Last period today with my A2 Economics class we used the time to construct different market structures with M&M’s. The idea being to emphasise that profit maximisation is where MC=MR – M&M’s. Below are some of the student creations.
With the exam season approaching in the northern hemisphere here is something on the kinked demand curve. In 1939 Paul Sweezy of Harvard University wrote his paper ‘Demand Under Conditions of Oligopoly’ in which he explained conditions around the kinked demand curve. He suggest that rivals in a market react differently according to whether a price change is upward or downward.
If producer A raises his price, his rival producer B will acquire new customers. However if producer A lowers his price, his rival producer B will lose new customers. From the point of view of any particular producer this means simply that if he raises his price he must expect to lose business to his rivals (his demand curve tens to be elastic going up), while if he cuts price he has no means to believe he will succeed in taking business away from his rivals (his demand curve tends to be inelastic going down). In other words, the imagined demand curve has a “corner’ at the current price.
MR curve at 0 output
An important point to note with a kinked demand curve is that as revenue falls if the price increases or decreases the MR curve must cut the horizontal axis at this output. Therefore, as well as being where MC=MR profit maximisation output it is also revenue maximisation. If a seller reduces the price of the product below P1, his rivals will also reduce their prices. Though he will increase his sales, his revenue would be less than before. The reason is that the AR portion of the kinked demand curve below P is inelastic and the corresponding part of marginal revenue curve after Q1 is negative. Thus in both the price-raising and price-reducing situations, the seller will be a loser. He would stick to the prevailing market price P1 which remains rigid.
A lot of textbooks draw the second part of the MR above the horizontal axis which indicates that total revenue is still increasing. Below is a useful mindmap on the topic
For more on the Kinked Demand Curve view the key notes (accompanied by fully coloured diagrams/models) on elearneconomics that will assist students to understand concepts and terms for external examinations, assignments or topic tests.
Different objectives of firms could be part of an essay question on market structures – perfect and imperfect competition.
The standard neo-classical assumption is that a business seeks to maximise profits (MC=MR) from producing and selling an output in a market. However, there are other objectives that firms might decide to pursue and this has implications for price, output and economic welfare. Furthermore, it is sometimes difficult for firms to identify their profit maximising output because they cannot accurately calculate marginal revenue and marginal costs. Any company has various interest groups that have stakes in the company. These include employees, managers, shareholders and customers.
Each of these groups is likely to have different objectives or goals. What the managers want to do is not necessarily what the owners want them to do. Managers may have a lot of freedom to pursue their own objectives rather than those of the shareholders and may try to maximise their own utility rather than the profit levels of the company. Shareholders may not keep themselves well informed and therefore rely on the decision making of the managers of the company.
The dominant group at any moment in time can give greater emphasis to their own objectives, for example, the main price and output decisions may be taken at local level by managers, with shareholders taking only a distant view of the company’s performance and strategy. Below are some other objectives:
Satisficing – with all the interest groups in a company all with their own objectives (higher wages for employees, customer satisfaction, marketing, etc) the overall objectives of a company are the result of discussion, negotiation and bargaining with all these groups. The result of this is likely to be a compromise between parties that does not maximise anything, this is satisficing.
Market share – some firms may be motivated by increasing market share. This is prevalent when firms operate in markets with a few large competitors and try to attract new customers from other competitors.
Survival – some firms look at survival, – especially those new to a highly competitive market. Surival is also prevalent when an economy goes through a downturn and consumer spending falls throughout the economy.
Shareholder value – increase shareholder value means to increase the asset value of the business. Shareholder value is defined as the remaining value of the business once all debts have been paid.
Ethical goals – increasingly, firms are introducing ethical goals such as those associated with the environment and carbon emissions, and with fair trade. This may mean more investment into these goals that leads to a higher cost structure. However, advertising ethical goals to consumers could attract more demand.
Limit pricing – firms may adopt predatory pricing policies by lowering prices to a level that forces any new firms entering the industry to operate at a loss. This allows firms to sustain a monopoly position in a market.
Sales volume maximisation – firm might wish to maximise the number of units sold, in turn maximising its share of the market, although this goal would have to be pursued subject to a profit constraint. The firm could expect to sell a large number of units if it dropped its price far enough, but at some point cutting price any further will involve making a loss. The output and price of a firm that wishes to maximise sales is subject to the constraint of making at least normal profit. Therefore output is set at the level where AR = AC. See graph below.
Sales revenue maximisation – total revenue is maximised when Marginal Revenue = zero (MR = 0), shown on the graph below. The shareholders of a business may introduce a constraint on the price and output decisions of managers, this is known as constrained sales revenue maximisation. Shareholders may introduce a minimum profit constraint designed to underpin the market valuation of their shares and maintain a dividend (a share of the company’s profits).
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I blogged on this before but thought it would appropriate to mention it again on the eve of the big game in Premier League today. When Liverpool play Manchester City at Anfield in the English Premier League on 10th March tickets will be very sought after (increase in demand) with both teams in the running for the EPL title. Because of the importance of such a game Liverpool FC can charge a higher price for tickets in order to maximise profits. This is referred to as variable ticket pricing (VTP) as ticket prices are set according to expected demand for a future game. This is widely used in the EPL and this year ticket prices at Anfield vary considerably for newly promoted Burnley and title holder Manchester City – see below. Prices from Live Football Tickets
From Liverpool’s perspective differences in demand create an opportunity for the club to maximise profits. The assumption is that attendances at Anfield will be similar for earlier games against clubs in the EPL – Nottingham Forest – 50,000 and Arsenal 58,000 (capacity). With the soon to be completed Anfield Road Stand the capacity is set to be 61,000.
For the firm profit is maximised at the rate of output where the positive difference between total revenues and total costs is the greatest. Using marginal analysis, the firm will produce at a rate of output where marginal revenue equals marginal cost. Remember that the firm will make profits as long as the extra revenue brought in from selling the last unit of output(MR) is greater than the extra cost which is incurred in producing it(MC).
In the graph it can be assumed that the marginal cost of hosting a game is essentially zero up to the point of the stadium’s capacity (58,000) as costs are about the same no matter how many fans attend. The demand curve for the Burnley game is AR2 and demand for the Manchester City game is AR1. A team using variable ticket pricing sets marginal revenue equal to marginal cost for each game – MC=MR1 and MC=MR2 resulting in prices of £399 and £189 respectively. Marginal analysis is in the syllabus of most introductory economics courses, in particular Cambridge A2 level, IB and NCEA Level 3.
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For the CAIE A2 Economics course and NCEA AS 3.2, below is a note on Imperfect Competition which tends to be a popular question in the exam. The rule for maximising profit or minimising a loss (the equilibrium) for a monopoly is the same as any other firm. The most profitable output or smallest loss is where marginal revenue (MR) = marginal cost (MC). Any other position will result in a smaller profit or greater loss
Therefore, the equilibrium output (determined from the intersection of the MC and MR curves is at a price of PM ($8) and quantity Qm ($200m). The average revenue (AR) = $8 and the average cost (AC) = $5.
A monopoly charges more and produces less than it would be the case if the firm operated as a perfect competition. Operating at the equilibrium output position creates a deadweight loss = ABE green shaded area. At the equilibrium position the market is not allocatively efficient because consumer surplus and producer surplus are not maximised. The new consumer surplus is the area above the profit maximising price – light blue shaded area.
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Duopoly is a form of oligopoly and exists in a market when two companies control nearly all the market share of a product or service. The $400bn market for passenger aircraft has been dominated by Airbus and Boeing and the two companies share almost exclusive control of the worldwide airplane supply business for large commercial jets. Their established brands are Boeing’s 7-series and Airbus’s A-series of jets. These aircraft include narrow-body aircraft, wide-body aircraft, and jumbo jets.
The recent blowout of a door plug on Boeing’s 737 Max series during Alaska Airlines flight and the two catastrophic accidents in 2018 (346 people killed) has seen Boeing’s continued loss of market share in the plane manufacturing business. On the contrary Airbus has bounced back with an order for 7,197 A320 series of smaller, single-aisle jets. Airbus holds a market share of 62% in the narrow-body segment. Overall the popularity of Airbus’s single-aisle planes is evident in orders – Airbus backlog = 8,598 and Boeing backlog = 5,626. However the A320neo has been a reason for Airbus’s success in this market. By 2019, the A320neo had a 60% market share against the competing Boeing 737 MAX. As of December 2023, a total of 10,354 A320neo family aircraft had been ordered
Concerns over Airbus dominance
The rivalry between Boeing and Airbus has led to a huge increase in passenger numbers and innovations that have reduced operating costs and fares. Michael O’Leary of Ryanair has emphasised the fact that there needs to be a competitive duopoly structure so that there are further innovations and benefits from service to passengers.
The Chinese challenge.
However, the Chinese are now challenging the duopoly’s market share by introducing its alternative to the Boeing and Airbus options. COMAC, a Chinese state-owned planemaker, has its C919 plane as a competitor to the Airbus 320 and Boeing’s 737 . Eventhough COMAC is state backed there are still significant barriers to entry for the commercial airline manufacturer.
Although the weakening of Boeing relative to Airbus is a concern for competition and innovation, the cost of technology, in which is an already a very expensive industry, is of greater concern.
Source: How Boeing’s troubles are upsetting the balance of power in aviation. FT January 28 2024
Below are some notes from the eLearnEconomics site. For more information click on the link.
A natural monopoly is when one firm has the ability to supply the entire market at lower prices than two or more firms. A natural monopoly faces downward-sloping average cost (AC) for the entire range for which demand is applicable. The reason for its downward-sloping AC curve is usually that the initial investment in the infrastructure of the firm is large, but once it is in place, the marginal cost (MC) of production is low, for example hydro power. This high establishment cost is a strong barrier to entry and a natural monopoly could undercut any would-be competitor so they could not survive. Natural monopolies often involve some kind of network, for example water, gas,phone, rail.
Equilibrium Output-Natural Monopoly
The rule for maximising profit or minimising a loss (the equlibrium) for a natural monopoly is the same as any other firm. The most profitable output or smallest loss is where marginal revenue (MR) equals marginal cost (MC). Any other position will result in a smaller profit or greater loss. Therefore, the equilibrium output is at a price of Pe and quantity Qe (determined from the intersection of the marginal cost and marginal revenue curves). At the equilibrium output Qe the natural monopoly is making a supernormal profit (of $100m) and produces less than what society or consumers desire. Operating at the equilibrium output position creates a deadweight loss of BFG because consumer surplus and producer surplus are not maximised. The natural monopoly is charging a price in excess of marginal cost (P > MC), this is called mark-up pricing. At the equilibrium output in perfect competition, price and marginal cost are the same. Sellers cannot charge higher prices because they would immediately lose sales to competitors. This is called marginal cost pricing and occurs in perfect competition where at the equilibrium output position price equals marginal cost (P = MC). A natural monopoly charges more and produces less than would be the case if the firm operated as a perfect competitor.
Policies concerning natural monopoly
One way a government can regulate a monopoly is by administering price controls that do not allow a natural monopoly to operate at its preferred equilibrium output position where marginal revenue equals marginal cost. For this monopoly the equilibrium output is at a price of $7 (Pe) and quantity of 50m (Qe). The aim of price controls is to benefit the consumer with lower price and a greater quantity. Average cost pricing is a way that the government can improve resource allocation because it increases total surpluses in the market and reduces the deadweight loss that would be associated with a natural monopoly operating at its equilibrium position (MR = MC). Average cost pricing regulates the firm to charge a price equal to average costs (P = AC). In this instance the price would be $4 (Pn) and the quantity would be 80m units (Qn). The natural monopoly would no longer be maximising profits because the marginal revenue is less than marginal cost, the firm is making marginal losses on the increased output. The firm would make a normal profit instead of a supernormal profit. Normal profit is a return to the entrepreneur sufficient to keep them in their present activity. A natural monopoly regulated to a situation where price equals average cost is able to earn a fair rate of return. The net deadweight loss to society is reduced but not eliminated, the deadweight loss is now the area HKG. The natural monopoly is making a normal profit so they may lack the funds to do R & D and be less innovative, this could be viewed as a negative impact on resource allocation of fixing the price. A price set to equal average cost is more socially desirable than the equilibrium output position because consumers experience a significant increase in consumer surplus due to the lower price and higher quantity consumed. Average cost pricing has the advantage over marginal cost pricing of not having to provide a subsidy to a natural monopoly to keep the firm operating.
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The Airfinance Journal’s ‘The Airline Analyst,’ have selected 50 airlines with the highest recorded Latest Twelve Month (LTM) revenue ending between December 2022 and June 2023. Some points of note from the graph below:
This data only refers to revenue and passengers and not the cost structures for each airline – this is due to be published next month in the Airfinance Journal. The questions that need to be addressed is:
– Do wide body aircraft have greater economies of scale than narrow body aircraft?
– Is the cost per passenger lower in wide body than narrow body aircraft?
For more on Revenue and Costs view the key notes (accompanied by fully coloured diagrams/models) on elearneconomics that will assist students to understand concepts and terms for external examinations, assignments or topic tests.
The Economist had a short article on their correspondent getting a haircut in Dakar Senegal. Prices for a haircut in the low income countries should be a lot cheaper when compared to the developed world as a lot depends on operating costs, rents and wages – the saying goes that ‘when in poor countries get a haircut’. In India a haircut and head massage costs around 50 rupees which is less than 1 US$. In New York you could pay up to US$195. The Balassa-Samuelson effect explains differences in prices and incomes across countries as a result of differences in productivity. When you consider Dakar, the expectation is that in this developing country barbers should be cheap. Even though there are numerous cheap hair salons there are those that are very expensive with prices more reminiscent of New York or Paris. The clientele are affluent Senegalese and expats. Might jet-setting customers have their expectations anchored to prices in Paris or London, making haircuts, in effect, seem more traceable than they are?
Barbers are not perfectly competitive.
A variety of prices (high and low) of barbers in the developing world are most likely due to the reputation/expertise of the service provided. Since their prices differ widely within the same city it is an imperfect market. For market to be perfect products/services need to be identical – homogeneous. Yet the market for mohawks in Dakar casts doubt on this idea. Some barbers pull in customers by blasting Afrobeats whilst others have more comfortable chairs or screen the latest premier league football game. Perfect competition also requires clients to have perfect information about the options on offer. Yet many of the Senegal’s best barbers do not show up on the internet; most do business by word of mouth. The traffic congestion may keep extortionate stylists in business in swanky suburbs, while high rents and red tape may keep competitors out. The message is that you should get your hair cut not just in poor countries but once there in poorer areas of town. Below is a very good video from Marginal Revolution University where Alex Tabborak gets a haircut in India. Also a mindmap showing the main characteristics of perfect competition – good revision for the upcoming Cambridge and NCEA exams in New Zealand.
Source: The Economist: Cutting costs – June 18th 2022
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The word monopoly or monopolist probably brings to mind a business that takes undue advantage of the consumer, sells faulty products, gets rich and any other bad thoughts that one can have about big business. If we are to succeed in analysing and predicting the behaviour of non-competitive firms, however, we will have to be somewhat more objective in defining a monopolist. Our definition of monopoly is one that will be as applicable to small businesses as it is to companies selling on a nation-wide basis. Thus, a monopolist is defined as a single supplier that constitutes the entire industry.
A seller prefers to have a monopoly rather than to face competition. In general, we think of monopoly prices as being higher than competitive prices, and of monopoly profits as being higher than competitive profits. How does a firm obtain a monopoly in an industry? Basically, there must be barriers to entry that enable firms to receive monopoly profits in the long run. We define barriers to entry as those difficulties facing potential new competitors in an industry. What sort of difficulties might a new competitor face?
Source: Adapted from A Level Economics Revision Guide by Susan Grant
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More revision material for A2 students as the exam season approaches. Below is a useful mind map which summarises the topic. Quite a popular essay question at A2 which can be linked in with other market structures in imperfect competition.
Oligopoly
Firms that are interdependent cannot act independently of each other. A firm operating in a market with just a few competitors must take the potential reaction of its closest rivals into account when making its own decisions. For example, if a petrol retailer like Z (Shell in the UK) wishes to increase its market share by reducing price, it must take into account the possibility that close rivals, such as Mobil, Caltex and BP, may reduce their price in retaliation.
It is a mistake to believe that ALL oligopolists face a KINKED DEMAND CURVE. Oligopolists may either:
a) COMPETE VIGOROUSLY or
b) COLLUDE (e.g. in cartels) or
c) PLAY SAFE (as in Kinked Demand Curve Theory)
The amount an oligopolist sells depends on the prices charged by other producers and their reactions to changes in his own price and output. Therefore, there are several possible solutions. In practice, prices may not vary much in response to changes in costs and demand: hence the kinked demand curve phenomenon.
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With most schools approaching their mid-year exams in both CIE and NCEA here is a mindmap which covers the main points when studying perfect competition. This can be a popular essay in CIE Paper 4 making a comparison with imperfect competition and NCEA AS 3.2 – 91400 Demonstrate understanding of the efficiency of different Market Structures using Marginal Analysis
For more on Perfect Competition view the key notes (accompanied by fully coloured diagrams/models) on elearneconomics that will assist students to understand concepts and terms for external examinations, assignments or topic tests.
Natural Monopoly-Features
A natural monopoly is when one firm has the ability to supply the entire market at lower prices than two or more firms. A natural monopoly faces downward-sloping average cost (AC) for the entire range for which demand is applicable. The reason for its downward-sloping AC curve is usually that the initial investment in the infrastructure of the firm is large, but once it is in place, the marginal cost (MC) of production is low, for example hydro power. This high establishment cost is a strong barrier to entry and a natural monopoly could undercut any would-be competitor so they could not survive. Natural monopolies often involve some kind of network, for example water, gas,phone, rail.
Equilibrium Output-Natural Monopoly
The rule for maximising profit or minimising a loss (the equlibrium) for a natural monopoly is the same as any other firm. The most profitable output or smallest loss is where marginal revenue (MR) equals marginal cost (MC). Any other position will result in a smaller profit or greater loss. Therefore, the equilibrium output is at a price of Pe and quantity Qe (determined from the intersection of the marginal cost and marginal revenue curves). At the equilibrium output Qe the natural monopoly is making a supernormal profit (of $100m) and produces less than what society or consumers desire. Operating at the equilibrium output position creates a deadweight loss of BFG because consumer surplus and producer surplus are not maximised. The natural monopoly is charging a price in excess of marginal cost (P > MC), this is called mark-up pricing. At the equilibrium output in perfect competition, price and marginal cost are the same. Sellers cannot charge higher prices because they would immediately lose sales to competitors. This is called marginal cost pricing and occurs in perfect competition where at the equilibrium output position price equals marginal cost (P = MC).
A natural monopoly charges more and produces less than would be the case if the firm operated as a perfect competitor. Overpricing and not operating at the allocatively efficient (socially optimum) level means that a natural monopoly can be seen as socially undesirable. However, if consumers are not subject to competitive advertising and marketing, they receive the good or service at cost and the firm carries out R & D (research and development) a natural monopoly can be viewed as socially desirable. A natural monopoly may also be seen as socially desirable because it is wasteful to duplicate the existing infrastructure, so encouraging competition is seen as undesirable. If output is below equilibrium Qe (where MR equals MC), the firm would be missing out on marginal profits because the revenue from producing the last article is greater than its cost of production, implying that the firm could increase output and increase profit. However, increasing output beyond Qe reverses the position. The firm will be making marginal losses because the revenue from one additional article is now less than the cost of its production.
If increased output adds more to cost than to revenue, a firm has obviously passed the point of maximum profit (or minimum loss). Price discrimination may be practised by any monopolist. This is where they segment the market in some way, for example domestic and industrial users may be charged at different rates. A two-part tariff is a system where users are charged a fixed amount for a given time period and per unit charge for use, for example with the phone there is a line rental and a charge for toll calls. Off-peak pricing is a system of charging that results in a higher price at peak time usage than at off-peak times, for example toll calls made after 6 p.m. are at a cheaper rate.
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An interesting podcast from the BBC’s Business Daily looked at why internal airlines prices in Africa are around 45% more expensive than equivalent trips elsewhere. So why are they so expensive and what impact does this have for a lot developing economies that are dependent on tourism? In many cases if you want to travel domestically in Africa it is not possible to get direct flights between major cities and in some cases the cheaper option is to fly out of the continent and then come back in eg:
Nairobi to Cape Town – cheaper to fly to Dubai and then to Cape Town than flying direct.
In Africa there are: 54 countries – 1.5 billion people – 18% of world population – but less than 2% of global air traffic is in Africa
With no discounts, no budget airlines and no direct flights to destinations Africa is losing a lot of commercial opportunities as well as tourism. Aviation directly impacts an economy’s GDP through employment, tourism (bringing in foreign currency) and trade which Africa is missing out on. Add to the fact that a lot of the African countries are landlocked and with limited road / rail networks it is essential that there is a functional airline network. A further problem is that most airlines in Africa are bankrupt.
The distance from Kinshasa (DR of Congo) to Lagos (Nigeria) is comparable distance to flying from Berlin to Istanbul. The prices in the two continents are as follows:
Berlin to Istanbul.
US$140 one-way – direct flight – 2 hours and 50 minutes
Kinshasa to Lagos
US$700 one-way – via Jo’burg (South Africa), Kigali (Rwanda) – 18 hours
One of the issues about the carriers in Africa is that the vast majority of them are in financial bankruptcy. Africa airlines are bounded by bi-lateral agreements between countries which leads to restrictions if a country is not part of an agreement. This would include taxes, restricted flight times etc. Also standalone carriers are not viable as the cost structure is very inefficient. There needs to be some sort of African alliance between national carriers if the sector is to be capable of survival and stimulate growth in the African economy. If you look at the whole of Europe they have essentially just 3 carriers:
IAG – International Airlines Group
Aer Lingus – British Airways – IAG Cargo – Iberia – Iberia Express – LEVEL – Vueling – Avios Group
Lufthansa Group
Air Dolomiti – Austrian Airlines – Brussels Airlines – Eurowings – Lufthansa Cargo – Lufthansa- Swiss International Air Lines – Edelweiss Air
Air France / KLM Group
Air France – KLM
You also have the low-cost airlines like Ryanair and Easyjet.
Ethiopian Airways – a success story
In 2004 they looked at a new strategy focusing on the future growth of Africa and Asia – they now fly 45 destinations / week. They also appointed people into senior positions from within the company and although government owned it is run like a business. Ethiopian Airways were one of the few airlines not be bailed out during the COVID-19 crisis and reconfigured 35 of their passenger aircraft into cargo and became the go-to airline for PPE globally. Back in 2003 they employed 4,000 employees, today 17,000 and they own 6 other airlines in Africa.
If 12 key countries of Africa work together to open up markets, the increased connectivity could boost GDP by over $1bn and create 150,000 jobs across the continent. In 2000 Ethiopia was one of the poorest countries in the world but now fastest growing economies in the world – third largest GDP in subsaharan Africa. Ethiopian airlines is now the largest carrier on the continent therefore a lot of the passengers pass through the capital Addis Ababa which adds to the GDP as well as bringing in foreign currency
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A lithium cartel is being considered by Argentina, Chile, Bolivia and Brazil as electric vehicle (EV) market grows and with it the demand for mined lithium to turn into batteries. Bolivia, Chile and Argentina share part of the region which is rich in lithium reserves – known as the lithium triangle. Although Brazil is still establishing its extraction process, they do have experience in car manufacturing with low carbon emissions with the use of ethanol, biofuels and natural gas. With the opening of its Grota do Cirilo lithium mine in April, Brazil will have one of the few companies globally that has proven its ability to produce lithium in an environmentally sustainable manner.
Argentina is expected to produce 16% by 2030 that is up from 6% in 2021. They would overtake Chile as the No. 2 lithium producer in the world by 2027, behind only Australia.
A cartel could mean a higher cost for lithium which would then be passed onto EV buyers which could reduce the demand for EV cars. But a higher price could encourage a cheaper substitute material sodium-ion batteries for the EV market. However the cartel would most likely increase supply with a commitment from member governments. Below is a short video from the FT on the future of the lithium supply chain and how China controls about 60 per cent of global lithium processing. There is also mention of Latin American countries and their contribution to the global supply.
A2 Level Economics – Cartel notes.
A cartel operates in the Oligopoly market. It is a mistake to believe that ALL oligopolists face a KINKED DEMAND CURVE. Oligopolists may either:
Collusion in oligopoly
Where oligopolists agree formally or informally to limit competition between themselves they may set output quotas, fix prices, or limit product promotion or development. A formal collusive agreement is called a cartel. A cartel can achieve the same profits as if the industry were a monopoly. Covert (formal) collusion occurs where firms meet secretly and make decisions about prices or output. Tacit (informal) collusion is much more difficult to control. This is when firms act as if they have agreements in place without actually having communicated with each other.
Collusion between firms whether formal or informal is more likely when:
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Price discrimination involves charging different prices to different sets of consumers for the same good or service. So when you are on your next flight there are going to be different fares for the same class of seat whether it be in economy, business class or first class. What variables at work to bring about price discrimination in airline routes?
The video below is a very good especially the fare structure on the New York to Los Angeles route.
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With the recent World Cup in Qatar I thought I would share this post again on the Economics of Football. The David McWilliams podcast entitled ‘The Economics of Football’ in which he interviews Simon Kuper of Soccernomics fame, is particularly insightful. What he basically says is that the vast majority of clubs are not businesses and are not trying to make profits. They are pursuing trophies and with this intention spend what money they do make on buying the best players. If you look at the teams in the four English Divisions in 1921 there has been little change even when some clubs go bankrupt. As they are fan based institutions they seem to be unaffected by things like debt in a normal business. For example if a club (limited company) goes bankrupt you discard the old company and form a new limited company changing the name of the club (ABC City to ABC United) but playing at the same ground with the same strip etc. To put it in perspective a typical Premier League club is the size of a branch of IKEA.
Football clubs are huge emotional brands but not very big businesses. For example in 2019 Barcelona was the first club to made over $1bn in revenue but that equates to 0.02% of what Walmart made that year. The problem that football clubs have is how to monetise that passion for the club without affecting their fan base.
Bundesliga should be the richest league in Europe?
When you look at the economic indicators of the German economy – population size, income levels, GDP growth etc – it should be the league with the most money. Why is this not the case? The German FA doesn’t want foreign money coming into their clubs like Chelsea, Manchester City, Paris Saint-Germain etc. Also the German Bundesliga has a rule that over 50% of a club must be controlled by its supporters.
New breed of foreign owners and European Super League
The owners of Manchester United, Tottenham and Arsenal are more focused on making money out of the football club compared to others – Man City, Chelsea, PSG – whose owners want success at the expense of profit. This new breed of owner has come under a lot of pressure from the club’s supporters in that some are borrowing money to buy the club and then taking money out. Take for instance Man United – in the 5 years up to 2020, no owners in the Premier League have taken out more money than Man Utd £133m (dividends £112m, share buy back £21m). In stark contrast, some owners have put in significant funds: Everton £348m, Aston Villa £337m and Chelsea £255m – see graphic.
You can therefore see why some owners were keen on the European Super League. The proposed ESL was all but free-market capitalism with an American style franchise system with 12 teams guaranteed a place in the competition – significant barriers to entry and not conducive to competition. So much for Joseph Schumpeter’s creative destruction with a group of elite clubs protecting their market and the owners being rentier capitalists. The ESL’s proposed move is similar to what has been happening in the market place – a structure of businesses taking huge debt and taking little interest in competition as long as they are making money. Manchester United, probably the most famous club in the world, got knocked out of the Champions League in the group stage in 2021 but are still making a lot of money for the owners. It seems that the desire to win trophies has been superseded by profit – the proposed ESL avoids competition as member clubs are protected against the risk of failure. Not to say this is not already happening as the EPL and many other leagues in Europe are dominated by a small number of clubs which have significant funds available.
A topic in the A2 syllabus is Market Failure with special emphasis on Monopoly and Deadweight Loss.
In Perfect Competition we stated that the force of supply and demand establish an equilibrium situation in which resources are used most efficiently – MC (Supply) = AR(Demand) . Furthermore, in perfect competition the firm produces at MC = MR (profit max) which is also the same as producing at MC = AR (allocative efficiency). This is because AR and MR are the same in perfect competition. Therefore the same output represents allocative efficiency and profit max. Remember that long-run Perfect Competition is a significant output as it is where:
MC = MR – Maximum Profit or Minimum Loss
MC = AR – Allocative Efficiency (Supply = Demand)
AC = MC – Technical Optimum – Productive Efficiency
However for a monopolist because the AR and the MR curves are different we get separate outputs for Allocative Efficiency and Profit Max. The graph below shows that at profit maximising equilibrium, output Q2 is less than that in a competitive market (Q1), and the demand and supply (MC) curves do not intersect. Q1 represents the Allocative Efficiency level of output and P1 the price. The shaded area therefore represents the loss of allocative efficiency or the deadweight loss.
Use elearneconomics for immediate personalised feedback on Monopoly and Deadweight Loss with tasks designed for true student-centred learning and understanding that improves students results and grades.
In 1939 Paul Sweezy of Harvard University wrote his paper ‘Demand Under Conditions of Oligopoly’ in which he explained conditions around the kinked demand curve. He suggest that rivals in a market react differently according to whether a price change is upward or downward.
If producer A raises his price, his rival producer B will acquire new customers. However if producer A lowers his price, his rival producer B will lose new customers. From the point of view of any particular producer this means simply that if he raises his price he must expect to lose business to his rivals (his demand curve tens to be elastic going up), while if he cuts price he has no means to believe he will succeed in taking business away from his rivals (his demand curve tends to be inelastic going down). In other words, the imagined demand curve has a “corner’ at the current price.
MR curve at 0 output
An important point to note with a kinked demand curve is that as revenue falls if the price increases or decreases the MR curve must cut the horizontal axis at this output. Therefore, as well as being where MC=MR profit maximisation output it is also revenue maximisation. If a seller reduces the price of the product below P1, his rivals will also reduce their prices. Though he will increase his sales, his revenue would be less than before. The reason is that the AR portion of the kinked demand curve below P is inelastic and the corresponding part of marginal revenue curve after Q1 is negative. Thus in both the price-raising and price-reducing situations, the seller will be a loser. He would stick to the prevailing market price P1 which remains rigid.
A lot of textbooks draw the second part of the MR above the horizontal axis which indicates that total revenue is still increasing.
For more on the Kinked Demand Curve view the key notes (accompanied by fully coloured diagrams/models) on elearneconomics that will assist students to understand concepts and terms for external examinations, assignments or topic tests.
Just been covering this with my A2 class and as it is a popular topic in the multiple choice paper (P3). Here are some thoughts on the types of questions they could ask on natural monopoly graphs. Remember that the natural monopoly achieves economies of scale at all levels of output therefore the MC curve cuts the AC curve above the AR curve. The following are areas/points on the natural monopoly graph that you should know about. Loss of allocative efficiency is a popular question.
ECONFIX 