2/2 - Competitive Markets, Monopolies Flashcards
Competitive Market Definition
A market with numerous buyers and sellers that no one can effect the price on the market.
-Firms maximizes profit
-Consumer is making the best decision based on resources, preferences, and opportunity cost.
Competitive Market Characteristics
- Many buyers and sellers in the market.
- Goods offered by various sellers are the same in a large scale. (Homogenous goods/perfect substitutes.)
- Firms can freely enter and exit the market.
Sunk Cost Definition
A cost that has been committed and cannot be recovered.
Zero Profit Equilibrium
Economic profit is zero, but accounting profit is positive.
-Response of a market depends on time horizon.
(Competitive) Supply Curve usually slope down, but it can slope upward if:
- Some resources used in production may be available only in limited quantities.
- Firms may have different costs.
First Theorem of Welfare Economics
The allocation resulting from a competitive market (equilibrium price and quantity) is Pareto effect.
Monopoly Definitions
Single producer due to barriers to entry.
(Patents, Large fixed costs, Legislation).
A firm that is the sole seller of a product without close substitutes.
Fundamental Causes of a Monopoly are Barriers to Entry
(Forms of Monopolies)
- Monopoly Resources: A key resource is owned by a single firm.
- Government-created monopolies: The government gives a single firm the exclusive right to produce some good or service.
- Natural Monopolies: A single firm can produce output at a lower cost than can many producers.
Markets Allocating Scarce Resources
-Consumer’s Marginal Valuation of the Good = Price
(point in demand curve)
-Firms’ Marginal Cost of Production = Price
(point in supply curve)
-Consumers’ MB = Firms’ MC
(Can’t reallocate resources so one can benefit without reducing welfare of another.)
Ownership of Resources (Monopoly)
-Simplest way for monopoly to arise is for a single firm to own a key resource.
-Although exclusive ownership of a key resource may be the cause of monopoly, it usually doesn’t happen for this reason.
Why Restrict Competition in a Market?
-Economic profits serve as an incentive to enter a market/produce a new good.
-In equilibrium, entry and exit of firms will reduce economic profits to zero.
-By restricting competition, economic profits serve as an incentive to incurring large fixed costs or research and development of new products.
Government-Created Monopolies
-Monopolies arise because government has given the one firm the exclusive right to sell some good or service.
-Patent and copyright laws are examples of how the government creates a monopoly to serve the public interest.
–>Their benefit is the increased incentive for creative activity.
Natural Monopoly
-Arises because a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms.
-Arises when there are economies of scale over the relevant range of output.
Market Demand Curve on Monopoly
-Provides constraint on a monopoly’s ability to profit from its market power.
-By adjust quantity produced, monopolists can choose any point on demand curve but not outside of it.
-To maximize profit, it needs to choose a price and quantity to provide the market.
Monopoly Inelastic and Elastic Demand
Change in Revenue = Area A - Area B
Inelastic: Price goes up, revenue also goes up.
Elastic: Price goes up, revenue goes down.
Output Effect
More output is sold, so Q is higher, which tends to increase total revenue.
Price Effect
The price falls, so P is lower, which tends to decrease total revenue.
What Sets Monopolist Apart from Perfect Competitive Market
Monopolists are not price takers, therefore marginal revenue they receive is less than the price.
Profits Maximizing Decision
Choose Q and P so that MC = MR.
Producing more: MC > MR (losses)
Producing less: MC < MR (without profit)
If producing that P>ATC, economic profits greater than 0.
Marginal Cost / Revenue (Profit-Maximizing)
Competitive Firms (P = MR = MC)
Monopolist (P > MR = MC)
Monopoly Profit Formulas
TR - TC
(TR/Q-TC/Q) x Q
(P-ATC) x Q
Is Monopoly a Good Way to Organize a Market? (A question)
-It is possible that the benefits to the firm’s owners exceed the costs imposed on consumers, making monopoly desirable from the standpoint of society as a whole?
Welfare Effects of a Monopoly
Measured by comparing the level of output that the monopolist chooses with the level of output that a social planner would choose.
Problems with Monopolized Market
Because the firm produces and sells a quantity of output below the level that maximizes total surplus.
DWL measures how much surpluses is not realized.
Inefficiency is related to monopolists’s higher price: Consumers buy fewer units when the firm raises its price (change in quantity demanded).
Monopoly: Additional Units Sold
The reduction in price as additional units are sold (MR < P), the monopolist produces an inefficient allocation on the market.
-Price is higher than that in competitive market.
-Quantity is lower than that in competitive market.
-May be used to cover large rixed costs (natural monopoly)
–> May be used to provide incentives via profits (patents).
Price Discrimination Definition
The business practice of selling the same good at different prices to different customers.
(Ex. Hair Products: Pink tax (more inelastic). Bus fairs, bulk ordering, age, insurance.)
Requires the ability to separate customers according to their willingness to pay.
-Can raise economic welfare. (Higher PS than CS)
Degrees of Price Discrimination
1st: Each person pays their willingness to pay.
2nd: Consumers pay different amounts depending on quantity (quantity discounts).
3rd: Different types of consumers different prices (student discounts).
How Monopolists Differentiate Consumers (Price Disrimination)
Price discrimination is a rational strategy for a profit-maximizing monopolist.
-Separating customers according to their willingness to pay.
-Can raise economic welfare. Shows up as higher producer surplus than consumer surplus.
(Age, income, characteristic.)
Revelation Problem
It’s not always in an individual’s interest to truthfully reveal what they are willing to pay.
-Consider comparison with an auction.
-Ties to the first degree of price discrimination.
How Policymakers in Government Can Respond to Problem of Monopoly
- By trying to make monopolized industries more competitive.
- By regulating behaviour of the monopolies.
- By turning some private monopolies into public enterprises.
- By doing nothing at all.
