Econfin 7.pptx - JOHN HEAMAN Lecture 7 Imperfect...

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JOHN HEAMAN Lecture 7 Imperfect competition and oligopoly
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Outline of today’s topics Sunk costs 2 plant optimization 2 market optimization Cartels Monopolistic competition Oligopoly Winner takes all Winner’s curse
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Sunk costs Suppose that a nuclear power station has just been built at cost of £2 billion. Once it is turned on it will generate variable costs and clean up costs of £100 million per year. The extra revenue per year will be £80 million. It is argued that we must turn it on otherwise the £2 billion is wasted. What should be done? Decisions to scrap: original cost of a machine or factory is irrelevant to decision…..key thing is whether extra revenue generated by running it exceeds the extra cost (minus scrap value). If extra revenue exceeds the cost then it contributes to profit.
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Optimal allocation of work between two plants Suppose a firm has two plants producing the same product. One has lower unit costs (average costs) than the other. Should the higher cost plant be closed? Not necessarily. Profit maximizing output will be where marginal cost is equal in each plant, so each plant would be kept going so long as it covers AVC (in the short run and ATC in the long run) at the optimal output.
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Plant 1 Plant 2 price Q1 ATC MC MC ATC Q2 A profit maximizing firm with two or more plants making the same thing will produce where marginal cost is equal in each plant……..NOT where average cost is equal. BUT the firm would close any plant for which price (AR) did not exceed AC at any level of production.
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A Multi-Price Monopolist If a monopolist can segment its markets and sell at different prices to each segment (referred to as price discrimination) it can increase profits. It could set either different prices for different units (more for the first and then lower prices for subsequent units) or different prices to different customers. It will always sell more and earn greater profits than if it can only charge a single price. For segmentation to be possible, the seller must be able to distinguish individual units bought by a single buyer or to separate buyers into classes among whom resale is impossible. Example: airlines have cheaper fares if stay over Saturday night or Apex fares if stay 7 days. BUT do not confuse segmentation with peak and off peak pricing.
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MC [monopoly] = S [competition] D=MR q 0 Competitive price p 0 0 Complete price segmentation Quantity q m P r i c e E c Extra profit from selling to customers at maximum price each will pay
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If selling in two segmented markets, profit maximization is where marginal revenue is equal in each market.
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