lecture 3 More on price making firms Flashcards
Describe monopolistic Competition
Where there are many markets in which producers are price makers even with lots of firms and that each firm acts independently.
Why does price making occur in monopolistic competitive markets?
Because firms produce imperfcet substitutes.
e.g. pepsi vs coca cola
Describe the 4 main assumptions of the monopolistic competitive model.
- Seller influence on price- Monopolistic firms faces a downward-sloping firm specific demand curve. The firm has some control on the price of their goods. (due to differentiated goods)
- Sellers do not behave strategically- Firms do not consider the actions of rivals when making pricing or output decisions.
- Free entry into the market- There are no significant barriers to entry.
- Buyers are price takers- Consumers have no influence on the price of products.
What is the impact of free entry into monopolistic competitive markets?
Entry increases competition, reduces individual firm demand and eventually drives economic profits to zero in the long run.
Describe short run equilibrium for a firm in a monopolistic competitive market.
In the short run, the number of firms is fixed. Where each firm behaves similarly to a monopoly but operates with a framework where there are many firms producing differentiated products.
In the short run the economic profit of a firm must be positive- As the firm ensures that it is better off producing output than shutting down , as long as the average revenue exceeds average variable costs.
State some implications of a short run equilibrium model.
It resembles a monopoly
Firms ignore rivals reactions and so does not act strategically.
The short-run equilibrium assumes no entry or exit of firms.
Describe the analysis of a long run equilibrium for a monopolistic competitive market.
In the long-run, a monopolistically competitive market adjusts to ensure zero economic profit for all firms.
Describe the impact of the entry of a new firm in a long run monopolistically competitive market equilibrium.
The entry of a new firm will shift inwards the firm-specific demand and marginal revenue curves for a representative firm.
The entry of the new firm creates overcrowding and it may even be possible that incumbent firms suffer losses and some of them may even be forced to leave the market.
What are some implications of using Long-run equilibrium graph for monopolistically competitive firms?
Leads to the firm specific demand curve shifting inwards, as the new firm creates greater competition and reduced the market share of each existing firm.
Entry continues as long as the average revenue exceeds the average cost for some output level, allowing firms to earn profits.
Excess Capacity, as frims are not producing at the lowest point on their ATC curve.
Explain some characteristics that are specific to a long-run equilibrium.
The firms demand curve and average cost curve must be tangent at the equilibrium output level.
The tangency ensures there is no output level where average revenue exceeds average cost, preventing further entry.
Zero economic profit- At the equilibrium output, the price equals the average cost of production.
This ensures that firms earn zero economic profit.
Explain the importance of variety and efficiency in a monopolistically competitive market.
Consumers value variety however, offering more choices increases production costs due to economies of scale.
Producing goods in bulk reduces average costs but reduces variety.
Consumers are willing to pay more for products that better suit their preferences.
Explain the excess capacity theorem
It claims that monopolistic competition leads to too many firms in the long run.
It also states that if the same industry output was produced by fewer firms, average costs would be lower due to economies of scale.
While firms might have lower production costs, reducing variety would impose costs on consumers (inconvenience or reduced satisfaction)
How is total surplus calculated?
Producer surplus + consumer surplus
W(n) = n * π(n) + CS(n)
W(n)- total surplus
n * π(n) - Industry profits/ producer surplus
CS(n)- Consumer surplus
Describe what consumer surplus is.
The benefits consumers gain from lower prices and greater variety.
What is the market outcome (nT) when finding the efficient number of firms in a monopolistic competitive market?
Where total surplus is maximised at the number of firms where the marginal benefit of adding a firm equals its marginal cost.
