final exam Flashcards
what is market structure
all market features that affect behaviour and performance of firms in the market
e.g. # & size of firms, knowledge of others behaviour, entry freedom, product differentiation
what is competitive behaviour
when firms actively vie w one another for business –> e.g. visa and mastercard have market power but engage in competitive behaviour
what is market power
firms ability to influence price of its products
what is perfect competition
when all the firms have no market power
what are the assumptions abt perfect competition
- all firms sell a homogenous product
- consumers know the nature of the products sold and the prices charged by each firm
- level of output where firms reach minimum LRAC is small relative to industries total output
–> all imply firms are price takers - industry has freedom of exit and entry
what is the demand curve like in perfectly competitive industries
demand curve for entire industry is negatively sloped, but demand curve for each firm is horizontal at equilibrium price since (realistic) variations in the firms output wont change market price –> perfectly elastic
what is total revenue
total amount received by the firm from selling products: TR = Q x p (quantity of units sold x price)
what is average revenue
amount of revenue per unit sold
AR = TR / Q –> AR = p since the average revenue is equal to the price the unit is sold at (perfect comp)
what is marginal revenue
MR = change in TR / change in Q –> MR = p in perfect comp as well
how do you calculate profit and what would indicate losses
profit = TR - TC –> if TR is lower than TC the firm is making losses
when should the perfectly competitive firm not produce
if total revenue is lower than total variable costs –> TR < TVC
also if market price is less than average variable costs –> p < AVC
what is a shut down price
when p = minimum AVC any market price below that means the firm can profit-maximize by producing no output (if the price rises the firm can produce again, if the price doesnt rise for long enough the firm may exit the industry)
what is the profit maximizing level of output
where MC = MR (with MC cutting MR from below) –> in perfect comp MR = p so perfect comp firms where MC = p (as long as price exceeds AVC)
where is the short run supply curve in perfect comp
firms supply curve = portion of MC curve that is above AVC curve
industry supply curve = horizontal sum of each firms MC curve that is above each firms AVC curve
when does short run equilibrium occur in perfect comp
when Qd = Qs & each firm is profit-maximizing given the circumstances –> firms could be making profits, breaking even, or losses in equilibrium
–> e.g. at Q1 MC = MR = p but p < ATC so the firm is making losses, however since
p > AVC the firm keeps producing at this profit maximizing level
what is profit per unit in perfect comp
total profit = p - ATC, total profits (or losses) associated w Q units produced = (p - ATC) x Q
what happens in the long run for perfectly competitive industries
entry or exit of firms:
at an entry attracting price: positive profits lead to new firms entering, supply curve shifts to the right, equi price goes down, and all firms lose profit
–> firms will continue to enter until price drops to 0 profit equi
at exit inducing price: negative profits lead to eventual exit of existing firms as capital becomes obsolete/too expensive to operate, supply curve will shift left, equi price goes up
–> firms will continue to exit until price drops to 0 profit equi
—–> longer it takes for firms capital to become obsolete/ too costly, the longer theyll take to exit (e.g. computer firms exit faster than railway)
what is the long run equilibrium in perfect comp and what are the 4 conditions needed
when firms make 0 profits
1. existing firms must be maximizing profit given existing capital: SRMC = p
2. existing firms must not be suffering losses
3. existing firms must not be making profits
4. existing firms must not be able to increase profits by changing the size of their production facilities: LRAC must be at minimum
how do changes in technology affect perfectly competitive firms
entry of progressively lower cost firms (with better tech) forces the price down and raises output –> older plants with higher costs remain in the industry as long as p > AVC
what are the three characteristics of perfect comp industries subject to continuous tech improvement
- plants of different ages with different costs coexist
- price is eventually determined by the ATC of the lowest cost plants
- old plants are discarded (mothballed) when price falls below their AVC even if the capital is not yet economically obsolete
what are declining industries
some industries fail with continually declining demand –> antiquated equipment is often an effect of declining industries not a cause
firms remain if p >/= ATC but eventually close
govt may prop up firms, but it prolongs their demise
what is the demand curve like for a single price monopolist (SPM)
negatively sloped demand curve –> tradeoff between price and output
what is the supply curve like for a SPM
there is no supply curve bc the monopolist is not a price taker, the monopolist is the industry
what is total revenue for a SPM
if monopolist charges the same price for all units then –> TR = p x q
what is average revenue like for a SPM
AR = TR / Q –> (p x Q) / Q –> p
since AR = p and the demand curve shows p, the SPM demand curve is also AR curve
what is a SPMs marginal revenue like
MR = change in TR / change in Q –> MR lies below the demand curve, since monopolist must reduce price on all previous units sold to sell extra units (bc of negative demand curve) –> MR < p
2 forces work on MR: decrease in price loses revenue, increase in output raises revenue –> MR can be negative
perfect comp MR = p since they are price takers, but monopolists must lower price to sell more
how does an SPMs MR relate to demand elasticity
+ MR = elastic demand (n > 1)
- MR = inelastic demand (n < 1)
what is the short run profit maximization for SPMs
when p > AVC and MR = MC
since p is always higher than MR, p is also higher than MC when profit maximizing
compare the market efficiency of monopolists v.s. perfect comp
perfect comp equi MC = p so society is neither better nor worse off if output changes –> the market is efficient
because p > MR for monopolists, the monopolist restricts output to MC = MR level which is below the demand curve, econ surplus is reduced, and deadweight loss created making them less efficient
what is needed for monopolies to exist
barriers to entry since profit attracts new firms –> natural and created
natural: 1. industry demand allows no more than 1 firm to produce at minimum efficiency scale
2. limited access to natural resources e.g. diamonds
3. network effects: customers only buy due to the large network e.g. facebook
created: govt regulations (e.g. airlines) patents (e.g. tesla patent) or threats (e.g. illegal crime monopolies)
what do SPMs lead to in the very long run
creative destruction: tech change and innovation to circumvent entry barriers –> replace old monopolies with new better ones (joseph schumpeter)
what is a cartel
organization of sellers who gather together and agree to operate as a monopolist to maximize profit (e.g. OPEC) cartelization in competitive industry can increase profit, but depends on ability to reduce output and increase price
what are the 2 problems cartels face
- enforcement of output restrictions: successful cartel reduces output to MR = MC levels –> since p > MC firms have incentive to cheat, but if they all cheat the cartel will fall apart
- restricting entry: needed for cartel to dominate the industry –> quotas, subsidies, licenses
what is price discrimination
selling the same product at different prices (not because of different costs but because of different buyer valuations) e.g. senior movie ticket 10$ regular ticket 15$
what are the 3 conditions that make price discrimination profitable for firms
- market power: firm must not be a price taker, monopoly firm
- different valuations of product: so the firm can tell whose willing to pay more or less
- prevent arbitrage: prevent ppl from buying at lower price and reselling at higher
what are the 2 forms of price discrimination
- PD among units: capture consumer surplus by charging different amount for different units sold (e.g. semi ticket)
- PD among market segments: easier to distinguish willingness of different segments (e.g. movie ticket pricing, more common)
–> firms w market power will identify segments and increase price for segments w more inelastic demand
what is hurdle pricing
get consumers to assign themselves to market segments by presenting barrier to get a lower price (e.g. coupons, or movie rental becoming cheaper over time)
what are the 3 consequences of price discrimination
- at any level of output PD will provide higher profits than the profit-maximizing single price
- profit maximizing monopolist that PDs among units will produce higher output than single priced monopolist –> leads to increased market efficiency
- some consumers are better off with PD some are worse off, no general relationship
with perfect price discrimination what is the consumer surplus
0 –> monopolist captures all of consumer surplus
what is imperfect competition
market structures in between monopolistic and perfect comp (more common)
what is monopolistic competition
industries with many small firms each with some degree of market power (e.g. hairdressers)
what is oligopoly
industries with a few large firms w more market power that compete amongst each other (e.g. grocery industry)
what is industrial concentration and how is it measured
industry with small # of large firms in highly concentrated, concentration ratio: fraction of total market sales controlled by largest few firms –> issue w measurement is defining market accurately
what are the 3 conditions needed for imperfect comp
- firms differentiate their products: similar enough to be same product but different enough to sell at different prices
- firms set their prices
- non-price competition: firms advertise, create different product features, brand, and create entry barriers
what is the key difference between oligopoly and mono comp
amount of strategic behaviour
what are the 4 assumptions about monopolistic competition
- each firm produces differentiated versions of industry product, so demand curve is negative, but lots of susbtitutes so demand is highly elastic
- all firms have access to the same tech so they have the same cost curves
- industry has so many firms they ignore competitors when setting price/output (not very strategic)
- freedom of entry and exit
what are the short run consequences for a mono comp & what is profit maximization
like monpolies: set output level at MR = MC, can make profits but can also make losses or break even
what happens in mono comp in the long run
profits attract new firms leading to the demand curve shifting left for existing firms until its tangent to LRAC –> firm still maximizing profits since MR = MC at tangency point but profits are 0
what is the excess capacity theorum
long run equi in mono comp will leave firms w excess capacity –> tangency point is at output level below lowest point on LRAC, (firms produce on falling portion of LRAC)
what is the tradeoff with mono comp
mono comp leads to higher cost of production but more brands –> tradeoff between cost and variety
what do oligopolists exhibit that mono comp firms dont
lots of strategic behaviour when deciding output level
what are cooperative v.s. non cooperative behaviours
oligopolists can cooperate (collude) with others to lower output (behave like monopolist) and raise price and profit, or not cooperate and only calculate their firms individual gains
what is game theory
used to study decision making when one firm anticipates the reaction of another firm to its actions
payoff matrix: if they both cooperate they get the same profit and its larger than if they both cheat, if they both compete they both get the same profit and its lower than if they both cooperate, if one cheats and the other doesnt the cheater gets the largest possible profit while the other one gets the lowest possible profit –> since they dont know the others behaviour, the nash equilibrium (for prisoners dilemma) is to cheat
what is collusion
cooperative behaviour, can be explicit or non-explicit
tacit collusion is collusion without an explicit agreement occuring
what are the forms of competitive behaviour
companies compete w each other through pricing, advertising, product control, and innovation –> consumers usually gain from competition
how do oligopolists create entry barriers
- brand proliferation: more differentiated brands in the industry leaves less room for new firms
- advertising costs (high)
- predatory pricing: existing firms intentionally keep prices low even if it temporarily hurt them to discourage competition
- purchasing rival firms as an entry barrier: aquisition
what is a problem with oligopoly
need to keep firms competing instead of colluding and keep them focused on innovation instead of entry barriers
output is usually less than perfect comp –> but more efficient than monopoly –> some believe oligopoly is most efficient bc of the high level of strategic behaviour
what does efficiency require, and what are examples of inefficiency even when that requirement is fulfilled
requires all factors of production be fully employed –> can still be inefficient
1. firms dont use least-cost method
2. if MC is not the same for all firms then the industry is inefficient
3. if there is too much of one product and not enough of another the entire economy is inefficient
what is productive efficiency (2 types)
- productive efficiency for firm: firm operates at lowest possible cost
- productive efficiency for industry: all firms in industry have equal MCs –> if both occur economy is on PPB not inside it
what is allocative efficiency
when MC = p for all goods in the economy –> pareto efficiency output level
if MC > p too much of that good is produced, if MC < p too little is produced
point where supply and demand curves intersect is allocative efficiency point –> turn S & D curve diagram on its side and intersect point will be the allocative efficiency point on the PPB
which market structures are efficiency
- perfect comp: firm is efficient (each firm at lowest LRAC point) industry is efficient (all firms have same MC) econ is efficient (MC = p)
- Monopoly: firm efficient (lowest LRAC) firm = industry so industry efficient, p > MC so econ is inefficient
- mono comp & oligopoly: firm efficient (at lowest LRAC point), cant say for industry, p > MC so econ inefficient
–> rival activity pushes oligopoly MC closer to p so its more efficient than mono comp
—–> market failure when market econs fail to produce efficient outcome
what are externalities
costs/benefits imposed on economic agents not involved in the market transaction
what is competition policy
a.k.a antitrust policy –> mostly used by govt with natural monopolies (where size of industry is such that only one first can operate at MES w large distribution networks –> response is crown corporation or private owned but heavily regulated
what are 3 pricing policies used to regulate natural monopolies
- marginal cost pricing: set price to where demand and MC intersect –> allocatively efficient but firms suffering losses since p < AC (when AC are falling and p = MC firms will lose)
- two-part tariff: customers pay 1 time fee to gain access and second price for additional units –> used to help long term effects of marginal cost pricing by covering fixed costs
- average cost pricing: allow firms to set price just high enough to cover LRAC –> not allocatively efficient but firms wont suffer losses or gain profits –> issue in the long run firms wont have incentive to build new capital or invest bc they will always be breaking even
what are some regulation issues
regulators struggle to properly estimate demand so it becomes profit regulation instead of price regulation
rate of return regulation: avg cost priced monopolies can overspend to report 0 profit instead of genuinely making 0 profit –> concepts of MC and allocative efficiency ignored in regulation
why is there skepticism over regulation and what are the trends over time
oligopolies create innovation & regulators can be captured to work for the firm instead of public good –> 1980s shift to deregulation and privatization but now theres concerns about increasing corporate concentration
what was canadian competition policy like in the 1950s
3 things illegal: 1. price fixing that lessened competition
2. mergers/monopolies that hurt public interest
3. unfair trade practices
what was canadian comp policy like by the 80s and 2000s
1986 canadian comp act put previous policies in place and allowed for civil complaints w comp bureau serving as watch dog
2009 act was amended to: 1. increase penalties for marketing deception 2. greater prosecution of cartels 3. two-stage merger review process 4. monetary penalties for abusing dominant position in market
what are the challenges globalization poses for competition policy
- more important to define market on intl basis
- firms will locate in countries w lax comp policies giving reason for countries to standardize their policy
what is a monopoly of violence
govt ability to control violence so only police and military can use it when needed: 2 duties of sovereign, protect from other nations, and protect from other citizens
–> when monopoly of violence is secure, people can go about their regular business
what does the govt do for people
define & enforce property rights so people can secure claims to the fruits of their labor
what are the two defenses of free markets
- formal: based on allocative efficiency, perfect comp free markets means MC = p 2. informal defense: applies to all free markets whether or not they r perfect comp –> 3 parts
what are the informal free market defenses 3 arguments
- automatic coordination: adam smith invisible hand of the market, without central planning price changes and market signals change behaviour
- innovation and growth: stimulated by pursuit of profits, trial and error bc profits are not planned
- decentralization of market power: typically encourages competition, issues now w corporate concentration (e.g. google)
what is market failure and what is required for social costs or benefits
when unregulated free markets fail to achieve allocative efficiency
requires social MC = social MB (marginal benefit)
what are the types of externalities and how do they effect allocative efficiency
externalities: costs/benefits effected on parties not involved in the transaction production or consumption of a commodity –>
negative externalities: social MC above private MC (S curve) –> free market Q is too high for allocative efficiency
positive externalities: social MB above private MB (D curve) –> free market Q is too low for allocative efficiency
what are the 4 types of goods
private: excludable & rivalrous (e.g. food) common property goods: rivalrous but not excludable, overused by firms and consumers (e.g. timber)
club goods: excludable but not rivalrous, MC of providing one additional person good is almost 0 (e.g. library)
public: non excludable & non rivalrous, govt provides up to MC = MB point (e.g. national defense)
what is asymmetric info
when one party has more/better info in a transaction –> moral hazards & adverse selection
what is a moral hazard
when one party in the transaction has ability/incentive to impose costs on other party (e.g. dentist recommends unnecessary crown)
what is adverse selection
self selection within a risk party of persons with knowingly above average risk (e.g. adding insurance knowing (but not disclosing) you have a rare heart condition)
what are the 4 broad instances of market failure
- market power (monopolies charge more than MC)
- externalities
- common property overused & public undersupplied
- asymmetric info
why would a govt intervene if there isnt a market failure
to achieve broader social goals (e.g. income redistribution for fairness allocatively inefficiency as they reduce the rich’s incentive to work)–> leaky bucket analogy, social intervention always causes inefficiencies but you can make them less leaky (less inefficient)
what are some ways govts intervene for social goals
- preferences of public provisions: some things are expected to be publicly provided e.g. police
- to protect people from others: e.g. minimum age of work to protect children
- paternalism: to protect people from themselves e.g. seatbelt laws
- social responsibility: cant sell your vote because its not socially responsible
what are the 3 ways govts intervene when markets fail
- public provisions when markets fail to do so
- redistribution programs like tax-transfer programs
- regulations for all levels of market failure
what are the direct & indirect costs of govt intervention
direct: intervention uses real resources which are costly
indirect: costs on firms and households -> 1. changes in prod costs (e.g. enviro regulations)
2. costs of compliance (e.g. opportunity costs of lost time to filing taxes)
3. rent seeking (e.g. individuals seek rents from corrupt govts at cost of public good)
what is a major cause of govt failure and what is the public choice theory
when govts dont work in publics interest
public choice theory: 3 maximizing groups in govt –> elected officials (votes) civil servants (salaries/power) voters (personal utility) –> may cause govt to not work in public interest
govts also share same cost minimization issues as private firms but bc they are monopoly producers without shareholders they can be slow to innovate or respond to change
what is an open economy & autarky
open economy: engages in intl trade, autarky: only consume what you produce, no intl trade
what are the gains from trade + comparative & absolute advantage
increased output from specialization made possible by trade
absolute: countries ability to produce a good at a lower absolute cost than another country
comparative: countrys ability to produce a good with less forgone output of other goods compared to another country –> based on opportunity cost –> world ouput increased if countries specialize in what they have comparative advanatages for
when a country’s PPB is concave, what are the two gains from trade seen
- bundle of goods consumed is different from bundle of goods produced –> can get more of comparative disadvantage good normally outside PPB
- profitable change in pattern of production can occur –> new PPB can be beyond old one for all goods
what are the additional gains from trade with variable costs
- economies of scale: in small countries with industries that have differentiated products they can reach economies of scale moving down the LRAC curve through intl trade
- learning by doing: specialization leads to workers becoming more experienced and producing at a lower cost moving the entire LRAC curve downwards
what are the 4 sources of comparative advantage
- factor endowments: heckscher-ohlin model, countries should specialize in goods that intensively use LLK they are best endowed with
- climates: countries can have same factor endowments but produce different goods (e.g. costa rica and iceland have same LLK but specialize in different things)
- human capital: aquired skills amongst people (e.g. iranians have been making beautiful rugs for generations)
- acquired comparative advantage: not static due to human capital and changing tech (e.g. why silicon valley exists)
what is the law of one price
when a product is intl traded, the price will only vary but the transportation costs of moving that product between countries
what determines intl patterns of trade
- countries export goods if world price exceeds no-trade domestic price –> export CA goods
- countries import goods if the world price is lower than no-trade domestic price –> import CDA goods
is the theory of comparative advantage obsolete, and what has changed it
theory that its obsolete has been disproven, but CA can be created by private firms & public policy (e.g. taiwan govt created CA in tech industry) –> global supply chains created by globalization & economies of scale change how we view comparative advantage
what are terms of trade
ratio of avg price of countries exports to avg price of countries imports
–> if import price rises without export price, terms of trade fall
–> if export price rises without import price, terms of trade rise
how do you measure terms of trade
(index of export prices / index of import prices) x 100 –> rise = improvement, decrease = deterioration
what are the 2 types of trade barriers
- tariff: tax on import of goods & services 2. non-tariff barriers: restrictions on trade other than tariffs e.g. import quotas or cumbersome customs procedures
what is the case for free trade
comparative advantage means specialization maximizing global production and increasing global living standards –> does not make every individual better off
what is the case for protection (5 parts)
- promoting diversification: dont want to be overly reliant on one industry –> helps volatility but loss in ntl income from not investing in CA industry
- protecting specific groups that face distributional costs from free trade: e.g. unskilled workers in US
- improve terms of trade: large countries w market power can improve terms of trade w tariffs (small countries cannot)
- protect infant industries until they reach econs of scale domestically (ISI) but infant industries never grow up
- earning economic profits in foreign markets: subsidizing strategic firms to help them in global markets (e.g. airlines) risk of transferring costs from consumers to firms
what are the 4 invalid arguments against trade
- keep money at home: cad $ dont go abroad, we purchase foreign curency by selling domestic to country that wants to buy our products
- protect against low-wage foreign labor: we want to be able to buy cheap products
- exports are good imports are bad: standard of living depends on consumption not production, if we only export we wont consume
- create domestic jobs: only in industry that are less advantageous, help certain groups but overall worse off
how do tariffs change economic surplus
tariffs raise domestic price, lower domestic consumption, and raise domestic production –> domestic producer surplus increases, govts receive tax revenue of tariff, consumer surplus decreases, overall econ surplus decreases
what is an import quota and how does it change economic surplus
maximum quantity that can be imported every year, raises domestic price, lowers domestic consumption, raises domestic production –> producers surplus increases, consumer surplus decreases, and overall econ surplus decreases by more than before since the govt doesnt receive any tax revenue –> quotas make the econ worse off than tariffs
what are the two non-tariff barriers that begun as trade remedy law but became protectionist
- anti-dumping: against import prices below producers domestic market price –> og against predatory price discrimination, now more protectionist
- countervailing: tariff by importing country used to offset effects of specific subsidies foreign govt imposes, also now more protectionist
how does climate policy effect trade
policies designed to reduce GHG emissions are unfair to domestic producers facing lower prices from imports from countries without climate regulation costs
border carbon tariffs: used to offset the effects of this, unclear whether the WTO will accept this
what are the GATT and WTO
GATT created in 1947 w each country agreeing not to make unilateral tariff increases –> WTO replaces GATT in 1995 –> creates a dispute settlement mechanism & increases free trade
what are regional trade agreements and the 3 types
RTAs: seek to liberalize trade over a smaller group of countries than the WTO 1. free trade area: 2 or more countries agree to abolish trade tariffs among themselves but doesnt affect trade policy with the rest of the world (e.g. NAFTA)
2. customs union: group of countries that agree to free trade among themselves and a common set of barriers with the rest of the world (e.g. Mercosur)
3. common market: customs union with free movement of labor and capital (e.g. EU)
what is trade creation v.s. trade diversion
trade creation: reduce trade barriers increases trade with group of countries while trade w the rest of the world remains the same
trade diversion: reduce trade barriers leads to trade within the group replacing trade that used to happen outside of the group –> can be inefficient, argument against RTA is diversion costs outweigh creation benefits
describe NAFTA’s creation, fundamental principle, and dispute mechanism
created 1994, extension of 1989 US-Can FTA, replaced by USMCA 2020
principle of national treatment: laws cant discriminate based on nationality (e.g. enviro laws in canada cant apply differently to US company with canadian factory)
creates dispute settlement mechanism reviewed by intl panel –> USMCA changed to bilateral panel review (less effective)
what are 5 major provisions in NAFTA
- all tariffs eliminated by 2010
- national treatment applies to foreign investment once it enters country but foreign investment can be screened
- some restrictions like on cultural industries and supply managed agri industries are not eliminated
- trade in most non-agri industries liberalized
- signifigant amount of govt procurement is open to cross border bidding (still a lot exempt tho)
what were the results of NAFTA
industry restructured to increase trade in all 3 countries –> especially Canada-US and especially inter-industry trade (greatest potential for trade diversion with Mexico due to cheap labor)
