Exam 2 Flashcards
Market power
When firms are able to restrict competition to keep prices above marginal cost
Monopoly
100% market power
Strategy to gain market power
Limit competition (sustain any factors that do this)
Market strategies to restrict competition:
- Guarding trade secrets
- Control of essential resource
- Exclusive contracts (Coke on campus)
- Collusion (form a cartel, agree on price, act as a monopoly)
Non-market strategies to restrict competition
- Patent or trademark protection
- Trade regulations
- Government licensing
- Govt or NGO certification
Optimal sales target
Where marginal revenue equals marginal cost
If MR > MC…
Increase sales, firm could make a profit by selling one more unit
If MC > MR…
Avoid sales, firm will lose money selling one more unit
Optimal price
Given optimal sales target, price is found as markup over cost where markup factor depends on demand for the product
Firm with market power sets price (1) and output (2) than efficient levels
(1) - higher, (2) - lower, too few units being produced
Perfect price discrimination:
Each consumer is charged a price equal to her willingness to pay
- No social inefficiency, but all surplus goes to producer
- Example: dutch auction
Imperfect price discrimination
Groups of consumers are charged different prices
- Profits increased relative to single price but not as high as perfect
- Consumer surplus decreased but not equal to 0
Under imperfect, profit and socially efficient are…
Different. There is a gap between the profit and socially efficient max because of the step nature of imperfect
Players
Decision makers within the game
Examples: firms, government, interest groups
Strategies
Decision choices
Examples: price, products, advertising, campaigning, lobbying, regulation
Payoffs
Outcomes of the decision choices (in terms of profits or losses usually) –> politics, probability of winning
Dominant strategy
A strategy that results in the highest payoff for a player regardless of what strategy their rival plays
Secure strategy
In absence of a dominant strategy, play the strategy that guarantees the highest payoff given the worst payoff
Think like your Rivals
In absence of a dominant strategy, look at the game from your rivals perspective
Nash equilibrium
A condition describing a set of strategies in which no player can improve her payoff by unilaterally changing her strategy given her rivals strategy
Extensive-form Game
Players, available information, available strategies, resulting payoffs and the sequence of moves
Subgame perfect equilibrium
A set of strategies that allows no player to improve his own payoff at any stage of the game by changing strategies -> work backwards from your rivals strategy
Role of government:
-To promote competition
Antitrust policies
US has enacted to make it illegal to attempt to monopolize a market
-Department of Justice uses industry sales concentrations as an indication of the level of competition
4-Firm Concentration Ratio (C4)
- The fraction of the industry sales that goes to 4 largest firms in the industry
- A C4 closer to 1 means uncompetitive industry (sum all, 1 means lacks competition)
Herfindahl-Hirshman Index (HH)
- Sum of squared market shares of firms in an industry multiplied by 10,000
- HH above 2500 signals uncompetitive industry (FTC will look into it over this number)
When to export?
- When the world price is above the domestic price, the domestic industry has the comparative advantage
- Domestic industry exports to world
When economy opens up border…
TAKES price, does not make price
Exports enhance welfare of domestic country because:
Producer surplus increases more than consumer surplus decreases
When TAKES world price…
Excess supply, more willing to ship to the rest of the world, whole area gained from trade
When to import:
When the world price is below the domestic price, foreign producers have the comparative advantage
-Domestic industry imports from the world
Imports enhance the welfare of the domestic country because:
Consumer surplus increases more than producer surplus decreases
When Imports…
Takes lower world price, shortage in domestic supply so must import, area gained by trade
Tariff
A tax that is placed on imports
-Directly affects the domestic price charged on imports
Tariffs result in:
- Higher domestic prices
- Under-consumption in the domestic market
- Over-production by the domestic producers
- Less imports to the domestic market
Quota
Maximum quantity placed on imports, indirectly affects the domestic price by creating a situation of excess demand
Quotas result in:
- Less imports to the domestic market
- Under-consumption in the domestic market
- Over-production by domestic producers
- Higher domestic prices
Tariffs v. quotas
- Tariffs raise revenue, quotas do not
- If quotas are combined with licensing fee, can raise revenue
Which can cause more inefficiency?
Quotas: If licensing fee does not take away from price premium, foreign producers will have an incentive to lobby –> spend resources which leads to more inefficiency
Why do firms lobby for license?
When entering a market where there is a quota, the price is higher than the world price so there is a potential for foreign gains
If fee = (Pq - Pw)
Government revenue
If fee < (Pq - Pw)
Split between foreign gains and government revenue
Less restriction means:
Less inefficiency
Why do nations adopt trade restrictions?
- National Defense
- Retaliation against dumping (selling lower than production costs in foreign markets)
- Infant Industry argument
- Special interests influences
FG =
[(Pq - Pw) - Fee] * imports
Less foreign gain, less inefficiency
Do trade restrictions save jobs?
Overall, no. Imports and exports linked through income creation, import restrictions raise prices on inputs, and jobs will be lost in industries that rely on cheap imported material.
