Chapter 12 Flashcards
1
Q
Describe the industry characteristics of perfect competition. [6]
A
- Many small firms
- Firms sell identical products
- All firms are price takers
- Free entry and exit
- Zero profits in long-run equilibrium
- Price = MC
2
Q
Describe the industry characteristics of monopolistic competition. [6]
A
- Many small firms
- Firms sell differentiated product
- Each firm has some power to set price
- Free entry and exit
- Zero profits in long-run equilibrium
- Price > MC; less output than in perfect competition; excess capacity
3
Q
Describe industry characteristics of oligopoly. [7]
A
- Few firms, usually large
- Strategeic behaviour among firms
- Firms often sell differentiated products and are price setters
- Often significant entry barriers
- Usually economies of scale
- Profits depend on the nature of firm rivalry and on entry barriers
- Price usually > MC; output is usually less than in perfect competition.
4
Q
Describe the industry characteristics of monopoly. [4]
A
- Single firm faces the entire market demand
- Firm is a price setter
- Profits persist if sufficient entry barriers
- Price > MC; less output than in perfect competition
5
Q
What is productive efficiency for the firm and for the industry?
A
- Productive efficiency for the firm requires the firm to be producing its output at the lowest possible cost.
- Productive efficiency for the industry requires that the marginal cost of production be the same for each firm.
- If firms and industries are productively efficient, the economy will be on, rather than inside, the production possibilities boundary.
6
Q
What is allocative efficiency? [3]
A
- A situation in which the output of each good is suh that its market price and marginal cost are equal
- When utility-maximizing consumers face their market price for some good, they adjust their consumption of the good until their marginal value is just equal to the price.
- Price reflects the marginal value to consumers.
- If the level of output of some good is such that marginal cost to producers exceeds marginal value to consumers, too much of that good is being produced.
- If the level of output of some good is such that the marginal cost to producers is less than the marginal value, too little of the good is being produced.
- When the combination of goods produced is allocatively efficient, economists say that the economy is Pareto efficient.
7
Q
Is perfect competition efficient?
A
- In long-run equilibrium, each perfectly competitive firm is producing at the lowest point on its LRAC curve. Every profit maximizing firm is productively efficient.
- All firms face the same market price and equate their own marginal cost to the price, so marginal cost is equal across are firms. The industry as a whole is productively efficient.
- If perfect competition were the market structure for the whole economy, P = MC in each industry, resulting in allocative efficiency across the entire economy.
8
Q
Is monopoly efficient?
A
- A monopolist’s profits are maximized when it adopts the lowest-cost production method, so a profit-maximizing monopolist operates on its LRAC curve and will be productively efficient.
- Since the firm is alone in the industry, the industry is also productively efficient.
- P > MC, so the monopoly is not allocatively efficient.
9
Q
Are monopolistic competition and oligopoly efficient?
A
- Maximize profits when they adopt the lowest-cost production method, so they operate on their LRAC curves and are productively efficient.
- It is impossible to conclude whether the industry is productively efficient since all firms sell differentiated products and there is no single industry-wide price.
- P > MC, so neither market structure is allocatively efficient.
10
Q
How does a monopolist generate deadweight loss?
A
By restricting output below the competitive level.
11
Q
What is market failure?
A
- Market failure occurs when market economies fail to produce efficient outcomes.
- Market transactions may impose costs or confer benefits on economic agents who are not involved in the transaction
- Cases like these are called externalities because they involve economic costs or benefits for parties that are external to the transaction.
12
Q
Describe regulation of natural monopolies.
A
- One response to natural monopoly is for the government to assume ownership of the firm (crown corporations)
- Another response to the problem of natural monopoly is to allow private ownership but to regulate the monopolist’s behaviour.
- Three general types of pricing policies exist for regulated natural monopolies: marginal cost pricing, two-part tariffs, and average-cost pricing.
13
Q
Describe marginal cost pricing in response to natural monopoly.
A
- Price is set where the market demand curve and the marginal cost curve intersect.
- The outcome is allocatively efficient.
- The monopoly suffers losses.
- When a natural monopoly with falling average costs sets price equal to marginal cost, the outcome is allocatively efficient but the firm will suffer losses.
14
Q
Describe two-part tariffs in response to natural monopoly.
A
- The situation of losses with marginal-cost pricing cannot be sustained for long.
- A two-part tariff: customers pay one price to gain access to the product and a secondd price for each unit consumed.
15
Q
Describe average-cost pricing in response to natural monopoly.
A
- Average-cost pricing allows the natural monopoly to set prices just high enough to cover total costs, thus generating neither profits nor losses.
- The firm produces the level of output at which the demand curve cuts the LRAC curve.
- For a natural monopoly with falling average costs, a policy of average-cost pricing will not result in allocative efficiency because price exceeds marginal cost.
