ajaz_eco204_2009_chapter_5.2

# ajaz_eco204_2009_chapter_5.2 - University of Toronto...

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University of Toronto, Department of Economics, ECO 204 2009 2010 S. Ajaz Hussain ECO 204 2009 2010 S. Ajaz Hussain (Draft) Chapter 5.2: Firms with Market Power 1 Please help improve the course by sending me an e mail about typos or suggestions for improvements 1. Firms with “Market Power” A competitive firm sells output as a price taker : it believes that its output does not impact the price, so that its demand curve is horizontal at the market price. Price Output Competitive Firm’s Demand In contrast, a firm with market power sells output as a price maker : its output does impact the price, so that the firm’s demand curve is downward sloping: Note to self: for summer 2010 show students how to estimate demand from data. Maybe do math in 1 st two classes and an Excel class in estimating functions. But then how to do multiple regressions? 1 ECO 204 (Draft) Chapter 5.2

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University of Toronto, Department of Economics, ECO 204 2009 2010 S. Ajaz Hussain Price Output Market Power Firm’s Demand The firm’s demand curve may or may not coincide with the market demand curve: if the firm is a monopoly then its demand curve is also the market demand curve, otherwise the demand curve is a component of the market demand curve. To say that a firm has market “power” simply means that the firm’s output (price) has the power to affect price (output) where in order to sell more output the firm must lower price, and vice versa. Conversely, raising the price results in lower sales, and vice versa. We can express market power by the statement that price is a function of output: ܲ ൌ ݂ሺܳሻ The following expression also says price is a fun tput: ction of ou ܲ ൌ ݃ሺܳሻ Observe it doesn’t matter whether we use the symbol ݂ሺڄሻ or ݃ሺڄሻ for the “function notation”. In ECO 204, the statement price is a function of output pressed as: will be ex ܲ ൌ ܲሺܳሻ Note : We could’ve also expressed market power by the statement that output is a function of price: ܳ ൌ ݂ሺܲሻ or ܳ ൌ ܳሺܲሻ . It really doesn’t matter whether we work with ܲ ൌ ܲሺܳሻ or ܳ ൌ ܳሺܲሻ since we can always go from one statement to the other. For example, suppose: ܳ ൌ ܳሺܲሻ ൌ 100 െ 10 ܲ Can be re expressed as: 10 ܲ ൌ 100 െ ܳ ܲ ൌ 10 െ 0.1ܳ 2 ECO 204 (Draft) Chapter 5.2
University of Toronto, Department of Economics, ECO 204 2009 2010 S. Ajaz Hussain That is: ܳ ൌ ܳሺܲሻ ൌ 100 െ 10 ܲ can be re expressed as ܲ ൌ ܲሺܳሻ ൌ 10 െ 0.1ܳ . Market “power” should not be interpreted – typical of leftists and humbugs – to be that “the firm can force customers to do anything” (only North Korea ’s Great leader has that power!). As with the competitive firms, observe that a firm with market power may or may not hire inputs as a price taker but always sells output as a price maker (i.e. the definition of firms with market power is independent of whether the firm hires inputs as a price taker or maker). It goes without saying that

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