🙋 Student Q&A (Lecture 7)

Click here to learn about timestamps and my process for answering questions. Section agendas can be found here. Email office hour questions to munger.e1010@gmail.com. PS1Q2=“Question 2 of Problem Set 1”

📅 Questions covered Thursday, Apr 2

🕣 near end
❔ Could you explain what elasticity means? How does it correlate to monopoly power?

✔ Elasticity is how we measure price sensitivity.

If elasticity is high (by which I mean if it’s a very negative number), then customers are price sensitive. If elasticity is low (by which I mean a not very negative number), then customers are not very price sensitive.

Market power refers to the ability to raise price over marginal cost. This is possible when demand is inelastic. Apple = more inelastic demand → has market power. LG = more elastic demand → has less market power.

🕣 9:53pm
❔ When we see MC - is it related always to a firm, or can it be for the market as a whole?

What does it mean for the market?

✔ MC for a firm is easy to understand.

MC for the market is harder to understand. To calculate it, you’d have to add up the total costs of all of the firms serving the market at a given price. This would give you a Market Total Cost. The change in Market Total Cost (MTC) as you produce one more unit would be Market Marginal Cost.

📅 Questions covered Sunday, Apr 5

🕣 7:40pm
❔ I know a monopoly has no supply curve. Could you go over why it has no supply curve based on the charts?

It’s slide 29 on the condensed slides.

✔

🕣 7:48pm
❔ Could you go over how we determine the various block pricings for 2nd degree discrimination prices?

✔

🕣 7:50pm
❔ Some questions in the PS6 mentioned ‘price discriminating’ monopolist. Is there any difference between a ‘price discriminating’ and a ‘profit maximizing’ monopolist?

✔ That’s a good distinction to make. A profit maximizing monopolist sets a single price where MR=MC. A price discriminating monopolist charges different prices to different groups of consumers. Some companies may not have an effective way to price discriminate. They can still profit maximize by choosing the optimal price and quantity.

🕣 7:56pm
❔ I’m trying to clarify my understanding of how monopolists determine quantities for price inelastic consumers. Since these consumers aren’t as affected by price changes, wouldn’t they want to sell as many as possible as determined by the demand curve? How does elasticity affect quantity supplied?

✔ It depends on whether you’re talking about perfect inelasticity or just highly inelastic. If something is highly inelastic, you’re going to do exactly the same process. You’re going to calculate the marginal revenue curve. You’re going to intersect marginal revenue with marginal cost, and that will lead to you charging a lot more. You’re just going to charge more because inelastic means that consumers are not price sensitive when deciding how much to buy. They’ll still buy a lot if you charge a lot, so you can get away with charging a lot and you will charge a lot. That’s what the analysis will lead to.

To answer your first question, which is about clarifying your understanding of how monopolists determine quantities, they do it in exactly the same way. It does happen to lead to a higher price. Sorry, I guess they’re willing to do a lower quantity in order to get the higher price, because they know that the price will go up a lot when they decrease the quantity. That’s a little bit different when you have perfect inelasticity. When you have perfect inelasticity, you don’t have to decrease the quantity at all. You can just charge a higher and higher and higher price until it eventually, I don’t know, gets to infinity. Perfect inelasticity is kind of a special case, so theoretically you charge them an infinite amount and they’d still buy the same amount. If it was perfectly inelastic, it’s kind of weird. Remember, perfect inelasticity means that the demand curve is perfectly vertical.

With a conceptual question, sometimes it’s helpful, anyway, to send me the problem number, but let me do the next conceptual question you asked here, since consumers aren’t affected by price changes when they want to sell as many as possible, determined by the demand curve. They do want to sell as many as possible, but with price inelasticity, if you cut the quantity just by one unit, the price goes up by a lot. You’re like, “Okay, I’d like to sell more, but if I cut the price a little bit, I get to… sorry, if I cut the quantity a little bit, people will be willing to buy at a higher price.”

Again, the typical example for highly inelastic would be air or insulin. Air is currently free, but if you increased the cost of air by a very, very large percentage, up to like a penny per gallon, sorry, a penny per 10 cubic meters, people are still going to pay that, and you could probably double it again and people would pay that. They are not going to be very price-sensitive, so if you were solely profit-maximizing, the mathematics of that says that you would make it more expensive and you would, as a result, sell less. Inelasticity means that you can cut the quantity a little bit and charge more. Perhaps a better way to say that is that I’m used to thinking in terms of quantity, but a more intuitive way to say that would be you can raise the price, and when you raise the price, the quantity will go down, but not by that much. You’re just going to raise the price, and the amount that people will buy will go down by a little bit, but whatever.

The characteristic example of this, the most famous and chilling example of this, is, I think, Pharma Bro Martin Shkreli. I am saying that right? Look at that smile; everybody wanted to slap him, a very slappable smile. His company, or one that he had control over, obtained the manufacturing license for the anti-parasitic drug daraprim and raised the price to insurance companies from $13.50 to$750. The idea being that, even though he was making the price go up by 40 times, because they more or less had a monopoly on this, I think it was a generic drug, people are still going to buy it if they needed it, because it would save people’s lives or, I don’t know, just be really, really helpful. That’s a perfect example of inelastic demand and how one can do the calculations and arrive at a conclusion. Naturally, you have to use all these things in the context of a larger picture; you have to say that, when you’re using these tools, you have to say, “Well, most companies wouldn’t do that because of the PR backlash.”