Principles of Economics - Term Paper Example

TITLE: The title is: Principles of Economics 1. You own a local sub shop in a college town. You primarily serve two groups of people: local residents (both students and other local residents) and visitors to your town. Devise a price discrimination strategy that will increase your revenues compared to a single-pricing strategy. 1.As owner of the local sub shop owner, I can increase my revenues by following a price discrimination strategy instead of a single pricing strategy. Price discrimination is the strategy to charge different prices for the same product or service from different customers ( Thomas Nagle, Reed Holden, 2008 ) . My local sub shop in the college town serves two groups of customers. The first group consists of local customers who include the students of the college and the local residents. The second group of customers consists of visitors coming to the town. The price discrimination strategy that will maximize the revenues for my sub shop will charge lowest prices from the students. Students are price sensitive and they have a very high price elasticity of demand . A slightly higher price will be charged from the local residents who are not college students. They are less price sensitive than the students and their price of elasticity of demand is less elastic than local students. The visitors to the town will be charged a much higher price because the demand of visitors for the products of the sub shop is inelastic. They can afford to pay higher for the products . The pricing strategy will charge three different prices for the products of the sub shop from the three different groups of customers. This price discrimination strategy will maximize the revenues of the sub shop. This price discrimination strategy has elements of both first degree price discrimination and third degree price discrimination. 2. Suppose the cable TV industry is currently unregulated. However, due to complaints from consumers that the price of cable TV is too high, the legislature is considering placing a price ceiling on cable TV below the current equilibrium price. If the government does make this price ceiling law, diagram and explain the effects with supply and demand analysis. If the cable TV company is worried about disgruntling customers, suppose that the company may introduce a different type of programming that is cheaper for the company to provide yet is equally appealing to customers. Explain what would be the effects of this action. 2.If the government does make the price ceiling law then this price will be below the market clearing equilibrium price. The demand at this lower ceiling price will exceed the supply of cable Television at this price. This will create a shortage. FIG 1: REGULATORY PRICING. In the above graph : A is the equilibrium point where market clears. B is the regulatory ceiling price. Q is the supply at the regulatory ceiling price B P is the demand at regulatory ceiling price B Shortage due to regulatory pricing: P – Q If the TV cable company succeeds in introducing a cheaper programming then this will reduce the shortage induced by the price ceiling due to the legislation. The shortage will reduce because the supply will increase. If the TV cable company is able to reduce prices to the level of the ceiling price then market equilibrium will once again be restored. 3. Consider a perfectly competitive market. Analyze and explain in detail using graphical tools to show what you expect to happen to the number of firms and firm profitability in the short run and long run a) if demand for the product falls and b) if demand for the product rises. 3. In a perfectly competitive industry, no firm is large enough to affect the market or has the market power to affect the price of a homogeneous product. a) Suppose in a perfectly competitive industry, the demand for the product decreases. The demand curves for firms in a perfectly competitive industry have perfect elasticity. The fall in demand will mean that the price too will fall down. Firms in a perfectly competitive industry are price takers. If the reduced price due to reduced demand is enough to cover the fixed costs of the firm (i.e. the shut down point) then the firm will continue to operate. The supply curve of a perfectly competitive firm is its marginal cost curve above the shut-down point ( Paul Samuelson, William Nordhaus, 2000 ). If the price falls to a point where it is not enough to cover the fixed costs, then the firms in the perfectly competitive industry will start leaving the industry. Therefore because of the fall in the demand, the profitability will decrease in the short run and the number of firms will also decrease in the short run in the perfectly competitive industry. In the long run, the equilibrium will be restored. In this equilibrium firms in the industry will make zero economic profits. The equilibrium will be restored because the supply will be decreased because of the exit of a number of firms. The zero economic profit point will occur when the horizontal demand curve of the perfectly competitive firm will be touched by the average total cost curve at its lowest point. At this point: Average Revenue will be equal to marginal revenue (AR = MR). FIGURE 2 : Economic profits of a perfectly competitive firm in the short run. b) If the demand for product rises in the short run then the price too will rise. In the short run the profitability of the firms will increase and the number of firms in the industry may also increase because of the perfectly competitive nature of the industry. In the long run due to increased supply and increased number of firms the balance will again be restored and firms in the industry will earn zero economic profits. Figure 3: ZERO ECONOMIC PROFITS OF A PERFECTLY COMPETITIVE FIRM IN THE LONG RUN 4. Discuss why some long-run average cost curves are steeper on the downward side than others. Discuss fully. 4. Long run average cost curves are reflections of the economies of scale and diseconomies of scales of a firm (Paul A. Samuelson, 1947). Some long run average cost curves are steeper on the downwards side than others. This happens when the change in costs due to increased production (economies of scale) is not that high. Firms with steeper downward sides in their long run average cost curve realize slower and lower economies of scale than firms with a less steep downward side in their long run average cost curve. Their costs fall faster with increased production than of the firms with a steeper downward side. 5. If you purchased a new model of a digital camera right after it is released, you will likely pay more than if you purchase it six months after release. Explain why this is an example of price discrimination on the part of the firm. 5. A new model of a digital camera is priced higher immediately after its release than it is priced six months later. This is an example of price discrimination. The new model immediately after its release is priced higher because the company is targeting those users who have a lower price elasticity of demand. These are early adopters and they are lesser price sensitive. After six months the price of digital camera is now reduced because the company is now targeting the average customers who are more price sensitive and therefore have higher price elasticity of demand. This is an example of price discrimination because the digital camera company is charging different prices for the same product from different groups of customers (early adopters and late users). 6. Explain the rationale and the implications of the new guidelines used by the Department of Justice and the Federal Trade Commission for evaluating proposed mergers. 6. The revised guidelines of the Federal Trade commission and Department of Justice concern Horizontal mergers. This is the first major revision of merger guidelines in 18 years. The main rationale behind these revised guidelines is to help agencies identify and challenge competitively harmful mergers while avoiding unnecessary interference with mergers that are competitively beneficial or are likely to have no competitive impact on the marketplace. The revised guidelines detail the techniques and the main types of evidence that agencies use to assess whether a proposed horizontal merger will substantially lessen competition. A likely implication of this revision in guidelines will be that many horizontal mergers that are not done with the motive of gaining monopoly power will face lesser regulatory hurdles. Mergers that will be beneficial for competition are expected to pass through more smoothly because of the revised guidelines. Mergers that comply with US Antitrust laws will also face lesser regulatory hurdles. This will accelerate the whole process of mergers and increase the ease of doing business. If mergers do not distort competition, then there is no rationale for blocking them. The revised guidelines of the Federal Trade Commission and Department of Justice underline this point. References: Paul Samuelson, William Nordhaus. Economics. New York: Prentice Hall, 2000. Print. Krugman, Paul R.; Maurice Obstfeld . International Economics - Theory and Policy. New York: Prentice Hall, 2003. Print. Thomas Nagle, Reed Holden. The Strategy and Tactics of Pricing. Oxford: Oxford University press, 2008. Print. Paul A. Samuelson. Foundations of Economic Analysis. Harvard: Harvard University Press, 1947. Print.  Read More