2.11 MARKET FAILURE-MARKET POWER Flashcards
Summary of Perfect Competition
Many small firms, Identical products, perfect comp., low barriers to entry, and no market power.
Summary of Monopoly
One large firm, unique products, no competition, high barriers to entry, dominant market power.
Summary of Monopolistic Competition
Many small firms, differentiated products, strong competition, and low barriers to entry.
Summary of Oligopoly
A few large firms, have identical or differentiated products, limited competition, high barriers to entry, and limited market power.
Barriers to Entry
Refers to the degree of difficulty involved with firms entering or exiting a market.
Revenue
Total Revenue=Price*Quantity
Marginal Revenue=The change in revenue of an additional quantity
MR=Delta TR/Delta Q
AR=TR/Q
Cost
Total Cost=Cost*Quantity
Marginal Cost=The cost of producing one additional unit
MC=Delta TC/Delta Q
AC=TC/Q
Types of Barriers
Economies of Scale
Innovative Technology
Geography or Ownership of Raw Materials
Government Created Barriers
Economies of Scale
The larger a firm gets the more efficient it is, and it can lower its cost, making it more profitable.
Short-Run
A period when at least one factor of production is fixed.
Long-Run
A period when all factors of production are variable.
The Law of Diminishing Marginal Returns
In the short run, when at least one capital resource is fixed, the addition of inputs will initially increase marginal returns but will eventually diminish marginally.
Profit Maximization
The profit-maximizing rule is used by EVERY firm to determine the quantity the firm should produce to maximize profits.
REMEMBER!!! MR=MC
Concentration Ratio
Tells if an industry is an Oligopoly, Monopoly, or Monopolistic Competition.
Perfect Competition Diagram
Two diagrams are put together side-by-side when drawing a firm that participates in Perfect Competition.
Perfect Competition Diagram
Since no firm has control over the price, MR is equal to the Price. Firms must take the price from the market - Price Takers. (MR=D=AR=P)
Short-Run Profits/Loss
When firms make abnormal profits or losses in the short run, other firms react by either leaving or entering the market. Perf. Comp. has low barriers=easy join or leaving.
Adjustment to Long-Run
As firms join, the equilibrium price in the market decreases, and quantity increases. As firms are Price Takers, they adjust to the new price until eventually, everyone in the market makes normal economic profit.
In Perfect Competition…
Firms can only make abnormal profits or losses in the short run.
All firms will make Normal Profits in the long run.
Economies of Scale Sources
Typically, firms start small with limited expertise. Monopolists can charge a lower price than newcomers.
Natural Monopoly Sources
Only enough revenue and economies of scale to support one firm.
Legal Barriers Sources
Patents, Copyright, Licenses, etc.
Branding Sources
Customers may be loyal to a certain firm due to marketing. Kleenex, Band-Aid, etc.
Anti-Competitive Behavior Sources
A monopolist can charge lower costs due to economies of scale. Therefore, they can lower their price to suffocate upcoming competitors.
Monopoly
Monopolies can make abnormal profits in the short and long run.
Monopoly Key Components
One diagram, a singular firm IS the market.
Cost curves are the same (AC, MC)
The profit Maximizing rule still worked to find the quantity. (MR=MC)
MR does not equal D = AR = P
Natural Monopoly
A monopoly that can produce enough output to cover the entire needs of a market while still experiencing economies of scale. Its average costs will be lower than those of two or more firms in the market
Natural Monopoly
When economies of scale make it impractical for multiple firms to participate, a natural monopoly is preferable.
Natural Monopoly
Natural Monopolies MUST use economies of scale; therefore, their AC and MC curves look different.
Advertising and Branding
Because products are so similar, firms must attempt to differentiate their products with marketing. Obtaining loyal customers leads to higher market power and the ability to raise prices.
Graphing Monopolistic Competition
Differentiation means MR is not equal to demand, but more firms offer substitutes which = MR and Demand more elastic. Abnormal profits and losses only in the short run. Normal profit in the long run
Graphing Monopolistic Competition
Low barriers of entry mean profit will attract other firms to enter and steal demand. The demand curve will shift accordingly. In the long-run equilibrium, there will always be normal profit.
Interdependence
The dependence of two or more people or things on each other.
Interdependence
In an oligopoly, each firm has a significant share of market power and can therefore influence the market. Therefore, each firm must monitor other firms closely.
Interdependence
Oligopolies have an incentive to collude. If collude, they become a monopoly. Simultaneously, firms may also desire to compete with one another to gain higher market shares.
Dominant Strategy
There is one choice you should always make, regardless of your opponent’s decision.
Non-Dominant Strategy
Your best choice is dependent upon your opponent’s decision
Nash Equilibrium
When firms choose the optimal outcome with no incentive to change.
Non-Price Competition
Since firms in oligopolies prefer to avoid engaging in a price war, must find alternative ways to gain market power and compete in alternative ways.
Government Intervention to Market Dominance
Governments may intervene to attempt to solve market power dominance by the use of:
1. Legislation
2. Nationalization
3. Regulation
