Market Structures

Question 1

What are the 6 assumptions/characteristics of perfect competition

Answer 1

1. Firms produce the same (homogenous) product
2. Firms are price takers
3. No barriers to entry or exit
4. Average cost curves end up sloping upwards
5. Perfect information between buyers and sellers
6. Firms maximize profits

Question 2

A firm will choose an output (to maximize profits) where…

Answer 2

marginal cost = marginal revenue

Question 3

Under perfect competition MR = P, why?

Answer 3

Because firms can sell as much as they want at the given market price

Question 4

What does the part of the SR marginal cost curve that lies above the average variable cost curve show?

Answer 4

The firm’s supply curve

Question 5

Under perf comp can a firm make a loss in the short run? What about the long run?

Answer 5

Yes in Sr, but in LR the firm will exit the market

Question 6

Under perf comp, the average revenue curve is equal to 2 other things, what are they?

Answer 6

Marginal revenue and demand (and price)

Question 7

What happens when firms make super-normal profit in LR?

Answer 7

More firms are attracted to the market -> the industry supply curve shifts right -> market price falls -> profits fall and are eventually completely competed away

Question 8

What are the 3 key characteristics of a monopoly

Answer 8

1. One large firm that supplies the market
2. Price maker
3. Significant barriers to entry/exit

Question 9

In a monopoly - why does MR lie below the demand curve?

Answer 9

Higher output reduces price on all output units, so MR will be less than price

Question 10

What are the differences in output and price under a monopoly compared to perfect competition?

Answer 10

Output is lower under a monopoly, price is higher under a monopoly

Question 11

What impact will a regulated price below the market price have on perfect competition and monopoly?

Answer 11

Perfect competition - reduce supply and cause excess demand
Monopoly - increase supply

Question 12

What are the 6 characteristics of monopolistic competition?

Answer 12

1. Many firms
2. Freedom of entry and exit
3. Product differentiation
4. Price makers
5. Productively and allocatively inefficient

Question 13

Why is demand curve downward sloping in monopolistic competition?

Answer 13

Product differentiation, transport costs, information problems, brand loyalty/habits

Question 14

Can monopolistic firms make profits in the SR and the LR?

Answer 14

Yes in SR, in LR no they are competed away

Question 15

What are the characteristics of an oligopoly

Answer 15

1. A few large firms (5-firm concentration ratio > 50%)
2. Some barriers to entry
3. Possibility of collusion
4. Product differentiation
5. Interdependence of firms

Question 16

What is the kinked demand curve? Where is it more/less elastic

Answer 16

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

Question 17

Define “game” in game theory?

Answer 17

A situation in which decisions by rational economic agents (e.g. oligopolist firms) are interdependent

Question 18

Define “dominant strategy” in game theory?

Answer 18

Where a player’s best strategy is independent of those chosen by others

Question 19

Define “Nash equilibrium” in game theory?

Answer 19

Each player has chosen a strategy and no player can benefit by changing strategies while the other players keep theirs unchanged

Question 20

What is the prisoners’ dilemma?

Answer 20

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

Question 21

What is collusion?

Answer 21

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.

Question 22

Why are cartels/collusion unstable?

Answer 22

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

Question 23

What is a Cournot competition oligopoly?

Answer 23

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

Question 24

What is a Stackleberg oligopoly?

Answer 24

Firms choose quantity in sequence, homogenous goods

Question 25

What is a Bertrand oligopoly?

Answer 25

Firms simultaneously choose prices

Question 26

What is a price leadership oligopoly?

Answer 26

Firms choose prices in sequence

Question 27

What is the difference in quantity produced and profits for leaders between Cournot and Stackleberg models of oligopoly?

Answer 27

In Stackleberg leader produces more than in Cournot
Stackleberg leader’s profits are higher than in Cournot

Question 28

When does a natural monopoly arise? Give an example?

Answer 28

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.

Question 29

Why do natural monopolies have to be government regulated?

Answer 29

They are uncontestable and firms have no real competition therefore without intervention they could abuse market power and set higher prices.

Question 30

Why do monopolies arise?

Answer 30

Barriers to entry because a firm owns a single resource, the government gives rights to produce to a single firm or a natural monopoly

Question 31

What is price discrimination?

Answer 31

Where firms in a monopoly charge higher prices to consumers with higher willingness to pay