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CHAPTER 12 - PHALL-82241 PINDYCK CHAPTER 12 page 4 of 14...

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Unformatted text preview: PHALL-82241 PINDYCK CHAPTER 12 page 4 of 14 FIGURE 12.1 A Monopolistically Competitive Firm in the Short and Long Run $/Q $/Q MC MC AC AC PSR PLR DSR DLR MRSR MRLR QSR (a) Quantity Quantity QLR (b) Because the firm is the only producer of its brand, it faces a downward-sloping demand curve. Price exceeds marginal cost and the firm has monopoly power. In the short run, described in part (a), price also exceeds average cost, and the firm earns profits shown by the yellow-shaded rectangle. In the long run, these profits attract new firms with competing brands. The firm’s market share falls, and its demand curve shifts downward. In long-run equilibrium, described in part (b), price equals average cost, so the firm earns zero profit even though it has monopoly power. Fig 12-01.EPS PHALL-82241 PINDYCK CHAPTER 12 page 5 of 14 FIGURE 12.2 Comparison of Monopolistically Competitive Equilibrium and Perfectly Competitive Equilibrium MC AC MC AC PMC Pc D � MR D MR Qc (a) Quantity QMC Qc Quantity (b) Under perfect competition, as in (a), price equals marginal cost, but under monopolistic competition, price exceeds marginal cost. Thus there is a deadweight loss, as shown by the yellow-shaded area in (b). In both types of markets, entry occurs until profits are driven to zero. Under perfect competition, the demand curve facing the firm is horizontal, so the zero-profit point occurs at the point of minimum average cost. Under monopolistic competition the demand curve is downward-sloping, so the zeroprofit point is to the left of the point of minimum average cost. In evaluating monopolistic competition, these inefficiencies must be balanced against the gains to consumers from product diversity. Fig 12-02.EPS PHALL-82241 PINDYCK CHAPTER 12 page 6 of 14 FIGURE 12.3 Firm 1’s Output Decision P1 D1(0) MR1(0) MC1 MR1(75) MR1(50) 12.5 25 D1(75) 50 D1(50) 75 Firm 1’s profit-maximizing output depends on how much it thinks that Firm 2 will produce. If it thinks Firm 2 will produce nothing, its demand curve, labeled D1(0), is the market demand curve. The corresponding marginal revenue curve, labeled MR1(0), intersects Firm 1’s marginal cost curve MC1 at an output of 50 units. If Firm 1 thinks that Firm 2 will produce 50 units, its demand curve, D1(50), is shifted to the left by this amount. Profit maximization now implies an output of 25 units. Finally, if Firm 1 thinks that Firm 2 will produce 75 units, Firm 1 will produce only 12.5 units. Fig 12-03.EPS Q1 PHALL-82241 PINDYCK CHAPTER 12 page 7 of 14 FIGURE 12.4 Reaction Curves and Cournot Equilibrium Q1 100 Firm 2’s Reaction Curve Q* (Q1) 2 75 50 x Cournot Equilibrium 25 12.5 x Firm 1’s Reaction Curve Q* (Q2) 1 25 x 50 75 100 Q2 Firm 1’s reaction curve shows how much it will produce as a function of how much it thinks Firm 2 will produce. (The xs at Q2 = 0, 50, and 75 correspond to the examples shown in Figure 12.3.) Firm 2’s reaction curve shows its output as a function of how much it thinks Firm 1 will produce. In Cournot equilibrium, each firm correctly assumes the amount that its competitor will produce and thereby maximizes its own profits. Therefore, neither firm will move from this equilibrium. Fig 12-04.EPS PHALL-82241 PINDYCK CHAPTER 12 page 8 of 14 FIGURE 12.5 Duopoly Example Q1 30 Firm 2’s Reaction Curve Competitive Equilibrium 15 Cournot Equilibrium 10 Collusive Equilibrium 7.5 Firm 1’s Reaction Curve Collusion Curve 7.5 10 15 The demand curve is P = 30 ? Q, and both firms have zero marginal cost. In Cournot equilibrium, each firm produces 10. The collusion curve shows combinations of Q1 and Q2 that maximize total profits. If the firms collude and share profits equally, each will produce 7.5. Also shown is the competitive equilibrium, in which price equals marginal cost and profit is zero. Fig 12-05.EPS 30 Q2 PHALL-82241 PINDYCK CHAPTER 12 page 9 of 14 FIGURE 12.6 Nash Equilibrium in Prices P1 Firm 2’s reaction curve Collusive equilibrium $6 $4 Firm 1’s reaction curve Nash equilibrium $4 $6 Here two firms sell a differentiated product, and each firm’s demand depends both on its own price and on its competitor’s price. The two firms choose their prices at the same time, each taking its competitor’s price as given. Firm 1’s reaction curve gives its profit-maximizing price as a function of the price that Firm 2 sets, and similarly for Firm 2. The Nash equilibrium is at the intersection of the two reaction curves: When each firm charges a price of $4, it is doing the best it can given its competitor’s price and has no incentive to change price. Also shown is the collusive equilibrium: If the firms cooperatively set price, they will choose $6. Fig 12-06.EPS P2 PHALL-82241 PINDYCK CHAPTER 12 page 10 of 14 FIGURE 12.7 The Kinked Demand Curve $/Q MC′ P* MC D Quantity Q* MR Each firm believes that if it raises its price above the current price P*, none of its competitors will follow suit, so it will lose most of its sales. Each firm also believes that if it lowers price, everyone will follow suit, and its sales will increase only to the extent that market demand increases. As a result, the firm’s demand curve D is kinked at price P*, and its marginal revenue curve MR is discontinuous at that point. If marginal cost increases from MC to MC’, the firm will still produce the same output level Q* and charge the same price P*. Fig 12-07.EPS PHALL-82241 PINDYCK CHAPTER 12 page 11 of 14 FIGURE 12.8 Prime Rate versus Corporate Bond Rate 10 Prime Rate 9 Percent per Year 8 7 6 AAA Corporate Bond Yield 5 4 3 Jan 93 Jan 94 Jan 95 Jan 96 Jan 97 Jan 98 Jan 99 Jan 00 Jan 01 Jan 02 Jan 03 Jan 04 Jan 05 Jan 06 Jan 07 Jan 08 The prime rate is the rate that major banks charge large corporate customers for short-term loans. It changes only infrequently because banks are reluctant to undercut one another. When a change does occur, it begins with one bank, and other banks quickly follow suit. The corporate bond rate is the return on long-term corporate bonds. Because these bonds are widely traded, this rate fluctuates with market conditions. Fig 12-08.EPS PHALL-82241 PINDYCK CHAPTER 12 page 12 of 14 FIGURE 12.9 Price Setting by a Dominant Firm Price D SF P1 MCD P* DD P2 QF QD Quantity QT MRD The dominant firm sets price, and the other firms sell all they want at that price. The dominant firm’s demand curve, DD, is the difference between market demand D and the supply of fringe firms SF. The dominant firm produces a quantity QD at the point where its marginal revenue MRD is equal to its marginal cost MCD. The corresponding price is P*. At this price, fringe firms sell QF, so that total sales equal QT. Fig 12-09.EPS PHALL-82241 PINDYCK CHAPTER 12 page 13 of 14 FIGURE 12.10 The OPEC Oil Cartel TD Price Sc P* DOPEC MC OPEC Pc′ MR OPEC Qc QOPEC QT Quantity TD is the total world demand curve for oil, and Sc is the competitive (non-OPEC) supply curve. OPEC’s demand DOPEC is the difference between the two. Because both total demand and competitive supply are inelastic, OPEC’s demand is inelastic. OPEC’s profit-maximizing quantity QOPEC is found at the intersection of its marginal revenue and marginal cost curves; at this quantity, OPEC charges price P*. If OPEC producers had not cartelized, price would be Pc, where OPEC’s demand and marginal cost curves intersect. Fig 12-10.EPS PHALL-82241 PINDYCK CHAPTER 12 page 14 of 14 FIGURE 12.11 The CIPEC Copper Cartel Price TD Sc MCCIPEC P* Pc DCIPEC MR CIPEC Q CIPEC Qc QT Quantity TD is the total demand for copper and Sc is the competitive (non-CIPEC) supply. CIPEC’s demand DCIPEC is the difference between the two. Both total demand and competitive supply are relatively elastic, so CIPEC’s demand curve is elastic, and CIPEC has very little monopoly power. Note that CIPEC’s optimal price P* is close to the competitive price Pc. Fig 12-11.EPS ...
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