Final Exam Flashcards
What are price takers?
Individual firms that have no impact on market price
Perfect competition
What does the demand curve of price takers look like?
Face horizontal, perfectly elastic
What are price searchers?
Firms that have at least some influence on market price
What does the demand curve of price searchers look like?
Face downward sloping demand curve
What is market power?
The ability of a firm to raise its price above the competitive level
What is a monopoly?
A market with a single supplier of a good
What are the constraints of a monopoly?
Constrained by the demand curve
What is the profit maximizing condition?
Firm will continue to produce as long as the additional revenue from an additional unit of output is greater than the additional cost from an additional unit of output
When will a profit maximizing condition stop producing?
When marginal revenue = marginal cost (or last unit for which marginal revenue > marginal cost)
How does a monopolist attract new customers?
Lower price
What is a price effect?
After a price increase, each unit sold sells at a higher price, which tends to raise revenue
What is a quantity effect?
After a price increase, fewer units are sold, which tends to lower revenue
What is true of marginal revenue for a monopolist?
At any given quantity, marginal revenue will be less than price (due to price effect)
What is the marginal revenue received from selling an additional unit is equal to?
The price received for the additional unit (quantity effect)
What is the marginal revenue lost from selling an additional unit equal to?
Lost revenue from lowering the price to existing customers willing to pay more (price effect)
If the total revenue curve is increasing at a decreasing rate
Quantity effect dominates price effect
If the total revenue curve is decreasing at an increasing rate
Price effect dominates quantity effect
Explain the shape of the total revenue curve at low levels of output
Quantity effect is stronger than the price effect
As the monopolist sells more, it has to lower the price on only very few units, so the price effect is small
Explain the shape of the total revenue curve at high levels of output
Price effect is stronger than the quantity effect
As the monopolist sells more, it now has to lower the price on many units of output, making the price effect very large
What is elasticity?
Measure of responsiveness of one variable to changes in another variable
If demand for a good is elastic
Quantity effect will dominate the price effect
Decrease in price will increase total revenue
Increase in price will decrease total revenue
If total revenue is increasing, what must be true of marginal revenue?
It is positive
If demand for a good is inelastic
The price effect will dominate the quantity effect
A decrease in price will decrease total revenue
If total revenue is decreasing, what must be true of marginal revenue?
It is negative
What does the total revenue curve look like in the elastic region?
It is increasing at a decreasing rate
What does the total revenue curve look like in the inelastic region?
It is decreasing at an increasing rate
If demand for a good is unit elastic
The price and quantity effects will offset
Marginal revenue will be zero
Marginal revenue curve crosses the horizontal axis at this point
How will a monopoly maximize profit?
The monopolist will continue to produce more units of a good until the additional revenue from the last unit produced equals the additional cost
MR = MC
Difference between where perfectly competitive firms and monopolies produce
Perfectly Competitive Firms:
P = MC
Monopolies:
P > MR = MC
Compared with a competitive industry, a monopolist will produce (quantity)
Monopolies will produce a smaller quantity than a competitive industry
Compared with a competitive industry, a monopolist will produce (price)
Monopolies will charge a higher price than competitive industries
Monopolists Profit Equation
Profit = TR - TC
= (P x Q) - (ATC x Q)
=(P - ATC) x Q
When will a monopoly shutdown in the short run
Price < Average Variable Cost
When will a monopoly shutdown in the long run
Price < Average Total Cost
What is the welfare effect of a monopoly?
Monopolist charges a price higher than marginal cost and produces output at a level lower than the efficient, perfectly competitive output level
What is the effect of welfare effects on society
Monopolies cause deadweight loss to society
Is consumer surplus higher in a monopoly or in perfect competition?
Perfect competition
Why do monopolies exist?
Monopolists have market power
In order for profits to persist in the long-run, some form of barrier to entry must be in place
What does it mean that a monopolist has market power
Charges a higher price than perfectly competitive outcome
Produces a lower quantity than the perfectly competitive outcome
Creates deadweight loss
Generates economic profits for the firm
What are 3 barriers of entry?
- Control of scarce resource or input
- Cost advantages
- Government created monopoly
What are cost advantage barriers?
Large set-up costs initially
Natural monopoly (local utilities: water, gas, electricity)
What are government created monopolies?
Government license (government grants firm exclusive right to serve given area)
Patents and copyrights
(Patents: 20 years from date of filing
Copyrights: 70 years post death)
Regulation of monopolies?
- Break-up monopoly
- Price regulation
- Increase competition
How do you break-up monopoly?
Anti-trust legislation
What is the point of price regulation in a monopoly?
Set a price ceiling. If set at proper amount can get rid of welfare losses
How can competition by increased in a monopoly?
- Grant more licenses
- Reduce trade barriers for foreign firms
- Alter patent laws
- Subsidize competing firms (offer tax breaks)
How does a price ceiling affect a monopoly?
If the monopolist must now charge a price equal to average total cost. This leads to expansion of consumer surplus, and zero profit for the monopoly
What is price discrimination?
Charging different prices to different consumers for the same good
Why do firms attempt to price discriminate?
To earn a profit
Why is price discrimination a thing?
There are differences in consumer willingness to pay for a good
When is price discrimination profitable?
Consumers differ in their sensitivity to the price
What is the key element to price discrimination?
It is profit-maximizing to charge a higher price to consumers who are relatively more price inelastic and charge a lower price to consumers who are more price sensitive (elastic)
What is the risk in price discrimination to price sensitive consumers?
Charging them a higher price may drive them out of the market
What are 3 conditions necessary for price discrimination?
- Firms must have market power
- Firm must be able to identify differences in willingness to pay between consumers
- Firm must be able to limit resale of product
Do perfectly competitive firms have market power?
NO
What are 4 types of price discrimination?
- Perfect Price Discrimination
- Quantity Discrimination
- Multi-Market Price Discrimination
- Two-Part Tariff
What is perfect price discrimination?
Charge the maximum amount each consumer is willing to pay
Price = Marginal Value
What is quantity discrimination?
Firm charges a different price for large quantities than for small quantities
All customers who buy a given quantity pay the same price
What is multi-market price discrimination?
Charge different groups of customers different prices depending on their willingness to pay for the group
What is a two-part tariff?
Charge customers a lump-sum fee for the right to buy the good at specified price
Pt 1. Lump Sum Fee
Pt 2. Per-Unit Price
Marginal Revenue Curve for Perfect Price Discrimination?
Marginal Revenue Curve becomes the Demand Curve
What are the results of a perfectly price discrimination monopoly?
Net benefits to society are maximized
No deadweight loss
Benefits to producer in a perfectly price discrimination monopoly?
All benefits go to producer in this case
Benefits to consumer in a perfectly price discrimination monopoly?
Consumer surplus is zero
How do producers take advantage of the demand curve using quantity discrimination?
Consumers are willing to pay a lower price for successive units
What is the most common type of price discrimination?
Multi Market Price Discrimination
How do producers identify which group an individual belongs to?
Observable Characteristics
Get consumers to self-select themselves into different groups
What is imperfect competition?
Competition among firms who have some market power
What is an oligopoly?
Industry with a small number of producers
Barriers to entry exist, just not as strong as with monopoly
What is a duopoly?
Oligopoly with two firms
What are the two types of imperfect competition?
- Non-Cooperative
2. Cooperative
What is non-cooperative imperfect competition?
Each firm makes decision about output and price without consulting each other
What is cooperative imperfect competition?
Decisions made jointly
Price or quantity setting (typically illegal)
Collusion
What is collusion?
Two or more firms acting together to set prices or quantity rather than competing?
What is a cartel?
Firms acting together as if a monopoly
What is game theory?
How economists model strategic behavior
What is Nash equilibrium?
Occurs when, holding the strategies of all other players constant, no single player can obtain a higher payoff by choosing a different strategy
Given what the other players are currently doing, no player can given by altering their own strategy
What is the dominant strategy?
Strategy that gives the player a higher payoff no matter what strategy the opponent is playing
What is tit for tat strategy?
Tit for tat involves playing cooperatively at first, then doing whatever the other player did in the previous period
Is the dominant strategy always the best possible outcome for the player?
No, sometimes the dominant strategy is not the best possible outcome for all players collectively (see prisoners dilemma)
What do the payoffs in game theory consist of?
Both costs and benefits (positives and negatives)
Do all games in game theory have a dominant strategy?
No
Is Nash equilibrium the same as the dominant strategy?
No, Nash equilibrium is an outcome, while dominant strategy is a strategy
Profit maximizing condition for a monopoly?
MR = MC
Profit maximizing condition for an oligopoly?
MR = MC
Profit maximizing condition for perfect competition
P = MR = MC
Does a monopoly have the ability to set price?
Yes, they are price searchers
Does an oligopoly have the ability to set price?
Yes, they are price searchers
Can firms price set when in perfect competition?
No, they are price takers
What kind of market power does a monopoly have?
Price > Marginal Cost
What kind of market power does an oligopoly have?
Price > Marginal Cost
What kind of market power is there in perfect competition?
Price = Marginal Cost
Entry into a monopoly?
No entry
Entry into an oligopoly?
Limited entry
Entry into perfect competition?
Free entry
Number of firms in a monopoly?
1
Number of firms in an oligopoly?
Few
Number of firms in perfect competition?
Many
Long-Run profits for a monopoly
≥ 0
Long-Run profits for an oligopoly?
≥ 0
Long-Run profits in perfect competition?
0
Is strategy dependent on rival firms in a monopoly?
No
Is strategy dependent on rival firms in an oligopoly?
Yes
Is strategy dependent on rival firms in perfect competition?
No
What is true of a non-cooperative oligopolies?
They compete with other firms
What is true of cooperative oligopolies?
They will collude with other firms
Will collectively want to act like a monopoly
Why does a colluding duopolist have an incentive to change production levels when a monopolist does not?
Differences in size of price effect
What are 4 conditions for cooperations in a duopoly?
- Repeated interactions over time
- Easy to monitor other firms
- Entry by non-colluding firms difficult
- Merge
Why does being easy to monitor other firms incite cooperation?
Good information concerning prices and output levels
How much will non-colluding oligopolists collectively produce?
More than a monopoly but less than a perfectly competitive industry
What has less deadweight loss, a noncooperative oligopoly or a monopoly?
Noncooperative oligopoly
