price maker so they can set the price wherever they want.
Since we are not allocatively or productively efficient, we can expect that there will also be deadweight loss.
Where is the DWL on the graph?
It is the triangle to the right of the quantity that "points" to the intersection of Demand and MC.
What about Consumer Surplus (CS) and Producer Surplus (PS)? They are still located in the same places. CS is located above the price and below Demand.
Normally we say that PS is below the amount of money the supplier gets to keep (in this case the Price) and above the Supply line. But we don't have a supply line. For monopolies (and monopolistic competition and oligopoly) the MC line is NOT the Supply line. But we still use it to find PS.
On the graph that is above it would be hard to find the PS and CS because of the way it is drawn. However, in some of the work you were given, Activity 3-12 and Activity 3-15, the graphs are drawn in such a way that you can.
You should now be able to do all of the work in the worksheets I handed out. If you can't please ask for help!
Remember that a PC firm is both allocatively and productively efficient. Why?
They are allocatively efficient because they always produce where MR = MC = P. That isn't a problem for them because, like all businesses they are trying to maximize their profit. So they want to produce where MR = MC. Since the MR line and the Price line are the same, it all works out perfectly.
PC firms are also productively efficient. On our MACG graph, a firm is productively efficient if it is producing at the bottom of the ATC curve. Again this happens naturally in a PC firm because it is a price taker. And we know that the market has a long run equilibrium that is at the bottom of the ATC curve. The bottom of the ATC curve is also the point at which the MC line passes through. So once again the firm wants to produce at that location.
What about monopolies?
Because the MR line is no longer the same as the DARP line there is really no way for the monopoly to produce where MR = MC = P. Thus the Monopoly is inherently not allocatively efficient.
Monopolies are also not productively efficient. Because the DARP line is downward sloping, in order for the price line to pass through the bottom of the ATC, there would also have to be an area to the left of that in which the monopoly could earn a profit.
If you owned a monopoly and you had a choice between breaking even at the bottom of the ATC curve or reducing your quantity a little and making a profit, which would you choose? Remember that the monopoly is a price maker so they can set the price wherever they want.
Since we are not allocatively or productively efficient, we can expect that there will also be deadweight loss.
Where is the DWL on the graph?
It is the triangle to the right of the quantity that "points" to the intersection of Demand and MC.
What about Consumer Surplus (CS) and Producer Surplus (PS)? They are still located in the same places. CS is located above the price and below Demand.
Normally we say that PS is below the amount of money the supplier gets to keep (in this case the Price) and above the Supply line. But we don't have a supply line. For monopolies (and monopolistic competition and oligopoly) the MC line is NOT the Supply line. But we still use it to find PS.
On the graph that is above it would be hard to find the PS and CS because of the way it is drawn. However, in some of the work you were given, Activity 3-12 and Activity 3-15, the graphs are drawn in such a way that you can.
You should now be able to do all of the work in the worksheets I handed out. If you can't please ask for help!
Wednesday, March 25, 2020
AP Lessons Online
AP has been holding live lessons every day for all of the AP classes. Here's a schedule.
They are doing this based upon their own schedule and order of topics. I'm not sure where they are at in relation to our class, but you might find it useful.
They are doing this based upon their own schedule and order of topics. I'm not sure where they are at in relation to our class, but you might find it useful.
March 25 - Monopolies Day 3
Today we are moving on to the Monopoly Day 2 PPT.
It's got three different short topics.
1) Elasticity.
Hopefully you remember when we looked at Elasticity that a straight, downward sloping line actually has three types of elasticity. The upper, left side of the line is elastic. The lower right side of the line is inelastic. And somewhere there will be a Unit Elastic tipping point.
Remember when we measure elasticity, we aren't actually measuring the line. We are measuring the movement along the line. Thus there isn't a Unit Elastic Zone. Instead it is one spot.
If we move along the line in a way that has equal amounts of distance on both sides of the Unit Elastic point then the answer will be Unit Elastic. However, if more of the movement is on either side, then the result will be whichever side has more of the movement.
On our monopoly graph, the Demand line on our MACG graph is a downward sloping line. Thus the monopoly will have a portion of its demand line that is elastic and a portion that is inelastic. But how do we find the Unit Elastic tipping point?
It ends up being exceedingly easy to find. We just look for the place where MR is 0. If we go straight up from that point until we hit the Demand line, that will be the place where the line shifts from Elastic to Inelastic.
2) Economies of Scale and Monopolies
Economies of Scale (EOS) is the idea that we can minimize our costs in the long run by harnessing the power of going big. Remember how we look at the example of someone starting up a car manufacturing business. We saw that even though there were millions of dollars in startup costs we could effectively minimize the problem by producing a lot of units. ($500,000,000 in startup costs seems like a lot. But if we produce a million units, that is only $500 per item.)
When looking at a Long Run Average Total Cost Curve (LRATC) the downward sloping portion of the line is the EOS.
It works the same way for a monopoly. In fact the idea of EOS is sometimes why the market is a monopoly.
Imagine an industry that has very high startup costs. It's LRATC does have a downward sloping EOS section, but it slopes downward very slowly over a long stretch. It might look something like this:
Notice how increasing our quantity does not really get us a huge benefit. Unlike the car example above, increasing our quantity a lot only gives us a very slight benefit in cost reduction.
Without cluttering our graph with a bunch of lines, imagine that the market wants a set number of units of this product. Let's pretend the market wants 1000 units. If one person makes all of the units they will barely make enough money to earn a very small profit. On the graph they would be a very tiny amount above the LRATC. Like this:
What would happen if there were a second firm in the market and each of them only got to sell 500 units?
At 500 units we are now under the LRATC and are losing money.
Suddenly what was a profitable industry for 1 firm, is now a losing industry for both.
It simply doesn't make sense to have more than one firm in the industry.
This is a "Natural Monopoly".
I don't have any work for you based on these concepts. Use today to finish up any of your old items that you haven't yet completed.
It's got three different short topics.
1) Elasticity.
Hopefully you remember when we looked at Elasticity that a straight, downward sloping line actually has three types of elasticity. The upper, left side of the line is elastic. The lower right side of the line is inelastic. And somewhere there will be a Unit Elastic tipping point.
Remember when we measure elasticity, we aren't actually measuring the line. We are measuring the movement along the line. Thus there isn't a Unit Elastic Zone. Instead it is one spot.
If we move along the line in a way that has equal amounts of distance on both sides of the Unit Elastic point then the answer will be Unit Elastic. However, if more of the movement is on either side, then the result will be whichever side has more of the movement.
On our monopoly graph, the Demand line on our MACG graph is a downward sloping line. Thus the monopoly will have a portion of its demand line that is elastic and a portion that is inelastic. But how do we find the Unit Elastic tipping point?
It ends up being exceedingly easy to find. We just look for the place where MR is 0. If we go straight up from that point until we hit the Demand line, that will be the place where the line shifts from Elastic to Inelastic.
Economies of Scale (EOS) is the idea that we can minimize our costs in the long run by harnessing the power of going big. Remember how we look at the example of someone starting up a car manufacturing business. We saw that even though there were millions of dollars in startup costs we could effectively minimize the problem by producing a lot of units. ($500,000,000 in startup costs seems like a lot. But if we produce a million units, that is only $500 per item.)
When looking at a Long Run Average Total Cost Curve (LRATC) the downward sloping portion of the line is the EOS.
It works the same way for a monopoly. In fact the idea of EOS is sometimes why the market is a monopoly.
Imagine an industry that has very high startup costs. It's LRATC does have a downward sloping EOS section, but it slopes downward very slowly over a long stretch. It might look something like this:
Notice how increasing our quantity does not really get us a huge benefit. Unlike the car example above, increasing our quantity a lot only gives us a very slight benefit in cost reduction.
Without cluttering our graph with a bunch of lines, imagine that the market wants a set number of units of this product. Let's pretend the market wants 1000 units. If one person makes all of the units they will barely make enough money to earn a very small profit. On the graph they would be a very tiny amount above the LRATC. Like this:
What would happen if there were a second firm in the market and each of them only got to sell 500 units?
At 500 units we are now under the LRATC and are losing money.
Suddenly what was a profitable industry for 1 firm, is now a losing industry for both.
It simply doesn't make sense to have more than one firm in the industry.
This is a "Natural Monopoly".
I don't have any work for you based on these concepts. Use today to finish up any of your old items that you haven't yet completed.
Tuesday, March 24, 2020
March 24 - Monopolies - Day 2 - Graphs and More
Let's start by looking at the answers for the chart posted in yesterday's blog.
If you don't understand something on this chart, please ask!
Yesterday we discussed why in a monopoly Marginal Revenue (MR) is always less that Price (P) and Average Revenue (AR).
What about Total Revenue (TR)? How is that different in a monopoly?
In a PC firm TR is a straight line that goes diagonally upward. This is because you can always sell another unit for the same price. Thus as quantity increases TR always increases by the same amount, the price.
In a Monopoly things are different. Since P and AR go down as quantity increases, it means TR does not go up by the same amount every time. In fact, it will eventually start going down.
We can see all of this on the chart that is above. Note how the amount TR increases (also known as MR) slowly gets smaller and smaller. Then once the MR becomes a negative number TR starts going down.
Now for some graphing!!!!!!!
Let's start with the Total Cost Graph (TCG). Because TR goes up and then comes back down, it is shown by an arch or parabola. The TC and TVC lines on the TCG are still the same. Here's a sample graph:
Even though we now have an arch instead of a diagonal line, the rules for our TCG are essentially the same. Since Profit is Revenue minus Cost, then Total Profit is Total Revenue minus Total Cost.
Tπ = TR - TC
If the TR line goes above the TC line at any point, then just like in a PC graph we are looking for the place where the TR line is vertically the highest above the TC line. It the TR does not go above the TC line then we are losing money and are looking to minimize our losses. To do that we look for the place where the TR line is vertically the closest to the TC line.
Now for the Marginal Average Cost Graph (MACG).
All of our cost lines on the MACG are going to look the same. Our DARP line is now downward sloping and our MR line slopes down faster below it. (The MR and DARP lines are NOT parallel. They will always look like a pair of chopsticks.)
Here's a sample:
The DARP line is the line we look to for most of our data. At any given quantity it will tell us all of our revenue and profit. Thus, it is the line we look to when we want to determine if we can make a profit.
However this doesn't mean that the MR line is unimportant, because we know that profit is maximized at MR = MC.
Thus, when we are looking at the MACG, the first thing we should find is the spot where the MR and MC lines cross. If we head straight down from there, that will tell us our profit maximizing quantity.
Once we have found that, we are pretty much done with the MR line. However we still need to determine the price.
Fortunately we have a Price line. (After all it is the P in DARP).
At the quantity we determined, we go straight up until we hit the DARP line. From that point we go straight left to the y-axis. That tells us the price we are selling at.
Once we know how to find price and quantity, it's pretty simple to use the same logic as with a PC firm to determine whether we should shut down or not in the short term.
We still have the same four positions and we still apply the same reasoning. We are just doing it with the DARP line (instead of a MRDARP line). The relative height of the MR line does not impact our decision. We only look at the DARP line.
Our four positions are:
1) Making a profit: If the DARP line is above the ATC line at any point, then the company is making a profit in that area.
2) Breaking even: If the DARP line touches the ARC but does not go over it, then the company is breaking even. Because DARP is downward sloping, this will be more on the side of the ATC and will NOT be at the bottom of the ATC.
3) Losing money but stay open: If the DARP line is above AVC but does not touch the ATC in any location, we are losing money but should still stay open. The reasoning is the same as a PC firm, we are losing money, but we are covering all of our variable costs and part of our fixed costs. We would lose more money shutting down because then we would lose all of our fixed costs.
4) Losing money and should shut down: If the DARP Line never even touches the AVC then the firm should shut down in the short term. If they stay open they will be losing all of their fixed costs and part of their variable costs. Whereas if they shut down they will only owe their fixed costs. (Because their variable cost will be $0).
Maximizing Revenue:
Last but not least we can look once again at maximizing revenue.
Remember in a PC firm revenue was never maximized. This was seen on the MACG because the MRDARP line was perfectly elastic (horizontal). MR was always the same. Thus we could always sell one more unit at the market price and revenue will go up by the same amount (the price). On the TCG we could see it because the TR line went diagonally upward forever at a constant slope.
Things are once again different for the monopoly firm. Because the MR is downward sloping, at some point it will become zero. Thus at some point the amount of revenue being added will become zero and thereafter be negative. So we can find a place where revenue is maximized. For a monopoly TR is maximized where MR is equal to zero. It's the place where MR hits the x-axis. On a TCG, TR is clearly maximized at the top of the arch.
Remember, even though we know where revenue is maximized, that doesn't mean that is where we are producing. A business is not in business to maximize revenue. It is in business to maximize profit!
That brings us to the end of the Monopoly Day 1 notes.
You should be able to complete most of the four worksheets that I gave out before we left.
Here is a list of them:
Revenue Functions of a Monopoly (Activity 3-10)
Profit Maximization by a Monopoly (Activity 3-11)
Comparing Perfect Competition and Monopoly (Activity 3-15)
PC vs Monopoly Graphs
Again I don't have the right to post the first three, but I did some poking around yesterday and I believe you can find them on the internet if you look.
Please try and complete the PC vs Monopoly Graphs sheet. If you do, feel free to take a picture or scan it and send it to me. I'll be glad to see how you did and help you fix any mistakes.
Tomorrow we'll move into the left over bits with monopolies
Price
|
Quantity
|
Total
Revenue (TR)
|
Average
Revenue (AR)
|
Marginal
Revenue (MR)
|
$100
|
1
|
100
|
100
|
100
|
$90
|
2
|
180
|
90
|
80
|
$80
|
3
|
240
|
80
|
60
|
$70
|
4
|
280
|
70
|
40
|
$60
|
5
|
300
|
60
|
20
|
$50
|
6
|
300
|
50
|
0
|
$40
|
7
|
280
|
40
|
-20
|
If you don't understand something on this chart, please ask!
Yesterday we discussed why in a monopoly Marginal Revenue (MR) is always less that Price (P) and Average Revenue (AR).
What about Total Revenue (TR)? How is that different in a monopoly?
In a PC firm TR is a straight line that goes diagonally upward. This is because you can always sell another unit for the same price. Thus as quantity increases TR always increases by the same amount, the price.
In a Monopoly things are different. Since P and AR go down as quantity increases, it means TR does not go up by the same amount every time. In fact, it will eventually start going down.
We can see all of this on the chart that is above. Note how the amount TR increases (also known as MR) slowly gets smaller and smaller. Then once the MR becomes a negative number TR starts going down.
Now for some graphing!!!!!!!
Let's start with the Total Cost Graph (TCG). Because TR goes up and then comes back down, it is shown by an arch or parabola. The TC and TVC lines on the TCG are still the same. Here's a sample graph:
Even though we now have an arch instead of a diagonal line, the rules for our TCG are essentially the same. Since Profit is Revenue minus Cost, then Total Profit is Total Revenue minus Total Cost.
Tπ = TR - TC
If the TR line goes above the TC line at any point, then just like in a PC graph we are looking for the place where the TR line is vertically the highest above the TC line. It the TR does not go above the TC line then we are losing money and are looking to minimize our losses. To do that we look for the place where the TR line is vertically the closest to the TC line.
Now for the Marginal Average Cost Graph (MACG).
All of our cost lines on the MACG are going to look the same. Our DARP line is now downward sloping and our MR line slopes down faster below it. (The MR and DARP lines are NOT parallel. They will always look like a pair of chopsticks.)
Here's a sample:
The DARP line is the line we look to for most of our data. At any given quantity it will tell us all of our revenue and profit. Thus, it is the line we look to when we want to determine if we can make a profit.
However this doesn't mean that the MR line is unimportant, because we know that profit is maximized at MR = MC.
Thus, when we are looking at the MACG, the first thing we should find is the spot where the MR and MC lines cross. If we head straight down from there, that will tell us our profit maximizing quantity.
Once we have found that, we are pretty much done with the MR line. However we still need to determine the price.
Fortunately we have a Price line. (After all it is the P in DARP).
At the quantity we determined, we go straight up until we hit the DARP line. From that point we go straight left to the y-axis. That tells us the price we are selling at.
Once we know how to find price and quantity, it's pretty simple to use the same logic as with a PC firm to determine whether we should shut down or not in the short term.
We still have the same four positions and we still apply the same reasoning. We are just doing it with the DARP line (instead of a MRDARP line). The relative height of the MR line does not impact our decision. We only look at the DARP line.
Our four positions are:
1) Making a profit: If the DARP line is above the ATC line at any point, then the company is making a profit in that area.
2) Breaking even: If the DARP line touches the ARC but does not go over it, then the company is breaking even. Because DARP is downward sloping, this will be more on the side of the ATC and will NOT be at the bottom of the ATC.
3) Losing money but stay open: If the DARP line is above AVC but does not touch the ATC in any location, we are losing money but should still stay open. The reasoning is the same as a PC firm, we are losing money, but we are covering all of our variable costs and part of our fixed costs. We would lose more money shutting down because then we would lose all of our fixed costs.
4) Losing money and should shut down: If the DARP Line never even touches the AVC then the firm should shut down in the short term. If they stay open they will be losing all of their fixed costs and part of their variable costs. Whereas if they shut down they will only owe their fixed costs. (Because their variable cost will be $0).
Maximizing Revenue:
Last but not least we can look once again at maximizing revenue.
Remember in a PC firm revenue was never maximized. This was seen on the MACG because the MRDARP line was perfectly elastic (horizontal). MR was always the same. Thus we could always sell one more unit at the market price and revenue will go up by the same amount (the price). On the TCG we could see it because the TR line went diagonally upward forever at a constant slope.
Things are once again different for the monopoly firm. Because the MR is downward sloping, at some point it will become zero. Thus at some point the amount of revenue being added will become zero and thereafter be negative. So we can find a place where revenue is maximized. For a monopoly TR is maximized where MR is equal to zero. It's the place where MR hits the x-axis. On a TCG, TR is clearly maximized at the top of the arch.
Remember, even though we know where revenue is maximized, that doesn't mean that is where we are producing. A business is not in business to maximize revenue. It is in business to maximize profit!
That brings us to the end of the Monopoly Day 1 notes.
You should be able to complete most of the four worksheets that I gave out before we left.
Here is a list of them:
Revenue Functions of a Monopoly (Activity 3-10)
Profit Maximization by a Monopoly (Activity 3-11)
Comparing Perfect Competition and Monopoly (Activity 3-15)
PC vs Monopoly Graphs
Again I don't have the right to post the first three, but I did some poking around yesterday and I believe you can find them on the internet if you look.
Please try and complete the PC vs Monopoly Graphs sheet. If you do, feel free to take a picture or scan it and send it to me. I'll be glad to see how you did and help you fix any mistakes.
Tomorrow we'll move into the left over bits with monopolies
Sunday, March 22, 2020
March 23 - Monopolies - Day 1 - MR less than DARP
We looked at monopolies a little bit on the last Friday we had at school.
For this post, let's focus on the main differences between the basics of Perfect Competition and Monopoly. (We'll look at graphs on Tuesday.)
If we are just looking at numbers and calculating costs and profits, there isn't really much of a difference. If we had one of our usual charts to fill out, we would have all of the same columns and we would be using the same formulas as before with one addition. There is really only two differences.
The first difference is that demand, average revenue and price now decrease as the quantity increases.
In perfect competition each individual firm represented such a small portion of the total production, that each firm could produce and sell any amount of product. (Graphically, that was shown by the horizontal MRDARP line.)
In a monopoly there is only one firm. They represent all of the supply in the market and thus they must meet all of the demand in the market. For each firm there is only a limited number of people who are willing to buy at any given price. Thus if a firm wants to increase the number of products they are selling, they will have to convince more people to buy. The only way to do that is to lower the price.
For a chart this means that we will probably need to add a column for price. But as price and average revenue are still equal to each other, the new price column will be a copy of the average revenue column.
The second difference is that Marginal Revenue is now also different. It also now decreases as quantity increases. However, it is no longer the same as Demand, Average Revenue and Price. In fact, MR will always be lower than DARP.
Why?
This is a question that they like to ask. So being able to give a good explanation is key. Here's one way to say it:
In a monopoly the "additional revenue generated from the sale of another product" (aka - Marginal Revenue) is always less than the price and the "average amount generated from all products" (aka - Average Revenue) because those two lines are downward sloping. To increase the quantity sold we have to reduce the price. But we do not just reduce the price on the new unit sold. We also reduce the price on all previous units we were going to sell Thus the new money brought in by the new unit is reduced by the money we are no longer getting from the previous units.
Wow, that's a mouthful. Here's some basic math to help us understand.
I'm currently thinking about setting my price. I know that if I set my price at $100, I will sell 5 units. I'd like to sell more than 5, but to do that I would have to offer all of my customers a lower price.
If I were to offer a price of $95 then I would sell 6 units.
Looking at those facts, it might seem like the additional revenue I gain from selling a sixth unit is $95. But it isn't. Yes, the sixth unit would bring in $95, but I have to remember the first 5 units are no longer bringing in $100. They are now also only bringing in $95. Each of those 5 is now making $5 less.
Thus my revenue is going to change by: $95 - (5 x $5) or $95-$25 or $70
My marginal revenue is $75 and not the $95 dollars that represents the new price.
[Remember, I haven't actually sold any units yet. I'm still figuring things out. So, I haven't received the $100 for the first five units. I know if I set my price at $100 I will sell 5 units, but if I set my price at $95 I will sell 6. Nothing has actually been sold.]
Here's another way to look at it.
The total revenue from selling 5 units at $100 is $500
The total revenue from selling 6 units at $95 is $570
My TR only increased by $70. Saying that another way, my MR is $70
My AR at 6 units is still $95. Because I sold all 6 units at $95. Thus the average amount I took in was $95. But my MR is less.
Let's trying giving a shorter explanation for why MR is always less than DARP in a monopoly.
The MR is less than DARP because in order to sell a greater number of units, I have to lower the price on each additional unit sold, as well as lowering the price on all of the units I would have sold at the higher price.
Here's a bit more practice. For this chart, figure out the TR, AR and MR for each price level.
We don't have enough information here to determine where we should produce. (We'd need some data about costs to do that.) But we can say for sure that we wouldn't want to produce 7 units. Why?
Worksheets:
Hopefully you got a copy of these before we left. If not ask a friend to get you a copy of theirs.
For this post, let's focus on the main differences between the basics of Perfect Competition and Monopoly. (We'll look at graphs on Tuesday.)
If we are just looking at numbers and calculating costs and profits, there isn't really much of a difference. If we had one of our usual charts to fill out, we would have all of the same columns and we would be using the same formulas as before with one addition. There is really only two differences.
The first difference is that demand, average revenue and price now decrease as the quantity increases.
In perfect competition each individual firm represented such a small portion of the total production, that each firm could produce and sell any amount of product. (Graphically, that was shown by the horizontal MRDARP line.)
In a monopoly there is only one firm. They represent all of the supply in the market and thus they must meet all of the demand in the market. For each firm there is only a limited number of people who are willing to buy at any given price. Thus if a firm wants to increase the number of products they are selling, they will have to convince more people to buy. The only way to do that is to lower the price.
For a chart this means that we will probably need to add a column for price. But as price and average revenue are still equal to each other, the new price column will be a copy of the average revenue column.
The second difference is that Marginal Revenue is now also different. It also now decreases as quantity increases. However, it is no longer the same as Demand, Average Revenue and Price. In fact, MR will always be lower than DARP.
Why?
This is a question that they like to ask. So being able to give a good explanation is key. Here's one way to say it:
In a monopoly the "additional revenue generated from the sale of another product" (aka - Marginal Revenue) is always less than the price and the "average amount generated from all products" (aka - Average Revenue) because those two lines are downward sloping. To increase the quantity sold we have to reduce the price. But we do not just reduce the price on the new unit sold. We also reduce the price on all previous units we were going to sell Thus the new money brought in by the new unit is reduced by the money we are no longer getting from the previous units.
Wow, that's a mouthful. Here's some basic math to help us understand.
I'm currently thinking about setting my price. I know that if I set my price at $100, I will sell 5 units. I'd like to sell more than 5, but to do that I would have to offer all of my customers a lower price.
If I were to offer a price of $95 then I would sell 6 units.
Looking at those facts, it might seem like the additional revenue I gain from selling a sixth unit is $95. But it isn't. Yes, the sixth unit would bring in $95, but I have to remember the first 5 units are no longer bringing in $100. They are now also only bringing in $95. Each of those 5 is now making $5 less.
Thus my revenue is going to change by: $95 - (5 x $5) or $95-$25 or $70
My marginal revenue is $75 and not the $95 dollars that represents the new price.
[Remember, I haven't actually sold any units yet. I'm still figuring things out. So, I haven't received the $100 for the first five units. I know if I set my price at $100 I will sell 5 units, but if I set my price at $95 I will sell 6. Nothing has actually been sold.]
Here's another way to look at it.
The total revenue from selling 5 units at $100 is $500
The total revenue from selling 6 units at $95 is $570
My TR only increased by $70. Saying that another way, my MR is $70
My AR at 6 units is still $95. Because I sold all 6 units at $95. Thus the average amount I took in was $95. But my MR is less.
Let's trying giving a shorter explanation for why MR is always less than DARP in a monopoly.
The MR is less than DARP because in order to sell a greater number of units, I have to lower the price on each additional unit sold, as well as lowering the price on all of the units I would have sold at the higher price.
Here's a bit more practice. For this chart, figure out the TR, AR and MR for each price level.
Price
|
Quantity
|
Total Revenue (TR)
|
Average Revenue (AR)
|
Marginal Revenue (MR)
|
$100
|
1
|
|||
$90
|
2
|
|||
$80
|
3
|
|||
$70
|
4
|
|||
$60
|
5
|
|||
$50
|
6
|
|||
$40
|
7
|
We don't have enough information here to determine where we should produce. (We'd need some data about costs to do that.) But we can say for sure that we wouldn't want to produce 7 units. Why?
I'll post the answers on Tuesdays blog post.
Power Point:
Worksheets:
Hopefully you got a copy of these before we left. If not ask a friend to get you a copy of theirs.
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