Exam -2 Chapter 8 Perfect Competition And Monopoly Flashcards
Firms can be classified into 4 industry types. What are they?
Perfect competition
Monopolistic competition
Oligopoly
Monopoly
Perfectly competitive industries
Are composed of many small firms selling identical products with free entry and exit of firms and perfect information
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.
Any business that wishes to maximize its profits will price
Where marginal revenue is equal to marginal cost [MR=MC]
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
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.
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
When does monopoly exist?
When monopoly when there is one seller of a good and there are complete barriers to entry of competing firms.
Why do monopolies exist?
Monopolies exist because of the control of a natural resource, economies of scale, legal restrictions, or network externalities
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.
Price discrimination
A monopoly may charge more than one price for its goods. This is called price discrimination
What are the three types of price discrimination?
First degree price discrimination
Second degree price discrimination
Third degree price discrimination
First degree price discrimination
Is the discrimination among buyers
Second degree price discrimination
Is quantity based price discrimination.
Third degree price discrimination
Is charging different prices to different markets.
To use price discrimination
A firm must be a price searcher, must be able to identify its consumers and no arbitrage must be possible
A multiple price monopoly
Will convert even more consumer surplus into revenue than a single price monopoly, but not create a dead weight lost.
Monopolies do not exhibit
Either productive efficiency or resource allocative efficiency
Industry
Is a group of businesses that compete for the same consumers with products viewed as substitutes.
What are the three ways that economist classify industries?
- Perfect competition.
- Monopoly
- Monopolistic competition
- Oligopoly
Perfect competition
Many small firms producing identification products. Easy businesses to start. Also called competitive markets. (Farming)
Monopolistic competition
Many small firms producing differentiated (not identical) products. Easy businesses to start (restaurants, hair stylists)
Oligopoly
A few firm that are interdependent (the actions of one affects the others). (Auto makers, airlines, television networks)
Monopoly
one firm (electrical power, cable TV)
Perfect competition might be a
Misnomer (a wrong or inaccurate name)
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.
What are the characteristics of perfectly competitive or competitive industries
- Many small firms
- Homogeneous products
- Easy entry and exit
- Perfect information
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.
Homogeneous products
The products produced in a competitive industry are identical. Consumers cannot differentiate one firms product from that of any other.
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.
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.
How do economists analyze the competitive?
They analyze it along 4 linked dimensions: price, output, cost, and profit.
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
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
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
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.
What determines the price of the good
Demand and supply
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
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
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
Marginal revenue of a good
Is the additional revenue gained by selling one more unit of it.
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.
What determines the best output for the firm to produce
Marginal revenue and marginal cost
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.
Should the firm in the previous example increase its output?
Yes the firm should increase output as doing so will increase its profit
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
Should the firm in the previous example decrease output
Yes the firm should decrease output as doing so will increase its profit
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.
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.
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.
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.
What do we use to make decisions about what is best for the firm to do?
Marginal cost and marginal revenue. MC and MR
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.
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.
What is another name for average revenue?
Market price
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
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
Normal profit
Normal profit is enough to stay in business
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
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
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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
