Final Exam Flashcards
Perfect competition
Market structure is characterized by a very large number of firms producing a standardized product. New firms can enter the industry very easily.
Monopoly
Market structure one firm is the sole seller of a product or service. Entry of additional firms is blocked, one firm constitutes the entire industry. The monopolist produces a unique product, so product differentiation is not an issue.
Monopolistic competition
Relatively large number of sellers produce differentiated products. Non price competition (focuses rather on attributes like design and quality). Entry to monopolistic competitive industries is quite easy.
Oligopoly
Only a few sellers of a standardized or differentiated product; each firm is affected by the decisions of its rivals and must take those decisions into account when determining its own price and output.
Characteristics of Perfectly Competitive Markets
- very large numbers
- standardized product
- price-takers (can’t change the market price, but can only adjust to it).
- easy entry and exit
Demand curve for perfectly competitive markets
Perfectly elastic since the firm can sell as much output as it wants at market price.
TR=
P x Q
AR=
TR/Q
MR=
Change in TR/change in output
TR, AR, MR relationship in perfect competition
- price and AR are the same thing
- in perfect competition, MR and P are equal
Demand for perfectly competitive INDIVIDUAL firm
Perfectly price elastic demand (firm is a price taker, not a price maker), firm cannot increase price, firm can sell all it produces at market price
Demand for a perfectly competitive INDUSTRY
Can only adjust its own output. Firm cannot adjust its selling price.
TR - TC rule
- profit is maximized where the vertical diatance between TR and TC is greatest.
- profit= TR-TC
- firm will choose the output level where the “belly” is largest (max economic profit).
- break even points are where TR=TC
MR-MC rule
- short run profit maximization rule: short run profit maximization occurs where MR (=P)= MC.
- firm should produce last unit for which MR > MC.
- firm shuts down if P < AVC
- profit/loss calculation: profit= Q (MR- MC) x ATC
MC curve in perfect competition
-firm’s short-run supply curve is the portion of its MC curve above minimum AVC
Firm’s supply in perfect competition
Supply curve shifts:
- a wage increase shifts the supply curve upward and to the left (decreasing supply).
- technological progress would shift the supply curve downward to the right (increasing supply).
Profit Maximization in the short-run
- TR-TC Approach
- MR-MC Approach
- loss-minimizing case MR > MC
- shutdown case P
Profit Maximization in the long-run
Easy entry and exit
-only long run adjustment that we consider
Identical costs
-all firms in the industry have identical costs
Constant-cost industry
-entry and exit do not affect resource prices
Long-run dynamics: ENTRY
entry eliminates profits
- firms enter
- supply increases
- price falls
Long-run dynamics: EXIT
Exit eliminates losses
- firms exit
- supply decreases
- price rises
Economic profit in the long run
Is equal to zero
Constant-cost Industry Definition
An industry in which the entry of new firms has no effect on resource prices and thus no effect on profuction costs
Constant cost industry
- entry/exit does not affect long run ATC
- constant resource price
- special case
Increasing cost industry definition
An industry in which the entry of new firms raises resource prices and thus increases production costs
Increasing cost industry
- most industries
- long-run ATC increases with expansion
- specialized resources
Decreasing cost industry definition
An industry in which the entry of firms lowers resource prices and thus decreases production costs
Decreasing cost industry
- personal computer industry
- increasing cost if output contracts
- firm experiences lower costs as the industry expands
Perfectly competitive marker and efficiency
Long run equilibrium
- triple equality occurs P (and MR) = MC = min ATC.
- each firm produces output level Q associated with the triple equality.
- earn only normal profit by producing with the MR (=P) =MC rule in the long run.
- pure competition leads to the most efficient use of resources.
- generates both productive and allocative efficiency
Productive efficiency
Producing where P=min ATC
- goods must be produced in the least costly way.
- firms produce at the min ATC of production and charge at a price that’s consistent with that cost.
- if a firm does not do this, then it will not survive.
Allocative Efficiency
Producing where P=MC
- assuring that societies scarce resources are directed toward producing the goods and services that people most want to consume.
- occurs when it is impossible to produce any net gains for society by altering the combination of goods and resources they’re produced from society’s limited supply of resources.
Consumer surplus
Difference between what a consumer is willing to pay for a good and what the consumer actually pays.
-extra benefit from paying less than the maximum price.
Producer surplus
Difference between the actual price a producer receives and the minimum price they would accept.
-extra benefit from receiving a higher price
Characteristics of Monopoly
- single seller
- no close substitutes
- price-maker (controls quantity supplied and has a large control over price)
- blocked entry (barriers keep competitors from entering the industry)
- nonprice competition (product either standardized or differentiated)
How do monopolies form?
Barriers to entry and scarce resources
Monopolist demand
- monopolist is the industry
- demand curve= market demand curve (downsloping demand curve)
- MR < P
- monopolist is the price maker
- monopolist sets price in the elastic region of demand curve
Output and Price Determination (Monopoly)
Cost data
-assume competitive factor markets
MR=MC Rule
-will produce output until the point where MR=MC
No monopoly supply curve
-possible for different demand conditions to bring different prices at the same output. So monopolist has no supply curve
Misconceptions of Monopoly Pricing
Don’t charge the highest price
-monopolist seeks to maximize total profit, not maximum price.
Total profit
-monopolist seeks to maximize total profit, not maximum unit profit.
Possibility of losses
Monopoly and Efficiency
Monopoly yields neither productive nor allocative efficiency.
- Monopoly price exceeds minimum ATC
- Monopoly under produces
Deadweight loss
Refers to the net loss of consumer surplus and producer surplus. At Q, MB > MC showing that the monopolist it not producing as much as the consumers would like. Allocative Efficiency is not achieved.
X-Inefficiency
Occurs when a firm produces output at a higher cost than is necessary to produce it.
Economic Effects of Monopoly
- income transfer
- cost complications
Rent-seeking behavior
Actively designed to transfer income or wealth to a particular firm or resource supplier at someone else’s, or even society’s expense. Monopolist can obtain an economic profit even in the long-run
Assessment and Policy Options
Three policy options:
- Charges under Canada’s anti-combines laws
- Regulate prices and operations of natural monopolies
- Ignore monopolies which are unsustainable over the long term.
Price Discrimination
- charging maximum price customer will pay
- charging customer one price for 1st set purchased and lower price for subsequent units
- charging some customers one price, others another
Necessary conditions for price discrimination
- Monopoly power
- market segregation
- no resale
Elasticity and Price Discrimination
Charge high price to groups with inelastic demand.
Charge low price to those with elastic demand.
Regulated monopoly
- socially optimal price where P=MC
- fair-return price where P=ATC
Dilemma of Regulation
Setting price at P=MC -firm earns losses Setting price at P=ATC -underallocation of resources Regulation can improve outcomes
Monopoly and Deadweight Loss
- net loss of consumer and producer surplus is the deadweight loss
- Monopolist also loses producer surplus, but gains producer surplus at the expense of consumer surplus
- consumers lose consumer surplus.
Characteristics of Monopolistic Competition
- Relatively large number of sellers
- small market shares
- no collusion
- independent action - Differentiated products
- service/location
- brand name and packaging
- some control over price - Easy entry and exit
- firms are small - Advertising
- nonprice competition
Herfindahl index
Sum of the squared market shares
Price and Output in Monopolistic Competition
- Demand is highly elastic
- The short run: profit or loss
- produce where MR=MC - The long run: only a normal profit
- entry and exit - Inefficient
- Product variety
- much less boring market for consumers
Monopolistic competition and efficiency
Inefficient
Productive inefficiency
P > min ATC
Allocative Inefficiency
P > MC
Excess capacity
Gap between min ATC and output.
Main characteristics of an Oligopoly
- a few large producers
- homogeneous or differentiated products
- control over price (mutual interdependence and strategic behavior)
- entry barriers
- mergers (combining of two or more competing firms)
One time game
Firms select their optimal strategy in a single time period without regard to possible interactions in subsequent time periods
Dominant strategy
An option that is better than any alternative option regardless of what the other firm does
Equilibrium
Outcome neither rival wants to deviate
Repeated game
Game that recurs more than once. Optimal strategy may be to cooperate and refrain from competing as hard as possible
First mover advantage
Final outcome may depend upon which firm moves first
Credible threat
A statement of coercion that is believable by the other firm
Empty threat
A statement of coercion that is not believable by the threatened firm
Collusion
Agreement with rivals
Price leadership
Practice evolves whereby the dominant firm initiates a price change and all the other firms follow.
Oligopoly and efficiency
Oligopolies are inefficient.
Productive and allocatively inefficient
