Exam -2 Chapter 8 Perfect Competition And Monopoly Flashcards by l l l l

Firms can be classified into 4 industry types. What are they?

Perfect competition
Monopolistic competition
Oligopoly
Monopoly

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Perfectly competitive industries

Are composed of many small firms selling identical products with free entry and exit of firms and perfect information

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Competitive firms

Competitive firms a price takers. They are unable to influence the price of goods because of homogeneous nature of the good and the small size of the firm.

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Any business that wishes to maximize its profits will price

Where marginal revenue is equal to marginal cost [MR=MC]

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In the short run, competitive firms

May earn an economic profit, but this cannot occur in the long run. New firms will enter the market, following the signal that economic profits are available. This will lower the price of the good

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Productive efficiency

Competitive firms produce at the lowest point on their average total cost curves (produce at the lowest possible cost per unit). This is called productive efficiency.

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Allocative efficiency

Competitive firms produce where the price paid by consumers is equal to the cost of producing the good. (P = MC). This is called allocative efficiency

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When does monopoly exist?

When monopoly when there is one seller of a good and there are complete barriers to entry of competing firms.

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Why do monopolies exist?

Monopolies exist because of the control of a natural resource, economies of scale, legal restrictions, or network externalities

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Single price monopolies

Restrict output to raise the price of the good they produce.
This converts consumer surplus into revenue for the firm.
It also creates dead weight loss as some consumers are priced out of the market.

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Price discrimination

A monopoly may charge more than one price for its goods. This is called price discrimination

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What are the three types of price discrimination?

First degree price discrimination
Second degree price discrimination
Third degree price discrimination

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First degree price discrimination

Is the discrimination among buyers

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Second degree price discrimination

Is quantity based price discrimination.

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Third degree price discrimination

Is charging different prices to different markets.

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To use price discrimination

A firm must be a price searcher, must be able to identify its consumers and no arbitrage must be possible

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A multiple price monopoly

Will convert even more consumer surplus into revenue than a single price monopoly, but not create a dead weight lost.

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Monopolies do not exhibit

Either productive efficiency or resource allocative efficiency

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Industry

Is a group of businesses that compete for the same consumers with products viewed as substitutes.

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What are the three ways that economist classify industries?

Perfect competition.
Monopoly
Monopolistic competition
Oligopoly

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Perfect competition

Many small firms producing identification products. Easy businesses to start. Also called competitive markets. (Farming)

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Monopolistic competition

Many small firms producing differentiated (not identical) products. Easy businesses to start (restaurants, hair stylists)

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Oligopoly

A few firm that are interdependent (the actions of one affects the others). (Auto makers, airlines, television networks)

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Monopoly

one firm (electrical power, cable TV)

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Perfect competition might be a

Misnomer (a wrong or inaccurate name)

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Why is perfect competition called perfect competition?

Because it has the maximum amount of competition possible, which results in outcomes economists view as highly desirable for consumers and for society as a whole.

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What are the characteristics of perfectly competitive or competitive industries

Many small firms
Homogeneous products
Easy entry and exit
Perfect information

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Many small firms

There are so many small firms in a competitive industry that none is able to influence the market.
There are also a large number of consumers none of which are able to influence the market.

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Homogeneous products

The products produced in a competitive industry are identical. Consumers cannot differentiate one firms product from that of any other.

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Easy entry and exit

No barriers exist for the creation of the competitive firms, nor are there legal or other restrictions on the closing of such a firm.

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Perfect information

All the businesses and consumers in the market have essentially perfect information. This means that they know what the prices are, what products are available, and that the products of the firms are identical.

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How do economists analyze the competitive?

They analyze it along 4 linked dimensions: price, output, cost, and profit.

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Why no firm in a competitive industry has no influence individually over the price of the goods they produce and sell

Due to many firms and homogeneous products

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Why does a consumer buy the least expensive good they can find

Because all goods are identical, so price is the only factor that might differentiate them

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Prices in competitive industries

All the prices must be the same, and since none of them can influence the market, they will take a price that comes from the market, whether they like it or not

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What do economic just call firms in perfect competition

Price takers. This means that they are unable to influence the price charged, and must accept whatever price comes from the market.

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What determines the price of the good

Demand and supply

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Why does the demand curve appear to be a flat, straight line to the firm

Because the price of goods is given to the firm . for example the price of wheat is determined by the national and global markets for wheat

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What two things do the economists know about prices in the competitive industry

They know that there is only one price, and it is set by unbridled supply and demand

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How does the firm determine what amount of output to create

It will choose to produce the amount of output that will maximize its profit

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Marginal revenue of a good

Is the additional revenue gained by selling one more unit of it.

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In a competitive industry

Because the price is fixed, the marginal revenue of a good and it’s price are equal.
For example if the price of a bushel of wheat is five dollars, then the marginal revenue to wheat producers is five dollars.

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What determines the best output for the firm to produce

Marginal revenue and marginal cost

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If a firm has a marginal revenue of five dollars and it’s marginal cost is three dollars

So the firm will gain five dollars in revenue and will pay three dollars in cost and have a net gain or profit of two dollars.

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Should the firm in the previous example increase its output?

Yes the firm should increase output as doing so will increase its profit

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If marginal revenue is five dollars and marginal cost is seven dollars

the firm will gain five dollars in revenue and pay seven dollars in cost and have a net loss of two dollars

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Should the firm in the previous example decrease output

Yes the firm should decrease output as doing so will increase its profit

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When marginal revenue is equal to marginal cost

The additional revenue of selling one more is equal to the additional cost.
Also at this point, selling less of the good, or selling more of the good, will decrease profits.

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How to changes in the market order the behavior of the competitive business?

Changes and supply and demand in the market for a product will change the price of the product.

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How will a firm respond to the increased demand in the market?

By increasing its production. The firm will be better off, because it can sell more products at a higher price.

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The increased competition [supply from the new entrants into the business]

Lowers the equilibrium price for the product, which shifts the firms demand curve and marginal revenue downwards.

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What do we use to make decisions about what is best for the firm to do?

Marginal cost and marginal revenue. MC and MR

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Why does marginal cost and marginal revenue not tell us the final result about whether or not the firm is earning a profit?

Because marginal cost and marginal revenue reflect only the last unit produced, and do not tell us important factors in profitability such as fixed costs.

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How can we figure out if the firm is making a profit or not?

To discover whether or not the firm is making profits, and how much the profit is, we need to compare the average revenue to the average total cost.

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What is another name for average revenue?

Market price

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A profitable firm will have

A market price for its products greater than or equal to the cost per unit of production, which we call the average total cost. ATC

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What are the two rolls we need to know about costs in perfect competition?

Output that will maximize profits or minimize losses:MC =MR
Amount of profit or loss:compare price to cost per unit [ATC].IF
ATC>market price : LOSS
ATC = MARKET PRICE: normal profit, but no economic profit
Market price >ATC: BOTH NORMAL profit and economic profit

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Normal profit

Normal profit is enough to stay in business

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Economic profit

Economic profit is profit in excess of normal profit

In the short run, the competitive firm

May earn an economic profit. This will be a signal to the entrepreneurs that more resources should be devoted to the production of a good.

Economic profit

Economic profit =revenue minus opportunity cost

lower price and quantity means

lower revenue, The economic profit of the firm will decline

In the long run, therefore, the competitive firm

Will just break even. This means that they are earning a profit, but a normal profit only.

To most people, perfect competition is

Neither perfect nor really competition

Firms in perfect competition

Have no control over prices
Produce identical goods
Are at the mercy of of the market when it comes to profitability

Why does a perfectly competitive business have no reason to advertise

Because they can sell all they produce at one price, regardless of what else they may wish. So advertising would simply be a waste of money and lowers the profits of the firm.

Why is a perfect competition, perfect to the economists?

It creates incentives to the firm to produce at the lowest possible cost
It creates the best possible allocation of resources.

In a competitive industry

The demand, price, and marginal revenue of each firm are equal.

What is the only way for a business to maximize its profits if the price of a good is fixed and the firm has no control over it?

To produce at the lowest possible cost.

Incentives in perfect competition

To be efficient

Allocative efficiency

How can firms survive in the long run?

Firms can survive in the long run if the price is no lower than the lowest possible average total cost. That is, the price must remain equal to or above the minimum cost per unit of producing the goods.

Productive efficiency

Occurs when the firms produce at the lowest possible average total cost. This will happen in the long run in perfect competition.

Allocative efficiency

In a perfect world ,The value of a good to consumers is exactly equal to the value of the resources used to create it. Economists call this resource allocative efficiency or just allocative efficiency.

The value of the resources used to create a good is measured by

Its marginal cost

The value to the last consumer is measured by

The price they paid.

When does resource allocative efficiency exist

When price is equal to marginal cost

In a perfect competition

Price = marginal cost, because the price of the goods is constant , the marginal revenue is constant at the price.

So in a competitive market

MR=MC is the same as P=MC. Thus the profit maximizing price and quantity for the firm will create allocative efficiency.

A competitive industry has both

Productive efficiency and allocative efficiency

Monopoly

Monopoly exist when there is only one seller of a good

Monopoly power

Means that some firms that are not monopolies can act in whole or in part like monopolies

3 basic assumptions of monopoly industries

One seller
No close substitutes
Complete barriers to entry

One seller

There is only one seller of the good

No close substitutes

There are No close substitutes for the good.
For example only burger king makes whoppers, but it is not a monopoly because big mac and many other hamburgers are close substitutes

Complete barriers to entry

Restrictions to the creation of a competing business exist and are so strong that no competing business can be started

Why monopolies exist

Legal restrictions
Control of natural resources
Natural monopoly
Network externalities

Legal restrictions include

Public franchise

Patent

Public franchise

Is a business that has been granted a license by the government (federal, state , city or county) that gives it the monopoly right to sell a good within the city or county.
Example: electrical power, cable TV, local telephone company

Patent

Is the legal right to be the sole seller of a good toy invent or create for a period of years.
Example if a company invents a new drug that cures a particular disease, it cab be the only seller of that good for 17 years. So the drug will sell at a higher price and the seller will earn a greater profit.

A monopoly can also exist

By controlling the supply of a natural resource.

Example this natural resource can be diamond or geographical area such as harbor.

Natural monopoly

Has low costs. And so, is able to charge a lower price than would be possible if the firm were smaller.

Network externalities

Occurs when the value of a good increases as the number of users of it increases.

Name a problem that goods with network externalities face

Lock ins

Occurs when the owner of the good faces a substantial cost to change to another good.
Example video game systems have network externalities and lock in.

Disadvantage of network externalities

The cost of changing to a different operating system or other software becomes so large , we may never be willing to do it.

Consumer surplus

Is the difference between the price a consumer pays and the highest price they would have paid. OR
It is the gain in utility a consumer gains from making a trade above the value of the money they paid.

Why would a monopoly or any other business be considered a detriment to consumers?

If it would take away their consumer surplus, lowering the gain to be made from the exchange.

A competitive industry operates

At the intersection of supply and demand, where the equilibrium price and quantity are found.

The market demand curve represents

The quantity of the good that consumers are willing and able to buy at each price, so the demand curve shows the maximum price that consumers are willing to pay.

The equilibrium price is the

Price they actually pay.

Consumer surplus

The area between the demand curve and the equilibrium price is Consumer surplus

Why will a monopoly be bad

If it lowers the amount of Consumer surplus in the market.

Single price monopoly

Monopolies t hat sells all their production for the same price

Monopolies may charge

A single price of the good they produce or multiple prices. Example, diamonds of the same quality sell for the same price and electricity sells for a variety of different prices.

What is strategy adopted from the single price monopoly

Restrict the output available for sale which will artificially inflate the price of the goods

Organization of Petroleum Exporting Countries (OPEC)

OPEC Is a group of nations that controls a substantial portion of world’s petroleum reserves.
- by changing the quantity of oil produced, they are able to set the price to their benefits.

Why every businesses wish it was a monopoly?

So that the profit of the firm rise. It will take greater revenue and have smaller cost.

Deadweight loss

Occurs when one party suffers a loss that does not become a gain for the other

Very few monopolies are

Single price monopolies

Vast majority of firms

Charge more than one price to their customers

Price discrimination

Is the name given be economist to the practice of charging more than one price to different buyers of the same good.

What are the conditions that must exist before price discrimination can be used?

The firm must be able to identify its consumers and charge them different prices. Price discrimination on drugs works less well in southern California because consumers can cross the border into Mexico easily and buy their medicine.
The firm must be a price searcher with some monopoly power.
Arbitrage must be not possible.

Arbitrage

The purchase of a good for the purpose of reselling it to another consumer.

Why would drug companies not be able to price discrimination if California pharmacies could bring large quantities of prescription medicine into the united states from mexico?

Because the resale of the Low price medicine

Will all firms capable of price discrimination use it?

Yes, unless all their consumers are identical. So long as some consumers are willing and able to pay different maximum prices fort the good (value the good differently.) price discrimination will be useful to the firm

Most firms that price discriminate

Will be able to use second degree or third degree price discrimination, but not first degree

What is the importance of price discrimination

It changes one basic outcome of the monopoly pricing and behavior story: the marginal revenue curve of the multiple price monopoly firm is identical to the demand curve. When the price discriminating firm lowers price to sell more, it finds a way to lower price for some, but not all consumers.

In a competitive industry, if- the firms earns economic profit in the short run

The entry of new firms into the industry will eliminate those profits leaving the firm with only normal profits

In a monopoly, there is by definintion

No entry entry of new firms. If economic profits exist, they remain a signal to entrepreneurs to try to enter the industry. Since they cannot, economic profits may persist in the long run.

Are there any incentive in the monopoly?

No, because monopoly restricts output, and because there is no threat of new entry, the monopoly firm has much less incentive to produce at low cost, and will not operate at lowest point on its average total cost curve. So the monopoly is less efficient than a competitive industry, and does not have productive efficiency

Does the monopoly have allocative efficiency?

No because in a competitive firm consumers will pay the price equal to the amount they value the good. This is maximized consumer surplus in the competitive industry. Whereas in monopolies this transfers value to the firm greater the marginal cost of producing the good.

What is the result monopoly power is left uncheck?

It will result in higher prices and less efficiency than pure competition would dictate.

Antitrust policy

Antitrust policy by the government is an attempt to control the effects of monopoly power on the economy.

Regulation

Regulation by the government may have the same effect like antitrust policy. It may also be used for a variety of other reasons such as protecting uninformed public or allocating a scarce resource of national interest.

Trust

Trust occurs when the competing firms in the industry are linked financial, making them in some ways a single entity.
- today we have a similar concept in the holding company where one company owns a series of others.

Congress passed a series of laws

Designed to end trust monopolies.

Why do economist favor the laws passed by congress to end trust in monopolies?

Because economist feel that competition promotes economic efficiency and innovation. Both of which are required for the economy to grow at its maximum potential.

What is the legal foundation of the antitrust laws?

The commerce clause of the constitution which gives congress the power to regulate interstate commerce.

Sherman act 1890

Two provisions.

It outlawed contracts or other agreements that were in restraint of trade.
It made illegal monopolies attempts to monopolize and conspiracy to monopolize.

Clayton act 1914 provisions:

It outlawed price discrimination except in certain cases such as when actual cost differences exist.
It outlawed exclusive dealing and tying contracts.
It prevented acquisition of competitors.
It banned interlocking directorates.

Exclusive contracts

Are those that lock a supplier to a producer so that the supplier is unable to sell to competitors.

Tying contracts

Force a buyer of one product to also buy another product. For example, a copier company might attempt to require its customers to buy their supplies from that company only.

Interlocking directorates

Are when the boards of directors of competitors are made up of the same people.

Treble damages

An amount equal to three times their loss

The federal trade commission act (1914)

This act primarily creates the federal trade commission that has authority, along with the antitrust division of the justice department to enforce antitrust laws. The act did make illegal act of “unfair competition” and “Deceptive practices”

Rule of reason

That acknowledges that is impossible to draw a hard and fast line between what constitutes “unfair” competition? What price are “Deceptive”. Instead, the courts look. At whether something is reasonable or not.

Rule of reason

Regulation of industry

By the government takes many forms all intents end to protect the consumer in some way.

Regulation businesses

In many cases capture the regulatory agency and use it for its own benefit.
- this occurs when the industry hires away low paid government workers into high paying industry jobs.

Revolving door

Where the regulators can except to make a lot of money if they are good to the businesses they regulate, so they help them out in return for good positions at the firms.

Natural monopoly

Occurs when the cost curves of the firm decline continuously, giving a large firm a considerable cost advantage over smaller rivals.

Natural monopolies include

Electrical utilities, local telephone companies, natural gas suppliers.

Natural monopolies are allowed to earn

A certain specified percentage over their cost, and prices are set accordingly.

What trick natural monopolies use?

The inflate cost on paper at least so that profits grow. Example, a large salary for am anger equate to higher profits, since the company will be allowed to earn a percentage on cost.

What is the name European Union to antitrust

Anti-competitive

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Exam -2 Chapter 8 Perfect Competition And Monopoly Flashcards

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