MICRO ECONOMICS

TUOTRIAL 7

Price consumption curve

- A graph that trace the utility maximising point of 2 products that customer will purchase
when price of one good change
- Plot the quantity of two products at 2 different axis

Income consumption curve

- A graph that trace the utility maximising point of 2 products the consumer will purchase
when income changes
- Plot 2 different products at both axis

Engel Curve

- A graph that links the quantity changes of a product that customer will purchase when
income changes
- Plot income at vertical axis and quantity at horizontal axis

Demand Curve

- A graph that shows how price change affect the quantity purchase of a product
- Plot the price at vertical axis and quantity demanded of a product at horizontal axis

Substitution Effect

- Measures the change in quantity demanded of a product when price of that product
changes with marginal utility held constant.
- This change in price changes the slope of the budget line, causes consumer to move along
the indifference curve with a different MRS

Income effect

- Income effect is due to price change. It measures how the consumption of the product is
when there is a change in purchasing power with relative prices held constant.
- This change in price moves the consumer to a higher or lower indifference curve

CAN A PRODUCT BE AN INFERIOR GOOD AT ALL INCOME LEVELS?

Cannot. Inferior goods are the products that you will consume more or it as income falls. However,
as income falls, towards zero at some point you are no longer have enough income to consume
more. Thus all goods will not be inferior at all times.

PRICE FALLEN OF CHICKEN FEED CAUSES PRICE OF CHICHKEN FALLS AS WELL.

USE INCOME EFFECT AND SUBSTITUTION EFFECT TO EXPLAIN WHETHER CONSUMER WILL INCREASE
THE QUANTITY BOUGHT OF CHICKEN

Predict that the quantity purchase will increase according to the law of demand
Income effect- when the price of chicken has fallen, consumer becomes relatively richer, and they
seems to have a higher purchasing power, they are able to afford more
Substitution effect- because of price of chicken has fallen, consumer will buy less of other relatively
expensive products like fish and buy more of the chicken, which is substituting fish for chicken.
TUTORIAL 12
Imperfect competitive market
An industry which individual firms has some control over the price of the products they are selling

Market power
The power to raise the price without decreasing losing all the Qd for its product

Monopoly
A single firm that produce a product that do not have close substitute.
There is a significant barriers to enter (legal, natural constraint) to prevent other firms from entering
industry to compete for profits.
Thus they are the price maker.

Perfect price discrimination

Charging the maximum amount that buyers are willing to buy

Price discrimination
1//Different price is given to different buyer. The price difference is not influenced by the cost
difference
2//All products can be bought for a single price, consumer benefits. This consumer benefit is called
consumer surplus.
3//Price discrimination is an attempt by a monopoly to capture the consumer surplus for its
revenue

***Condition for price discrimination * price discrimination is possible under these conditions
1. Monopoly: sellers must possess some ability to control its price or output
2. Market segregation: seller must be able to distinguish among buyers who would willing to pay
different prices (based on different elasticity of demand)
3. No resale: the original purchaser cannot resell the product or services. Ability to prevent those
who pay the lower price from reselling the product to those who pay the higher price.

First degree price discrimination (( perfect price discrimination

If the firm can perfectly price discriminate, each consumer is charged exactly what they are willing
to pay.
If a firm can identify those who are willing to pay a higher price for a good, it can earn more profit
from them by charging a higher price.

Second degree price discrimination (( bulk discount

The establishment of a pricing structure for a particular good based on the units sold.
Eg. Quantity of discounts
Seller charges a higher per unit price for fewer units sold and a lower per unit price for larger
quantities purchased

Third degree price discrimination (( market segregation

Practice of dividing consumers to two or more groups with separate demand curves and charging
different price to each group
Firm will set a higher price if the demand for the market is inelastic and lower price if demand is
elastic.
BARRIERS TO ENTER? COMPETITION AMONG FIRMS IN THE INDUSTRY
 Economic of scale can be achieved by increasing production and lowering cost
There are certain factors that causes barriers to entry in monopoly market, which prevent new firms
from entering and competing in imperfectly competitive industry.
Typical forms of barriers to enter are economic of scale, ownership of key resources and legal
restriction.
Economic of scale, which also describe as natural monopoly. An industry is most efficient and able to
achieve large eos when only a single firm is producing that good or services
Ownership of scare resources. A firm is able control the whole industry when he owns the entire
supply of the input of a production that requires a particular input.
Legal restrictions: only a range of firms has exclusive rights to produce certain goods or services
eg patents 专利 (barrier to entry that grants exclusive use of the patented product or process to the
inventor), government rules ( impose entry restrictions on firms as a way of controlling activity.

Typical forms of barriers to enter are as follows:

EOS natural monopoly
An industry is the most efficient and achieved large economic of scale when only a single firm is
producing that goods or services
Ownership of scare resources.
A firm that has the control on the whole industry when he owns the entire supply of an input of the
production that requires the particular input
Legal restrictions
Only certain range of firm has the exclusive rights to produce certain product or services. Eg patents
and government rules.
MONOPOLISTIC COMPETITION
 CHARACTERISTICS
- Many sellers
Many firms competing the same group of customers
There are three implications:
= Each firm has only a small market share and has limited market power to influence the
price of its goods and services
= firm is sensitive to the average market price but no firm pays attention to the actions of
the other and no firm’s action directly affect the actions of other firms
= collusion or conspiring to fix price is impossible in monopolistic competition
- Free entry and exit, no barrier to enter
Firms can enter or exit without restrictions
Number of firms in the market adjust until 0ep
- Selling differentiated products
A strategy that firms use to achieve market power accomplished by producing goods that
differ from others in the market
- Price searcher
The firms have some market power can charge a higher price than a competitor without
losing all its customer

 Variety of products// product differentiation

- Horizontal product differentiation *price same
Goods are different but at a same price
Consumer will chose depends on their preference
* Specific features
Eg coke and pepsi

- Vertical product differentiation *price differ

Goods are different and at different price
Consumers will prefer one over the other if they are at the same price
* Price and quality
Eg perodua vs BMW

 Differences between monopolistic and perfect competitive firm

- Excess capacity
The firm withhold their ability to produce more
Output is less than the efficient scale of perfect competition
- Markup over marginal cost

 TUTORIAL QUESTIONS
OLIGOPOLY
Market structure
 Few dominant firms
 Homogeneous or differentiated goods
 Significant barriers to enter eg monopoly ( patents, economic of scale, technology =
ownership of scarce resources) name recognition and strategic action
 Price maker but determined by level of coordination among the other firm

Four models of oligopoly behaviour:

- Cartel (collusion) the group behave as one (monopoly)
- Kinked demand model (duopoly)
- Price leadership
- Game theory

Why are firms in oligopoly interdependent?

What creates an incentive for firms in a collusive agreement to cheat and increase output?
Because each firm has large market shares and each decision has a major influence on its
competitor’s profit. Firms face the temptation to collude because if they can successfully collude,
they can boost their economic profit
All firms in a collusion agreement face the same optimal strategies. Their payoff is high if they
comply, but the payoff to any one firm that cheats is even higher if all the other firm comply. This
motivates each firm to cheat on this agreement.

COLLUSION:
Agreement among firms to divide the market or fix the price
Cartel: a combination of firms acting as one single firm, which they can sets price as a monopoly
Eg: OPEC organisation of petroleum exporting countries
:: Increase economic profit by restricting output, for this they must assign output quota to members
firm
:: if the cartel can limit the entry of other firms they can increase their profits
Although oligopolist would like to form cartels and earn monopoly profits, it is not possible because
of antitrust laws that prohibits explicit agreement among oligopolists as a matter of public policy

Kinked demand curve

In the kinked demand curve model of oligopoly, each firm believes that if it raises its price, its
competitors will not follow, but if it lowers down its price its competitors will follow
:: based on the kinked demand curve model of oligopoly::
Each firm faces a demand curve kinked at the current prevailing price P*
Above P* an increase in price, which will not be followed by competitors results in large decrease of
the firm’s quantity demand as the demand is elastic
Below P* price decreases are followed by competitors so the firms does not gain as much quantity
demanded, which the demand is inelastic
MR is discontinuous in kinked demand curve
Because in the gap in MR, price may be stable even if cost changes
Firm has no reason to change its price if MR shifts is within the gap in the MR curve
** price is relatively inflexible and rigid.
GAME THEORY
The study of how people behave in strategic situations
Strategic decisions on deciding what actions to take, consider how others might respond to that
action and tries to determine optimal strategy for each player
Because the number of firms in oligopoly market is small, each firm must act strategically.
Each firm knows that its profit depends on not only how much it produces but also how much the
other firm produce.
All game theory involves three feature, rules, strategies and payoffs

DOMINANT STRATEGY
The optimal strategy of a firm no matter what an opponent does

NASH EQUILIBRIUM
An outcome where both players believe that they are on their best strategy, while fully aware the
strategy that everybody else is doing

PRISONER’S DILEMA explain and how to apply to oligopolies?

Is a game between two prisoners that shows why it is hard to cooperate, even when it would be
beneficial to both players to work together (in a situation where players cannot communicate with
each other)
Each firm has a great incentive to cheat on any cooperative agreement to make himself better off
Thus firm have a difficult time on maintaining a cooperative agreement.