No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Eight: Market Structure: From competition to monopoly 186 additional unit sold will result in a lower price for all units sold, this causes the marginal revenue curve to fall below the demand curve. The price searcher will still maximize profits by producing the quantity that equates the marginal revenue with marginal costs, which is Q M in Figure 8.5 . She will then charge the price that consumers are just willing to pay at that quantity, P M . The price searcher outcome leads to socially undesirable results—some gains from trade are “left on the table” while price searchers are able to appropriate some of the consumer’s surplus (compared to the competitive model). Because the price searcher sets a price greater than her marginal cost, the quantity produced is less than the competitive model, and potential utility increasing trades will not occur, as seen in the blue triangles in Figure 8.5 . Notice that there is a loss of both consumer’s surplus and producer’s surplus in the “deadweight” loss. Deadweight loss is caused by the reduction in mutually beneficial exchanges when output falls from Q* to Q M . The price searcher is willing to suffer her portion of the deadweight loss since she will obtain the much larger area of the consumer’s surplus (the orange rectangle area above P* in Figure 8.5 ) . If she were to expand production out to Q*, then she would have to lower the price for all other units sold and would not maximize her profits (notice that MR < MC at quantities greater than Q M ). There is one way to secure some of the additional gains from trade for some price searchers. If it is possible to charge differing prices to different buyers and prevent those buyers from trading with each other, then the price searcher may produce larger quantities and gain even more profits. Charging differential prices is called price discrimination (or market segmentation), since the price searcher discriminates against some consumers by charging them a higher price. This happens all the time: theaters may charge lower prices for kids; restaurants may give “senior citizen” discounts; or stores might give discounts to “Internet” purchasers. The classic example is airline tickets, where airlines are able to charge business customers higher fares than recreational travel customers. How do they distinguish between the two? Recreational travel is usually known well in advance, while business travel is often short notice. Airlines understand that the recreational travelers have many more options (substitutes) Deadweight loss: the loss in producer’s and consumer’s surplus due to the decrease in mutually beneficial trades. Price discrimination: occurs when a producer is able to charge differing prices to customers according to their differing demands. Figure 8.5, Price Searcher (Monopoly) Equilibrium. In a price searcher model, the firm must determine the demand curve by trial and error. If the firm can only charge one price, the marginal revenue line will fall below the demand curve, as each additional sale is at a lower price, which must be charged to all units. A price searcher will still maximize profits at MC=MR, at Q M and charge P M . The blue-shaded triangle is the deadweight loss due to lost trade, and the consumer and producer surpluses are the green and orange areas respectively. P ($) Q (#) Q * P * Q M P M Consumer Surplus Deadweight Loss Producer Surplus Profit D S=MC MR Monopolist “CHRISTIANS ARE SKEPTICAL OF UTOPIAN MODELS” Christians should not succumb to the siren song of the “nirvana” fallacy—comparing some hypothetical outcome against the real world. The competitive model is, after all, a model. While we may not like all the results of any model, Christians are skeptical of a utopian “perfect” model that purports to describe an ideal state in our fallen world.