How to calculate socially optimal price and quantity relationship

how to calculate socially optimal price and quantity relationship

to increase overall market demand or to improve goodwill or public relations. . TR=optimal price * optimal quantity (the combined area of the blue and grey Determine the profit maximizing quantity and price for a single priced monopolist. .. The economically efficient or social optimum price would occur where price. For example monopolies produce less than the socially optimal output level and produces at higher costs than competitive firms. We'll find tutors who can help. 3 . International Law, International Relations, International Studies, Investing, iOS Programming, ISEE, ISEE (essay), ISEE (math), ISEE (quantitative reasoning ). The marginal social cost adds to the marginal private cost the cost of the externality, . Thus to determine the socially optimal amount of the good or service, we do a . he holds men accountable for their acts in relation to them' ( D&C ).

Being nonrival, more than one person can enjoy the good. Thus to determine the socially optimal amount of the good or service, we do a vertical summation of each individuals willingness to pay. For the second lighthouse, individual one is only willing to pay 10 dollars and individual two is only willing to pay 5 dollars.

If the marginal cost of providing a lighthouse were 30 dollars, one lighthouse would be socially optimal. Note that due to the free-rider problem, no one individual would be willing to provide a lighthouse, since the marginal cost exceeds her willingness to pay. To correct this market failure, government will typically tax individuals and provide the good or service to the public.

We have discussed two of the main types of goods. Goods can be classified in one of four different categories: Most goods fall into the category of private goods and because they are excludable the market can provide the socially optimal quantity. Ocean fishing may be nonexcludable but rival, since the fish caught by one can not be caught by another — it is a common resource good. What is the Grand Canyon worth?

Alternatively, if this proposal was to go forward but the government wanted to compensate you for the loss of the Grand Canyon, how much would they have to pay you?

As you think of the answers to these three questions, you should ask yourself if all three of these answers might be the same? In many cases they will differ since what an individual is willing to pay is subject to his budget constraint so he may have a low willingness to pay, yet he may consider the government to have no budget constraint so his willingness to accept is very large.

This presents a challenge when determining the value of a public good, since we can not look to the market to see the current price for a Grand Canyon or some endangered species. If individuals are concerned about the amount they will be taxed to provide or protect a good, their stated value may not reflect their true value.

how to calculate socially optimal price and quantity relationship

Thus, the hypothetical value stated by individuals may not reflect their true value for the item. Joseph Smith reached into his pocket and pulling out his money, and said, " I feel sorry to the tune of five dollars'" and he gave it to the man. Willingly giving the man the money, reflects his actual willingness to pay. Since benefits and costs may occur at different time periods, we convert future values to a present value for a common comparison. Consider the example below.

Comparing the present value of the benefits to the present value of the costs is useful in determining if it is worthwhile to undertake a project. Another challenge associated with the provision of certain goods can be determining where to locate the item.

Demand for power in some states has increased dramatically, yet state residents have resisted the development of new power sources to meet the growing demands. Watch the following video: Adverse selection can arise when information is known to one party in a transaction that is not known to the other, at the time the contract is made.

This is best illustrated with an example: Adverse selection would suggest that poor quality vehicles adverse are most likely. The seller may not disclose all he knows about the mechanical defects of the vehicle. Not knowing the honesty of the seller means, the price offered for the vehicle will likely be less to account for this risk. Similarly, those who need insurance the most are those most likely to purchase full coverage with low deductibles. Due to this risk, insurance premiums are increased which causes some healthy individuals to decide not to purchase coverage; this further increases the cost of the insurance and results in greater adverse selection.

Another asymmetric information problem is moral hazard. Moral hazard occurs when the behavior of one changes after the contract is made. For example, those who purchase insurance may be less inclined to take precautions after the purchase, knowing that they are insured.

This may be the case, even if the borrower is a stellar customer and has never carried a balance on the credit cards, because of the potential that a large amount of credit could easily be obtained. However, after paying the claim, the insurance had the man arrested and charged with 24 counts of arson after he cashed the check.

how to calculate socially optimal price and quantity relationship

Country singer Brad Paisley summarize what happens in the song, The Cigar. Health insurance companies, for example, typically have individuals fill out a health history and complete a physical exam to determine the premiums they will charge to the individual.

Credit scores can also help companies assess the likelihood of individuals repaying their loans and allow them to charge an appropriate interest rate.

Those with good credit scores get better rates, while those who have not managed their finances appropriately in the past are charged a higher rate. Credit scores are also used in other areas, such as car insurance, since individuals who are irresponsible with their finances have a higher likelihood of being irresponsible in other behaviors as well. Deductibles are designed to prevent the problem of moral hazard. If individuals have to bear at least a portion of the cost when they make an insurance claim, they are less likely to make a claim.

Furthermore, the threat of having increased premiums or being dropped by the insurance company, can be a deterrent from moral hazard. Product reports and reviews also provide information to help individuals make an informed decision. Publications such as Consumers Report are an independent review of products ranging from cars to washing machines.

Movie reviews can be beneficial to individuals trying to make an informed decision about the content of a movie and what to watch. A monopolist may or may not be productively efficient; it depends on whether it is producing at a point where ATC is at the minimum point. Productive efficiency means least-cost and this occurs where ATC is at its minimum point.

In general, monopolies are not productively efficient. Monopolies may also suffer from what is called x-inefficiency. These monopoly protecting actions are also called rent-seeking activities. Monopolies will often pursue rent seeking activities spending time or money on activities that are not related to the production of the good or service but intended to increase the market power and profitability of the firm.

Microeconomics Practice Problem - Utility Maximization Using Marginal Utility and Prices

For example, major soft drink companies, such as Coke or Pepsi, will offer millions to a university or stadium if they are allowed to be the sole soft drink vendor. Likewise athletic wear firms may offer a university payments or discounts if they are allowed to be the sole vendor of apparel.

These expenditures are not related to the production of the good or service but give them a monopoly in the respective markets.

Legal cartel theory suggests that some industries may seek to be regulated or desire that regulation continues, so that the number of firms is limited and the existing firms can act like a monopoly. Regulation such as limiting the number of firms or individuals in a market e. Price Discrimination Price Discrimination If instead of charging each consumer the same price, a firm could price discriminate, which means charging different prices to different consumers based upon their willingness to pay, how would they behave?

What would be required for a firm to be able to price discriminate? Certain conditions must hold in order for a firm to charge different prices for the same product. First, a firm must be able to set the price i.

Second, the firm must be able to segment the market into groups based upon either their willingness to pay or their different elasticities of demand. Third, the firm must be able to prevent resale of the item from one market segment to another. These may seem like difficult or unlikely conditions.

But in fact, price discrimination can be found in a variety of sectors including automobile sales, movie and airline tickets, utilities and phone rates.

Even student discounts are a form of price discrimination. First Degree or Perfect Price Discrimination There are three different degrees or levels of price discrimination. These levels are related to how well the monopolist can identify individual willingness to pay and segment the market accordingly. First degree or perfect price discrimination is when a firm charges each consumer their maximum willingness to pay, which is reflected by the demand curve.

So it would be willing to sell its products up to the point where the MC curve crosses the demand curve, i. This means that not only will the firm would be willing to sell more units than it did as a single priced monopolist, but it will also be allocatively efficient because price equals marginal cost at the last unit. However, each consumer is now paying her maximum willingness to pay, and therefore receives no consumer surplus.

Third Degree Price Discrimination When a monopolist cannot perfectly identify and segment consumers based upon individual willingness to pay, there still may be a way to extract some but less consumer surplus to increase profits.

Second degree price discrimination to be discussed later and third degree price discrimination might be employed under the right conditions. Third degree price discrimination may be employed when the firm cannot identify individual demands, but can identify groups of consumers that have similar demands and can segment them based upon some easily identifiable characteristic such as age, time of purchase, residency, or location.

Then the monopolist charges different prices to the different groups based on their relative elasticities of demand. The more inelastic the demand, the higher the price. This type of price discrimination is most common. Being able to segment the market, into groups that have different elasticities, allows the firm to charge different prices and increase overall profitability.

Recall that the firm must be able to prevent the resale of the good for price discrimination to work. This is why we often see third degree price discrimination in the service sector, where the nature of the product or service makes the resale of the good to another segment of the market difficult or impossible.

Here are a few examples of third degree price discrimination.

Movie theaters often charge different prices based on the time of consumption and age. The elasticity of demand for those attending a matinee is more elastic than those during primetime, so a lower price is charged for the matinee. Young children and senior citizens have different elasticities of demand than young adults, which allow the theaters to price accordingly.

Airlines also price discriminate. Those purchasing tickets at least two weeks in advance typically get a lower price than individuals purchasing tickets only a day or two before the flight. The distance and destination of the flight also make a difference since there are fewer substitutes if one is flying to say Hawaii verses another city within the state.

Social Optimal Price | Finance & Economics!!!

Gas stations within the same city often price discriminate charging a higher price at stations located close to the interstate or on the main roads. Some theme parks, such as Disneyland and Disney World, offer residents of California and Florida different prices than non-state residents.

Second Degree Price Discrimination Second degree price discrimination is implemented when the monopolist knows that there are two or more groups of consumers with different willingness to pay, but she cannot identify which consumers belong to each group. But if the she does this, consumers in the H group will claim to be from the L group and everyone will get the low price.

Second degree price discrimination or block pricing charges different prices to different consumer groups based on the quantity consumed. That is, the firm knows that the H consumers are willing to purchase a higher quantity than the L consumers at the same price. The volume discount encourages the H consumers to buy the larger package and also allows the firm to extract more of their consumer surplus, because they get them to buy a larger quantity otherwise they would only buy the 4 roll package.

Unlike perfect price discrimination that extracts all of the consumer surplus, in second degree price discrimination, the high demand group still keeps some. Two-Part Tariff There are a number of pricing strategies that do not seem like price discrimination, but in fact are!

One is worthy of note: The two-part tariff charges individuals an upfront membership fee then also charges them a per use fee. Under the right conditions, the two-part tariff makes perfect price discrimination possible.

For example, some golf courses and health clubs charge an annual membership fee in addition to the per use fee for each round of golf or workout.

If the marginal cost of providing a round of golf is ten dollars, then the golf club charges a ten dollar per use fee and the golfer decides to play 25 rounds of golf per year. If there was no membership fee the area below the demand curve and above the price would be consumer surplus, however, by charging a membership fee equal to the area of consumer surplus recall the area of a triangle is. This is of course, first degree or perfect price discrimination if the membership fee differs by consumer based upon willingness to pay.

Either way, the firm extracts some of the consumer surplus as additional profits. Another example of a two-part tariff would be a cell phone company that charges a monthly fee in addition to a per minute charge. Although other pricing strategies exist, you should be able to understand the incentive for why firms would want to price discriminate. Antitrust and Regulation Performance and Structure Monopolies and firms that collude to act like monopolies, reduce competition and create inefficiencies in the market.

how to calculate socially optimal price and quantity relationship

We have seen that single priced monopolists are neither allocatively efficient price equals marginal cost at the last unit produced nor productively efficient producing at the lowest average cost. Consequently, the United States government has passed certain laws that restrict monopolies. Government can evaluate a market based on the structure of the market, i.

how to calculate socially optimal price and quantity relationship

Should a monopoly exist, the government can pursue a variety of options: Whenever firms become large in size or large relative to their industry, policy-makers recognize that these firms are more able to pursue monopoly-type conduct and obtain inefficient market outcomes. At the same time, growth of a firm, as we have seen, allows it to capture economies of scale and scope. So when large firms merge, the benefits have to be measured against the potential for efficiency losses.

There are three basic types of mergers. A horizontal merger is the merger or consolidation of two or more producers of the same product or service. For example, if a flour mill buys another flour mill.

Vertical mergers occur when firms at different stages of production of a product merge. For example, a flour mill that buys a wheat farm would be an example of an upstream vertical merger upstream means input-supplyingwhile the flour mill buying a bakery would be an example of a downstream vertical merger downstream means output-using. Conglomerate mergers occur when the merging firms produce unrelated products, such as a flour mill purchasing a computer company. Conglomerate mergers may allow a firm economies of scope or to diversify.