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2 Eco Micro Romania March 2014
2 Eco Micro Romania March 2014
Objectives
Programme structure
Cost analysis (II)
SUPPLY
SUPPLY
DEMAND
DEMAND
Demand analysis
DEMAND ANALYSIS
Different perspectives
Consumer choices (utility theory)
Individual Demand
aggregation
Market Demand
Demand Curves
Individual Demand
Reservation price
aggregation
Market Demand
p
q
Prof. Patrick GOUGEON ESCP Europe/ 2014
Consumer
surplus
At this price
Supply > Demand
Producer
surplus
quantity
Except the marginal consumer , most consumers will pay a price which is lower
than the maximum price they would accept (reservation price).
This is the origin of the consumer surplus
Suppliers would also accept to sell for a lower price.
This is the origin of the producer surplus
Prof. Patrick GOUGEON ESCP Europe/ 2014
x
Consumers &
suppliers share the
tax burden
p inc. Tax
supply
p1
p bef. Tax
q2
q1
quantity
If consumers have to pay x as tax for each unit, then the demand curve moves down
(for any price p, suppliers receive p-x only)
price
Consumers pay 25
more per unit
supply
550
Suppliers receive 25
less per unit
50
q2
425
q1
450
quantity
price
inelastic demand
Consumers pay 42
more per unit
supply
650
Suppliers receive 8
less per unit
q2
542
q1
550
quantity
Demand is inelastic, consumers are less price sensitive, therefore suppliers dont
need to reduce their price much!
Elasticity ratios
q
q
Price elasticity: ep = p
p
Market demand
p
p0
p1
<0
q0 q1
q
q
Y
Y
qi
qi
pj
pj
> 0 ; substitutes
< 0 ; complements
COST FUNCTIONS
and related concept
Production function
Production
)
Productionfunction
function::QQ==F(x
F(x11,x,x22,.x
,.xi,.x
i,.xnn)
The level of output Q, depends on the quantity of inputs, (x 1, x2,.xi,.xn),
used in the production process
Types of inputs: Capital, Labour, energy, raw material, components,
Few remarks
Inputs are assumed to be, at least partly, substitutes, so that there exist various
inputs combinations for the same output Q.
If we adopt a short term perspective with reference to a given technology in
place, some inputs are fixed (Capital ) whereas the quantity of other factors
can vary to adjust the output
In the long term the objective is to select the best factor combination
considering all the possible technologies. For a given output Q, considering the
cost of using each factor, there exist an optimal combination (x 1*,..xi*,xn*)
for which the total production cost C(Q) is minimum.
Prof. Patrick GOUGEON ESCP Europe/ 2014
Productivity ratios
Definition:
Definition: ouput/inputs
ouput/inputs
Assuming
Assumingtwo
twofactors
factorsonly:
only:Capital
Capital(K)
(K)and
andLabour
Labour(L)
(L)
Q
Q == F(K,L)
F(K,L)
Factor productivity:
Q/L ; Q/K
Q/(K+L)
TCi
AC = MC
Qi
Q*
AC
MC
ACi = TCi/Qi
Q*
Prof. Patrick GOUGEON ESCP Europe/ 2014
Price
Margin
Critical
output
Q*
Some
Someissues:
issues:
Companies tend to adopt more capital intensive technologies, how does it affects
their flexibility?
Why is a broader client base likely to partly solve the flexibility constraint ?
With reference to flexibility, analyse the strategic advantage provided by
subcontracting
Prof. Patrick GOUGEON ESCP Europe/ 2014
CCGT
20
830
80%
550000
3.8
31
10%
Technology
Number of years of utilisation
size (MW)
Capacity factor
Investment cost per MW (000)
Opex per MWh
Fuel cost per MWh
Discount rate
CCGT
20
830
80%
550000
3.8
31
10%
44.1
(Min for 80% capacity factor)
The marginal cost is a trigger: as soon as the market price is over the
marginal cost, the plant should start producing......
But to get a profit over a period of time, the average market price
should be above the average cost
Prof. Patrick GOUGEON ESCP Europe/ 2014
Average cost
Long Term Average Cost
Low fixed costs
High variable costs
Quantity
Efficient size
Economies of scope
Synergies
Gains from exprience
Market Structures
Normative approach
Perfect competition versus monopoly
Positive approach
Oligopoly (few firms); monopolistic competition,...
Competition
the regultors view
Market analysis: methodology
Perfect competition vs Monopoly
Issues on competition & market regulation
Market regulation
A place where supply meets demand
price
Demand
Supply
Market
price
quantity
A voting place
A place where information are available for firms
to allocate resources efficiently
A place where inefficiency is sanctioned
Prof. Patrick GOUGEON ESCP Europe/ 2014
Max :
q = Rm - Cm = 0
Rm = Cm
Marginal income = Marginal Cost
= [ P(q) x q ] - C(q)
Demand to the firm
Cost, Profit
Rm
Total Cost
max
Cm
Quantity
Profit
max
Break
even
Prof. Patrick GOUGEON ESCP Europe/ 2014
Quantity
q*
Perfect competition
Definition
Atomicity
Free entry
Transparency
Homogeneity
Factors mobility
Perfect competition
Mecanisms
individual supply
Market
Cost, price
Supply
price
Demand
(N firms)
(marginal cost Cm = P)
Firm
Supply
Average cost
Market price
imposed to all firms
demand function:
P = P, Rm = P
(N+n firms)
Free entry
margin
Long term market price
(price = average cost = Cm)
quantity
P*
QN
QN+n
quantity
= N qN i
qN+ni qNi
Monopoly
Demand to the firm = Market demand
P= - a q + b
R(q) = P x q = - a q2 + b q
Rm
Rm==--22aaqq++bb
price
Cm
P*
Average cost
P max
P
Rm = Cm
q*
P*
P*>>Cm
Cm
Demand: - a q + b
quantity
Rm: - 2 a q + b
P min = Cm
Monopoly
P - Cm
measure of
competition
intensity
Perfect
competition
Antitrust
Agreements which restrict competition are prohibited (Article 81 of the Treaty). This is for example the case of price-fixing agreements
and cartels between competitors;
Firms in a dominant position may not abuse of that position (Article 82 of the EC Treaty). This is for example the case for predatory
pricing aiming at eliminating competitors from the market
Mergers
Control of concentration to assess the impact on competition
Liberalisation
"ensuring that competition in the internal market is not distorted"
State aid
State aid that distorts competition in the Common Market is prohibited by the EC Treaty.
The EC Treaty, however, allows exceptions to the ban on state aid where the proposed aid schemes may have a beneficial impact in overall
Union terms. Article 87 of the EC Treaty allows the following forms of aid:
aid having a social character, granted to individual consumers;
aid to make good the damage caused by natural disasters or exceptional occurrences;
aid designed to:
- promote the economic development of underdeveloped areas (regarded as particularly
backward in accordance with Community criteria);
- promote the execution of an important project of common European interest or to remedy a
serious
disturbance in the economy of a Member State;
- facilitate the development of certain activities or areas,
- promote culture and heritage conservation;
International
The EU has established bilateral agreements on competition, particularly with the principal trading partners of the EU, and continues to
develop further bilateral relations. It has also been at the forefront of multilateral co-operation efforts, for example, being among the first
to propose the inclusion of competition policy as a subject for discussion in the World Trade Organisation, and playing a key role in the
International Competition Network.
Prof. Patrick GOUGEON ESCP Europe/ 2014
Supply substitution
This requires that suppliers be able to switch production to the relevant products and market them in the short term (4) without incurring
significant additional costs or risks in response to small and permanent changes in relative prices
Potential competition
If required, this analysis is only carried out at a subsequent stage, in general once the position of the companies involved in the relevant
market has already been ascertained, and such position is indicative of concerns from a competition point of view.
Imperfect markets
Oligopoly
Oligopoly
Concentration
Concentration measures
measures
Monopoly
Monopoly and
and price
price discrimination
discrimination
Entry
Entry barriers
barriers
Monopolistic
Monopolistic competition
competition
Imperfect markets
Corporate strategy, a main objective: avoid competition
Regulators view
Atomicity
Free entry
Transparency
Homogeneity
Factors mobility
companys view
Concentration
Entry barriers
Information asymmetry
Differentiation
Imperfect markets
Atomicity
Free entry
Transparency
Homogeneity
Factors mobility
Monopoly
Duopoly
OLIGOPOLY
HHI =
i n
2
P
i1 i
n firms: i = 1,.n
Pi market share of firm
(1/HHI can be understood as the
equivalent number of firms)
In the B2C power sector, six countries have an HHI score of 1.0, indicating the existence
of a monopoly that is not exposed to competition. The average EU27 HHI index of
0.67* in the B2C gas sector reflects the high degree of market concentration and the lack
of effective retail competition in the market. The UK is the most competitive B2B gas
market in terms of its HHI score of 0.10*.
100%
Total
market
share
Lower
concentration
ratio
30%
90%
Proportion of of firms
(increasing size)
100%
II
IIII
companies
companies Market
MarketShare
Share Market
MarketShare
Share
AA
25,0%
60,0%
25,0%
60,0%
BB
21,0%
6,0%
21,0%
6,0%
CC
16,0%
6,0%
16,0%
6,0%
DD
15,0%
5,0%
15,0%
5,0%
EE
10,0%
5,0%
10,0%
5,0%
FF
4,0%
5,0%
4,0%
5,0%
GG
3,0%
5,0%
3,0%
5,0%
HH
3,0%
4,0%
3,0%
4,0%
II
2,0%
3,0%
2,0%
3,0%
JJ
1,0%
1,0%
1,0%
1,0%
total
100,0%
100,0%
total
100,0%
100,0%
C4
C4
77,0%
77,0%
77,0%
77,0%
100,0%
100,0%
120,0%
120,0%
80,0%
80,0%
100,0%
100,0%
60,0%
60,0%
80,0%
80,0%
40,0%
40,0%
60,0%
60,0%
20,0%
20,0%
40,0%
40,0%
0,0%
0,0%
1
20,0% 1
20,0%
0,0%
0,0%
2
2
11
3
3
22
4
4
33
5
5
44
6
6
7
7
8
8
55
66
77
9 10 II
9 10
88
99 10
10
P
q
Rm
Cm
Price stability is
most likely
Rm = Cm
II
I
Increase
output
For
Forboth,
both,the
the
decision:
decision:
increase
Dont increase
leads totothe
thebest
best
increaseleads
outcome
outcome
output whatever
whateverthe
the
other
decides
other decides
Increase
output
100; 100
200; 70
Dont
increase
output
70; 200
150; 150
However,
However,
would
wouldthey
they
collude,
both
collude, both
would
wouldachieve
achieve
aabetter
better
outcome
outcome
Prof. Patrick GOUGEON ESCP Europe/ 2014
Imperfect markets:
Monopoly with price discrimination
Objective: capture the consumer surplus resulting from a single price strategy
Three kinds of price discrimination
First-degree (perfect price discrimination)
Each consumer is charged his reservation price
That is the maximum he is ready to pay!
(idealistic)
Third-degree
Different groups of customers are identified
with different price sensibility, the firm offers
the same product for different prices
Prof. Patrick GOUGEON ESCP Europe/ 2014
Imperfect markets
Monopoly behaviour: bundling *
Willingness to pay for software components
Type of consumers
Type A
Type B
Word processor
120
100
Spreadsheet
100
120
Brand
Brandand
andreputation
reputation
Scale
Scaleand
andexperience
experience
lock
lockin
inand
andswitching
switchingcost
cost
Upstream
Upstreamand
anddownstream
downstreamcontrol
control
Imperfect markets
Atomicity
Free entry
Transparency
Homogeneity
Factors mobility
MONOPOLISTIC
COMPETITION
price
Average Cost
margin
New entries
quantity
Rm
As compared with perfect competition, the
price is higher (over the minimum long term
average cost)