Market Equilibrium is Pareto Efficiency: Linear Demand Log-Linear De Monopolistic firm should always

No one can be better off without Choke Price No Choke Price operate in the E>1 range
Someone worse off P↗ -> E↗ Constant Elasticity If E<1 => Price inelastic -> Raise Price ->
More elastic @ =β Get more revenue
higher price Raise Price -> Produce less -> Less Cost
When P = 0, Q = When P = 0, è Gain more profit, free lunch
finite Q->∞
Outliner has large Outliner has small Role of Fixed Cost & Sunk Cost:
impact impact

Revenue Curve:
𝑇𝑜𝑡𝑎𝑙 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 = 𝑃𝑟𝑖𝑐𝑒 ∗ 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦
𝑇. 𝑅 = 𝑃 ∗ 𝑄
Price movement are movement along the 𝑇. 𝑅 = 𝑃 ∗ (𝛼 − 𝛽𝑃)
curve, non-price movement shift the 𝑇. 𝑅 = 𝛼𝑃 − 𝛽𝑃-
curve 𝑑𝑇. 𝑅 𝛼
Tax and imperfect competitions create a = 𝛼 − 2𝛽𝑃 = − 2𝑃 = 𝑃+ − 2𝑃
𝑑𝑃 𝛽
deadweight loss: &'
Revenue maximization : 𝑃 = - ; 𝐸 = 1

$ + $ +!
OR 𝑇. 𝑅 = 𝑄 ∗ C% − % D = % 𝑄 − %
𝑑𝑇. 𝑅 𝛼 2𝑄
= − = 𝑀𝑅 𝑐𝑢𝑟𝑣𝑒
𝑑𝑄 𝛽 𝛽
$
Revenue Maximization at 𝑄 =
-
Inverse Demand Curve
𝛼 𝑄
𝑄 = 𝛼 − 𝛽𝑃 => 𝑃 = −
Demand Curve 𝛽 𝛽
𝑄! = 𝛼 − 𝛽𝑃! + 𝑋" 𝑃" + 𝑋# 𝑌
XB > 0 -> if PB↗ -> QB↘ & QA↗ -> B & A is 𝑑𝑃
𝑀𝑅 = 𝑃 + ∗𝑄
substitute goods 𝑑𝑄
XB < 0 -> if PB↗ -> QB↘ & QA↘ -> B & A is 1
𝑀𝑅 = 𝑃 ∗ G1 − H
complemented goods 𝐸
If XY > 0 -> if Y↗ -> QA↗-> Normal Goods Marginal revenue = current price + extra
If XY < 0 -> if Y↗ -> QA↘-> Inferior Goods unit that will be sold
When we fix all other -> Demand curve: 𝛼 𝑄
𝑄 = 𝛼 − 𝛽𝑃 => 𝑃 = −
𝑄 = 𝛼 − 𝛽𝑃 𝛽 𝛽
Short cut ONLY FOR LINEAR CURVE 𝑑𝑃 1 Always do the following steps:
$
=−
1. Choke Price: 𝑃+ = % 𝑑𝑄 𝛽 1. Find Q at which MC= MR
&
Sub the 2 above into MR 2. Put it on the demand curve to
2. Elasticity E @ P =&'(& (only for Linear) MR= 𝑃+ −
-+
%
find P*
3. Higher Choke price, less elastic
Profit maximization => MC = MR
Elasticity Formula: -+ '''(01)%
(& To eliminate deadweight loss, we can
%∆+ ,+ &
E =- %∆& = ,& ∗ + MC= 𝑃+ − => 𝑄∗ =
% - price 2 segments differently
$ (&' (01)% &' 01 &' 301
Extreme Example: P*= % − =-+ = 2 Segment will have different demand
-% - -
Perfectly inelastic demand -> E = infinity curve but cost curve is the same
è Mid-point theory (only linear)
Perfectly elastic demand -> E= zero & & Profit maximization if MC = fix
Given 𝐸 = &'(& => 𝑃+ = 4 + 𝑃 𝑄! 𝑠𝑜 𝑡ℎ𝑎𝑡 𝑀𝑅 (𝑄! ) = 𝑀𝐶
Unit elastic good -> E = 1 -> buy the same
1 𝑃(𝐸 + 1) 𝑄" 𝑠𝑜 𝑡ℎ𝑎𝑡 𝑀𝑅 (𝑄" ) = 𝑀𝐶
amount ($20) regardless of price 𝑃+ = 𝑃 G + 1H =
Key relationship: 𝐸 𝐸 Put QA & QB on the demand curve to
&(435) 01 -4(4(5 01
𝑃∗ = -4 + - => 𝑃 -4 = - find PA & PB
4 Profit maximization if MC = Variable
=> 𝑃∗ = 4(5 ∗ 𝑀𝐶 (all demand curve)
𝑄! 𝑠𝑜 𝑡ℎ𝑎𝑡 𝑀𝑅 (𝑄! )
Yellow because it’s a golden formula. = 𝑀𝐶 (𝑄! + 𝑄" )
Profit maximize price is a function of a 𝑄" 𝑠𝑜 𝑡ℎ𝑎𝑡 𝑀𝑅 (𝑄" ) = 𝑀𝐶 (𝑄! + 𝑄" )
MC adds a mark-up that depends on
Elasticity
 Advise on Price setting
• Raise your price if your Marginal Cost
(mc) increases
• Never choose a price at which demand
is inelastic
• Advertising shifts your demand curve
up so, charge a higher price
• Raise your price if consumer income
increases
• Lower your price if a complementary
good’s price increase
• Charge a higher price if the Choke Price
is high (i.e. less-elastic goods)
• Use Price Discrimination => extract
more consumer surplus
Cost function
𝑐(𝑓𝑟𝑡𝑡 𝑒𝑒𝑏 4𝑒𝑥 𝑄) 𝑑 𝑐(𝑄)
=
𝑄 𝑑𝑄
Cost graph:
AC always > AVC. MC start lowest
Point of efficiency = minimum average
cost => MC = ATC
I.e: MC = ATC when ATC is the lowest
Shape meaning
1. Rising Marginal Cost: MC upward
2. U-Shape ATC: ATC = AFC + AVC
Falling portion of ATC: should produce
more to reduce
Minimize ATC is efficient scale
3. When MC < ATC, ATC is falling
4. When MC > ATC, ATC is rising
Competitive market
Sellers are price taker, no pricing power
Products are identical
Free entry & exit
Firm demand = horizonal line
∆%+
E=∞= => 𝑀𝑅 = 𝑃(𝑚𝑎𝑟𝑘𝑒𝑡)
∆%&
Use industry demand curve to find P*
P* = MC (q) of firm to find optimal
production level -> Marginal-Cost Pricing
5. Supply curve = (inverse) MC
SHORT-RUN shutdown: P< min (AVC)
P > MC = AVC à Produce at capacity
P < MC = AVC àIdle plant
LONG-RUN shutdown: P< Min (AC)
P > AC à Product at capacity
P < AC: Exit
ALWAYS CHECK FOR SR/LR shutdown
Free entry:
Weak: Cost structures are different
Strong: Cost structures are similar/same
In strong form market:
P > min AC: Firm will enter
P < min AC: firm will exit
P = min. AC = MC
1(+) ,6(+)
Equate 𝐴𝐶 = +
= ,+
-> get optimal Q
Equilibrium: No incentive to enter / Exit
Profit = 0
AC includes opportunity cost. So how?
1. Cost Leader 2. Differentiation 3. First
mover 4. Reduce competition/ entry with
govern intervention
You can explicit market segmentation
1. Market Power (ability to set price)
2. Observability (can easily separate the
groups)
3. No arbitrage / resales
First, explicitly segment market
Second, implicitly segment market
What is price discrimination
1. Price difference is not reflective of cost
difference
2. Explicit segment: people cannot easily
switch, firm can identify
3. Implicit segment: Firm don’t know.
Use: versioning, bundle, to extract
customer’s willingness to pay
4. High wtp customers might switch low
price option
Example: Issue coupon but hard to
redeem:
Instead of lower price P1->P0, coupon:
At P1, all we get is A+B + square
At P0, no coupon, we gain C, lose A + B
Now we issue coupon, people with WTP
at P1 will not redeem, people at low
WTP of P0 will redeem. So image B stays
and A redeem-> Gain, C, lose only A
Game Theory
Simultaneous: Row player bottom left,
column player Top right
Dominant Strategy: strategy gives her
higher payoffs regardless of what others
do.
Dominated Strategy: this strategy is
never a best response; Bad strategy
1. If you have a dominant strategy, use
it
a. Expect your oppornent to use her
dominant strategy if she has one
b. Nash Equi = both using dominant
strategy
2. If you have dominated strategy,
avoid them
a. Successively eliminate dominated
strategies to predict outcome
b. If only 1 outcome survive, this is Nash
3. If no dominant / dominated, look for
a Nash Equilibrium (a pair of best-
responses
 Sequential Move game Cournot Capacity Game
Draw a game tree, first number represent Identical Good, 2 firm, same cost. Firm
pay-off of the 1st mover are price taker, only decide how much to
Calculate backward to identify best make
solution MC = 30. P = 150 – Q. Q = Q1 + Q2
Step 1: Find Q1 as Q2 when Profit 1 is
max
𝜋1 = (150 − (𝑄1 + 𝑄2) − 30) ∗ 𝑄1
𝜋1 = (120 − 𝑄1 − 𝑄2) ∗ 𝑄1
𝜋1 = (120 − 𝑄2) ∗ 𝑄1 − 𝑄1-
,:5
Profit max,+5 = 0 = 120 − 𝑄2 − 2𝑄1
Profit max when 2Q1= 120 – Q2
To derive collusive outcome, write revenue Step 2: Find Q2 as Q1 when Profit 2 is
and cost of the joint between 2 max
Commitment devices And make MR1 = MC1 ; MR 2= MC2 Profit max when 2Q2= 120 – Q1
1. Must be visible Try to eliminate everything else, leave only Step 3: Plot Q1 & Q2, intercept = Nash
2. Must be credible: Expensive, cheap talk P1 & P2 to solve SHORTCUT: identical firm -> Q1 = Q2 = 40
is not sufficient Revenue = P1Q1 + P2Q2
3. Must be irreversible: reversible Sub in 𝑄5 = 64 − 4𝑃1 + 2𝑃2
commitment =no commitment. 𝑄- = 50 − 5𝑃2 + 𝑃1
Sometimes, it’s about burning your 𝑑𝑇𝑅(𝑗𝑜𝑖𝑛𝑡)
𝑀𝑅1 = = 64 − 8𝑃1 + 3𝑃2
options 𝑑𝑃1
𝑑𝑇𝑅(𝑗𝑜𝑖𝑛𝑡)
4. Could signal irrationality: give up 𝑀𝑅2 = = 50 − 10𝑃2 + 3𝑃1
control, room for nego 𝑑𝑃2
Sub in MR1 = MC1; MR2=MC2
Oligopoly
- Get the result for P1 & P2
𝐻𝐻𝐼 = V(𝑆ℎ𝑎𝑟𝑒7 ) > 1000 = 𝑂𝑙𝑖𝑔𝑜𝑝𝑜𝑙𝑦 Price Game 2: Bertrand with differentiated
product Collusion: P=150 – Q, MC1=MC2=30
7
Max HHI = 10k, monopoly 1. Less dangerous. Prisoners Dilemma P choke = 150. P* = 90. Q* = 60.
HHI >2000 = highly concentrated & heavily 2. Nash profit < collusive profits Q1=Q2=30
scrutinized 3. Mergers is good, but likely opposed Bertrand Game Cournot Game
Price Game: Bertrand Trap with identical Pricing Power Low Pricing Power
goods, perfect substitute Tacit or implicit collusion Firm set Price Exchange set price
1. Price war = inevitable. BAD, dangerous - Play repeatedly Short-run Long-run
2. Market Share are most dangerous - No ending Play during slumps Play during booms
Setup: 2 firms competing, perfect - Few firms Better to collude
substitute. Nash: P1 = P2 = MC - “Leadership Role”: initiate be nice
Price Game 2: Bertrand with - Communication è
differentiated product - Safe Tot-for tat
𝑸𝟏 = 𝟔𝟒 − 𝟒𝑷𝟏 + 𝟐𝑷𝟐 - Unforgiving, reciprocate
𝑸𝟐 = 𝟓𝟎 − 𝟓𝑷𝟐 + 𝑷𝟏 𝐶𝐹(𝑐𝑜𝑙)
𝑴𝑪𝟏 = 𝟓 ; 𝑴𝑪𝟐 = 𝟒 𝑃𝑉 (𝑐𝑜𝑙𝑙𝑢𝑑𝑒) = 𝐶𝐹 (𝑐𝑜𝑙𝑙𝑢𝑑𝑒) +
𝑟
Step 1: find each other’s optimal price 𝐶𝐹(𝑏𝑎𝑑)
based on the other 𝑃𝑉 (𝑐ℎ𝑒𝑎𝑡) = 𝐶𝐹 (𝑐ℎ𝑒𝑎𝑡) +
𝑟
A. In this case, find choke price: Should collude if PV (collude) > PV Cheat
𝑄5 = 0 = 64 − 4𝑃1 + 2𝑃2 è All depend on r & how bad is bad
64 + 2𝑃2 è Very easy in infinity game
++++
𝑃1 = = 16 + 0.5 𝑃2
4 Tit-for-tat
B. From choke price, use mid-point: è Start of cooperate
+++++ + 𝑀𝐶) 16 + 0.5 𝑃2 + 5
(𝑃1 è Do what rival did in the previous
𝑃∗ = =
2 2 è Good but punishing to mistake
è P1* = 10.5 + 0.25 P2 Grim Trigger
C. Similarly, find P2* in term of P1 è Start of cooperate
è P2* = 7 + 0.1 P1 è Once they cheat, you punish them
Step 2: Plot a graph of P1 vs P2, get the è Do not forgive
intercept, that’s Bertrand-Nash
Step 3: Calculate individual profit
 Question Type:
1. Effect of tax: Shift demand curve to the
left. If tax increases, how much is born by
buyer/ seller: Equate demand & supply
function but keep Pb & Ps. E,g: 900 – 45
Pb = 300 + 5 Ps. Then take Pb = Ps + tax
($2), solve for Pb & Ps. Compare with
original price to see who get more tax
2. Elasticity soduku:
More substitute = higher elasticity
Differentiation = lower elasticity
Particular goods = higher elasticity than
an “industry” average
More ads = less elasticity
Lower income = higher elasticity
Demand is more elastic in long run
If consumers expect price to be
temporary, short run demand is more
elastic.
3. Natural Monopoly: when Total average
cost just keep going down with amount
produce, I.e: no U-shape curve
4. Cost curve key relationship:
Area under MC @ Q = variable cost of Q
Average fixed cost (AFC) – decreasing
AC approaches AVC as Q↑ (AC=AFC+AVC)
AC approaches ∞ when Q->0
AC↓ if AC>MC & AC ↑ if AC<MC
5. Solving for Max profit w/o short-cut
1. Identify TR as a function of Q
2. Differentiate d(TR)/dQ to get MR
3. If don’t know MC, find Total Cost.
Differentiate d(TC)/dQ to get MC
4. Equate MR = MC to get optimal Q*
5. Substitute into demand function for P*
6. Bundling with WTP
1. Draw out WTP & segment in a table
2. Identify all the option: A, B, bundle
3. Calculate Consumers surplus for each
option
4. Choose the highest consumer surplus
option
7. How to set two-part tarrif
1. Set per unit cost = MC
2. Calculate for Q at MR = MC, what’s the
customers’ consumer surplus
3. Set tariff = this consumer surplus

GOLDEN RULE OF PROFIT MAXIMIZATION: MR = MC

MR MC How to solve
Monopoly ,;.= ,& 𝑑 𝑐(𝑄) Get MR & MC separately, equate them to get
,+
OR 𝑃 + ,+ ∗ 𝑄 𝑀𝐶(𝑄) =
5 𝑑𝑄 Q*
OR 𝑃 ∗ C1 − 4 D Find P*
Cournot Capacity 𝑑𝑀𝑅1 The Cournot-Nash
𝑀𝑅5 =
game: 𝑑𝑄1 Focus on MR side, use MR1 and MR2 to see
2 firm, identical = 𝑎 𝑓𝑢𝑛𝑐𝑡𝑖𝑜𝑛 𝑜𝑓 𝑞2 where they intercept, solve for Q1 & Q2
Firm choose Similarly, MR2 = a function of Collusive:
capacity Q1 Use total demand to find MR for market and
How to find min. AC maximize profit for total
Equate AC = MC ->
Competitive market MR = P 1. Get P = MC. Q is fix -> Get price
solve for Q
Same product No trade off Short run: firm cannot entry and exit: N = fix
Everyone cannot =n
OR
decide price 1. Use demand with P = MC to get market Q
2. Divide Q/n to get firm production
ATC = Total cost / Q
,!;1
Long run: firm can entry & exit, economic
Get ,+5 = 0 profit = 0
P = AC and also form above P = MC
Longrun equilibrium price
P = AC = MC, I,.e where AC intercept MC,
which is also min. AC
From P, find big Q -> based on P, get q – firm
production. N* = Q / q
Long run equilibrium is where no incentive to
entry / exit
No incentive to entry: P < Pentry
No incentive to exit: P> P exit