S2 - monopoly Flashcards
what is the supply function
of the industry is the sum of each firms short run marginal cost function
Provided the MC function is above the minimum point of the firms short run average cost function
Profit is the difference between AR and ATC - encourages incumbents in short run and new firms in the long run
Long run equilibrium: P(AR) = min LRATC when MC = MR
Short run equilibrium: P(AR) = min SRATC when MC = MR
what is change in demand
not persistent = incumbents alter supply
Persistent = new firms enter and existing firms alter scale of operation to reach equilibrium
when should a firm shut down
P(AR) > ATC, profits are earned (economic rent)
P(AR) = ATC, normal profits earned (transfer payment)
P(AR) < ATC, losses are made
SAVC < P(AR) < ATC, firm covering variable costs and making some contribution so stay in business
If P = minSAVC the firm is indifferent
what is monopoly
single firm supplies entire market for product
No close substitutes
HHI = 1
Barriers to entry so P>ATC
Firm can choose price or output but not both
what are structural barriers
based on factors outside a firms control
Control of essential resources
Marketing advantages of incumbents
Financial barriers
Economies of scope
Economies of scale and natural monopolies
what are strategic barriers
when the incumbent deliberately deters entry
Limit pricing
Predatory pricing
Excess capacity
Heavy advertising
Asymmetric information
what is deadweight loss
higher prices lead to deadweight loss of economic welfare because it restricts output and lead to an increase in inequality
Area of triangle
what is long run equilibrium
new firms enter market as attracted by excess profits
Demand curve and marginal revenue curve shift inwards
P = ATC
P > MC
Allocative and productive inefficiency
what is oligopoly
small number of firms producing differentiated products
Interdependence, therefore conjectural variation
what is cournot duopoly
two firms produce identical products
Compete by output
Market price determined by demand and supply
Each firm assumes other will not react to its output decision
MC = 0
what is the cournot solution
SP = selling price
X = constant
P = X - Q
Q = q1 + q2
TR1 = Pq1
TR1 = (X-q1-q2)q1
Profit = Xq1 - q1^2 - q1q2 - SPq1
Take derivative
X - 2q1 - q2 - SP
set to 0 and solve for q1
Q1 = ((X-SP) - q2 ) /2
Same for q2
Q2 = ((x-SP) - q1) /2
Sub q2 into q1 and solve
what are the charsceteristocs of cournot
if firm 2 produced 0, output maximising level for firm 1 would be q1
When firm 2 increases output, AR and MR for firm 1 decline
Profit maximising response by firm 1 is to reduce output
what are isoprofit curves
defines combination of outputs of all firms that yield a given firm the same level of profits
Lie closer to firm 1s monopoly output are associated with higher profits
Reach peak where they intersect firm 1s RF
what are the criticisms of cournot
how long does it take to reach equilibrium
Adjustment process is inconsistent with the assumption that the opponent will not react
More firms means closer to perfect competition
More competition on price than output
what is the Bertrand model
each firm assumes other firms will not react to its price decision
Assume products are homogenous an price is the only variable
Played for one period only
Firms have excess capacity to meet extra demand if price declines
Every firm sells at the same price, firm with lowest price secures the market
(P - mc) / p = 0
Zero profits for all firms - Bertrand paradox
Firms probably collude to increase profits
how to address the Bertrand paradox
relax assumption of homogenous products - some ability to raise prices without losing customers
Multi period competition - short term gains outweighed by subsequent reaction of rivals
Capacity constraints - one firm at capacity, other can raise price above MC as other firm may not be able to respond by increasing output
what is the stackleberg model
alternative perspective on oligopoly
Few firms serving many consumers
Homogenous or differentiated
Leader chooses output before followers
Barriers to entry and exit
Each follower behaves like a cournot oligopolist
Leader takes other firms RF into account
Cournot equilibrium is here two reaction functions intersect
Leader benefits from first mover advantage
Maximise leaders profit: (a + c2 - 2c1) / 2b
what is the kinked demand curve
rivals are assumes to match price reductions but not increases
Reductions don’t increase market share but increases mean a loss of market share
Kink results in a discontinuity in the MR function which follows the path ACEF
Generates price stickiness - moderate changes in MC do not result in price changes
Model doesn’t explain how the initial price is generated or how long before equilibrium is restored
