final

Question 1

degree of competition

Answer 1

as the number of economic agents increases there is a greater potential for competition in that market
the more competitive a market structure is, the less influence individual economic agents have over market outcomes (price)

Question 2

market power

Answer 2

when individual sellers can influence the market prices for goods
inversely related to the degree of market competition

Question 3

concentration

Answer 3

the portion of industry output that is controlled by the largest firms in the market
percentage of total market output, the greater the proportion that is controlled by a small number of firms the greater the degree of concentration

Question 4

barriers to entry

Answer 4

more financial and technological barriers that limit the entry of firms means the market is less competitive and more concentrated

Question 5

product differentiation

Answer 5

monopolistically competitive firms compete by selling products that are highly substitutable for one another but not perfect substitutes

Question 6

market share (Si)

Answer 6

percent of total sales in an industry generated by one firm
Si=qi/QMKT (output of the firm/output of the market)

Question 7

n-firm concentration ratio (CRn)

Answer 7

measures the share of total market output attributed to the n largest firms
CRn=sum of all firms(Si)
can range from 0 to 100
total sales by n of largest firms/total sales in industry

Question 8

characteristics of perfectly competitive

Answer 8

large number of buyers and sellers - HIGH COMPETITION, the actions of one firm cannot change the market
price takers - each individual firm sells a sufficiently small proportion of total output so their decisions have no impact on market price (price of good is predetermined)
homogenous product - all firms produce exact same product, all perfect substitutes of each other, if a single firm changes price buyers will switch providers
perfect mobility of resources - free entry and exit, no barriers to entry
perfect market knowledge - all economic agents have access to relevant market information about the product, prices, production processes, resources etc

Question 9

short run outcomes for perfect competition

Answer 9

operating decisions - goal is to maximize profit (or minimize losses) –> must decide how much to produce in the short run
max pi(q) = TR(q) - TC(q) = (P bar x q) - TC(q)
pi>0 = economic rents (economic profit) - net returns are above a normal profit (TR>TC)
pi=0 = normal profit - the profit is just enough to keep the firm in business (TR=TC)
pi<0 = economic losses - the firms revenues cannot cover its total economic costs (TR<TC)
- the difference between TR and TC curves is at its highest point or at its lowest point
q* occurs when the slope of the TR curve is equal to the slope of the TC - allows us to employ marginal analysis

Question 10

profit maximization and loss minimization for perfectly competitive

Answer 10

loss minimization:
unable to earn normal profit from goods
pi=0, will attempt to minimize losses by selecting lowest negative profit
q=TR<TVC pi<0
shutdown = q=0 - firm cannot earn enough TR to cover TVC, best option is to produce no profit
if TR<TVC q* should be 0 and profit becomes negative TVC
seasonal businesses
positive output = firm earns enough TR to cover its TVC, sets output to where pi=TR-TC at its lowest negative value
q=TR<TC and pi<0
profit maximization: q=0

Question 11

TR and TC approach to perfect competition

Answer 11

q* is when the slopes of the TC and TR curves are equal
the slope of TC = marginal cost (=change in total cost/change in output)
slope of TR = marginal revenue (=change in total revenue/change in output)
q* is MR=MC
at q*, slope of the profit function is 0

Question 12

marginal analysis

Answer 12

per unit costs and revenues
economic agents consider the incremental effects of a choice (the marginal benefits and marginal costs as a firm chooses its optimal output)
if MR=/=MC, the firm uses marginal analysis to determine the adjustment needed
if MR is greater than MC , economic profit increases if output increases
if MR is less than MC, economic profit decreases if the firm decreases output

Question 13

short run supply function, firm vs market (perfect competition)

Question 14

long run outcomes (perfect competition)

Answer 14

in the long run, firms respond to short run changes by entering and exiting the industry
- if firms are earning positive profit, there is incentive for new firms to enter the market (as new markets enter, market supply shifts right and equilibrium falls), o
- if firms are earning negative profit there is incentive for firms to leave market (market supply shifts left, equilibrium increases),
requirements: P=ATC, pi=0, all firms earn normal profits
all firms produce minimum point of ATC = allocative efficiency (P=MR=MC=min ATC)
long run equilibrium - firms in competition will earn a normal profit
maximum marshallian surplus in equilibrium
NO LONG RUN ECONOMIC PROFITS

Question 15

characteristics of a pure monopoly market

Answer 15

one seller - no direct competition in the market , the firms output is the market output of the product
no exact substitutes
price searching firm - the firms output is the industry output so production decisions impact the market price (must determine optimum output and optimum price)
significant barriers to entry - significant costs that make it nearly impossible for other firms to enter (control of essential resources, economies of scale - enables one firm to supply the entire market at the lowest cost, institutional/legal entry barriers (legal monopoly - market in which competition and entry are restricted)
least competitive and most concentrated
LONG RUN ECONOMIC PROFITS ARE POSSIBLE

Question 16

determine profit-maximizing outcomes for a monopoly and illustrate results

Answer 16

profit maximizing occurs when TR is greater than TC by the largest amount
optimum output is when MR=MC
TR and TC and marginal analysis

Question 17

possible short run outcomes for monopoly

Answer 17

profit maximization
loss minimization
shut down
marginal revenue = marginal cost

Question 18

price discrimination

Answer 18

market conditions - firm is price searcher, firm can segment its market, firm is sealed (low buyers cannot resell to higher priced buyers)
potential benefits to the firm - likely to result in higher total revenue
firm that charges different prices for a product to different groups of buyers without justification

Question 19

regulated monopoly outcomes

Answer 19

full cost pricing
some industries are subject to regulatory oversight
taxation - taxes or fees on profits, firm produces at the profit maximizing rate and changes the standard monopoly price then the regulatory body collects a tax that reduces profit
price regulation - setting or approving prices,

Question 20

characteristics of monopolistic competition

Answer 20

large number of firms
each firm produces a differentiated product (highly substitutable for one another but not perfectly)
firms have limited price control and price setting ability (downward sloping demand curve)
firms compete for customers and may rely on marketing and advertising
low barriers to entry
market examples - independent retailers, restaurants, home services

Question 21

short run outcomes in monopolistic competition

Answer 21

profit maximization
loss minimization
normal profit with marginal analysis
firms make their output and price decisions by profit mazimization - q–>MR=MC
determines P from the firm’s demand curve

Question 22

long run outcomes in monopolistic competition

Answer 22

free entry and exit of firms –> pi=0
can lead to firms entering or exiting the industry
entry of new firms causes a decrease in demand, exit of firms causes an increase in demand
in the long run, economic profit is competed away and each firm makes 0 economic profit
LONG RUN ECONOMIC PROFITS ARE NOT POSSIBLE

Question 23

characteristics of oligopolistic industry

Answer 23

high degree of concentration - small number of firms create a large portion of output
mutual interdependence - each firm is aware of its rivals and must consider the potential reactions of other firms when pricing and output decisions are made
barriers to entry - natural or legal barriers
price searchers - depending on conditions, firms must determine their product price
market power - firms are large enough that their production decisions may affect market prices
identical products - pure oligopoly (steel, cement, lumber)
differentiated - differentiated oligopoly (video game industry, automotive industry)
examples
LONG RUN ECONOMIC PROFITS ARE POSSIBLE

Question 24

sweezy (kinked demand curve model)

Answer 24

key assumption: rival firms will match price reductions and ignore price increases
- if prices raise above the current P* , none of the competitors will follow suit and the firm will lose sales (more elastic)
- if prices fall , all of competitors will follow suit and sales will increase only to the extent that market quantity demanded increases, firm does not gain market share over its rivals (less elastic)
key result: price rigidity with fluctuations in cost
illustrate and explain with per-unit cost and revenue curves
at higher prices, demand is more elastic
illustrates price rigidity - firms are more reluctant to change prices even if costs change

Question 25

low-cost price leadership model

Answer 25

when a single firm exerts enough market influence that it can effectively determine the product price for an entire market , price leader is the strongest firm with no immediate rival
key assumption: price leader has cost advantage and sets the industry price, price follower typically chooses same price
- industry has 2 firms , firm A is price leader and firm B is follower (MCa< MCb)
- total market demand is shared
outcomes: firm A selects optimum output and price (qA–>Pa) –> firm B can chose profit maximizing output OR follow firm A
- option 2 is more likely
illustrate this with demand, MR and MC functions

Question 26

cartel model (collusion)

Answer 26

firms in an oligopoly market attempt to operate as a shared monopoly to increase profits
cartel - a group of firms that collude and attempt to operate a market as a shared monopoly (firms can make more money if they cheat on the cartel)
illustrate the potential for higher profits as firm collude
standard outcomes: cartels are unstable and generally illegal under antitrust laws (prohibits firms from explicitly agreeing to take actions to reduce competitions)

Question 27

non-cooperative game theory model (collusion)

Answer 27

collusion?
two options for being in cartel: comply or violate agreement for additional profits
as firms in an oligopoly market follow their dominant strategies to increase profits, the nash equilibrium suggests that cartel outcomes are unstable - each firm evaluates their “dominant strategy” by evaluating the potential profit outcomes and usually leads to cheating on the cartel agreement (each firm discounts their product) - the nash equilibrium
4 outputs - 2x2 payoff matrix shows the outcomes of each firms actions