Chapter 10 Price Searcher Markets with Low Entry

Chapter 10 Price Searcher Markets with Low Entry Barriers 1

Overview n n n How a price searcher is different from a price taker. Analyze the price searcher graph Long run equilibrium in a price searcher market Contestable markets Entrepreneurship Price discrimination 2

Competitive Price Searcher: A firm that 1. 2. Has low barriers to entry Faces a downward sloping demand curve (because they produce differentiated products) 3

Competitive Price Searcher 4

Competitive Price Searcher Differentiated Products: Products that are distinguished from similar products by characteristics like quality, design, and method of production Ex. Nike Shoes vs. other shoes Ex. Miller Beer vs. Natural Light 5

Competitive Price Searcher Because good substitutes are available, the demand curve faced by competitive price searchers is highly elastic An decrease in price will increase the quantity sold. 6

The Price Searcher Graph In order to sell a higher quantity, a price searcher will have to lower price. Marginal Revenue will always be less then price for a price searcher MR < P 7

Maximizing profits A price searcher maximizes profits by producing where MR=MC. 1. 2. If price > ATC, then firm makes an economic profit If price < ATC, then firm makes an economic loss 8

Long-run equilibrium When firms in a price searcher market make an economic profit (loss), new firms will enter (exit) and drive price down (up). In the Long-run, firms will make zero economic profit. 9

Economics of Business Failure Competition will drive failing firms out of business and free up the resources used by that firm for more productive use. 10

Price Takers vs. Price Searchers n 1. 2. In Long-run equilibrium, both price takers and price searchers: Have price equal to average total cost (ATC) Make zero economic profit However, price taker: P = MR = MC competitive price searcher: P > MR = MC n 11

Contestable Markets Contestable markets are markets in which firms can enter and exit with minimal risk Ex. an airline route 12

Contestable Markets A contestable market has 2 important conditions 1. 2. Prices above the level necessary to achieve zero economic profits will not be maintained The costs of production will be kept to a minimum 13

Entrepreneurship An Entrepreneur is a person who introduces new products or improved technologies. Successful entrepreneurs will increase the value of resources Ex. Henry Ford Ex. Ray Kroc Ex. Bill Gates 14

Entrepreneurship: Who Knew? Ken Olson, chairman/founder of Digital Equipment Corp. , 1977: "There is no reason anyone would want a computer in their home. " Fred Smith’s (Fed. Ex) Yale University Senior Project Grade Remark: "The concept is interesting and well-formed, but in order to earn better than a 'C, ' the idea must be feasible. " 15

#2 Be Entrepreneurial Who would have thought…. 16

Entrepreneurship 17

Entrepreneurship and Economic Growth Creative Destruction: The replacement of old products and production methods by innovative new ones that consumers judge to be superior. This process generates economic growth and higher standards of living Think of life today compared to life 100, 50, or even 20 years ago! 18

n Our medicine n Our Entertainment Entrepreneurship and Economic Growth 19

Price Discrimination A practice whereby a seller charges different consumers different prices for the same product or service. 20

Price Discrimination Effective use of price discrimination requires 2 things: 1. Identify and separate at least two groups with different elasticities of demand 2. Prevent those who buy at the low price from reselling to those who buy at the high price. 21

Price Discrimination Examples of price discrimination: Ex. Movie theatre tickets (adult vs. children) Ex. Airline tickets (Saturday night stay) Ex. Books (paperback vs. hardback) 22

Bundling n n Bundling: the sale of two or more goods and services together. Ex. extra value meal Tying: the act of making the purchase of one good conditional on the purchase of a second good Ex. hospital room 23

Review 1. 2. 3. 4. Understand the concept of a price searcher and differentiated products. Be able to analyze the price searcher graph. Understand the concept of long-run equilibrium (comparing price searchers and price takers). Understand the concept of contestable markets. 24

Review 5. Understand the concept of creative destruction and how entrepreneurship leads to economic growth. 6. Understand the idea and process of price discrimination and bundling. 25