block 7 Flashcards
what is the minimum efficient scale
the production point where LAC stops falling relative to the size of the market demand
- gives insight on the competitiveness of an industry
- larger MES relative to market size = lesser number of firms in the industry
what are the characteristics of monopolistic competition
- market structure where there are many firms selling differentiated products
- no barriers to entry/ exit
- advertising is important
how is monopolistic competition similar to monopoly and perfect competition
perfect competition
- many firms
- no barriers to entry
monopoly
- has market power though less than that of monopoly
possible outcomes of monopolistic competition in the short and long run
short run:
- firm can make profit or loss
long run:
- firm can only make normal profit cuz theres no barriers to entry to entry or exit
what is the long run adjustments and equilibrium for monopolistic competition
long run adjustments
1. if the firms in monopolistic competition are making profits in the short run - new firms will be attracted cuz of absence of barriers to entry
- influx of new firms = increase in the number of available substitutes = decreased in demand faced by each individual firm
2. if the firms are making loses - firms will exit the market
- supply of the products decreases = demand for the remaining firms’ products increases, restoring profitability for the firms left
long run equilibrium
- in the long run, the entry and exit of firms will push the market to a point where each firm earns only normal profit
- normal profit = when P = ATC
- firms cover their explicit and implicit costs, but they dont earn economic profit (profit above normal profit)
why do firms monopolistic competition only earn normal profit in the long run
- if the firms were earning an economic profit, new firms would enter = increased competition and reduced demand for each firm’s product
- driving the prices down until only normal profits are being earned
- if the firms were making a loss, some firms would exit = reduced supply
- pushing pushes back up - restoring normal profits for the remaining firms
description of monopolistic competitive firm making profits in the in the long run
new firms enter
- entry of new firms : 1) reduces each firm’s market share (firm’s demand curve shifts downward)
2) increases the number of differentiated products ( the firms demand curve becomes more elastic)
- new firms will not enter once normal profits are is restored (when the demand curve is tangent to the AC curve at the new profit maximising output)
what is the difference between monopolistic competitive and perfectly competitive firms in the long run (in terms of normal profit)
- only the perfectly competitive firms is allocative efficient
- the monopolistic competitive firm is allocative inefficient as it produces the output where P>MC
what is a oligopoly market
- a market structure where there are a few dominant firms
- presence of strategic interactions/ mutual interdependence among firms in the industry
- firms must take each other’s actions into account
- products sold can be homogenous or differentiated
- barrier to entry is high
explain model of collusion
when firms collude, they act as monopolists
- objective: limit output, raise prices and increase profit
- difficult to sustain as there is incentive to “cheat” on the agreement
- the firm that cheats by producing more make more profit at the expense of the other firms who adhere to the agreement by restricting output
briefly explain model of no colluson (game theory) and explain prisoner’s dilemma
game theory: a framework to study strategic interactions between different players who recognise that their wellbeing depends on their own actions and that of others
- game consists of players, each one having strategies, payoffs and nash equilibrium
prisoner’s dilemma :
- describes a situation where the outcome of the game is sub-optimal
- happens cuz 2 players act selfishly
explain dominant strategies one-off game
shows how 2 firms (duopoly) decide on the output to produce (high or low output)
- each firm decides on the best strategy to adopt in response to the strategy chosen by the other firm
1.If B chooses high output, A’s best response = high output – makes a profit of 1
2. if B chooses low output, A’s best response = high output
therefore regardless of what B chooses, A’s best response = high output
- A’s dominant strategy = high output
nash equilibrium:
the outcome where the players are pursuing their best possible strategy given the strategies of the rival
- therefore no firm can improve its payoff by unilaterally changing its strategy if its rival’s strategy remains constant
- the nash equilibrium may not be the best outcome
explain games without dominant strategy and its nash equilibrium
player 1:
- if player 2 plays L, player 1’s best response is L
- if player 2 plays R, player 1’s best response is R
therefore there is not dominant strategy
have 2 nash equilibrium
what are the assumptions for Bertrand model
2 firms compete in price
- each firm takes the competitor’s price as fixed when deciding on the price to charge
assumption :
- if both firms charge the same price, they share the market equally
- if one firm charges a lower price, it takes the entire market
2 firms will undercut each other’s prices until they reach the marginal cost where they cannot lower prices any further without incurring loss
nash equilibrium:
- both firms set price equal to MS
- outcome of this model = outcome of perfect competition
explain cournot model
firms compete by choosing quantities
firm 1’s perspective: treats the outcome of its competitor as fixed and decides how much to produce to maximise its profit
