Microeconomics FINAL Flashcards
monopoly
Market with only one seller.
market power
Ability of a seller or buyer to affect the price of a good.
marginal revenue
Change in revenue resulting from a one-unit increase in output
Average and marginal revenue are shown
for the demand curve
PROFIT IS MAXIMIZED WHEN
MARGINAL REVENUE EQUALS MARGINAL COST
Q* (WITH OUT SECRIFICES) is the output level at
which
MR = MC
MR =
Elasticiry of demand
A monopolistic market has no
supply curve
monopoly power—
it can profitably charge a price greater than marginal cost.
Remember the important distinction between a perfectly competitive firm and a firm with monopoly power:
For the competitive firm, price equals marginal cost; for the firm with monopoly power, price exceeds marginal cost.
Lerner Index of Monopoly Power
Measure of monopoly power calculated as excess of price over marginal cost as a fraction of price.
Three factors determine a firm’s elasticity of demand
- The elasticity of market demand. Because the firm’s own demand will be at least as elastic as market demand, the elasticity of market demand limits the potential for monopoly power.
- The number of firms in the market. If there are many firms, it is unlikely that any one firm will be able to affect price significantly.
- The interaction among firms. Even if only two or three firms are in the market, each firm will be unable to profitably raise price very much if the rivalry among them is aggressive, with each firm trying to capture as much of the market as it can.
If there is only one firm—a pure monopolist—its demand curve is the market
demand curve.
If there is only one firm—a pure monopolist—its demand curve is the market demand curve. In this case, the firm’s degree of monopoly power depends completely on the
elasticity of market demand
If there is only one firm—a pure monopolist—its demand curve is the market demand curve. In this case, the firm’s degree of monopoly power depends completely on the
elasticity of market demand
When several firms compete with one another, the elasticity of market demand
sets a lower limit on the magnitude of the elasticity of demand for each firm
When only a few firms account for most of the sales in a market, we say that the market is
highly concentrated
barrier to entry
Condition that impedes entry by new competitors
Sometimes there are natural barriers to entry:
- Patents, copyrights, and licenses
- Economies of scale may make it too costly for more than a few firms to supply the entire market. In some cases, economies of scale may be so large that it is most efficient for a single firm—a natural monopoly—to supply the entire market.
Because of the higher price, consumers lose:
Producer gains:
deadweight loss:
consumers lose A + B
producer gains A-C
deadweight loss B + C.
rent seeking
Spending money in socially unproductive efforts to acquire, maintain, or exercise monopoly
When the price is lowered to Pc, at the point where marginal cost intersects average revenue, output increases to its
maximum Qc. This is the output that would be produced by a competitive industry.
natural monopoly
Firm that can produce the entire output of the market at a cost lower than what it would be if there were several firms.
If the price were regulated to be Pc the firm would:
Set the price at Pr:
If price were regulated to be Pc the firm would lose money and go out of business.
Setting the price at Pr yields the largest possible output consistent with the firm’s remaining in business; excess profit is zero.
monopolistic competition
Market in which firms can enter freely, each producing its own brand or version of a differentiated product.
oligopoly
Market in which only a few firms compete with one another and entry by new firms is impeded.
cartel
Market in which some or all firms explicitly collude, coordinating prices and output levels to maximize joint profits.
A monopolistically competitive market has two key characteristics:
- Firms compete by selling differentiated products that are highly substitutable for one another but not perfect substitutes. In other words, the cross-price elasticities of demand are large but not infinite.
- There is free entry and exit: It is relatively easy for new firms to enter the market with their own brands and for existing firms to leave if their products become unprofitable.
Because the firm is the only producer of its brand, it faces a
downward-sloping demand curve.
Why firm has monopoly power?
Price exceeds marginal cost
Why yellowshaded rectangle shows the amount of profit?
Because price also exceeds average cost
In the long run, these profits attract new firms with competing brands. The firm’s market share falls, and its demand curve shifts
downward
(A MONOPOLISTICALLY COMPETITIVE FIRM IN THE SHORT AND LONG RUN)
In long-run equilibrium, described in part (b), price equals average cost, so the firm earns…
ZERO PROFIT
Under perfect competition, price equals
marginal cost
Under monopolistic competition, price exceeds
marginal cost
What yellow shaded area shows:
deadweight loss
Unlike firm in perfect competition monopoly faces a
downward sloping demand curve
Monopoly does not have a supply curve because
quantity supplied depends on demand curve
Firms with monopoly power can charge price above the MC, the degree of monopoly power is measured with the
the Lerner index
Monopoly power depends
on market elasticity of demand, number of firms in the market and interaction among those firms
Monopoly power leads to deadweight loss that can be minimized with
price regulation
Monopsony is
a market with only one buyer
In monopolistic competition firms face
downward-sloping demand curve like in monopoly, but zero economic profits like in perfect competition
In oligopolistic markets, the products may or may not be
differentiated
Nash equilibrium
Set of strategies or actions in which each firm does the best it can given its competitors’ actions.
duopoly
Market in which two firms compete with each other
Cournot model
Oligopoly model in which firms produce a homogeneous good, each firm treats the output of its competitors as fixed, and all firms decide simultaneously (tuo pačiu metu) how much to produce.
reaction curve
Relationship between a firm’s profit-maximizing output and the amount it thinks its competitor will produce
Cournot equilibrium
Equilibrium in the Cournot model in which each firm correctly assumes how much its competitor will produce and sets its own production level accordingly.
Cournot equilibrium is an example of
a Nash equilibrium
Bertrand model
Oligopoly model in which firms produce a homogeneous good, each firm treats the price of its competitors as fixed, and all firms decide simultaneously what price to charge.
noncooperative game
Game in which negotiation and enforcement of binding contracts are not possible.
payoff matrix
Table showing profit (or payoff) to each firm given its decision and the decision of its competitor
prisoners’ dilemma
Game theory example in which two prisoners must decide separately whether to confess to a crime; if a prisoner confesses, he will receive a lighter sentence and his accomplice will receive a heavier one, but if neither confesses, sentences will be lighter than if both confess.
price rigidity
Characteristic of oligopolistic markets by which firms are reluctant (nenoriai) to change prices even if costs or demands change
kinked demand curve model
Oligopoly model in which each firm faces a demand curve kinked at the currently prevailing (vyraujanti) price: at higher prices demand is very elastic, whereas at lower prices it is inelastic
price signaling
Form of implicit collusion in which a firm announces a price increase in the hope that other firms will follow suit
price leadership
Pattern of pricing in which one firm regularly announces price changes that other firms then match
game
Situation in which players (participants) make strategic decisions that take into account each other’s actions and responses
payoff
Value associated with a possible outcome
strategy
Rule or plan of action for playing a game
optimal strategy
Strategy that maximizes a player’s expected payoff
cooperative game
Game in which participants can negotiate binding contracts that allow them to plan joint strategies
noncooperative game
Game in which negotiation and enforcement of binding contracts are not possible
dominant strategy
Strategy that is optimal no matter what an opponent does.
equilibrium in dominant strategies
Outcome of a game in which each firm is doing the best it can regardless of what its competitors are doing
maximin strategy
Strategy that maximizes the minimum gain that can be earned
repeated game
Game in which actions are taken and payoffs received over and over again
tit-for-tat strategy
Repeated-game strategy in which a player responds in kind to an opponent’s previous play, cooperating with cooperative opponents and retaliating against uncooperative ones
sequential game
Game in which players move in turn, responding to each other’s actions and reactions
extensive form of a game
Representation of possible moves in a game in the form of a decision tree
auction market
Market in which products are bought and sold through formal bidding processes
English (or oral) auction
Auction in which a seller actively solicits progressively higher bids from a group of potential buyers
Dutch auction
Auction in which a seller begins by offering an item at a relatively high price, then reduces it by fixed amounts until the item is sold
sealed-bid auction
Auction in which all bids are made simultaneously in sealed envelopes, the winning bidder being the individual who has submitted the highest bid
first-price auction
Auction in which the sales price is equal to the highest bid
second-price auction
Auction in which the sales price is equal to the second-highest bid
private-value auction
Auction in which each bidder knows his or her individual valuation of the object up for bid, with valuations differing from bidder to bidder
common-value auction
Auction in which the item has the same value to all bidders, but bidders do not know that value precisely and their estimates of it vary
winner’s curse
Situation in which the winner of a common-value auction is worse off as a consequence of overestimating the value of the item and thereby overbidding
Aiškesnis paaiškinimas iš google: The winner’s curse is a tendency for the winning bid in an auction to exceed the intrinsic value or true worth of an item
derived demand
Demand for an input that depends on, and is derived from, both the firm’s level of output and the cost of inputs
marginal revenue product
Additional revenue resulting from the sale of output created by the use of one additional unit of an input
In a competitive factor market in which (……………1.……………) is a price taker, the buyer’s demand for an input is given by the marginal revenue product curve
- the producer
The MRP curve falls because
the marginal product of labor falls as hours of work increase
Note that the marginal revenue product tells us
how much the firm should be willing to pay to hire an additional unit of labor
As long as the MRPL is greater than the wage rate, the firm should
hire more labor
If the marginal revenue product is less than the wage rate, the firm should
lay off workers
The profit-maximizing condition is therefore
In a competitive labor market, a firm faces a perfectly elastic supply of labor SL and can hire as many workers as it wants at a wage rate:
w*
The firm’s demand for labor DL is given by
its marginal revenue product of labor MRPL
The profit-maximizing firm will hire L* units of labor at the point where
the marginal revenue product of labor is equal to the wage rate
MR =
average expenditure curve
Supply curve representing the price per unit that a firm pays for a good
marginal expenditure curve
Curve describing the additional cost of purchasing one additional unit of a good
Profit maximization requires that
marginal revenue product be equal to marginal expenditure
In the competitive case, the condition for profit maximization is
that the price of the input be equal to marginal expenditure
When the wage rate increases, the hours of work supplied increase initially but can eventually decrease as
individuals choose to enjoy more leisure and to work less
For a factor market, economic rent is
the difference between the payments made to a factor of production and the minimum amount that must be spent to obtain the use of that factor
The economic rent associated with the employment of labor is the excess of wages
paid above the minimum amount needed to hire workers
A buyer with monopsony power maximizes net benefit (utility less expenditure) from a purchase by buying up to the point where marginal value (MV) is
equal to marginal expenditure
For a firm buying a factor input, MV is
ust the marginal revenue product of the factor MRP
ME=MRP
Marginal revenue product
tells us how much the firm should be willing to pay to hire an additional unit of labor
Profit-maximizing condition is that the marginal revenue product of labor has to be equal to
the wage rate, just as in the output market MR=MC
Individual supply of labour curve is backward bending because
leisure time becomes more valuable with an increase of income
Similarly as in output markets too low wage can create
labour shortage and too high wage can lead to labour surplus
A buyer with monopsony power buys up to the point where
marginal value (MV) is equal to marginal expenditure (ME)
If labour union is a monopolist
it can choose whether to maximize the employment or wage paid to workers
comparative advantage
Situation in which Country 1 has an advantage over Country 2 in producing a good because the cost of producing the good in 1, relative to the cost of producing other goods in 1, is lower than the cost of producing the good in 2, relative to the cost of producing other goods in 2.
absolute advantage
Situation in which Country 1 has an advantage over Country 2 in producing a good because the cost of producing the good in 1 is lower than the cost of producing it in 2.
WHAT HAPPENS WHEN NATIONS TRADE
Competitive markets fail for four basic reasons:
market power, incomplete information, externalities, and public goods
Market Power
A firm with market power chooses the output quantity at which marginal revenue (rather than price) is equal to marginal cost and sells less output at a price higher than it would charge in a competitive market.
(Suppose that unions gave workers market power over the supply of their labor in the production of food. Too little labor would then be supplied to the food industry at too high a wage (wF) and too much labor to the clothing industry at too low a wage (wC))
Incomplete Information
Lack of information may give producers an incentive to supply too much of some products and too little of others. In other cases, while some consumers may not buy a product even though they would benefit from doing so, others buy products that leave them worse off.
Lack of information may also prevent some markets from ever developing. These informational problems can lead to competitive market inefficiency.
There is an externality when
a consumption or production activity has an indirect effect on other consumption or production activities that is not reflected directly in market prices
public good
Nonexclusive, nonrival good that can be made available cheaply but which, once available, is difficult to prevent others from consuming
externality
Action by either a producer or a consumer which affects other producers or consumers, but is not accounted for in the market price
Externalities can be negative—
when the action of one party imposes costs on another party
Externalities can be positive when
the action of one party benefits another party
marginal external cost
Increase in cost imposed externally as one or more firms increase output by one unit
marginal social cost
Sum of the marginal cost of production and the marginal external cost
When there are negative externalities, the marginal social cost MSC is
higher than the marginal cost MC
marginal external benefit
Increased benefit that accrues to other parties as a firm increases output by one unit
marginal social benefit
Sum of the marginal private benefit plus the marginal external benefit
When there are positive externalities, marginal social benefits MSB are higher
than marginal benefits D
The efficient level of factory emissions is the level that
emissions is the level that equates the marginal external cost of emissions MEC to the benefit associated with lower abatement costs MCA. The efficient level of 12 units is E*.
emissions standard
Legal limit on the amount of pollutants that a firm can emit
emissions fee
Charge levied on each unit of a firm’s emissions
tradable emissions permits
System of marketable permits, allocated among firms, specifying the maximum level of emissions that can be generated
stock externality
Accumulated result of action by a producer or consumer which, though not accounted for in the market price, affects other producers or consumers
Kitas paaiškinimas: Stock externalities represent a type of consumption externality in which individual consumption of a particular good leads to production of a public bad, such as in the arms race and in the greenhouse effect.
property rights
Legal rules stating what people or firms may do with their property
Economic efficiency can be achieved without government intervention when
the externality affects relatively few parties and when property rights are well specified
Coase theorem
Principle that when parties can bargain without cost and to their mutual advantage, the resulting outcome will be efficient regardless of how property rights are specified
common property resource
Resource to which anyone has free access
public good
Nonexclusive and nonrival good: The marginal cost of provision to an additional consumer is zero and people cannot be excluded from consuming it
nonrival good
Pirmas paaiškinimas: Good for which the marginal cost of its provision to an additional consumer is zero
Kitas paaiškinimas: A good that can be consumed or possessed by multiple users
Pavyzdys: One example of non-rivalrous goods is a television show
nonexclusive good
Good that people cannot be excluded from consuming, so that it is difficult or impossible to charge for its use
free rider
Consumer or producer who does not pay for a nonexclusive good in the expectation that others will
In order to explain trade we should look not only at competitive advantage, but also
comparative advantage
Competitive (……………….) due to market power, incomplete information, externalities, and public goods
markets fail
(………………………..) describes action of producer or consumer that affects consumers and/or producers, but is not accounted in the market price
Externality
(…………………………………………………………..) is where MSB = MSC, but unregulated market may not necessarily produce at that level
Efficient level of output
Inefficiencies can be corrected by (……………………………) (fees, standards and tradable permits)
market interventions
asymmetric information
Situation in which a buyer and a seller possess different information about a transaction
adverse selection
Form of market failure resulting when products of different qualities are sold at a single price because of asymmetric information, so that too much of the low-quality product and too little of the high-quality product are sold
market signaling
Process by which sellers send signals to buyers conveying (perteikiama) information about product quality
moral hazard
When a party whose actions are unobserved can affect the probability or magnitude of a payment associated with an event
Kitas paaiškinimas: Moral hazard is the risk that a party has not entered into a contract in good faith or has provided misleading information about its assets, liabilities, or credit capacity
Bails out - gelbėja
principal–agent problem
Problem arising when agents (e.g., a firm’s managers) pursue their own goals rather than the goals of principals (e.g., the firm’s owners)
An agency relationship exists whenever
there is an arrangement in which one person’s welfare depends on what another person does
agent
Individual employed by a principal to achieve the principal’s objective
A principal–agent problem arises when
agents pursue their own goals rather than the goals of the principal
principal
Individual who employs one or more agents to achieve an objective
efficiency wage theory
Explanation for the presence of unemployment and wage discrimination which recognizes that labor productivity may be affected by the wage rate
shirking model
Principle that workers still have an incentive to shirk if a firm pays them a market-clearing wage, because fired workers can be hired somewhere else for the same wage
efficiency wage
Wage that a firm will pay to an employee as an incentive not to shirk
Asymmetric information between buyer and seller about the product creates another type of market failure –
adverse selection
Market signaling can help to obtain information about
different types of goods
Moral hazard can often create inefficiencies in the insurance market as people tend to invest
less into protection of insured goods
homogeneous good
A good which has uniform properties: every unit of the good is identical. Goods which differ in specifications or quality, or bear different brand names which convey information to customers, are not homogeneous. Units of money, or securities of the same type, are completely homogeneous
What factors determine the amount of monopoly power an individual firm is likely to have?
Explain each one briefly.
Three factors determine the firm’s elasticity of demand and hence its market power:
- the elasticity of market demand
- the number of firms in the market, and
- the interaction among firms in the market.
The elasticity of market demand depends on the uniqueness of the product, i.e., how easy it is for consumers to substitute for the product. As the number of firms in the market increases, the demand elasticity facing each firm increases because customers have more choices. The number of firms in the market is determined by how easy it is to enter the industry (the height of barriers to entry). Finally, the ability to raise price above marginal cost depends on how other firms react to the firm’s price changes. If other firms match price changes, customers have little incentive to switch to another supplier, and this increases market power.
If the government wants to set a price ceiling that maximizes the monopolist’s output, what price should it set?
When a price ceiling is imposed, MR is equal to the price ceiling for all quantities less than or equal to the quantity demanded at the price ceiling. For example, in the diagram the price ceiling is set at P′, which is below the profit-maximizing price P*. The MR curve becomes the line P′A and then jumps down to B and follows the original MR curve beyond that point. The optimal output for the monopolist is then Q′, which is greater than the profit-maximizing output.
If the government wants to maximize output, it should set a price ceiling at the point where
the demand curve and the marginal cost curve intersect, point C in the diagram.
π =
R – C
R=
Q*P
Mokesčiai skaičiuojami nuo galutinės sumos ir atimami nuo
REVENUE
PRICE
P =
AR = MR
The kinked demand curve illustrates the
interdependence (tarpusavio priklausomybė) of firms in an oligopoly market.
The reason why there is a kink in the demand curve is that there are
two demand curves: one that is inelastic and one that is elastic. The kink occurs when both demand curves intersect each other.
The kinked demand curve describes price rigidity. Explain how the model works. What are its limitations? Why does price rigidity occur in oligopolistic markets?
According to the kinked demand curve model, each firm faces a demand curve that is kinked at the currently prevailing (vyraujanti) price. Each firm believes that if it raises its price, the other firms will not raise their prices, and thus many of the firm’s customers will shift their purchases to competitors. This reasoning implies a highly elastic demand for price increases.
On the other hand, each firm believes that if it lowers its price, its competitors will also lower their prices, and the firm will not increase sales by much. This implies a demand curve that is less elastic for price decreases than for price increases. This kink in the demand curve leads to a discontinuity (nenutrūkstamumas) in the marginal revenue curve, so only large changes in marginal cost lead to changes in price.
What do the Cournot and Bertrand models have in common?
What is different between the two models?
Both are oligopoly models in which firms produce a homogeneous good. In the Cournot model, each firm assumes its rivals will not change the quantity they produce. In the Bertrand model, each firm assumes its rivals will not change the price they charge. In both models, each firm takes some aspect of its rivals’ behavior (either quantity or price) as fixed when making its own decision. The difference between the two is that in the Bertrand model firms end up producing where price equals marginal cost, whereas in the Cournot model the firms will produce more than the monopoly output but less than the competitive output
Suppose that two identical firms produce widgets and that they are the only firms in the market. Their costs are given by C1 = 60Q1 and C2 = 60Q2, where Q1 is the output of Firm 1 and Q2 the output of Firm 2. Price is determined by the following demand curve: P = 300 − Q where Q = Q1 + Q2.
a) Find the Cournot-Nash equilibrium. Calculate the profit of each firm at this equilibrium.
π1 = R1 – C1 = (300 – Q1 – Q2)Q1 – 60Q1 = 240Q1 – Q1Q2 – Q1^2
Derivative with respect to Q1 equals to 0: π’1 = 240 – Q2 – 2Q1 = 0 Q1 = (240 – Q2) / 2 = 120 – 0.5Q2
Same cost structure for firm 2, so: Q2 = 120 – 0.5Q1
Q1 = 120 – 0.5 (120 – 0.5Q1) = 60 + 0.25Q1 = 80
P = 300 – 80 – 80 = $140
π1 = π2 = 140 * 80 – 60 * 80 = $6400
Suppose that two identical firms produce widgets and that they
are the only firms in the market.
Their costs are given by C1 = 60Q1 and C2 = 60Q2, where Q1 is
the output of Firm 1 and Q2 the output of Firm 2. Price is
determined by the following demand curve: P = 300 − Q where Q
= Q1 + Q2.
b) Suppose the two firms form a cartel to maximize joint profits.
How many widgets will be produced? Calculate each firm’s profit.
π = R – C = (300 – Q) * Q – 60Q
π’ = 300 – 2Q – 60 = 240 – 2Q = 0
Q = 120
Profit for each firm is:
π = (180 * 120 – 60 * 120) / 2 = $7200
Explain the meaning of a Nash equilibrium. How does it differ from equilibrium in dominant strategies?
A Nash equilibrium is an outcome where both players correctly believe that they are doing the best they can, given the action of the other player. A game is in equilibrium if neither player has an incentive to change his or her choice, unless there is a change by the other player. The key feature that distinguishes a Nash equilibrium from an equilibrium in dominant strategies is the dependence on the opponent’s behavior. An equilibrium in dominant strategies results if each player has a best choice, regardless of the other player’s choice. Every dominant strategy equilibrium is a Nash equilibrium, but the reverse does not hold.
MRPL =
(MPL)(MR)
Why is a firm’s demand for labor curve more inelastic when the firm has monopoly power in the output market than when the firm is producing competitively?
In a competitive industry, the marginal revenue curve is perfectly elastic and equal to price. For a monopolist, marginal revenue is downward sloping.
