Lecture 6 Flashcards
What is defined as monopoly?
only one firm sells a product with NO CLOSE SUBSTITUTES
has market power- the ability to influence the market price of the product it sells. A competitive firm has no market power.
BECAUSE BARGAINING STRENGTH COMES THROUGH SCARCITY. (if you control scarce resource, can dictate terms of transaction(price,qty,qlt) )
Why do monopolies arise?
barriers to entry — other firms cannot enter the market.
What are the sources of BTE?
What is the source of BTE for natural monopoly?
single firm owns a key resource
government gives a single firm the exclusive right to produce the good.
Natural Monopoly:
when a single firm can produce the entire market Q at lower cost than several firms.
In competitive markets, what is the market demand curve and the individual firm’s demand curve?
Market : Downward sloping
Individual: Horizontal
In competitive markets, why is the individual firm’s market demand horizontal?
price taker, can sell many units as it wants at market price
Can increase quantity without fall in price, as its actions are insignificant as compared to the entire market
What is the shape of the monopolists’ market demand curve and why?
monopolist is the only seller,
so it faces the market demand curve.
To increase Q,
the monopolist lower P.
Thus MR ≠ P.
How does a monopoly sell more units?
must lower price on ALL units it sells
Explain the effect of increase in Q on revenue
Increase in Q results in
Output effect: Increase Q lead to Increase Revenue
Price effect: Price decrease leads to revenue decrease
To sell more units,must lower price on ALL units it sells
When is MR negative?
when price effect dominates the output effect
Explain how monopoly charges price?
maximizes profit by producing the quantity where MR = MC.
sets the highest price consumers are willing to pay for that quantity
determines this price from the demand curve.
How does monopoly result in deadweight loss?
In a competitive market equilibrium,
P = MR = MC and total surplus is maximized. Price or the value to consumers = cost to producers
In the monopoly equilibrium,
P > MR = MC.
The value to buyers of an additional unit (P ) exceeds the cost of the resources needed to produce that unit (MC).
The monopoly Q is too low; total surplus could be increased by increasing Q.
Grey triangle is dwl, as between qm and qc, the demand curve which represents the buyers value of good,is above the producer cost of producing good, if these units are transacted, either producer, consumer or both would have realized gains from trade, but cause monopolywant to maximise profit, and single market price, monopolist produces at qm, grey triangle means gains of trade in competitive market, but they wont be realized in monopoly
What is price discrimination?
selling the same good at different prices to different buyers
What characteristic of consumers is used in price discrimination?
willingness to pay.
A firm can increase profit by charging a higher price to buyers with higher WTP.
How does producer surplus and consumer surplus arise from perfect price discrimination
D=MR
To maximise profit, would want to price each buyer willingness to pay, mr of 2nd unit is the price charged to 2nd buyer, and 3rd buyer and son on . MR curve is the same curve as the dd curve, as willingness to pay is depicted by dd curve. Produce where buyer willingness to pay is at least as gbreat as the marginal cost of that unit. Produce at mr=mc
Cpnsumer surplus is the differnece between the price they pay (charged according to what each buyer willing and able to apy along demand curve) and the amount they are willing to pay
BOTH ARE THE SAME, HENCE CONSUMER SURPLUS IS 0
Producer surplus is area above the mc curve, below the demand curve, paid by each byer from 0 to q. Firms are able to charge exactly what the marginal buyers wtp. Producer captire all consumer surplus as profit, BUT NO DWL
Why is perfect price discrimination not possible?
No firm knows every buyer’s WTP.
Buyers do not announce their WTP to sellers.
How do firms get around not having perfect price discrimination?
firms divide customers into groups based on some observable trait (e.g., age) that is likely related to WTP.
What are the 3 types of price discrimination?
charge differnet price for same product
“Unique target” (first-degree price discrimination)
“Group target” (third-degree price discrimination)
“Self-incrimination”
Why do many firms in real wolrd have market power?
selling a unique variety of a product
having a large market share and few significant competitors
What are most commonly observed in the real world with monopoly?
mark-up of price over marginal cost
deadweight loss
What is third degree price discrimination?
based on groups with some assumption on typical behaviour
What is first degree price discrimination?
first degree price discriinination, where you are charged exactly what you can pay
What are the characteristic of monopolistically competitive?
There are many buyers and sellers.
Sellers offer differentiated products.
Sellers can freely enter or exit the market.
What is the profit of monopolistically competitive market and why?
0 profit
cause if making positive, then new firms will enter, profit driven down to 0
Depends on freedom of exit and entry
Monopolistic competition only face just a nicahe of competition
Are number of firms in monopolisitcally competitive markets optimal for society?
THINK ABOUT EXTERNALITIES
The product-variety externality: the surplus that consumers get from the introduction of new products.
The business-stealing externality: the losses incurred by existing firms when new firms enter the market.
Producer get negative, consumer get positive externality
What do we use to measure concentration of oligopoly?
N-Firm Concentration Ratio:
the percentage of the market’s total output supplied by the N largest firms.
The higher the concentration ratio, the less competition there is.
What is characteristic of oligopoly?
only a few sellers offer similar or identical products.
firm’s decisions about P or Q can affect other firms and cause them to react. The firm will consider these reactions when making decisions.
What is game theory?
study of how people behave in strategic situations.
What is collusion?
an agreement among firms in a market about quantities to produce or prices to charge.
What is cartel?
a group of firms acting in unison.
act like monopoly
Why is it difficult for oligopoly firms to form cartel and honour agreements?
Both firms would be better off if
they both stick to the cartel agreement.
But each firm has an incentive to cheat.
What is nash equilibrium?
a situation in which players interacting with one another each chooses his best strategy
given the strategies that all the others have chosen.
What is dominant strategy?
a strategy that is best for a player
in a game regardless of the strategies chosen by the other players.
What is prisoner’s dilemma?
a game between two captured criminals that illustrates why cooperation is difficult even when it is mutually beneficial.
What is the nash equilibrium and dominant strategy of a typical prisoner dilemma?
Nash equilibrium: both confess
dominant strat: both confess
Explain the derivation of nash equilibrium
If both player choose option a, but there is still the best outcome out there, if player 1 chooses optiona, then player 2 should choose option b to get the best outcome. If both switch to option b, then you get the bad bad outcome. Even if you don’t watnt ot cheat, you still want to cheat anyways to avoid the worst outcome
NASH Equilibrium which is correct?
cut fares
$80 million
cut fares
NOT ABOUT PAYOFFS!!!`
Explain the nash equilibrium for comon resource usage
All would be better off if everyone conserved common resources, but each person’s dominant strategy is overusing the resources.
How does the prisoner dilemma affect welfare in oligoplies?
Bad for oligopoly firms:
They are prevented from achieving monopoly profits.
Good for society:
Q is closer to the socially efficient output.
P is closer to MC.
In other prisoners’ dilemmas, the inability to cooperate may reduce social welfare, e.g., arms race, overuse of common resources.
What happens in games in the logn run?
Cooperation
What strategies are there to lead to cooperation?
Grim (If your rival cheats in one round,
you cheat in all subsequent rounds)
Tit-for-tat (Whatever your rival does in one round (whether cheat or cooperate),
you do in the following round.)
In prisoner dilemma both players have _____ strategies that lead to _____ outcomes
Dominant
Inefficient (bad bad)
