Factor markets worked example

WEBVTT
Kind: captions
Language: en

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- [Narrator] We're told that Epic Eats

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is a perfectly competitive,
profit-maximizing producer

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of stuffed sandwiches, and hires workers

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in a perfectly competitive labor market.

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Part A says, draw side-by-side
graphs for the labor market

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and for Epic Eats and show
each of the following.

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So pause this video and see
if you could have a go at it

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before we do it together.

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All right, now let's do it together.

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So we're gonna do side-by-side graphs,

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one for the market, and
one for the firm Epic Eats.

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So let me do that.

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So, this will be my market.

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This is my market graph.

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And so this is going to
be quantity of labor.

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Quantity of labor.

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And then on the vertical
axis, I have my wages,

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which you could view as the
price of labor, the wage rate.

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And so this is the market.

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And then over here, I
wanted it side-by-side.

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This is going to be the firm.

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This is going to be Epic Eats.

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Once again, I have
quantity, quantity of labor.

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And I'm going to have the wage rate.

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And this is Epic Eats.

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That's the firm level.

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Now, they want us to show the market wage

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and the quantity of workers
hired in the market.

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Well, to do that, we're
going to have to think about

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the demand for workers in the market.

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Well, at a high wage
rate, there's not gonna be

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a lot of labor demanded.

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And then as the wage goes
down, more, more people

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are going to wanna hire people.

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This is the market labor demand curve.

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Demand curve.

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And then then supply curve
is gonna be upward sloping.

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At a low wage rate, not a lot
of people are going to wanna

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give their labor.

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But then as wages go up, people will,

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more and more people are likely do enter,

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want to be part of the labor force.

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So this is going to be the
market labor supply curve.

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And then we have our equilibrium wage,

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which they want us to label W sub M.

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So that is going to be right over here.

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W, sub lowercase M.

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And then the quantity of
workers hired in the market

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is going to be capital L, sub lowercase M.

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Capital L, sub lowercase M.

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So we did this first part, the fact part

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that focuses on the market.

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Then they want us to focus on
the marginal factor cost curve

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labeled MFC.

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Well that's what it's
going to cost Epic Eats

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to hire folks.

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And we're dealing with a,

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it hires in a perfectly
competitive labor market.

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So which is gonna pay the market wages.

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So let me do that.

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So this is going to be the
price it pays for labor

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which is its marginal factor cost curve,

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MFC, just like that.

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So I did the second part.

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The marginal revenue product, labeled MRP.

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Well the way you typically look at it,

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it is for Epic Eats that it has some

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marginal revenue product
at a certain quantity.

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And then as it hires more and more people,

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intends to have diminishing returns.

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So typical marginal revenue product curve

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looks something like this.

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So it's MRP, did that part.

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The wage paid by the
firm, labeled W sub F,

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and the quantity of
workers hired by the firm,

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labeled L sub F.

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Well the wage paid by the firm,

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that's dictated by the market wage.

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So we can say that this is
equal to the market wage,

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which is equal to the
wage paid by the firm.

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And you could put this over here.

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The wage paid by the
firm is right over there.

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So I did this first part,

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and the quantity of
workers hired by the firm.

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Well what would be rational is,

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is that they would keep hiring people

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until the marginal revenue
product is no longer higher

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than that marginal cost of
hiring that extra unit of labor.

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So it's right at that
point of intersection.

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And so that is the quantity
of workers hired by the firm,

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so L.

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Now let's do the next part.

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It says, assume that there is an increase

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in the price of Epic
Eats' stuffed sandwiches.

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In the short run, will
the wage paid by Epic Eats

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be higher than, lower
than, or equal to W, sub F?

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Explain.

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So pause this video and
see if you can answer that.

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Well in the short run, Epic Eats,

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no matter how much it
hires or doesn't hire,

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it's just going to pay the same wage.

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So we could say, it is
going to be equal to.

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Equal, equal.

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So pay equal to WF

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because operating

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in perfectly competitive

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labor market.

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Labor market.

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In the short run, what will
happen to the number of workers

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hired by Epic Eats?

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Explain.

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So in the short run, if
the wage is being the same,

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but hey had a price increase.

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So that means that the MRP is
going to shift to the right

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because per unit, they're
going to be able to sell it

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for more, you're gonna a have a situation

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where the MRP switches
shifts to the right,

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or right and up.

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And so you're gonna have MRP to,

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this is after the price increase.

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And notice, now we intersect
the MFC line at a higher point.

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And so what will happen to
the number of workers hired?

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So number of workers goes up

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because

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MRP shifts up

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due to price increase

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which causes it

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to intersect

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your marginal factor
cost curve, MFC at higher

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quantity of labor hired.

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All right, now let's do part C.

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Epic Eats uses capital and labor

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in the production of sandwiches.

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The marginal product of the
last unit of capital used

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is 4,000 units and the marginal
product of the last unit

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of labor used is 3,000.

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If Epic Eats minimizes costs
and the rental rate of capital

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is $400, what is the wage rate?

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So pause this video and see
if you could answer that.

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All right, so they give us a few things.

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So the marginal product of
the last unit of capital.

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So you say, marginal product
of the last unit of capital.

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I used K for capital even
though I know it's...

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Not to confuse ourselves
with something else.

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Although, you could argue
to use C, but we'll use K

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to ease confusion.

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So the marginal product
of the unit of capital

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is equal to 4,000 units.

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We know that the marginal
product of the last unit of labor

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is equal to 3,000 units.

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And we could view this right of here.

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The rental rate of
capital, you can view this

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as the price of capital.

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You could also view this
as the marginal factor

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cost of capital, but I'll just call this

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the price of capital is equal to $400.

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And they want us to get the wage rate..

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So you could view this
as the price of labor

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is equal to what?

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And they tell us that
it's minimizing cost.

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And what we can think about
it is, the number of units

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per dollar that the firm
gets it on the margin,

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if they're able to get
more units per dollar

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by switching, by putting
that extra dollar into labor

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versus capital, or capital versus labor,

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they're going to do it.

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So what we would assume is,
is that the number of units

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per dollar that they're
getting at this point

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are going to be the
same whether they invest

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in labor or capital.

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And so the number of units per
dollar that they're getting

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from the capital is the
marginal product of the capital

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divided by the price of the capital

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this is the number of units per dollar.

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And this needs to be equal to
the number of units per dollar

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that they're getting from
that last unit of labor.

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So that's the marginal product of labor.

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So the units they're getting
from labor on the margin

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divided by the price
of labor on the margin,

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and then we just solve for this.

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So this will get us to,
we're gonna have 4,000,

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this is 4,000 units divided by $400.

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It's going to be equal
to 3,000 units divided by

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the price of labor.

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So you can manipulate this a little bit,

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you could divide both sides by 400.

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So this is going to be
10 units per dollar.

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So let me scroll down a
little bit right over here.

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So we could, this is, let's see...

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Yup, this is going to
be 10 units per dollar

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is going to be equal to
3,000 units divided by

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the price of labor.

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And so, you just do a
little bit of manipulation,

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multiply both sides by the price of labor,

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divide both sides by 10.

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You do a little bit of Algebra.

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This gets you to $300 per,

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for the incremental cost of labor.

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So this is going to get
us to the price of labor

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is equal to $300.

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And you can verify that,
you could plug it back in

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if you like.

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And we're done!


Shifts in demand for labor

WEBVTT
Kind: captions
Language: en

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- [Instructor] We are now
going to continue our study

00:00:02.250 --> 00:00:04.940
of labor markets, and in this video,

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we're going to focus on
the demand curve for labor.

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So let's imagine that we're
talking about a market

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for people who work in
the pant making industry,

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so each of these firms right over here,

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they produce pants, let's say
they produce bell bottoms.

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This is my quick drawing of bell bottoms,

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these are someone's pants right over here,

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they flare out at the bottom,

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and let's say for some strange reason,

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bell bottoms all of a
sudden go back in style.

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So bell bottoms are going back in style.

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The first is, at least in the short run,

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is able to get more per
unit for its bell bottoms,

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so its marginal revenue goes up,

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and if its marginal revenue goes up,

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its marginal revenue
product is going to go up,

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and so we would have a shift to the right

00:00:54.710 --> 00:00:56.560
of the marginal revenue product curve,

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or you could even do that as a shift up.

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For a given quantity of
labor, you're going to have

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a higher marginal revenue product,

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so we could call this marginal
revenue product curve 2.

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Now what was likely to
happen in the market?

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Well if it's a general fashion trend,

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it's not just for this
firm's goods or product,

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but it's for everyone,
all of the pant producers.

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Well then they're all going
to want a lot more people

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who can work in the
pant producing industry,

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or another way to think about it

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is the market labor
demand curve is just a sum

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of the marginal revenue product curves

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for all of the various firms,

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and if all of them have shifted
to the right or shifted up,

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well the same thing is going to happen

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to the market labor demand curve.

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And so the market labor demand curve

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might now look like this.

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So market,

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labor,

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demand,

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curve,

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sub 2.

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Now what does that do

00:01:55.150 --> 00:01:57.340
to the equilibrium wages and quantities?

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Well our equilibrium wage has gone up,

00:02:00.140 --> 00:02:02.890
which seems reasonable 'cause
the demand curve has shifted

00:02:02.890 --> 00:02:07.890
to the right, and our equilibrium
quantity has also gone up.

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I'll put a little Q sub 2.

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Now what does that do
the marginal factor cost?

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For the firms operating in this market,

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the ones that are hiring this labor.

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Well, the wages have gone up so

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so has the marginal factor cost.

00:02:26.770 --> 00:02:28.100
So in this situation,

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we now have a marginal factor cost sub 2,

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and now we have a new
quantity that is rational

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for this firm to actually go out and hire.

00:02:41.223 --> 00:02:43.760
And you can imagine things
going the other way,

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so here, we saw things shift to the right,

00:02:48.020 --> 00:02:50.330
both the marginal revenue product curves

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and the market labor demand curve,

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but maybe things aren't going well,

00:02:55.170 --> 00:02:58.074
and the marginal revenue
goes down for these firms.

00:02:58.074 --> 00:03:00.610
Well then you can imagine a situation

00:03:00.610 --> 00:03:04.100
where on the firm level, your
marginal revenue product curve

00:03:04.100 --> 00:03:06.030
shifts down and to the left,

00:03:06.030 --> 00:03:08.080
maybe it does something like that,

00:03:08.080 --> 00:03:11.785
marginal revenue product
3, and in aggregate,

00:03:11.785 --> 00:03:15.360
that would cause the
market labor demand curve

00:03:15.360 --> 00:03:20.250
to shift to the left, and you
would see the opposite happen.

00:03:20.250 --> 00:03:22.760
You would see a lower equilibrium wage,

00:03:22.760 --> 00:03:25.480
let me just label this market,

00:03:25.480 --> 00:03:26.820
labor,

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demand,

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curve,

00:03:29.450 --> 00:03:30.490
3.

00:03:30.490 --> 00:03:33.593
You would have a lower
equilibrium wage now,

00:03:34.680 --> 00:03:38.503
and you would have a
lower quantity of labor,

00:03:38.503 --> 00:03:43.230
equilibrium quantity of
labor in that market, sub 3,

00:03:43.230 --> 00:03:46.010
and then you would have a lower,

00:03:46.010 --> 00:03:49.580
a lower marginal factor cost

00:03:49.580 --> 00:03:53.280
assuming a perfectly
competitive labor market.

00:03:53.280 --> 00:03:56.140
And so this might be
the equilibrium quantity

00:03:56.140 --> 00:04:01.140
right over there, Q for the
firm, sub 3 with a star.

00:04:01.230 --> 00:04:04.090
Once again, not counterintuitive.

00:04:04.090 --> 00:04:07.380
This is what we've seen in other markets

00:04:07.380 --> 00:04:10.210
when we talked about what
would cause shifts in demand.

00:04:10.210 --> 00:04:12.970
The firms for whatever
reason are not able to get

00:04:12.970 --> 00:04:16.330
as much incremental benefit per unit,

00:04:16.330 --> 00:04:18.250
per extra unit of labor,

00:04:18.250 --> 00:04:21.300
well that's going to
shift things to the left,

00:04:21.300 --> 00:04:23.850
both at the firm level
and at the market level,

00:04:23.850 --> 00:04:27.710
and if for some reason the
firms are able to get a lot more

00:04:27.710 --> 00:04:30.840
incremental benefit per
extra unit of labor,

00:04:30.840 --> 00:04:33.468
well that's going to shift both
the marginal revenue product

00:04:33.468 --> 00:04:35.450
at the firm level to the right,

00:04:35.450 --> 00:04:38.980
and the market labor demand
curve at the market level

00:04:38.980 --> 00:04:39.813
to the right.


Changes in labor supply

WEBVTT
Kind: captions
Language: en

00:00:00.210 --> 00:00:01.270
- [Instructor] In a previous video,

00:00:01.270 --> 00:00:03.500
we took a look at the labor markets,

00:00:03.500 --> 00:00:06.770
and we thought about it in the
context of the entire market

00:00:06.770 --> 00:00:09.580
and how it might impact a firm.

00:00:09.580 --> 00:00:13.190
So let's say that all of a sudden,

00:00:13.190 --> 00:00:16.050
the nation's immigration policy changes

00:00:16.050 --> 00:00:19.020
where they're willing to
bring in a lot more folks

00:00:19.020 --> 00:00:21.950
who have the skills
necessary to participate

00:00:21.950 --> 00:00:25.410
in the labor market that
we are studying right now.

00:00:25.410 --> 00:00:27.620
So when that immigration opens up

00:00:27.620 --> 00:00:30.300
and more people immigrate
into the country,

00:00:30.300 --> 00:00:34.410
what is going to happen
in this labor market?

00:00:34.410 --> 00:00:36.630
Pause this video, and also think about

00:00:36.630 --> 00:00:40.810
what is going to be the new
equilibrium quantity of labor

00:00:40.810 --> 00:00:43.800
and our new equilibrium wage?

00:00:43.800 --> 00:00:46.823
And how might that affect
this particular firm?

00:00:47.980 --> 00:00:49.600
All right, now let's do this together.

00:00:49.600 --> 00:00:52.980
So if all of a sudden, you
have a lot of immigration,

00:00:52.980 --> 00:00:56.800
new folks who can participate
in this labor market,

00:00:56.800 --> 00:01:00.410
well, that's going to increase
the supply at a given wage.

00:01:00.410 --> 00:01:03.430
So if this is the market
labor supply curve,

00:01:03.430 --> 00:01:05.450
let's call that sub one,

00:01:05.450 --> 00:01:07.570
it's going to shift to the right.

00:01:07.570 --> 00:01:11.470
At a given wage, you're
going to have more labor,

00:01:11.470 --> 00:01:13.970
so it's going to be like this.

00:01:13.970 --> 00:01:17.610
So this is the market labor

00:01:18.580 --> 00:01:22.750
supply curve two.

00:01:22.750 --> 00:01:26.010
Now what does that do
to the equilibrium wage

00:01:26.010 --> 00:01:30.110
and the quantity of labor?

00:01:30.110 --> 00:01:34.720
Well, our new equilibrium
wage is going to be lower.

00:01:34.720 --> 00:01:37.430
Could put it right over there,
I'll call that W sub two,

00:01:37.430 --> 00:01:38.570
with a little star there.

00:01:38.570 --> 00:01:42.850
And then we have a higher
equilibrium quantity of labor.

00:01:42.850 --> 00:01:45.860
So Q sub two, I'll put
a star right over there.

00:01:45.860 --> 00:01:47.810
Now what happens for this firm?

00:01:47.810 --> 00:01:50.900
Well, our equilibrium wage
in the market has gone down.

00:01:50.900 --> 00:01:52.920
And we assume that this firm,

00:01:52.920 --> 00:01:56.790
it is a perfectly
competitive labor market,

00:01:56.790 --> 00:01:58.330
so this firm is just going to pay

00:01:58.330 --> 00:02:00.480
whatever the market wage is.

00:02:00.480 --> 00:02:04.040
And so the marginal factor cost

00:02:04.040 --> 00:02:06.820
for the firm has now shifted down.

00:02:06.820 --> 00:02:09.130
It is now, this is
marginal factor cost one.

00:02:09.130 --> 00:02:11.570
Now this is marginal factor cost two.

00:02:11.570 --> 00:02:13.990
And now it is actually rational

00:02:13.990 --> 00:02:16.960
for the firm to produce more.

00:02:16.960 --> 00:02:18.260
So this is sub one,

00:02:18.260 --> 00:02:22.320
and let's call this
quantity of labor sub two.

00:02:22.320 --> 00:02:24.160
And so what are other things

00:02:24.160 --> 00:02:27.350
that might shift the supply
curve for labor to the right?

00:02:27.350 --> 00:02:29.690
We just talked about
immigration into a country.

00:02:29.690 --> 00:02:31.650
You could also imagine more people

00:02:31.650 --> 00:02:33.610
that are already in the
country being willing

00:02:33.610 --> 00:02:36.800
or being able to participate
in that labor market.

00:02:36.800 --> 00:02:39.690
For example, in the second
half of the 20th century,

00:02:39.690 --> 00:02:42.160
it became more acceptable for women

00:02:42.160 --> 00:02:43.810
to participate in the labor force.

00:02:43.810 --> 00:02:45.820
And so something like
that where all of a sudden

00:02:45.820 --> 00:02:48.610
you have all of these women
entering into the labor force

00:02:48.610 --> 00:02:52.330
or into the labor market
for a given market,

00:02:52.330 --> 00:02:55.340
well, that could also shift
the curve to the right.

00:02:55.340 --> 00:02:57.020
Now let's think about the other way.

00:02:57.020 --> 00:03:01.430
Let's imagine that you have
net migration out of a country.

00:03:01.430 --> 00:03:04.590
What would happen to the
market labor supply curve?

00:03:04.590 --> 00:03:05.900
Well, in that situation,

00:03:05.900 --> 00:03:08.810
we would shift to the left like this.

00:03:08.810 --> 00:03:10.320
At a given wage,

00:03:10.320 --> 00:03:12.880
there would be fewer people
that are willing to work.

00:03:12.880 --> 00:03:17.070
So this is the market labor

00:03:17.070 --> 00:03:20.290
supply curve.

00:03:20.290 --> 00:03:22.330
I will call that sub three.

00:03:22.330 --> 00:03:23.750
There's other things that could cause it.

00:03:23.750 --> 00:03:25.550
Maybe people's preferences change.

00:03:25.550 --> 00:03:27.870
And in this particular labor market,

00:03:27.870 --> 00:03:30.110
people aren't willing
to work there as much.

00:03:30.110 --> 00:03:32.970
Maybe social norms change
where it's just not cool

00:03:32.970 --> 00:03:34.900
to work in that labor market.

00:03:34.900 --> 00:03:38.210
Maybe there's another labor
market in another industry

00:03:38.210 --> 00:03:40.340
that all of a sudden is paying better.

00:03:40.340 --> 00:03:42.260
In that situation, fewer
people would be willing

00:03:42.260 --> 00:03:43.980
to work in this labor market.

00:03:43.980 --> 00:03:48.910
And so when you shift to
the left, your market wages

00:03:50.020 --> 00:03:53.980
go up, so W sub three, just like that.

00:03:53.980 --> 00:03:56.240
The quantity of labor

00:03:57.392 --> 00:04:00.740
is going to go down, Q sub three.

00:04:00.740 --> 00:04:01.880
And then as we see,

00:04:01.880 --> 00:04:04.610
if we look at how it
impacts a particular firm,

00:04:04.610 --> 00:04:06.910
in a perfectly competitive labor market,

00:04:06.910 --> 00:04:09.490
this would be the marginal factor cost

00:04:09.490 --> 00:04:11.480
for a firm that's
participating in that market.

00:04:11.480 --> 00:04:15.310
So this is MFC sub three.

00:04:15.310 --> 00:04:17.890
And then now the quantity of labor

00:04:17.890 --> 00:04:21.240
that this firm would
hire is going to go down.

00:04:21.240 --> 00:04:23.560
So quantity that the
firm hires, sub three,

00:04:23.560 --> 00:04:26.980
put a star over there,
and it has gone down.

00:04:26.980 --> 00:04:28.390
So hopefully what we just went through

00:04:28.390 --> 00:04:30.210
isn't too much of a surprise for you.

00:04:30.210 --> 00:04:33.720
As you see, labor markets
behave very similarly

00:04:33.720 --> 00:04:35.970
to the markets for many other things.

00:04:35.970 --> 00:04:38.390
If more labor enters into a market,

00:04:38.390 --> 00:04:41.440
well, it's gonna shift the
supply of labor to the right.

00:04:41.440 --> 00:04:44.120
And if more labor leaves the market

00:04:44.120 --> 00:04:46.020
or doesn't want to be in that market,

00:04:46.020 --> 00:04:48.300
it's going to shift the market labor

00:04:48.300 --> 00:04:49.823
supply curve to the left.


Introduction to labor markets

WEBVTT
Kind: captions
Language: en

00:00:01.040 --> 00:00:03.140
- [Instructor] We've spent
a lot of time already

00:00:03.140 --> 00:00:05.850
thinking about markets
for the goods and services

00:00:05.850 --> 00:00:07.270
that firms produce.

00:00:07.270 --> 00:00:10.960
Now we're gonna talk about
the markets or the factors

00:00:10.960 --> 00:00:15.930
of production often known
as the factor markets.

00:00:15.930 --> 00:00:17.231
What are those factors of production?

00:00:17.231 --> 00:00:18.950
Well we've talked about
'em multiple times,

00:00:18.950 --> 00:00:22.030
things like land, labor,
capital, and in particular,

00:00:22.030 --> 00:00:25.920
we're going to focus
in this video on labor.

00:00:25.920 --> 00:00:29.330
So what we have here is some
axis where the vertical axis

00:00:29.330 --> 00:00:33.540
is labeled the wage rate, you
could do that as the price

00:00:33.540 --> 00:00:35.830
of labor, it'd be per unit time,

00:00:35.830 --> 00:00:38.350
and on the horizontal axis
in both of these cases,

00:00:38.350 --> 00:00:40.950
we have the quantity of labor
which would be the number

00:00:40.950 --> 00:00:45.250
of workers in that unit of time.

00:00:45.250 --> 00:00:48.310
And what we're gonna do on
the right hand side right here

00:00:48.310 --> 00:00:51.950
is think about it form the
point of view of a firm,

00:00:51.950 --> 00:00:54.410
and then on the left hand side,
we're gonna think about it

00:00:54.410 --> 00:00:58.680
from the point of view
of the market as a whole,

00:00:58.680 --> 00:01:02.200
and to understand it first
on the firm's point of view,

00:01:02.200 --> 00:01:05.030
we can think about the demand from a firm.

00:01:05.030 --> 00:01:07.580
How much benefit is a firm getting

00:01:07.580 --> 00:01:11.100
when it hires that incremental worker?

00:01:11.100 --> 00:01:13.210
And to do that, we're
gonna think about something

00:01:13.210 --> 00:01:15.533
called marginal revenue product.

00:01:15.533 --> 00:01:18.602
Now marginal revenue
product sounds very fancy,

00:01:18.602 --> 00:01:20.850
but I'm gonna set up a little table here

00:01:20.850 --> 00:01:23.353
so that we can understand
in reasonable terms.

00:01:23.353 --> 00:01:26.510
So let's say that this is our labor again,

00:01:26.510 --> 00:01:28.960
so I'm gonna set up several columns here.

00:01:28.960 --> 00:01:32.636
This is how much product
the firm can produce

00:01:32.636 --> 00:01:35.970
based on the number of labor units.

00:01:35.970 --> 00:01:39.080
Then you have the
marginal product of labor

00:01:39.080 --> 00:01:41.240
which is for each
incremental unit of labor,

00:01:41.240 --> 00:01:43.090
how much more are you able to produce?

00:01:43.090 --> 00:01:45.200
So let me make some columns here,

00:01:45.200 --> 00:01:47.660
and I'm going to add more
columns in a little bit.

00:01:47.660 --> 00:01:50.550
So let's say we could
have zero units of labor,

00:01:50.550 --> 00:01:52.747
one unit of labor, two units of labor.

00:01:52.747 --> 00:01:55.330
When you have zero units, you're
definitely going to produce

00:01:55.330 --> 00:01:57.530
zero units in that time period.

00:01:57.530 --> 00:02:00.560
Let's say when you have one unit of labor,

00:02:00.560 --> 00:02:03.350
one worker in the time period,
you're able to produce two.

00:02:03.350 --> 00:02:07.840
When you have that second
labor, or that second worker,

00:02:07.840 --> 00:02:10.580
you're now able to produce
six, and so we can think

00:02:10.580 --> 00:02:12.472
about the marginal product of labor.

00:02:12.472 --> 00:02:16.427
That first worker is able to
produce an incremental two,

00:02:16.427 --> 00:02:19.660
we went from zero to two,
but that second worker,

00:02:19.660 --> 00:02:21.970
by adding them, now you're able to produce

00:02:21.970 --> 00:02:25.550
an incremental three units, and so here,

00:02:25.550 --> 00:02:28.180
this might be due to
specialization, things like that,

00:02:28.180 --> 00:02:30.240
but over time you might have diminishing

00:02:30.240 --> 00:02:32.118
marginal products of labor,

00:02:32.118 --> 00:02:34.332
but then if you want to think about

00:02:34.332 --> 00:02:35.700
well what's the real benefit to the firm,

00:02:35.700 --> 00:02:37.420
it's not just what is being produced

00:02:37.420 --> 00:02:39.710
but how much the firm can get for that.

00:02:39.710 --> 00:02:42.210
So we can think about
the marginal revenue,

00:02:42.210 --> 00:02:45.080
and so let's just say that
that is, I don't know,

00:02:45.080 --> 00:02:48.260
four dollars, and it's just
a constant four dollars,

00:02:48.260 --> 00:02:52.129
and then we can think about
the marginal revenue product

00:02:52.129 --> 00:02:54.765
which is just going to be
the marginal product of labor

00:02:54.765 --> 00:02:58.265
times the amount of dollars
or incremental amount

00:02:58.265 --> 00:03:00.650
of dollars per unit so it's just gonna be

00:03:00.650 --> 00:03:03.700
two times four here which is
just going to be eight dollars.

00:03:03.700 --> 00:03:05.500
So one way to think about
it, when the firm goes

00:03:05.500 --> 00:03:09.337
from zero labors, or zero
workers, to one worker,

00:03:09.337 --> 00:03:12.770
you're going to have an
incremental eight dollars

00:03:12.770 --> 00:03:15.707
of revenue based on what
that worker can produce,

00:03:15.707 --> 00:03:17.920
and then when you add another worker,

00:03:17.920 --> 00:03:19.430
you get three times four,

00:03:19.430 --> 00:03:23.190
you get an incremental
12 dollars of revenue.

00:03:23.190 --> 00:03:26.103
And so we can graph this, and as I said,

00:03:26.103 --> 00:03:28.980
sometimes you might say
initially you could get

00:03:28.980 --> 00:03:30.893
some benefits of specialization,

00:03:30.893 --> 00:03:33.470
but then over time you
get diminishing returns,

00:03:33.470 --> 00:03:35.460
so it might look something like this.

00:03:35.460 --> 00:03:37.100
Typically, in an econ class,

00:03:37.100 --> 00:03:40.380
you'll just see a downward
sloping line for simplicity,

00:03:40.380 --> 00:03:45.280
but the firm's marginal revenue product,

00:03:45.280 --> 00:03:49.920
you can view it as that individual
firm's demand for labor.

00:03:49.920 --> 00:03:52.560
At those first few units of labor,

00:03:52.560 --> 00:03:55.580
it has a very high
marginal revenue product,

00:03:55.580 --> 00:03:57.550
but over time you have diminishing returns

00:03:57.550 --> 00:04:01.565
from adding more and more
people onto the staff.

00:04:01.565 --> 00:04:04.410
Now how would this look at the market?

00:04:04.410 --> 00:04:06.240
Well what you could do is you could add up

00:04:06.240 --> 00:04:08.190
all the marginal revenue products

00:04:08.190 --> 00:04:10.370
from all the firms in the market,

00:04:10.370 --> 00:04:12.170
and if you add them
up, you're going to get

00:04:12.170 --> 00:04:14.220
a market labor demand curve.

00:04:14.220 --> 00:04:16.130
And let me do this in a
slight different color.

00:04:16.130 --> 00:04:17.910
If you add all of these up,

00:04:17.910 --> 00:04:20.840
you are going to get something like this.

00:04:20.840 --> 00:04:21.730
Let me write that out.

00:04:21.730 --> 00:04:26.730
That is the market market
labor demand demand curve.

00:04:31.329 --> 00:04:35.500
Now what is going to be the
reasonable level of labor

00:04:35.500 --> 00:04:38.183
quantity both in the market
and how much would be rational

00:04:38.183 --> 00:04:40.282
for this firm to hire?

00:04:40.282 --> 00:04:41.650
Well to think about that,

00:04:41.650 --> 00:04:44.270
we think about the market
labor supply curve,

00:04:44.270 --> 00:04:46.130
and I'm gonna focus on the market first,

00:04:46.130 --> 00:04:48.930
and just like the market for most things,

00:04:48.930 --> 00:04:50.700
the higher the wage,

00:04:50.700 --> 00:04:52.590
you're going to have more folks

00:04:52.590 --> 00:04:55.310
willing to participate
in that labor market.

00:04:55.310 --> 00:04:56.950
So at a low wage, not a lot of people

00:04:56.950 --> 00:04:59.270
are going to want to
work in this industry,

00:04:59.270 --> 00:05:01.120
but as wages get higher and higher,

00:05:01.120 --> 00:05:03.880
well then more and more
people are going to be up

00:05:03.880 --> 00:05:06.588
for participating in this labor market,

00:05:06.588 --> 00:05:11.588
and so this right over
here is the market labor

00:05:12.830 --> 00:05:17.120
supply curve supply curve,

00:05:17.120 --> 00:05:19.997
and so what would be the
equilibrium price of labor

00:05:19.997 --> 00:05:22.470
which was really just the wage rate,

00:05:22.470 --> 00:05:25.890
well it's where your supply
and demand curves intersect

00:05:25.890 --> 00:05:28.060
and we've seen this
multiple times already.

00:05:28.060 --> 00:05:31.850
So this is I'll just call
that wage star like that,

00:05:31.850 --> 00:05:35.120
and then the equilibrium
quantity of labor,

00:05:35.120 --> 00:05:38.191
we can just call that
Q star right over here.

00:05:38.191 --> 00:05:41.262
Now how would that impact
what's going on in the firm?

00:05:41.262 --> 00:05:44.500
Well if we assume that this
is a perfectly competitive

00:05:44.500 --> 00:05:46.990
labor market, we'll assume that this firm

00:05:46.990 --> 00:05:50.090
can't set the wage, it's just
going to have to pay people

00:05:50.090 --> 00:05:53.105
whatever the equilibrium wage actually is,

00:05:53.105 --> 00:05:57.565
and so this right over here
is going to be the firm's

00:05:57.565 --> 00:06:00.782
what's known as marginal factor cost,

00:06:00.782 --> 00:06:04.031
the cost per incremental unit of labor,

00:06:04.031 --> 00:06:06.930
that's just the wage it's
going to have to pay.

00:06:06.930 --> 00:06:10.530
It can get as much of that
labor as we need, we assume,

00:06:10.530 --> 00:06:14.840
'cause we're talking about
a perfectly competitive

00:06:14.840 --> 00:06:16.420
labor market in this industry,

00:06:16.420 --> 00:06:18.260
I'm just trying to draw a straighter line.

00:06:18.260 --> 00:06:23.260
So this right over here is
our marginal factor cost,

00:06:24.230 --> 00:06:27.950
and so you can imagine what
is the rational quantity

00:06:27.950 --> 00:06:29.455
for this firm to hire?

00:06:29.455 --> 00:06:32.690
It would keep hiring all the way until

00:06:32.690 --> 00:06:37.024
the incremental revenue
per unit of labor it gets

00:06:37.024 --> 00:06:42.024
is no longer higher than the
incremental cost of that labor,

00:06:42.120 --> 00:06:44.690
and that would happen right over here.

00:06:44.690 --> 00:06:48.580
So this would tell us the
rational quantity of labor,

00:06:48.580 --> 00:06:50.550
I'll call that quantity for,

00:06:50.550 --> 00:06:55.160
I'll call it Q star for
the firm right over there.

00:06:55.160 --> 00:06:56.770
I'll leave you there now.

00:06:56.770 --> 00:06:57.760
The important thing to realize,

00:06:57.760 --> 00:07:00.550
this seems similar to what
we've seen before when we talked

00:07:00.550 --> 00:07:02.927
about things like marginal
revenue and marginal cost

00:07:02.927 --> 00:07:06.330
for a firm's good, but
here we're talking about

00:07:06.330 --> 00:07:10.624
a firm's inputs and so instead
of it being the marginal

00:07:10.624 --> 00:07:13.422
revenue in the price in a
perfectly competitive firm

00:07:13.422 --> 00:07:16.460
that is defined by the equilibrium price,

00:07:16.460 --> 00:07:19.350
here it is the firm's cost that is defined

00:07:19.350 --> 00:07:22.913
by the equilibrium wage in the market.


Game theory worked example from A P  Microeconomics

WEBVTT
Kind: captions
Language: en

00:00:00.290 --> 00:00:02.280
- [Instructor] What we have
here is a free response

00:00:02.280 --> 00:00:05.470
question that you might
see on an AP microeconomics

00:00:05.470 --> 00:00:07.750
type exam that deals with game theory,

00:00:07.750 --> 00:00:10.900
and it tells us Breadbasket and Quicklunch

00:00:10.900 --> 00:00:14.510
are the only two sandwich
shops serving a small town.

00:00:14.510 --> 00:00:16.210
So, we're in an oligopoly situation

00:00:16.210 --> 00:00:18.170
where we only have a few firms.

00:00:18.170 --> 00:00:21.320
Each shop can choose to set a high price,

00:00:21.320 --> 00:00:24.090
or a low price, for sandwiches.

00:00:24.090 --> 00:00:27.740
The payoff matrix below shows
the daily profits for each

00:00:27.740 --> 00:00:31.670
combination of prices that
the two shops could choose.

00:00:31.670 --> 00:00:34.500
The first entry shows
Breadbasket's profits,

00:00:34.500 --> 00:00:37.530
and the second entry shows
Quicklunch's profits.

00:00:37.530 --> 00:00:40.090
Assuming that both shops
know the information

00:00:40.090 --> 00:00:43.130
shown in the matrix, answer the following.

00:00:43.130 --> 00:00:46.160
So, just to make sure I
understand what's going on here,

00:00:46.160 --> 00:00:49.100
this is saying that for example
if bread, Breadbasket can

00:00:49.100 --> 00:00:51.630
either choose to charge
high prices or low prices.

00:00:51.630 --> 00:00:53.950
Quicklunch can either
choose to charge high prices

00:00:53.950 --> 00:00:55.150
or low prices.

00:00:55.150 --> 00:00:57.993
If Breadbasket chooses high prices

00:00:57.993 --> 00:01:00.940
and Quicklunch also chooses high prices,

00:01:00.940 --> 00:01:02.850
then what this tells us is the first one

00:01:02.850 --> 00:01:06.680
is Breadbasket's profit
per day would be $105,

00:01:06.680 --> 00:01:09.680
while Quicklunch's profit
per day would be $110,

00:01:09.680 --> 00:01:12.130
and then this is a
situation where Breadbasket

00:01:12.130 --> 00:01:14.500
is low and Quicklunch is high price,

00:01:14.500 --> 00:01:16.437
and then Breadbasket would make 120,

00:01:16.437 --> 00:01:19.830
and Quicklunch would make
80, and then when Quicklunch

00:01:19.830 --> 00:01:23.560
has low prices we can see
what are the profit of either

00:01:23.560 --> 00:01:25.360
when Breadbasket charges high prices

00:01:25.360 --> 00:01:27.400
or Breadbasket charges low.

00:01:27.400 --> 00:01:28.233
So, with that out of the way,

00:01:28.233 --> 00:01:30.120
let's try to answer these questions.

00:01:30.120 --> 00:01:34.200
Does each shop have a dominant strategy

00:01:34.200 --> 00:01:38.430
to set a high price, a dominant
strategy to set a low price,

00:01:38.430 --> 00:01:41.320
or does it have no dominant strategy?

00:01:41.320 --> 00:01:43.210
So, pause the video and
try to figure that out,

00:01:43.210 --> 00:01:45.860
and just as a bit of
a hint, or a reminder,

00:01:45.860 --> 00:01:49.830
a dominant strategy is
a strategy of regardless

00:01:49.830 --> 00:01:52.944
of what the other player
does you would still

00:01:52.944 --> 00:01:55.220
be better off to make that choice.

00:01:55.220 --> 00:01:57.500
So, a dominant strategy
of setting a high price

00:01:57.500 --> 00:02:00.140
would be regardless of
whether the other player

00:02:00.140 --> 00:02:02.830
decides to set a high or
low price a high price

00:02:02.830 --> 00:02:04.560
would always make sense for you.

00:02:04.560 --> 00:02:07.353
So, pause the video and try
to see if you can answer that.

00:02:08.420 --> 00:02:09.810
All right, now let's see what

00:02:09.810 --> 00:02:12.420
Breadbasket's situation is here.

00:02:12.420 --> 00:02:14.810
So, if we think, Breadbasket
of course can either choose

00:02:14.810 --> 00:02:16.440
to go high or low.

00:02:16.440 --> 00:02:21.420
Now, if Quicklunch goes high,
what should Breadbasket do?

00:02:21.420 --> 00:02:23.800
Well, then we are in
this column over here,

00:02:23.800 --> 00:02:25.810
and these two numbers are for Breadbasket,

00:02:25.810 --> 00:02:29.810
and so if Quicklunch goes
high then Breadbasket

00:02:29.810 --> 00:02:34.550
could go high and charge
105, or it could go low

00:02:34.550 --> 00:02:36.250
and charge 120.

00:02:36.250 --> 00:02:40.350
So, if Quicklunch goes high,
Breadbasket should go low.

00:02:40.350 --> 00:02:44.870
So, let me write this,
Quicklunch, Quicklunch,

00:02:44.870 --> 00:02:49.870
if it chooses to go high, then Breadbasket

00:02:49.960 --> 00:02:51.850
should go low.

00:02:51.850 --> 00:02:55.100
Now, what happens if
Quicklunch chooses to go low?

00:02:55.100 --> 00:02:58.040
Well, if Quicklunch chooses to go low,

00:02:58.040 --> 00:03:01.060
the two options for Breadbasket
are either $40 of profit

00:03:01.060 --> 00:03:03.060
per day if they have a high price,

00:03:03.060 --> 00:03:04.700
because a lot of their
business would go to Quicklunch

00:03:04.700 --> 00:03:07.370
in that situation, or
they could go low price

00:03:07.370 --> 00:03:09.120
and make $75 per day.

00:03:09.120 --> 00:03:11.660
So, even if Quicklunch goes
low it still makes sense

00:03:11.660 --> 00:03:14.100
for Breadbasket to go low.

00:03:14.100 --> 00:03:17.690
So, Breadbasket goes low.

00:03:17.690 --> 00:03:21.090
So, we see that Breadbasket,
no matter what Quicklunch does,

00:03:21.090 --> 00:03:23.710
it makes sense for Breadbasket to go low.

00:03:23.710 --> 00:03:25.810
So, Breadbasket has a dominant strategy

00:03:25.810 --> 00:03:27.340
to set a low price.

00:03:27.340 --> 00:03:31.860
So, the dominant, dominant strategy

00:03:33.540 --> 00:03:37.770
to set, let me write that
a little bit clearer,

00:03:37.770 --> 00:03:40.200
set low price.

00:03:40.200 --> 00:03:43.470
All right, now, Quicklunch,
so, we could do the same type

00:03:43.470 --> 00:03:46.770
of analysis based on what
Breadbasket might choose to do.

00:03:46.770 --> 00:03:51.250
So, if we see, okay, if
Breadbasket goes high,

00:03:51.250 --> 00:03:53.280
what should Quicklunch do?

00:03:53.280 --> 00:03:56.240
Well, let's see, then Quicklunch should,

00:03:56.240 --> 00:03:59.340
so, if Breadbasket goes high, Quicklunch,

00:03:59.340 --> 00:04:00.950
should it go high or low?

00:04:00.950 --> 00:04:04.860
So, it would have the option of $110,

00:04:04.860 --> 00:04:07.550
or it would have an option of $130.

00:04:07.550 --> 00:04:09.920
So, if Breadbasket goes high,

00:04:09.920 --> 00:04:12.670
Quicklunch is better off going low.

00:04:12.670 --> 00:04:13.850
So, let me write that down.

00:04:13.850 --> 00:04:15.460
Quicklunch should go low.

00:04:15.460 --> 00:04:20.460
And if Breadbasket goes low
what should Quicklunch do?

00:04:20.470 --> 00:04:23.840
So, if Breadbasket goes low,
Quicklunch can either make

00:04:23.840 --> 00:04:27.760
80 if it goes high or 70 if it goes low.

00:04:27.760 --> 00:04:30.130
So, in this situation
if Breadbasket goes low

00:04:30.130 --> 00:04:32.930
it makes sense actually
for Quicklunch to go high

00:04:32.930 --> 00:04:34.340
and make the 80.

00:04:34.340 --> 00:04:37.160
So, Quicklunch would go high.

00:04:37.160 --> 00:04:39.680
So, Quicklunch has no dominant strategy.

00:04:39.680 --> 00:04:41.690
It doesn't make sense for
them to always go low,

00:04:41.690 --> 00:04:45.200
or always go high regardless
of what Breadbasket is doing.

00:04:45.200 --> 00:04:46.890
Depending on Breadbasket,
it might make sense

00:04:46.890 --> 00:04:48.720
for them to go low if
Breadbasket goes high,

00:04:48.720 --> 00:04:50.850
or high if Breadbasket goes low.

00:04:50.850 --> 00:04:55.783
So, no dominant, dominant strategy.

00:04:58.210 --> 00:05:02.270
If the two shops do not
cooperate on setting prices,

00:05:02.270 --> 00:05:05.624
what will be the profit for each shop?

00:05:05.624 --> 00:05:07.550
Well, actually, just pause the video.

00:05:07.550 --> 00:05:09.793
See if you can answer that
before we work through it.

00:05:11.280 --> 00:05:13.780
Well, we already know that Breadbasket has

00:05:13.780 --> 00:05:15.590
a dominant strategy to set a low price.

00:05:15.590 --> 00:05:19.250
So, Breadbasket is gonna
go low, regardless.

00:05:19.250 --> 00:05:22.490
So, that we're going to end up
in this row right over here,

00:05:22.490 --> 00:05:26.090
and if we are in that situation
where Breadbasket goes low

00:05:26.090 --> 00:05:28.760
regardless we know that it
makes sense for Quicklunch

00:05:28.760 --> 00:05:31.540
to go high, because they
could either make 80 or 70.

00:05:31.540 --> 00:05:33.480
Well, they're gonna go high,
and so we're going to end up

00:05:33.480 --> 00:05:35.900
in this column right over here.

00:05:35.900 --> 00:05:38.420
So, if the two shops do not
cooperate on setting prices,

00:05:38.420 --> 00:05:41.957
the profit of each shop would
be Breadbasket would be making

00:05:41.957 --> 00:05:46.957
$120 a day and Quicklunch
would be making $80 a day.

00:05:48.000 --> 00:05:52.160
And this is a Nash
equilibrium, because on its own

00:05:52.160 --> 00:05:57.100
no firm can change its decision
to optimize its prices more,

00:05:57.100 --> 00:06:00.140
because if you are in this,
if you are in this cell

00:06:00.140 --> 00:06:01.330
right over here, Quicklunch can't

00:06:01.330 --> 00:06:02.640
change Breadbasket's decision.

00:06:02.640 --> 00:06:04.640
So, Quicklunch could say
I'm either gonna make 80

00:06:04.640 --> 00:06:06.890
or I'm gonna make 70, so,
it wouldn't make any sense

00:06:06.890 --> 00:06:09.610
for them to switch away,
and then Breadbasket,

00:06:09.610 --> 00:06:12.120
they can't make the
decision for Quicklunch.

00:06:12.120 --> 00:06:14.040
They can say, hey, we're
either gonna make 120

00:06:14.040 --> 00:06:16.350
or we're gonna make 105.

00:06:16.350 --> 00:06:18.880
And so, since we can't change
what Quicklunch is doing,

00:06:18.880 --> 00:06:20.720
well, of course we're going
to choose to make 120.

00:06:20.720 --> 00:06:23.224
So, people will stay in
this bottom left cell

00:06:23.224 --> 00:06:25.210
(mumbles) a Nash equilibrium.

00:06:25.210 --> 00:06:29.010
All right, so the next part
they ask us, or they tell us,

00:06:29.010 --> 00:06:30.900
the town government is concerned that

00:06:30.900 --> 00:06:32.740
food prices are too high.

00:06:32.740 --> 00:06:37.000
It decides to give a daily
subsidy of $20 to any shop

00:06:37.000 --> 00:06:40.390
that chooses to set a low
price for its food items.

00:06:40.390 --> 00:06:42.540
Redraw the payoff matrix under

00:06:42.540 --> 00:06:44.150
the government subsidy system.

00:06:44.150 --> 00:06:45.460
So, like always, pause this video,

00:06:45.460 --> 00:06:46.500
and go through that exercise.

00:06:46.500 --> 00:06:47.550
It'll be interesting.

00:06:48.460 --> 00:06:50.470
All right, now, let's do this together.

00:06:50.470 --> 00:06:53.960
So, we have Breadbasket,
and I'll try to write bread,

00:06:53.960 --> 00:06:56.550
actually, let me draw
my little matrix first.

00:06:56.550 --> 00:06:58.893
So, it's a two by two.

00:06:59.880 --> 00:07:04.343
So, almost done with my matrix.

00:07:06.350 --> 00:07:07.910
And one more.

00:07:07.910 --> 00:07:09.090
That wasn't near the middle.

00:07:09.090 --> 00:07:10.950
There you go, right around there.

00:07:10.950 --> 00:07:12.840
Still, maybe there.

00:07:12.840 --> 00:07:14.740
And then we have that there.

00:07:14.740 --> 00:07:19.630
And then we have high, low, high, low,

00:07:19.630 --> 00:07:21.043
and then you have Quicklunch.

00:07:22.180 --> 00:07:23.530
If I were actually doing this on the test

00:07:23.530 --> 00:07:24.920
maybe I'd write this a little bit lower

00:07:24.920 --> 00:07:29.363
so it's a little bit neater,
and then this is Breadbasket.

00:07:30.530 --> 00:07:32.360
And let's see.

00:07:32.360 --> 00:07:34.630
It's giving a daily subsidy of $20.

00:07:34.630 --> 00:07:37.500
So, if we could just do
that, that adds to the profit

00:07:37.500 --> 00:07:40.740
of a firm that is selling at low prices.

00:07:40.740 --> 00:07:42.210
So, if they're both at high prices,

00:07:42.210 --> 00:07:43.270
that's not, they're not going to be able

00:07:43.270 --> 00:07:45.230
to get that subsidy from the government.

00:07:45.230 --> 00:07:49.633
So, we're still going to be at 105 and 110

00:07:50.940 --> 00:07:54.300
for Breadbasket and
Quicklunch respectively.

00:07:54.300 --> 00:07:58.400
Now, if Breadbasket stays
high in this situation,

00:07:58.400 --> 00:08:00.857
well then, they're still
only going to make $40.

00:08:01.860 --> 00:08:04.460
But in this situation right over here

00:08:04.460 --> 00:08:06.980
Quicklunch is going to get a $20 subsidy

00:08:06.980 --> 00:08:08.910
because they are choosing to go low.

00:08:08.910 --> 00:08:12.130
So, they're going to make 130 plus 20.

00:08:12.130 --> 00:08:13.550
So, I'll write that in a different color.

00:08:13.550 --> 00:08:17.890
So, I will put that in
and I'll put this in red.

00:08:17.890 --> 00:08:19.500
So, 130 plus 20.

00:08:19.500 --> 00:08:22.200
They're going to make $150
because they're choosing

00:08:22.200 --> 00:08:23.240
to go low price here.

00:08:23.240 --> 00:08:26.170
That's what qualifies you for the subsidy,

00:08:26.170 --> 00:08:29.940
and in this situation if
Breadbasket goes low price

00:08:29.940 --> 00:08:33.340
they're going to make 120,
what they would have made

00:08:33.340 --> 00:08:35.140
in that situation, plus 20.

00:08:35.140 --> 00:08:38.170
So, this is going to be 140.

00:08:38.170 --> 00:08:40.950
But this is a situation
where Quicklunch is charging

00:08:40.950 --> 00:08:42.220
a high price.

00:08:42.220 --> 00:08:44.090
So, they're not going to get the subsidy.

00:08:44.090 --> 00:08:46.530
So they're still going to make $80.

00:08:46.530 --> 00:08:49.440
And then this cell is both
of them charging a low price.

00:08:49.440 --> 00:08:51.800
So they're both gonna get
$20 more than what you see

00:08:51.800 --> 00:08:52.860
right over here.

00:08:52.860 --> 00:08:57.480
So, Breadbasket would make $95, $95,

00:08:57.480 --> 00:09:02.480
and Quicklunch is going to
make $90 in this situation.

00:09:03.200 --> 00:09:05.980
And let's see, they ask us more questions.

00:09:05.980 --> 00:09:10.070
They say using your redrawn payoff matrix

00:09:10.070 --> 00:09:12.430
answer each of the following.

00:09:12.430 --> 00:09:16.230
Would Quicklunch choose to set
a high price or a low price?

00:09:16.230 --> 00:09:20.870
Explain using specific values
from your redrawn matrix.

00:09:20.870 --> 00:09:23.603
So, pause the video and
see if you can answer that.

00:09:24.850 --> 00:09:28.420
All right, so we're going
to look at Quicklunch now,

00:09:28.420 --> 00:09:30.650
and we could do the same type of analysis

00:09:30.650 --> 00:09:32.950
to see if they have a dominant strategy.

00:09:32.950 --> 00:09:37.950
We could say, okay, if
Breadbasket goes high, goes high,

00:09:38.760 --> 00:09:41.400
what is Quicklunch going to do?

00:09:41.400 --> 00:09:45.740
So, if Breadbasket goes
high, now in this situation

00:09:45.740 --> 00:09:48.870
Quicklunch will either
go high and make $110

00:09:48.870 --> 00:09:51.000
or it could go low and make 150.

00:09:51.000 --> 00:09:53.460
So Quicklunch is going to
go low in this situation,

00:09:53.460 --> 00:09:57.536
and if Breadbasket goes
low Quicklunch canmake $80

00:09:57.536 --> 00:10:00.460
if it goes high or it could
make $90 if it goes low.

00:10:00.460 --> 00:10:05.220
So once again, Quicklunch
is going to go low.

00:10:05.220 --> 00:10:08.817
So, Quicklunch, Quicklunch now has

00:10:14.090 --> 00:10:17.980
dominant, dominant strategy

00:10:20.950 --> 00:10:25.860
for low price, for low price.

00:10:25.860 --> 00:10:29.020
And I could try to explain this out.

00:10:29.020 --> 00:10:33.630
If Breadbasket goes high,
I'll write it out here.

00:10:33.630 --> 00:10:36.320
Normally you have a little
book to write this in, but,

00:10:36.320 --> 00:10:41.017
if bread, I'll abbreviate,
Breadbasket goes high

00:10:42.695 --> 00:10:47.695
Quicklunch is rational to
make $150 instead of 110,

00:10:51.820 --> 00:10:56.807
would want to make

00:10:58.167 --> 00:11:02.850
$150 versus 110

00:11:04.210 --> 00:11:07.233
by going low.

00:11:10.130 --> 00:11:14.677
If Breadbasket goes low,

00:11:16.060 --> 00:11:20.830
goes low, Quicklunch makes

00:11:22.297 --> 00:11:26.993
$90 versus, versus $80

00:11:28.370 --> 00:11:32.670
by going low.

00:11:32.670 --> 00:11:36.110
All right, would the profits
for Breadbasket increase,

00:11:36.110 --> 00:11:38.100
decrease, or stay the same?

00:11:38.100 --> 00:11:42.010
Explain with a comparison to
your answer in part B one.

00:11:42.010 --> 00:11:43.640
Use specific values.

00:11:43.640 --> 00:11:47.710
So, before subsidy,
actually pause this video

00:11:47.710 --> 00:11:49.620
and try to do this as well.

00:11:49.620 --> 00:11:52.370
Before subsidy, oh, now
we'll do it together.

00:11:52.370 --> 00:11:57.370
Before subsidy, Quicklunch,
or I should say Breadbasket,

00:11:58.020 --> 00:12:03.020
Breadbasket was making,
and we have it up here.

00:12:04.290 --> 00:12:07.500
So, if the two shops do not
cooperate on setting prices,

00:12:07.500 --> 00:12:08.730
what will be the profit of each shop?

00:12:08.730 --> 00:12:11.330
We saw Breadbasket would make $120,

00:12:11.330 --> 00:12:14.320
'cause that was that
Nash equilibrium state.

00:12:14.320 --> 00:12:18.763
After subsidy, after subsidy,

00:12:19.860 --> 00:12:20.810
so, let's look at it.

00:12:20.810 --> 00:12:25.810
We still have, Breadbasket
still has a dominant strategy

00:12:26.500 --> 00:12:30.830
to go low, because if Quicklunch goes high

00:12:30.830 --> 00:12:34.530
Breadbasket would wanna
make the 140 instead of 105,

00:12:34.530 --> 00:12:38.400
and if Quicklunch goes low
Breadbasket would wanna make 95

00:12:38.400 --> 00:12:40.290
instead of 40.

00:12:40.290 --> 00:12:42.980
But now they both have a
dominant strategy for going low.

00:12:42.980 --> 00:12:46.530
So, we're going to end
up in this bottom right,

00:12:46.530 --> 00:12:48.630
this bottom right cell.

00:12:48.630 --> 00:12:53.630
After subsidy, both have
dominant, dominant strategy

00:12:58.430 --> 00:13:03.200
to go low, resulting

00:13:05.099 --> 00:13:08.063
in $95 profit

00:13:10.500 --> 00:13:13.430
for Breadbasket.

00:13:13.430 --> 00:13:17.730
And so, $95 is less than $120.

00:13:19.390 --> 00:13:24.390
So, Breadbasket's profit goes,
or I should say it decreases,

00:13:27.130 --> 00:13:31.313
decreases, and we are done.


Long term economic profit for monopolistic competition

WEBVTT
Kind: captions
Language: en

00:00:00.170 --> 00:00:01.520
- [Instructor] We have
already thought about

00:00:01.520 --> 00:00:04.950
the demand curves for perfect
competition and monopolies

00:00:04.950 --> 00:00:08.060
and the types of economic
profit that might result in.

00:00:08.060 --> 00:00:10.350
And this video, we're
going to focus on something

00:00:10.350 --> 00:00:12.320
in between, which we've talked
about in previous videos,

00:00:12.320 --> 00:00:14.580
which is monopolistic competition.

00:00:14.580 --> 00:00:16.900
So, as you can see in all three scenarios,

00:00:16.900 --> 00:00:18.230
we have a similar cost structure.

00:00:18.230 --> 00:00:19.700
We have our marginal cost curve

00:00:19.700 --> 00:00:21.330
and our average total cost curve

00:00:21.330 --> 00:00:22.450
that's at a minimum point

00:00:22.450 --> 00:00:25.590
right where it intersects
the marginal cost curve.

00:00:25.590 --> 00:00:27.190
But it's very different
whether we're talking

00:00:27.190 --> 00:00:29.170
about a monopoly or perfect competition

00:00:29.170 --> 00:00:31.330
when it comes to the demand curve.

00:00:31.330 --> 00:00:34.410
For perfect competition,
it is one of many firms

00:00:34.410 --> 00:00:37.970
with an undifferentiated product
and no barriers to entry.

00:00:37.970 --> 00:00:40.250
So, these firms just
have to be price-takers.

00:00:40.250 --> 00:00:42.470
Whatever the price is in the market,

00:00:42.470 --> 00:00:45.220
each of those firms just
have to take that price.

00:00:45.220 --> 00:00:47.350
And that price is going
to be their demand curve

00:00:47.350 --> 00:00:49.070
and their marginal revenue curve.

00:00:49.070 --> 00:00:51.010
And we've talked about
that, in the long run,

00:00:51.010 --> 00:00:53.100
under perfect competition,
none of these firms

00:00:53.100 --> 00:00:55.350
are going to be able to
make an economic profit;

00:00:55.350 --> 00:00:57.340
that, if they are, they're
going to have more entrants,

00:00:57.340 --> 00:00:59.070
which is going to push this price down.

00:00:59.070 --> 00:01:01.650
And if they're making
negative economic profit,

00:01:01.650 --> 00:01:03.220
then you're going to have
people who are going to exit,

00:01:03.220 --> 00:01:04.610
which is going to push line up.

00:01:04.610 --> 00:01:06.710
And so, it's going to, in the long run,

00:01:06.710 --> 00:01:08.220
be at a point where none of the firms

00:01:08.220 --> 00:01:09.890
are making economic profit.

00:01:09.890 --> 00:01:11.160
And so, another way to think about it,

00:01:11.160 --> 00:01:13.707
where our marginal
revenue curve intersects

00:01:13.707 --> 00:01:15.560
with our marginal cost curve,

00:01:15.560 --> 00:01:17.680
which for any of these situations,

00:01:17.680 --> 00:01:20.180
is the rational amount to produce,

00:01:20.180 --> 00:01:22.210
the rational quantity to produce

00:01:22.210 --> 00:01:24.730
for a profit-maximizing firm,

00:01:24.730 --> 00:01:27.361
that's going to be exactly at a level

00:01:27.361 --> 00:01:31.120
where the price is equal
to average total cost,

00:01:31.120 --> 00:01:33.120
so you have zero economic profit,

00:01:33.120 --> 00:01:36.450
zero economic profit.

00:01:36.450 --> 00:01:38.040
Now, there's some interesting
things about this.

00:01:38.040 --> 00:01:40.200
We talked about how it's
allocatively efficient

00:01:40.200 --> 00:01:42.130
because we're producing at a quantity

00:01:42.130 --> 00:01:45.380
where marginal cost is equal to demand.

00:01:45.380 --> 00:01:46.897
It's also productively efficient

00:01:46.897 --> 00:01:49.380
because we're producing
at the minimum point

00:01:49.380 --> 00:01:51.140
of the average total cost curve.

00:01:51.140 --> 00:01:54.780
So, it's very efficient from
a productive point of view.

00:01:54.780 --> 00:01:57.310
Now, a monopoly is the opposite extreme.

00:01:57.310 --> 00:01:58.800
They are the only player in the market

00:01:58.800 --> 00:02:00.890
with insurmountable barriers to entry.

00:02:00.890 --> 00:02:03.500
And so, their demand curve,
they're the only player,

00:02:03.500 --> 00:02:05.490
so you could view this as
the market demand curve,

00:02:05.490 --> 00:02:07.040
but it's their demand curve

00:02:07.040 --> 00:02:08.530
'cause they're the only product there.

00:02:08.530 --> 00:02:11.810
So, at high prices, you have
a low quantity demanded;

00:02:11.810 --> 00:02:14.410
and at low prices, you have
a high quantity demanded.

00:02:14.410 --> 00:02:16.420
At in multiple videos,
we've talked about that,

00:02:16.420 --> 00:02:18.550
in many situations, a monopoly firm

00:02:18.550 --> 00:02:20.240
cannot do price discrimination.

00:02:20.240 --> 00:02:23.540
It has to charge the same
price to every consumer.

00:02:23.540 --> 00:02:25.430
Well, in that situation,
your marginal revenue

00:02:25.430 --> 00:02:27.240
is going to go down twice as fast

00:02:27.240 --> 00:02:28.810
because, as you go further and further

00:02:28.810 --> 00:02:29.650
down the demand curve,

00:02:29.650 --> 00:02:31.630
you're lowering the price for everyone.

00:02:31.630 --> 00:02:33.680
And we've studied this,
this is all review;

00:02:33.680 --> 00:02:35.320
but it never hurts to get more review.

00:02:35.320 --> 00:02:37.650
The rational quantity to produce,

00:02:37.650 --> 00:02:38.880
and once again, this is true for any firm,

00:02:38.880 --> 00:02:41.730
is where marginal revenue
intersects marginal cost.

00:02:41.730 --> 00:02:44.900
So, we would produce at that quantity.

00:02:44.900 --> 00:02:46.380
And the price at that quantity,

00:02:46.380 --> 00:02:49.290
we'd go to the demand curve,
it would be right over there.

00:02:49.290 --> 00:02:51.040
And you could see that this monopoly firm

00:02:51.040 --> 00:02:53.450
is able to get quite
a nice economic profit

00:02:53.450 --> 00:02:55.210
because the average total cost

00:02:55.210 --> 00:02:56.940
at that quantity is right over there.

00:02:56.940 --> 00:02:58.560
And so, on a per-unit basis,

00:02:58.560 --> 00:03:00.880
they're able to make that much
times the number of units.

00:03:00.880 --> 00:03:03.440
And so, you have a nice economic profit.

00:03:03.440 --> 00:03:06.400
Now, the negative, from a
economic or market point of view,

00:03:06.400 --> 00:03:08.510
if you were to be allocatively efficient,

00:03:08.510 --> 00:03:09.820
you'd be producing at a quantity

00:03:09.820 --> 00:03:12.840
where marginal cost intersects demand.

00:03:12.840 --> 00:03:15.060
But that is not happening over here.

00:03:15.060 --> 00:03:18.400
And so, you have all of this

00:03:18.400 --> 00:03:21.150
deadweight loss right over there.

00:03:21.150 --> 00:03:23.860
Now, to help understand
monopolistic competition,

00:03:23.860 --> 00:03:25.890
let's say you start as a monopoly;

00:03:25.890 --> 00:03:29.210
but now, all of a sudden, the
market dynamics have changed,

00:03:29.210 --> 00:03:31.615
where what were insurmountable
barriers to entry

00:03:31.615 --> 00:03:34.080
now become low barriers to entry.

00:03:34.080 --> 00:03:36.200
What is likely to happen?

00:03:36.200 --> 00:03:39.450
Well, you have this nice
economic profit going on here,

00:03:39.450 --> 00:03:42.220
so more firms are likely
to enter the market.

00:03:42.220 --> 00:03:44.660
And if more firms enter the market,

00:03:44.660 --> 00:03:48.920
what is going to happen
to your demand curve?

00:03:48.920 --> 00:03:51.810
Well, the demand for your specific product

00:03:51.810 --> 00:03:54.130
is going to go down because
there's other people

00:03:54.130 --> 00:03:56.780
who are offering similar alternatives.

00:03:56.780 --> 00:03:58.150
In monopolistic competition,

00:03:58.150 --> 00:03:59.930
you aren't completely undifferentiated.

00:03:59.930 --> 00:04:01.500
You might have a brand,
you might have certain

00:04:01.500 --> 00:04:02.980
features that are better or worse,

00:04:02.980 --> 00:04:05.760
but there are other substitutes
which people could go for,

00:04:05.760 --> 00:04:07.780
which are giving you that competition.

00:04:07.780 --> 00:04:09.090
So, as more and more people enter,

00:04:09.090 --> 00:04:10.620
as you have this economic profit,

00:04:10.620 --> 00:04:12.510
your particular demand curve

00:04:12.510 --> 00:04:14.560
is going to shift down and to the left.

00:04:14.560 --> 00:04:17.650
And so, your demand
curve will keep shifting

00:04:17.650 --> 00:04:21.120
until you're no longer able
to get any economic profit.

00:04:21.120 --> 00:04:23.770
And so, your demand curve
might go something like this.

00:04:23.770 --> 00:04:26.230
Once the firms aren't able
to get economic profit,

00:04:26.230 --> 00:04:27.660
well then it doesn't really make sense

00:04:27.660 --> 00:04:29.880
for more people to try to enter it.

00:04:29.880 --> 00:04:31.610
So, if you started a monopoly,

00:04:31.610 --> 00:04:34.070
your demand would shift
to the left, like that,

00:04:34.070 --> 00:04:35.990
to the point where you get like that.

00:04:35.990 --> 00:04:37.910
And your marginal revenue curve

00:04:37.910 --> 00:04:38.970
would look something like this,

00:04:38.970 --> 00:04:42.010
it would have twice the slope down,

00:04:42.010 --> 00:04:45.190
so this would be your
marginal revenue curve.

00:04:45.190 --> 00:04:47.290
And notice what has now happened.

00:04:47.290 --> 00:04:50.700
It is now rational for you to be producing

00:04:50.700 --> 00:04:55.060
at a quantity where the
price that you are getting

00:04:55.060 --> 00:04:57.560
is equal to your average total cost.

00:04:57.560 --> 00:04:59.990
So, once again, as more
and more people entered,

00:04:59.990 --> 00:05:01.360
because you were getting economic profit,

00:05:01.360 --> 00:05:02.660
and the players in this industry

00:05:02.660 --> 00:05:04.410
were getting economic profit,

00:05:04.410 --> 00:05:05.900
the demand curve has shifted left,

00:05:05.900 --> 00:05:10.900
so now there is zero economic
profit in the long run.

00:05:12.320 --> 00:05:14.540
Now, once again, this is a situation

00:05:14.540 --> 00:05:16.350
here you have deadweight loss.

00:05:16.350 --> 00:05:18.280
This is not allocatively efficient.

00:05:18.280 --> 00:05:19.850
You're not producing at a level

00:05:19.850 --> 00:05:22.500
where marginal cost is equal to demand.

00:05:22.500 --> 00:05:24.240
It's also not productively efficient.

00:05:24.240 --> 00:05:26.300
To be productively
efficient, you'd be producing

00:05:26.300 --> 00:05:29.670
at a quantity where you're
at the minimum point

00:05:29.670 --> 00:05:31.300
of your average total cost curve.

00:05:31.300 --> 00:05:33.360
And so, this difference right over here,

00:05:33.360 --> 00:05:35.870
we could view this as the quantity for,

00:05:35.870 --> 00:05:37.900
I'll call it efficient scale,

00:05:37.900 --> 00:05:40.543
this right over here, this distance,

00:05:41.460 --> 00:05:46.163
you could view this as excess
capacity, excess capacity.

00:05:47.870 --> 00:05:50.470
Now, one thing that might be
a little bit counterintuitive

00:05:50.470 --> 00:05:52.410
is, in previous videos, we talk about how,

00:05:52.410 --> 00:05:54.230
hey, as people enter and exit a market,

00:05:54.230 --> 00:05:56.270
it would shift the supply curve.

00:05:56.270 --> 00:05:58.170
But here, we're shifting the demand curve.

00:05:58.170 --> 00:06:00.060
Well, when people enter
and exit the market,

00:06:00.060 --> 00:06:04.310
it shifts the supply curve
for the entire market.

00:06:04.310 --> 00:06:08.210
It would not shift the demand
curve for the entire market.

00:06:08.210 --> 00:06:09.660
But what we have drawn over here

00:06:09.660 --> 00:06:12.320
is not the demand curve
for the entire market.

00:06:12.320 --> 00:06:14.550
What we have drawn here
is the demand curve

00:06:14.550 --> 00:06:17.440
for this particular firm's product.

00:06:17.440 --> 00:06:20.210
So, as there's more and more
entrants in the entire market,

00:06:20.210 --> 00:06:21.850
the demand for this particular

00:06:21.850 --> 00:06:24.553
firm's products are going down.


Monopolies vs. perfect competition

WEBVTT
Kind: captions
Language: en

00:00:00.570 --> 00:00:01.403
- [Instructor] In this video,

00:00:01.403 --> 00:00:02.290
we're going to dig a little bit

00:00:02.290 --> 00:00:07.060
into the idea of what it
means to be a monopoly,

00:00:07.060 --> 00:00:08.960
and so to help us appreciate that,

00:00:08.960 --> 00:00:11.700
let's think about the spectrum
on which firms can be.

00:00:11.700 --> 00:00:14.960
So this is going to be my
spectrum right over here.

00:00:14.960 --> 00:00:16.130
Now at the left end,

00:00:16.130 --> 00:00:20.390
we can imagine this idealized
perfect competition,

00:00:20.390 --> 00:00:22.773
perfect competition,

00:00:23.610 --> 00:00:25.450
and we've talked about
that in the other videos,

00:00:25.450 --> 00:00:29.600
but just as a review, this
is where you have many firms.

00:00:29.600 --> 00:00:34.080
This is where they are selling
an undifferentiated product

00:00:34.080 --> 00:00:35.360
or service,

00:00:35.360 --> 00:00:39.723
undifferentiated,
undifferentiated product.

00:00:41.200 --> 00:00:43.150
The firms over here,

00:00:43.150 --> 00:00:45.450
well, they have no
barriers to entry or exit,

00:00:45.450 --> 00:00:47.900
so no barriers

00:00:49.160 --> 00:00:50.620
to entry

00:00:52.070 --> 00:00:53.810
or exit.

00:00:53.810 --> 00:00:55.970
These firms that we've
talked about in other videos,

00:00:55.970 --> 00:00:57.510
they need to be price takers.

00:00:57.510 --> 00:00:58.660
Why do they need to be price takers?

00:00:58.660 --> 00:01:00.650
Well, whatever the market price is,

00:01:00.650 --> 00:01:02.980
since no one cares which of these firms,

00:01:02.980 --> 00:01:05.110
which of these many firms
they get the product from,

00:01:05.110 --> 00:01:07.790
none of those firms can
really set their own price.

00:01:07.790 --> 00:01:09.570
If they were to go above the market price,

00:01:09.570 --> 00:01:12.050
well then no one will buy from them,

00:01:12.050 --> 00:01:16.293
and so they will just
be price, price takers,

00:01:17.150 --> 00:01:20.240
and other things that we assume
about perfect competition is

00:01:20.240 --> 00:01:22.690
that all of the actors in
the market, both the buyers,

00:01:22.690 --> 00:01:24.470
the many buyers and the many sellers,

00:01:24.470 --> 00:01:27.310
they all know what the
transactions are going on for.

00:01:27.310 --> 00:01:31.110
They know who's selling
to whom for what amount.

00:01:31.110 --> 00:01:33.160
Now the other extreme,

00:01:33.160 --> 00:01:36.827
this is where we have
the monopoly, monopoly.

00:01:38.770 --> 00:01:42.950
Here, instead of many firms
selling or many firms producing,

00:01:42.950 --> 00:01:47.490
you have exactly one firm producing.

00:01:47.490 --> 00:01:49.200
Instead of an undifferentiated product,

00:01:49.200 --> 00:01:52.610
well, it's differentiated
because it's the only firm.

00:01:52.610 --> 00:01:54.640
Instead of no barriers to entry or exit,

00:01:54.640 --> 00:01:56.110
here we have the exact opposite,

00:01:56.110 --> 00:02:00.820
so you could say insurmountable,
insurmountable, mountable,

00:02:01.760 --> 00:02:06.760
I'll just abbreviate it,
barriers, especially to enter,

00:02:07.460 --> 00:02:11.690
and instead of being a price
taker, you are a price setter,

00:02:11.690 --> 00:02:13.000
price setter.

00:02:13.000 --> 00:02:14.150
You're the only player.

00:02:14.150 --> 00:02:16.260
You're the only actor
who is selling anything,

00:02:16.260 --> 00:02:19.040
So you can decide what
price to sell it at.

00:02:19.040 --> 00:02:21.040
Now, perfect competition
as I talked about,

00:02:21.040 --> 00:02:22.440
it's a bit of a theoretical idea.

00:02:22.440 --> 00:02:25.910
It's hard to say any market
that is absolutely perfect,

00:02:25.910 --> 00:02:29.120
but we can imagine markets
that are on this spectrum,

00:02:29.120 --> 00:02:30.910
some closer to perfect competition,

00:02:30.910 --> 00:02:33.020
some closer to a monopoly.

00:02:33.020 --> 00:02:34.760
Things that I can imagine that are closer

00:02:34.760 --> 00:02:37.740
to perfect competition
might be, let's say,

00:02:37.740 --> 00:02:41.110
agriculture or a certain
type of agriculture.

00:02:41.110 --> 00:02:44.220
Let's say you are buying
pistachios, and you might be,

00:02:44.220 --> 00:02:45.310
most people are indifferent

00:02:45.310 --> 00:02:46.790
as to where their pistachios come from,

00:02:46.790 --> 00:02:48.210
although some people might beg to differ

00:02:48.210 --> 00:02:50.680
that certain types of pistachios
are better than others,

00:02:50.680 --> 00:02:51.590
but for the most part,

00:02:51.590 --> 00:02:53.920
that'd be closer to perfect competition.

00:02:53.920 --> 00:02:57.060
There will be just a price
in the market for pistachios.

00:02:57.060 --> 00:02:59.040
If someone wants to grow pistachios,

00:02:59.040 --> 00:03:01.520
I'm not familiar with what
it takes to grow pistachios,

00:03:01.520 --> 00:03:03.300
and I apologize to any offense

00:03:03.300 --> 00:03:05.010
to any pistachio growers out there,

00:03:05.010 --> 00:03:07.010
but maybe they can just get enough land,

00:03:07.010 --> 00:03:09.190
and there's very close
to low barriers to entry,

00:03:09.190 --> 00:03:11.370
and they can start producing pistachios.

00:03:11.370 --> 00:03:14.670
As I mentioned, many would
perceive it as undifferentiated,

00:03:14.670 --> 00:03:18.000
and there might be many firms
in, say, the pistachio market.

00:03:18.000 --> 00:03:19.370
I actually don't know if that's the case,

00:03:19.370 --> 00:03:20.350
but let's just assume

00:03:20.350 --> 00:03:21.760
if that were the case it would be closer

00:03:21.760 --> 00:03:23.360
to a perfect competition.

00:03:23.360 --> 00:03:27.330
Now a monopoly, you can
imagine things like things

00:03:27.330 --> 00:03:30.010
that take a lot of infrastructure

00:03:30.010 --> 00:03:32.350
in order to do that service.

00:03:32.350 --> 00:03:37.020
So I can imagine things like,
over here, close to monopoly

00:03:37.020 --> 00:03:37.920
or at monopoly.

00:03:37.920 --> 00:03:42.870
You can imagine things like
utilities providers, utilities,

00:03:42.870 --> 00:03:46.840
where it's hard for multiple
people to run power lines

00:03:46.840 --> 00:03:48.810
to the various houses.

00:03:48.810 --> 00:03:50.500
You can imagine things like this.

00:03:50.500 --> 00:03:55.210
Telecom, telecom providers might be close,

00:03:55.210 --> 00:03:56.620
although in most geographies,

00:03:56.620 --> 00:03:58.390
you have more than one telecom providers,

00:03:58.390 --> 00:03:59.520
although in some parts of the world,

00:03:59.520 --> 00:04:01.510
you're getting pretty close
to one because, once again,

00:04:01.510 --> 00:04:03.630
there's very, very, very
high barriers to entry

00:04:03.630 --> 00:04:04.463
in either one of those.

00:04:04.463 --> 00:04:08.810
You gotta launch satellites
and put cable under the ground

00:04:08.810 --> 00:04:11.000
and dig up roads and
whatever until you get closer

00:04:11.000 --> 00:04:14.650
and closer to this notion
of maybe there's one firm.

00:04:14.650 --> 00:04:16.910
If you're in a situation
like telecom in a lot

00:04:16.910 --> 00:04:19.680
of the places where you have
only a handful of firms,

00:04:19.680 --> 00:04:21.650
that's known as an oligopoly,

00:04:21.650 --> 00:04:23.640
but let's just think about the extreme,

00:04:23.640 --> 00:04:26.140
when you're in a monopoly situation,

00:04:26.140 --> 00:04:27.410
and so the next few videos,

00:04:27.410 --> 00:04:28.690
we're gonna dive a little bit deeper

00:04:28.690 --> 00:04:30.710
into what it means to be a monopoly,

00:04:30.710 --> 00:04:34.020
and what is the rational quantity

00:04:34.020 --> 00:04:38.670
for a profit-maximizing monopolistic firm

00:04:38.670 --> 00:04:40.140
to actually produce,

00:04:40.140 --> 00:04:42.583
and what would be their economic profit?


Economic profit for a monopoly

WEBVTT
Kind: captions
Language: en

00:00:00.100 --> 00:00:02.090
- [Instructor] In this
video, we're going to think

00:00:02.090 --> 00:00:05.630
about the economic profit of a monopoly,

00:00:05.630 --> 00:00:07.110
of a monopoly firm.

00:00:07.110 --> 00:00:10.890
And to do that, we're gonna
draw our standard price

00:00:10.890 --> 00:00:15.283
and quantity axes, so that's quantity,

00:00:16.250 --> 00:00:18.143
and this is price.

00:00:19.130 --> 00:00:21.730
And this is going to of
course be in dollars,

00:00:21.730 --> 00:00:24.090
and we can first think about the demand

00:00:24.090 --> 00:00:25.880
for this monopoly firm's product.

00:00:25.880 --> 00:00:27.620
And the demand curve would look similar

00:00:27.620 --> 00:00:29.960
to other demand curves that
we've seen multiple times,

00:00:29.960 --> 00:00:33.800
that at a high price, people
wouldn't be demanding a lot,

00:00:33.800 --> 00:00:36.680
and then at a lower price,
or as price goes lower,

00:00:36.680 --> 00:00:39.050
people are going to demand a
higher and higher quantity,

00:00:39.050 --> 00:00:41.130
or the market will demand a
higher, and higher quantity.

00:00:41.130 --> 00:00:42.910
So that might be the demand curve.

00:00:42.910 --> 00:00:45.620
Now what's interesting
about any imperfectly

00:00:45.620 --> 00:00:48.300
competitive firm, and the
extreme case is a monopoly,

00:00:48.300 --> 00:00:50.010
is what the marginal revenue curve

00:00:50.010 --> 00:00:52.760
looks like given this demand curve.

00:00:52.760 --> 00:00:55.140
In a perfectly competitive firm,

00:00:55.140 --> 00:00:58.410
the marginal revenue curve
is equal to the demand curve,

00:00:58.410 --> 00:01:01.750
and in that situation, it's
actually a horizontal line.

00:01:01.750 --> 00:01:05.770
But here, because when the
monopoly firm reduces price,

00:01:05.770 --> 00:01:08.010
it doesn't just reduce it
on that incremental unit,

00:01:08.010 --> 00:01:09.990
it would be typical that
it would have to reduce

00:01:09.990 --> 00:01:12.520
its price on all of the
units, and we've studied

00:01:12.520 --> 00:01:13.740
this in other videos.

00:01:13.740 --> 00:01:15.530
You have a marginal revenue curve

00:01:15.530 --> 00:01:17.540
that would go down faster
than the demand curve,

00:01:17.540 --> 00:01:18.770
it would look something like this,

00:01:18.770 --> 00:01:20.300
and if this is unfamiliar to you,

00:01:20.300 --> 00:01:22.550
I encourage you to watch
some of those videos

00:01:22.550 --> 00:01:24.890
that go into depth why this is happening.

00:01:24.890 --> 00:01:27.220
So it's a monopoly, or
actually any imperfectly

00:01:27.220 --> 00:01:29.360
competitive firm, its
marginal revenue curve

00:01:29.360 --> 00:01:32.220
will go down faster than the demand curve.

00:01:32.220 --> 00:01:34.520
So what would be a rational quantity

00:01:34.520 --> 00:01:36.500
for this firm to produce?

00:01:36.500 --> 00:01:37.750
Well to think about that,
we have to think about

00:01:37.750 --> 00:01:39.960
its marginal cost curve.

00:01:39.960 --> 00:01:42.330
So its marginal cost
curve, the typical way

00:01:42.330 --> 00:01:44.700
we often think about
it is, at first you get

00:01:44.700 --> 00:01:47.420
some economies of scale,
but then you start having

00:01:47.420 --> 00:01:50.330
coordination costs, and maybe
some diseconomies of scale,

00:01:50.330 --> 00:01:52.000
your inputs start getting more expensive,

00:01:52.000 --> 00:01:53.980
and so your marginal cost curve might look

00:01:53.980 --> 00:01:55.180
something like that.

00:01:55.180 --> 00:01:58.010
And the rational quantity produced is,

00:01:58.010 --> 00:02:01.470
as long as your incremental
revenue for every unit

00:02:01.470 --> 00:02:03.760
is higher than your incremental
cost for every unit,

00:02:03.760 --> 00:02:06.400
you would wanna produce more,
and more, and more, and more

00:02:06.400 --> 00:02:09.120
until the point that your marginal cost

00:02:09.120 --> 00:02:11.570
is equal to your marginal revenue.

00:02:11.570 --> 00:02:13.470
And so the rational quantity to produce

00:02:13.470 --> 00:02:15.540
right over here would be right over there.

00:02:15.540 --> 00:02:18.380
I'll do that Q, I could
call that Q for the firm,

00:02:18.380 --> 00:02:20.300
I could also call that Q sub M,

00:02:20.300 --> 00:02:21.680
because we're dealing with a situation

00:02:21.680 --> 00:02:25.260
where the firm is, at least
from the producer side,

00:02:25.260 --> 00:02:27.240
it is the market, it is the only producer,

00:02:27.240 --> 00:02:28.620
it's a monopoly.

00:02:28.620 --> 00:02:30.240
But what's the price here?

00:02:30.240 --> 00:02:31.480
Well to know that, we just have to look

00:02:31.480 --> 00:02:32.313
at the demand curve.

00:02:32.313 --> 00:02:36.620
At this quantity, the
price is right over here.

00:02:36.620 --> 00:02:38.650
So the price is right
over here, and once again,

00:02:38.650 --> 00:02:41.820
we could call that the market price,

00:02:41.820 --> 00:02:44.380
and so something interesting
has happened here

00:02:44.380 --> 00:02:45.880
for the monopoly firm.

00:02:45.880 --> 00:02:50.040
In a perfectly competitive
firm, where the marginal cost

00:02:50.040 --> 00:02:52.930
and demand curves intersect,
that's what dictated

00:02:52.930 --> 00:02:54.857
the demand, because the demand curve

00:02:54.857 --> 00:02:57.060
and the marginal revenue
curve were the same.

00:02:57.060 --> 00:03:01.130
But here, we are now producing
a quantity less than that,

00:03:01.130 --> 00:03:04.150
we're producing a quantity where price

00:03:04.150 --> 00:03:06.530
is greater than marginal cost,

00:03:06.530 --> 00:03:07.410
you could see it right over there.

00:03:07.410 --> 00:03:11.400
At this quantity price is
greater than marginal cost,

00:03:11.400 --> 00:03:13.920
and so you can view this
difference right over here

00:03:13.920 --> 00:03:16.560
as kind of a markup that is possible

00:03:16.560 --> 00:03:19.890
for a monopoly firm to do
that would not be possible

00:03:19.890 --> 00:03:21.660
with a perfectly competitive firm.

00:03:21.660 --> 00:03:23.440
And this also introduces an idea

00:03:23.440 --> 00:03:24.920
of dead weight loss.

00:03:24.920 --> 00:03:28.200
Because at least in theory,
at a higher quantity,

00:03:28.200 --> 00:03:31.230
people were willing to pay
more than the marginal cost,

00:03:31.230 --> 00:03:33.230
so you would think that there is some type

00:03:33.230 --> 00:03:35.928
of a benefit that the
market as a whole could gain

00:03:35.928 --> 00:03:38.800
from that incremental unit,
or those incremental units,

00:03:38.800 --> 00:03:40.200
and then even some more incremental units.

00:03:40.200 --> 00:03:43.560
It feels like there's to
gain, but because of what

00:03:43.560 --> 00:03:45.320
is rational for this monopoly firm,

00:03:45.320 --> 00:03:47.300
and there's insurmountable
barriers for entry

00:03:47.300 --> 00:03:50.270
for other people to enter, this
is not going to be captured

00:03:50.270 --> 00:03:52.931
until you have this dead weight loss.

00:03:52.931 --> 00:03:55.410
Now an interesting
question, and this is where

00:03:55.410 --> 00:03:57.090
I started off is, well what would be

00:03:57.090 --> 00:03:59.770
the economic profit
for this monopoly firm?

00:03:59.770 --> 00:04:00.950
And to think about that, we have to think

00:04:00.950 --> 00:04:03.150
about the average total cost curve.

00:04:03.150 --> 00:04:06.550
And so the average total
cost, I'll draw a typical

00:04:06.550 --> 00:04:11.367
average total cost curve, it
might look something like this.

00:04:14.270 --> 00:04:16.930
While marginal cost is below
the average total cost,

00:04:16.930 --> 00:04:21.060
the average total cost
will trend downwards,

00:04:21.060 --> 00:04:23.560
and as soon as marginal cost is higher

00:04:23.560 --> 00:04:25.320
than average total cost,
well now of course,

00:04:25.320 --> 00:04:28.070
average total cost is going
to start trending upwards.

00:04:28.070 --> 00:04:31.122
So marginal costs intersects
the average total cost curve

00:04:31.122 --> 00:04:33.770
at the minimum point right over there.

00:04:33.770 --> 00:04:36.680
And so based on this
average total cost curve,

00:04:36.680 --> 00:04:37.980
it looks like this monopoly firm

00:04:37.980 --> 00:04:40.270
is earning an economic profit,

00:04:40.270 --> 00:04:42.880
because at that quantity,
this is the price

00:04:42.880 --> 00:04:44.430
per unit it's getting.

00:04:44.430 --> 00:04:47.020
This is the average cost per unit,

00:04:47.020 --> 00:04:50.180
so on average per unit,
it's getting this height,

00:04:50.180 --> 00:04:55.180
it's getting this
difference right over here,

00:04:55.350 --> 00:04:56.650
and then if you were to multiply it

00:04:56.650 --> 00:04:59.060
times the number of
units, well that's going

00:04:59.060 --> 00:05:00.430
to give you its economic profit.

00:05:00.430 --> 00:05:01.940
So you could view the economic profit

00:05:01.940 --> 00:05:06.110
in this situation as
being this shaded area

00:05:06.110 --> 00:05:07.670
of this rectangle.

00:05:07.670 --> 00:05:08.740
So I'll leave ya there.

00:05:08.740 --> 00:05:09.820
The big thing to appreciate is,

00:05:09.820 --> 00:05:12.050
when we're dealing with
imperfect competition,

00:05:12.050 --> 00:05:14.280
and the extreme form of a monopoly,

00:05:14.280 --> 00:05:17.280
your marginal revenue curve is
no longer your demand curve,

00:05:17.280 --> 00:05:20.350
and your marginal revenue
curve is downward sloping

00:05:20.350 --> 00:05:21.830
like this, it's not the flat curve

00:05:21.830 --> 00:05:23.870
that we saw with the perfect competition.

00:05:23.870 --> 00:05:26.650
And because of that, your marginal cost

00:05:26.650 --> 00:05:28.636
is going to intersect marginal revenue

00:05:28.636 --> 00:05:33.600
at a quantity where price is
greater than marginal cost,

00:05:33.600 --> 00:05:36.600
which introduces dead
weight loss in the market,

00:05:36.600 --> 00:05:39.750
and the way to think
about the economic profit

00:05:39.750 --> 00:05:41.760
is to compare what that
price in the market

00:05:41.760 --> 00:05:44.063
is at that quantity, to
the average total cost

00:05:44.063 --> 00:05:46.140
at that quantity.

00:05:46.140 --> 00:05:48.840
And what's also interesting
about this monopoly firm

00:05:48.840 --> 00:05:50.350
is because of the barriers to entry,

00:05:50.350 --> 00:05:52.920
we talked about in the long
run with perfect competition,

00:05:52.920 --> 00:05:54.920
if there's economic profit going on,

00:05:54.920 --> 00:05:56.513
more entrants would enter into the market,

00:05:56.513 --> 00:05:58.570
but that's not going
to happen in a monopoly

00:05:58.570 --> 00:06:01.990
because the barriers to entry are so high.

00:06:01.990 --> 00:06:04.410
So this monopoly is sitting pretty,

00:06:04.410 --> 00:06:06.750
it's going to be able to keep earning

00:06:06.750 --> 00:06:09.480
this type of economic profit,
unless something dramatically

00:06:09.480 --> 00:06:11.533
changes in the market somehow.