An example Elasticity of demand for Kodak film is-2 P=[EF(1+EF)ⅹMC P=[-2/(1-2)×MC P=2×MC Price is twice marginal cost Fifty percent of Kodaks price is margin above manufacturing costs Michael R Baye, Managerial Economics and Business Strategy, 3e. CThe McGraw-Hill Companies, Inc, 1999
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. , 1999 An Example • Elasticity of demand for Kodak film is -2 • P = [EF /(1+ EF )] MC • P = [-2/(1 - 2)] MC • P = 2 MC • Price is twice marginal cost • Fifty percent of Kodak’s price is margin above manufacturing costs
Markup rule for Cournot Oligopoly Homogeneous product Cournot oligopoly n=total number of firms in the industry Market elasticity of demand EM Elasticity of individual firm's demand is given by EF=NEM P=[EF/(1+EF)×MC,So P=NE/(1+NEM)×MC The greater the number of firms the lower the profit-maximizing markup factor Michael R Baye, Managerial Economics and Business Strategy, 3e. CThe McGraw-Hill Companies, Inc, 1999
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. , 1999 Markup Rule for Cournot Oligopoly • Homogeneous product Cournot oligopoly • N = total number of firms in the industry • Market elasticity of demand EM • Elasticity of individual firm’s demand is given by EF = N EM • P = [EF /(1+ EF )] MC, so • P = [NEM/(1+ NEM)] MC • The greater the number of firms, the lower the profit-maximizing markup factor
An Example Homogeneous product Cournot industry 3 firms ·MC=$10 Elasticity of market demand=-1/2 Profit-maximizing price? °EF=NEM=3×(-12)=-1.5 P=[EF/(1+EF)×MC P=[-1.5/(1-1.5]×$10 P=3×$10=$30 Michael R Baye, Managerial Economics and Business Strategy, 3e. CThe McGraw-Hill Companies, Inc, 1999
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. , 1999 An Example • Homogeneous product Cournot industry, 3 firms • MC = $10 • Elasticity of market demand = - 1/2 • Profit-maximizing price? • EF = N EM = 3 (-1/2) = -1.5 • P = [EF /(1+ EF )] MC • P = [-1.5/(1- 1.5] $10 • P = 3 $10 = $30
First-Degree or Perfect Price discrimination Practice of charging each consumer the maximum amount he or she will pay for each incremental unit Permits a firm to extract all surplus from consumers Michael R Baye, Managerial Economics and Business Strategy, 3e. CThe McGraw-Hill Companies, Inc, 1999
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. , 1999 First-Degree or Perfect Price Discrimination • Practice of charging each consumer the maximum amount he or she will pay for each incremental unit • Permits a firm to extract all surplus from consumers
Perfect price discrimination Price S Profits 10 5(4-0(10-2) $16 8 Total Cost MC 2 3 4 5 Quantity Michael R Baye, Managerial Economics and Business Strategy, 3e. CThe McGraw-Hill Companies, Inc, 1999
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. , 1999 Perfect Price Discrimination Price $ Quantity D 10 8 6 4 2 1 2 3 4 5 Profits: .5(4-0)(10 - 2) = $16 Total Cost MC