[Script Info]
Title: 
[Events]
Format: Layer, Start, End, Style, Name, MarginL, MarginR, MarginV, Effect, Text
Dialogue: 0,0:00:00.00,0:00:05.68,Default,,0000,0000,0000,,♪ [music] ♪
Dialogue: 0,0:00:08.89,0:00:11.56,Default,,0000,0000,0000,,- [Alex] In a competitive market,\Nwe know that price is equal
Dialogue: 0,0:00:11.56,0:00:13.93,Default,,0000,0000,0000,,to marginal cost and equilibrium.
Dialogue: 0,0:00:13.93,0:00:16.77,Default,,0000,0000,0000,,In a market with a monopoly,\Nwe now know the price
Dialogue: 0,0:00:16.77,0:00:19.51,Default,,0000,0000,0000,,will be greater than marginal cost.
Dialogue: 0,0:00:19.51,0:00:23.29,Default,,0000,0000,0000,,But how much greater?\NWhat determines the markup?
Dialogue: 0,0:00:23.29,0:00:24.85,Default,,0000,0000,0000,,What we're going\Nto show in this talk
Dialogue: 0,0:00:24.85,0:00:27.52,Default,,0000,0000,0000,,is that the monopoly markup\Ndepends upon
Dialogue: 0,0:00:27.52,0:00:29.74,Default,,0000,0000,0000,,the elasticity of demand.
Dialogue: 0,0:00:34.65,0:00:38.14,Default,,0000,0000,0000,,Okay, let's do a very brief review\Nwhere we ended up last time.
Dialogue: 0,0:00:38.34,0:00:41.16,Default,,0000,0000,0000,,Everything on this diagram\Nshould now be familiar.
Dialogue: 0,0:00:41.16,0:00:43.32,Default,,0000,0000,0000,,We know how to find\Nthe marginal revenue curve
Dialogue: 0,0:00:43.32,0:00:45.57,Default,,0000,0000,0000,,as a curve starting out\Non the vertical axis
Dialogue: 0,0:00:45.57,0:00:47.10,Default,,0000,0000,0000,,at the same point\Nas the demand curve
Dialogue: 0,0:00:47.10,0:00:48.58,Default,,0000,0000,0000,,with twice the slope.
Dialogue: 0,0:00:48.58,0:00:50.86,Default,,0000,0000,0000,,We know that the profit\Nmaximizing quantity is found
Dialogue: 0,0:00:50.86,0:00:53.36,Default,,0000,0000,0000,,where marginal revenue\Nis equal to marginal cost.
Dialogue: 0,0:00:53.36,0:00:56.64,Default,,0000,0000,0000,,And we know that we read\Nthe profit maximizing price
Dialogue: 0,0:00:56.64,0:00:59.66,Default,,0000,0000,0000,,as the highest price\Nthat people are willing to pay
Dialogue: 0,0:00:59.66,0:01:03.15,Default,,0000,0000,0000,,per unit for that quantity,\Nin this case that's $12.50.
Dialogue: 0,0:01:03.61,0:01:07.01,Default,,0000,0000,0000,,The monopoly markup\Nis the difference between price
Dialogue: 0,0:01:07.01,0:01:08.69,Default,,0000,0000,0000,,and marginal cost.
Dialogue: 0,0:01:08.98,0:01:10.80,Default,,0000,0000,0000,,We know that\Nin a competitive market,
Dialogue: 0,0:01:10.80,0:01:12.77,Default,,0000,0000,0000,,price would be equal\Nto marginal cost.
Dialogue: 0,0:01:12.77,0:01:15.92,Default,,0000,0000,0000,,Here in equilibrium\Nwe have price is much greater
Dialogue: 0,0:01:15.92,0:01:18.73,Default,,0000,0000,0000,,than marginal cost,\Nthat's a monopoly markup.
Dialogue: 0,0:01:18.73,0:01:21.73,Default,,0000,0000,0000,,And we can also read\Noff this diagram,
Dialogue: 0,0:01:22.23,0:01:26.01,Default,,0000,0000,0000,,total profits for the monopolist\Nwhich are above normal profits.
Dialogue: 0,0:01:26.01,0:01:29.42,Default,,0000,0000,0000,,And profits are the difference\Nbetween price and average cost
Dialogue: 0,0:01:29.42,0:01:32.18,Default,,0000,0000,0000,,times the quantity,\Nwhich is this shaded area.
Dialogue: 0,0:01:32.18,0:01:34.27,Default,,0000,0000,0000,,Okay, that's a review.
Dialogue: 0,0:01:34.27,0:01:39.08,Default,,0000,0000,0000,,Now let's give some intuition\Nfor what determines the size
Dialogue: 0,0:01:39.08,0:01:41.30,Default,,0000,0000,0000,,of the monopoly markup.
Dialogue: 0,0:01:43.18,0:01:46.27,Default,,0000,0000,0000,,For intuition, let's go\Nto our case of a pharmaceutical.
Dialogue: 0,0:01:46.27,0:01:50.08,Default,,0000,0000,0000,,Two effects are going to increase\Nthe monopoly markup in this case.
Dialogue: 0,0:01:50.08,0:01:52.98,Default,,0000,0000,0000,,First, the "you can't take it\Nwith you" effect.
Dialogue: 0,0:01:52.98,0:01:55.48,Default,,0000,0000,0000,,Namely, people\Nwith serious illnesses
Dialogue: 0,0:01:55.48,0:01:59.60,Default,,0000,0000,0000,,are going to be relatively\Ninsensitive to the price
Dialogue: 0,0:01:59.60,0:02:01.73,Default,,0000,0000,0000,,of life saving medicine.
Dialogue: 0,0:02:01.73,0:02:04.36,Default,,0000,0000,0000,,You can't take it with you\Nso may as well spend all you have
Dialogue: 0,0:02:04.36,0:02:05.82,Default,,0000,0000,0000,,trying to save your life.
Dialogue: 0,0:02:05.82,0:02:09.24,Default,,0000,0000,0000,,If the price of a life saving\Nmedicine goes up,
Dialogue: 0,0:02:09.24,0:02:13.89,Default,,0000,0000,0000,,the quantity demanded\Nisn't going to go down very much.
Dialogue: 0,0:02:14.70,0:02:18.11,Default,,0000,0000,0000,,Since the customers\Nare insensitive to the price,
Dialogue: 0,0:02:18.11,0:02:21.28,Default,,0000,0000,0000,,the monopolist is going to say,\N"Hey, I can increase the price
Dialogue: 0,0:02:21.28,0:02:24.49,Default,,0000,0000,0000,,and they're still going to buy,\Nso I should increase the price.
Dialogue: 0,0:02:24.49,0:02:28.08,Default,,0000,0000,0000,,It would be profit maximizing\Nfor me to increase the price."
Dialogue: 0,0:02:28.97,0:02:32.37,Default,,0000,0000,0000,,Another effect,\Nthe "other people's money" effect.
Dialogue: 0,0:02:32.37,0:02:34.78,Default,,0000,0000,0000,,If somebody else is paying \Nfor the medicine,
Dialogue: 0,0:02:34.78,0:02:38.20,Default,,0000,0000,0000,,the user, the consumer is going\Nto be less sensitive to the price.
Dialogue: 0,0:02:38.20,0:02:40.93,Default,,0000,0000,0000,,And we know for pharmaceuticals\Noften the insurance company
Dialogue: 0,0:02:40.93,0:02:43.61,Default,,0000,0000,0000,,or Medicaid or Medicare\Nor a government program,
Dialogue: 0,0:02:43.61,0:02:45.67,Default,,0000,0000,0000,,they're going to be paying\Nfor the pharmaceutical,
Dialogue: 0,0:02:45.67,0:02:48.97,Default,,0000,0000,0000,,so that the person who\Nis demanding the pharmaceutical --
Dialogue: 0,0:02:48.97,0:02:50.49,Default,,0000,0000,0000,,they're not paying the price.
Dialogue: 0,0:02:50.49,0:02:53.58,Default,,0000,0000,0000,,So even when the price goes up\Nthey're still going to ask
Dialogue: 0,0:02:53.58,0:02:56.00,Default,,0000,0000,0000,,for the pharmaceutical --\Nthe quantity demanded
Dialogue: 0,0:02:56.00,0:02:58.20,Default,,0000,0000,0000,,isn't going to go down very much.
Dialogue: 0,0:02:58.43,0:03:00.19,Default,,0000,0000,0000,,So the conclusion here
Dialogue: 0,0:03:00.19,0:03:05.49,Default,,0000,0000,0000,,is that the less sensitive\Nquantity demanded is to price,
Dialogue: 0,0:03:05.49,0:03:07.96,Default,,0000,0000,0000,,the higher the markup\Nis going to be.
Dialogue: 0,0:03:07.96,0:03:09.87,Default,,0000,0000,0000,,If people aren't sensitive\Nto the price,
Dialogue: 0,0:03:09.87,0:03:13.12,Default,,0000,0000,0000,,the monopolist is going to say,\N"Great. I can jack up the price
Dialogue: 0,0:03:13.12,0:03:16.70,Default,,0000,0000,0000,,and still sell almost as much\Nas I did before."
Dialogue: 0,0:03:17.28,0:03:21.68,Default,,0000,0000,0000,,In other words, the more inelastic\Nthe demand curve,
Dialogue: 0,0:03:21.68,0:03:24.96,Default,,0000,0000,0000,,the higher the markup,\Nand that's our basic lesson.
Dialogue: 0,0:03:25.94,0:03:29.02,Default,,0000,0000,0000,,Now that we have the intuition,\Nlet's test it with some diagrams,
Dialogue: 0,0:03:29.02,0:03:30.24,Default,,0000,0000,0000,,some demand curves.
Dialogue: 0,0:03:30.24,0:03:31.62,Default,,0000,0000,0000,,We have two demand curves.
Dialogue: 0,0:03:31.62,0:03:34.27,Default,,0000,0000,0000,,Which is more elastic,\Nthe demand curve on the right
Dialogue: 0,0:03:34.27,0:03:36.04,Default,,0000,0000,0000,,or on the left?
Dialogue: 0,0:03:36.80,0:03:40.59,Default,,0000,0000,0000,,The demand curve\Non the left is more elastic.
Dialogue: 0,0:03:41.02,0:03:44.97,Default,,0000,0000,0000,,The demand curve\Non the right is more inelastic.
Dialogue: 0,0:03:44.97,0:03:49.67,Default,,0000,0000,0000,,So going by our intuition,\Nwe should expect a low markup
Dialogue: 0,0:03:49.67,0:03:53.38,Default,,0000,0000,0000,,on the left and a high markup\Non the right.
Dialogue: 0,0:03:54.12,0:03:56.44,Default,,0000,0000,0000,,We know how to find\Nthe profit maximizing prices
Dialogue: 0,0:03:56.44,0:03:58.72,Default,,0000,0000,0000,,and quantities so let's do that.
Dialogue: 0,0:03:58.72,0:04:00.77,Default,,0000,0000,0000,,First, starting on the left.
Dialogue: 0,0:04:00.77,0:04:03.04,Default,,0000,0000,0000,,What we see is that\Nwhen the demand curve
Dialogue: 0,0:04:03.04,0:04:07.84,Default,,0000,0000,0000,,is relatively elastic,\Nwe get a small markup of price
Dialogue: 0,0:04:07.84,0:04:09.95,Default,,0000,0000,0000,,over marginal cost.
Dialogue: 0,0:04:09.95,0:04:11.95,Default,,0000,0000,0000,,What about on the right?
Dialogue: 0,0:04:11.95,0:04:15.89,Default,,0000,0000,0000,,Well now we have\Na relatively inelastic demand curve
Dialogue: 0,0:04:15.89,0:04:20.40,Default,,0000,0000,0000,,and what we see is that price rises\Nwell above marginal cost.
Dialogue: 0,0:04:20.40,0:04:22.47,Default,,0000,0000,0000,,We have a relatively\Ninelastic demand
Dialogue: 0,0:04:22.47,0:04:25.13,Default,,0000,0000,0000,,and we get a big markup.
Dialogue: 0,0:04:25.13,0:04:30.36,Default,,0000,0000,0000,,Notice the marginal cost\Nfor these two markets is the same.
Dialogue: 0,0:04:30.72,0:04:34.71,Default,,0000,0000,0000,,What differs is that the demand\Ncurve over here on the right
Dialogue: 0,0:04:34.71,0:04:36.51,Default,,0000,0000,0000,,is more inelastic.
Dialogue: 0,0:04:36.51,0:04:40.96,Default,,0000,0000,0000,,Remember the logic:\Nthe monopolist sees the consumers
Dialogue: 0,0:04:40.96,0:04:43.36,Default,,0000,0000,0000,,are insensitive to price.
Dialogue: 0,0:04:43.36,0:04:46.51,Default,,0000,0000,0000,,So it knows\Nthat if it raises price,
Dialogue: 0,0:04:46.51,0:04:50.03,Default,,0000,0000,0000,,the quantity demanded\Nwill fall by only a little.
Dialogue: 0,0:04:50.04,0:04:52.85,Default,,0000,0000,0000,,Therefore, an increase\Nin price will increase
Dialogue: 0,0:04:52.85,0:04:55.64,Default,,0000,0000,0000,,the monopolist's profits,\Nthat's what it wants,
Dialogue: 0,0:04:55.64,0:04:58.19,Default,,0000,0000,0000,,so the monopolist\Nwill increase the price
Dialogue: 0,0:04:58.19,0:05:01.57,Default,,0000,0000,0000,,and you get a big markup\Nof price over marginal cost.
Dialogue: 0,0:05:02.04,0:05:05.85,Default,,0000,0000,0000,,Remember also\Nthat for a competitive firm,
Dialogue: 0,0:05:05.85,0:05:10.38,Default,,0000,0000,0000,,the demand for its product\Nis perfectly elastic
Dialogue: 0,0:05:10.38,0:05:13.68,Default,,0000,0000,0000,,and in that case price\Nis equal to marginal cost.
Dialogue: 0,0:05:13.68,0:05:14.84,Default,,0000,0000,0000,,So it makes sense
Dialogue: 0,0:05:14.84,0:05:17.64,Default,,0000,0000,0000,,that the more elastic\Nthe demand curve is
Dialogue: 0,0:05:17.64,0:05:21.01,Default,,0000,0000,0000,,for a monopolist,\Nthe closer the pricing decision
Dialogue: 0,0:05:21.01,0:05:24.30,Default,,0000,0000,0000,,of the monopolist is\Nto that of a competitive firm.
Dialogue: 0,0:05:24.70,0:05:26.52,Default,,0000,0000,0000,,So when the demand curve\Nfor the monopolist
Dialogue: 0,0:05:26.52,0:05:30.16,Default,,0000,0000,0000,,is relatively elastic,\Nprice is going to be close
Dialogue: 0,0:05:30.16,0:05:31.67,Default,,0000,0000,0000,,to marginal cost.
Dialogue: 0,0:05:31.67,0:05:34.83,Default,,0000,0000,0000,,The more elastic\Nthe demand curve gets
Dialogue: 0,0:05:34.83,0:05:36.36,Default,,0000,0000,0000,,for the monopolist,
Dialogue: 0,0:05:36.36,0:05:40.82,Default,,0000,0000,0000,,the closer the monopolist's profit\Nmaximizing output is
Dialogue: 0,0:05:40.82,0:05:42.61,Default,,0000,0000,0000,,to that of a competitive firm.
Dialogue: 0,0:05:42.61,0:05:44.83,Default,,0000,0000,0000,,Price gets closer to marginal cost.
Dialogue: 0,0:05:44.83,0:05:45.100,Default,,0000,0000,0000,,Okay, very good.
Dialogue: 0,0:05:45.100,0:05:49.77,Default,,0000,0000,0000,,Again remember, big lesson,\Nthe more inelastic demand,
Dialogue: 0,0:05:49.77,0:05:51.44,Default,,0000,0000,0000,,the bigger the markup.
Dialogue: 0,0:05:51.90,0:05:54.91,Default,,0000,0000,0000,,Let's now try to see\Nif we can use our theory
Dialogue: 0,0:05:54.91,0:05:57.10,Default,,0000,0000,0000,,to solve a pricing puzzle.
Dialogue: 0,0:05:57.38,0:06:00.15,Default,,0000,0000,0000,,I recently looked at some flights\Non American Airlines
Dialogue: 0,0:06:00.15,0:06:03.66,Default,,0000,0000,0000,,and what I found was that a flight\Nfrom Washington to Dallas
Dialogue: 0,0:06:03.66,0:06:08.88,Default,,0000,0000,0000,,was more expensive than a flight\Nfrom Washington to San Francisco.
Dialogue: 0,0:06:09.11,0:06:11.65,Default,,0000,0000,0000,,Now, there's two things\Nwhich are puzzling about that.
Dialogue: 0,0:06:11.65,0:06:15.79,Default,,0000,0000,0000,,First, San Francisco is obviously\Nmuch farther from Washington
Dialogue: 0,0:06:15.79,0:06:18.05,Default,,0000,0000,0000,,than is Dallas,\Nso you'd expect the cost,
Dialogue: 0,0:06:18.05,0:06:20.72,Default,,0000,0000,0000,,fuel cost and so forth,\Nto be higher.
Dialogue: 0,0:06:21.13,0:06:25.41,Default,,0000,0000,0000,,Second, the puzzle is even deeper\Nbecause the flight from Washington
Dialogue: 0,0:06:25.41,0:06:29.01,Default,,0000,0000,0000,,to San Francisco\Nran through Dallas.
Dialogue: 0,0:06:29.37,0:06:32.99,Default,,0000,0000,0000,,In fact, the Washington\Nto Dallas segment
Dialogue: 0,0:06:32.99,0:06:35.43,Default,,0000,0000,0000,,of the Washington\Nto San Francisco flight
Dialogue: 0,0:06:35.43,0:06:40.19,Default,,0000,0000,0000,,was exactly the same flight\Nas the Washington to Dallas flight.
Dialogue: 0,0:06:41.02,0:06:44.07,Default,,0000,0000,0000,,So why would one segment\Nof the Washington
Dialogue: 0,0:06:44.07,0:06:47.43,Default,,0000,0000,0000,,to San Francisco flight\Nbe more expensive
Dialogue: 0,0:06:47.43,0:06:49.18,Default,,0000,0000,0000,,than the entire flight?
Dialogue: 0,0:06:50.23,0:06:53.65,Default,,0000,0000,0000,,The answer requires knowing\Nsomething about how airlines
Dialogue: 0,0:06:53.65,0:06:55.54,Default,,0000,0000,0000,,are structured\Nin the United States.
Dialogue: 0,0:06:56.13,0:06:58.77,Default,,0000,0000,0000,,Most of the airlines\Nhave a hub airport,
Dialogue: 0,0:06:58.77,0:07:00.72,Default,,0000,0000,0000,,often near the center\Nof the country,
Dialogue: 0,0:07:00.72,0:07:03.29,Default,,0000,0000,0000,,that's dominated\Nby one particular airline.
Dialogue: 0,0:07:03.61,0:07:06.23,Default,,0000,0000,0000,,In the case\Nof American Airlines, it's Dallas.
Dialogue: 0,0:07:06.23,0:07:08.09,Default,,0000,0000,0000,,In the case of United,\Nit's Chicago.
Dialogue: 0,0:07:08.09,0:07:12.17,Default,,0000,0000,0000,,Northwest dominates Minnesota,\NSt. Paul, and so forth.
Dialogue: 0,0:07:12.17,0:07:15.08,Default,,0000,0000,0000,,What this means is that if you\Nwant to fly to Dallas
Dialogue: 0,0:07:15.08,0:07:18.44,Default,,0000,0000,0000,,at a convenient time,\Nyou're much more likely to find
Dialogue: 0,0:07:18.44,0:07:22.66,Default,,0000,0000,0000,,a good flight on American Airlines\Nthan on another airline.
Dialogue: 0,0:07:22.66,0:07:25.15,Default,,0000,0000,0000,,And if you want to fly\Nto Minneapolis, St. Paul,
Dialogue: 0,0:07:25.15,0:07:26.82,Default,,0000,0000,0000,,it's going to be\Nmuch more convenient
Dialogue: 0,0:07:26.82,0:07:29.18,Default,,0000,0000,0000,,to fly Northwest and so forth.
Dialogue: 0,0:07:29.48,0:07:33.54,Default,,0000,0000,0000,,Okay, does that give you any ideas\Nabout solving the puzzle?
Dialogue: 0,0:07:34.72,0:07:37.50,Default,,0000,0000,0000,,Think about someone flying\Nfrom Washington to Dallas,
Dialogue: 0,0:07:37.50,0:07:39.64,Default,,0000,0000,0000,,what options do they have?
Dialogue: 0,0:07:39.64,0:07:42.73,Default,,0000,0000,0000,,Not many.\NThere are few substitutes.
Dialogue: 0,0:07:42.73,0:07:47.27,Default,,0000,0000,0000,,And few substitutes\Nmeans inelastic demand.
Dialogue: 0,0:07:48.31,0:07:51.67,Default,,0000,0000,0000,,Now think about someone flying\Nfrom Washington to San Francisco.
Dialogue: 0,0:07:51.67,0:07:55.22,Default,,0000,0000,0000,,What options do they have?\NWell, they have lots.
Dialogue: 0,0:07:55.22,0:07:59.35,Default,,0000,0000,0000,,They could fly through Chicago\Nor they could fly through Denver
Dialogue: 0,0:07:59.35,0:08:03.10,Default,,0000,0000,0000,,or Minneapolis, St. Paul\Nor they could fly direct.
Dialogue: 0,0:08:03.10,0:08:06.08,Default,,0000,0000,0000,,There are many more\Ngood options of flying
Dialogue: 0,0:08:06.08,0:08:09.33,Default,,0000,0000,0000,,from Washington to San Francisco,\Nsince San Francisco
Dialogue: 0,0:08:09.33,0:08:11.57,Default,,0000,0000,0000,,isn't a hub city.
Dialogue: 0,0:08:12.21,0:08:13.49,Default,,0000,0000,0000,,So what do we see?
Dialogue: 0,0:08:13.49,0:08:16.42,Default,,0000,0000,0000,,Well, we see that the demand\Nfor the Washington
Dialogue: 0,0:08:16.42,0:08:20.11,Default,,0000,0000,0000,,to San Francisco flight\Nis going to be relatively elastic
Dialogue: 0,0:08:20.11,0:08:22.63,Default,,0000,0000,0000,,and the demand\Nfor the Washington to Dallas flight
Dialogue: 0,0:08:22.63,0:08:25.02,Default,,0000,0000,0000,,is relatively inelastic.
Dialogue: 0,0:08:25.02,0:08:29.38,Default,,0000,0000,0000,,And what our theory tells us\Nis that with the elastic demand,
Dialogue: 0,0:08:29.38,0:08:31.57,Default,,0000,0000,0000,,we get a low markup.
Dialogue: 0,0:08:31.57,0:08:35.51,Default,,0000,0000,0000,,With the inelastic demand,\Nwe get a high markup.
Dialogue: 0,0:08:35.51,0:08:37.78,Default,,0000,0000,0000,,So the theory\Nis completely consistent
Dialogue: 0,0:08:37.78,0:08:40.90,Default,,0000,0000,0000,,with this pricing puzzle\Nand it explains the puzzle.
Dialogue: 0,0:08:42.03,0:08:43.66,Default,,0000,0000,0000,,- [Narrator] If you want\Nto test yourself,
Dialogue: 0,0:08:43.66,0:08:45.78,Default,,0000,0000,0000,,click "Practice Questions."
Dialogue: 0,0:08:45.78,0:08:49.59,Default,,0000,0000,0000,,Or if you're ready to move on,\Njust click "Next Video."
Dialogue: 0,0:08:49.59,0:08:53.80,Default,,0000,0000,0000,,♪ [music] ♪