Market Structures Flashcards
What are the 6 assumptions/characteristics of perfect competition
- Firms produce the same (homogenous) product
- Firms are price takers
- No barriers to entry or exit
- Average cost curves end up sloping upwards
- Perfect information between buyers and sellers
- Firms maximize profits
A firm will choose an output (to maximize profits) where…
marginal cost = marginal revenue
Under perfect competition MR = P, why?
Because firms can sell as much as they want at the given market price
What does the part of the SR marginal cost curve that lies above the average variable cost curve show?
The firm’s supply curve
Under perf comp can a firm make a loss in the short run? What about the long run?
Yes in Sr, but in LR the firm will exit the market
Under perf comp, the average revenue curve is equal to 2 other things, what are they?
Marginal revenue and demand (and price)
What happens when firms make super-normal profit in LR?
More firms are attracted to the market -> the industry supply curve shifts right -> market price falls -> profits fall and are eventually completely competed away
What are the 3 key characteristics of a monopoly
- One large firm that supplies the market
- Price maker
- Significant barriers to entry/exit
In a monopoly - why does MR lie below the demand curve?
Higher output reduces price on all output units, so MR will be less than price
What are the differences in output and price under a monopoly compared to perfect competition?
Output is lower under a monopoly, price is higher under a monopoly
What impact will a regulated price below the market price have on perfect competition and monopoly?
Perfect competition - reduce supply and cause excess demand
Monopoly - increase supply
What are the 6 characteristics of monopolistic competition?
- Many firms
- Freedom of entry and exit
- Product differentiation
- Price makers
- Productively and allocatively inefficient
Why is demand curve downward sloping in monopolistic competition?
Product differentiation, transport costs, information problems, brand loyalty/habits
Can monopolistic firms make profits in the SR and the LR?
Yes in SR, in LR no they are competed away
What are the characteristics of an oligopoly
- A few large firms (5-firm concentration ratio > 50%)
- Some barriers to entry
- Possibility of collusion
- Product differentiation
- Interdependence of firms
What is the kinked demand curve? Where is it more/less elastic
Kinked demand curve takes into account how demand will change when a firm changes its price in an oligopoly. The demand curve is more inelastic below market price because rivals are more likely to respond if the firm lowers its price - so demand in response to a price reduction is likely to be inelastic. Above market price it will be elastic as rivals are less likely to respond to a price increase and so demand will be more responsive
Define “game” in game theory?
A situation in which decisions by rational economic agents (e.g. oligopolist firms) are interdependent
Define “dominant strategy” in game theory?
Where a player’s best strategy is independent of those chosen by others
Define “Nash equilibrium” in game theory?
Each player has chosen a strategy and no player can benefit by changing strategies while the other players keep theirs unchanged
What is the prisoners’ dilemma?
Each firm has a dominant strategy to produce high, but firms would be better off if they both produced low (but need to be sure both would go low) so there is a strong incentive to cheat
What is collusion?
Two firms agree to fix price or output, resulting in higher joint profits than if they were competing (acts like a monopoly) and so the firms can then split the profits. It is also called a cartel.
Why are cartels/collusion unstable?
The dominant strategy under collusion is to cheat and not support the agreement. For each firm, MR>MC so each firm has an incentive to sell more by cutting prices
What is a Cournot competition oligopoly?
Firms simultaneously choose quantity without collusion, homogeneous goods, don’t choose prices they adjust to clear market and they are the same for all firms
What is a Stackleberg oligopoly?
Firms choose quantity in sequence, homogenous goods
What is a Bertrand oligopoly?
Firms simultaneously choose prices
What is a price leadership oligopoly?
Firms choose prices in sequence
What is the difference in quantity produced and profits for leaders between Cournot and Stackleberg models of oligopoly?
In Stackleberg leader produces more than in Cournot
Stackleberg leader’s profits are higher than in Cournot
When does a natural monopoly arise? Give an example?
When the most efficient number of firms in the industry is one, usually because of very high fixed costs. For example tap water/water companies.
Why do natural monopolies have to be government regulated?
They are uncontestable and firms have no real competition therefore without intervention they could abuse market power and set higher prices.
Why do monopolies arise?
Barriers to entry because a firm owns a single resource, the government gives rights to produce to a single firm or a natural monopoly
What is price discrimination?
Where firms in a monopoly charge higher prices to consumers with higher willingness to pay
