Chapter 4 - Competition, Equilibrium, and Efficiency

Question 1

perfectly competitive industry is an industry with…

Answer 1

…no barriers to competition

Question 2

main features of a competitive industry

Answer 2

1. Atomistic firms
2. Homogeneous products
3. Perfect information
4. Free entry

Question 3

Atomistic firms

Answer 3

= there are many competitors, all small relative to the market and unable to affect the market price through their actions

Question 4

Homogeneous products

Answer 4

competitors produce exactly the same product (compete head-to-head on price)

Question 5

Perfect information

Answer 5

Everyone (firms and consumers) knows about prices and product characteristics

Question 6

Free entry

Answer 6

there are no barrier to establishment of a new firm (other than “normal” entry costs). Imitation is possible: others can enter the business if they wish; and if they do, they incur the same costs as the incumbents do

Question 7

if a firm has a sustainable competitive advantage, that advantage must lie in…

Answer 7

…the violation of one of the conditions of the perfect competition model

Question 8

Each firm faces a … demand curve

Answer 8

flat

infinitely elastic demand: the firm can sell all it wants at market price and nothing at a higher price

Question 9

Profit maximising condition

Answer 9

MC (q) = p
each firm’s supply decision is governed by its marginal cost curve. it supplies the quantity at which marginal cost equals price

Question 10

industry supply curve

Answer 10

if we put all firms together, we sum their supply at each price, deriving the industry supply curve
S (p) = q1 + q2 + q3 + …

Question 11

Market equilibrium

Answer 11

the point of intersection between the demand and supply curves
none of the market participants have an incentive to change their behaviour

Question 12

excess supply

Answer 12

if price is above equilibrium, fewer people want to buy than sell
would drive the price down to equilibrium

Question 13

excess demand

Answer 13

if price is below equilibrium, fewer people would want to sell than to buy
would drive the price up

Question 14

law of supply and demand

Answer 14

price tends to move in the direction of the equilibrium price (where supply equals demand)

Question 15

comparative statics

Answer 15

is used by economists to describe the exercise of looking at what happens to equilibrium if an exogenous factor changes

Question 16

a rightward shift of the demand curve leads to an increase in quantity and a (1) in price
a rightward shift of the supply curve leads to an increase in quantity and a (2) in price

Answer 16

(1) increase

(2) decrease

Question 17

the impact on price or quantity depends on the … of the supply and demand curves

Answer 17

slope

for shifts in demand, the impact depends on the slope of the supply curve (and the other way around)

Question 18

short run

Answer 18

period when the number of firms is fixed

Question 19

long run

Answer 19

consider the possibility of entry and exit

Question 20

the short run equilibrium price might be above average cost

Answer 20

firms can make above normal profits in the short run

Question 21

in the long-run equilibrium under perfect competition firms produce at the minimum average cost and make zero profits

Answer 21

if the price is greater than the average cost, we would expect new firms to enter the industry
market supply shifts to the right, driving down market price
ultimate effect: firm’s profit goes down to zero

Question 22

if different firms have different cost structures, then in a long run competitive equilibrium, the marginal firm will be one for which p=…

Answer 22

p = MC = AC

Question 23

rent

Answer 23

any payment in excess of the costs needed to bring that factor into production
firms that have cost advantages will be able to make a positive profit (=rent)

Question 24

Model of competitive selection

Answer 24

same assumptions as perfect competition except

1. firms must pay a sunk cost in order to enter
2. not all firms have access to the same technology

Question 25

different firms have different productivity levels, different cost functions, and each firm is uncertain about its own productivity level

Question 26

variability of and uncertainty about firm efficiency reconciles the competitive model with empirical observation regarding simultaneous entry and exit; relative size of entrants/exiters vis-à-vis incumbents

Question 27

θ = the firm’s estimate of its efficiency parameter

the profit for a type θ firm is given by:

Answer 27

q^2/θ is the variable cost of the firm

firm size is correlated with firm efficiency

Question 28

Assumptions for monopolistic competition

Answer 28

1. there is a large number of firms, so that the impact of each firm upon its rivals is negligible
2. due to product differentiation, the demand curve faced by each firm is not horizontal, that is, each firm is a price setter, not a price taker
3. there is free entry and free access to available technologies

maintains all of the assumptions of perfect competition except that of product homogeneity

Question 29

long-run equilibrium in monopolistic competition

Answer 29

firms maximize profits, so that marginal revenue equals marginal cost
firms make zero profits (p=AC(q)), so that no active firm wishes to become inactive
-> equilibrium profits are zero, but firms do not produce at the minimum of their average cost

Question 30

consumer surplus

Answer 30

difference between the demand curve and the market price

all area over price and under demand curve

Question 31

producer surplus

Answer 31

difference between price and the supply curve

all area under price and over supply curve

Question 32

allocative efficiency

Answer 32

requires that resources be allocated to their most efficient use - no DWL

Question 33

productive efficiency

Answer 33

how close the actual production cost is to the lowest cost achievable
lower productivity of one firm to another in the same industry means higher costs, which lead to higher marginal cost

Question 34

dynamic efficiency

Answer 34

the rate of introduction of new products, the improvements in the production techniques of existing ones

Question 35

allocative efficiency requires that (1)
productive efficiency requires that (2)
dynamic efficiency refers to (3)

Answer 35

1. output be at the right level
2. such output be produced in the least expensive way given the available set of technologies
3. the improvement over time of products and production techniques

Question 36

the fundamental theorem

Answer 36

in a competitive market the equilibrium levels of output and price corresponds to the maximum total surplus
is about static efficiency