Test #3 (chapt. 14, 15, 16) Flashcards
List the four types of market structures
- Perfect Competition
- Monopolistic Competition
- Oligopoly
- Monopoly
Describe the characteristics of a pure monopoly
- one firm
- unique product - no close substitutes
- has considerable control over price
- other firms cannot enter industry
- ex. local utilities, subway systems
Describe the characteristics of an oligopoly
- a few firms
- price control is very minimal
- difficult for other firms to enter industry
- a lot of advertising
- ex. automobiles, banking, airlines
Describe the characteristics of a monopolistic competition
- many firms
- differentiated product
- some control over price, but limited
- easy for other firms to enter the industry
- heavy advertising, brand names
- ex. retail trade, pop, coffee shops
Describe the characteristics of pure competition
- lots of firms - each firm is a very small player and don’t have any real effect
- indistinguishable product to consumers - as long as the price is the same, consumers are indifferent
- easy entry
- perfect information
ex. agriculture, stock market, commodities markets (gold, oil)
Define market power
The extent to which a seller can charge a higher price without losing many sales to competing businesses
Market power informs your _______ strategy
pricing
Which market structure do most businesses operate in?
Imperfect competition (monopolist competition and oligopoly)
What are the big sources of market power?
The number of competitors
Product differentiation
What does imperfect competition among buyers mean for them
The buyers will have bargaining power
When there are limited buyers, keeping customers is important
Customers can negotiate lower prices
What are the two tools that firms use to figure out the optimal price?
- the firms demand curve
- the marginal revenue curve
If your firm is in perfect competition, what will your firms demand curve be like? (elasticity)
You have very little market power - if you change the price at all your quantity changes a lot - your demand curve is relatively flat - highly elastic curve
What is the elasticity of the firms demand curves in imperfect competition and a monopoly?
imperfect competition –> more inelastic then perfect competition
monopoly –> your firms demand curve IS the market demand curve - the most inelastic demand curve
How do you find total revenue?
Price x Quantity
How do you find the marginal revenue? (equation)
Change in total revenue / change in quantity
Explain the two forces at work with marginal revenue (the trade-off)
- The output effect: you gain revenue from selling a larger quantity of items (you receive the price of the extra item/items you sell)
- The discount effect: you lose revenue when you cut the price a bit - to sell the extra item you lower your price a bit, but this new price applies to ALL the units sold (change in price x old quantity)
Describe the relation between your firms demand curve and the marginal revenue curve on a graph
The marginal revenue curve essentially cuts the firms demand curve in half
- always below the demand curve due to the discount effect
- marginal revenue declines more sharply (the larger quantity sold, the bigger the discount effect)
what is the marginal rule for sellers?
sell one more unit if marginal revenue is greater than or equal to marginal cost
What are the firms steps to deciding on the optimal price (on the graph)
- find the quantity where marginal revenue intersects marginal cost
- move up to the the point on the demand curve - this will determine your price
What is the equation for profit
Total revenue - total cost
What is the equation for total cost
ATC x quantity
or
Fixed costs + variable costs
More market power = more ______ firm demand curve
inelastic
What are four not so great things that market power leads to?
- Higher prices
- inefficiently smaller quantity
- larger economic profit
- survival despite inefficiently high costs
The perfect competition optimal price is where the __________ curve intersects the _________ curve
marginal cost
firm demand
What are competition policies? What is the other name for them
Laws and regulations designed to ensure that markets remain competitive
Sometimes called antitrust policy
What are 4 policies that encourage competition
- Anti-collusion laws
- Merger laws
- Illegal to attempt to monopolize
- Encouraging international trade
What are anti-collusion laws?
Laws that prevent businesses from agreeing NOT to compete
- restricts them from divvying up the market, agreeing to not offer lower prices, etc. - makes them not able to act like a monopoly
What are merger laws?
laws that prevent competing businesses from combining to consolidate market power
- have to determine if the merger will benefit society (lower consumer prices), or harm society (yields greater market power)
What is predatory pricing?
Charging prices so low that you force your competitor out of business, with the goal of then raising prices later
Why is it legal to BE a monopoly but illegal to attempt to monopolize?
- some large companies acquire market power by outcompeting rivals and providing better service at lower prices (that’s fine)
- some companies use exclusionary practices: push suppliers to not sell to competitors, prohibiting stores from settling competitors product, etc.
What is one policy used to minimize the harm from exercising market power
Price ceilings can limit abuse of market power by not allowing monopolies to charge high prices - eliminates the incentive to restrict production
What is a natural monopoly? what’s the logic behind it
A market in which it is cheapest for a single business to service the market
ex. local water, gas, and electric companies are all natural monopolies
logic: big start-up costs, easy to supply once the network has been established, not cost-effective for a second business to start supplying
What is accounting profit?
The total revenue a business receives, minus its explicit financial costs (all the money that you spend - rent, wages, costs)
What is economic profit?
The total revenue a business receives, minus both the explicit financial costs and the implicit opportunity costs
What are the key implicit opportunity costs?
Forgone wages - how much would your earn pursuing your next best career option
Forgone interest - how much could you earn investing your funds somewhere else
What is your firms average revenue curve the same as?
it’s the same as your firms demand curve
What’s the equation to find average revenue?
Total revenue / quantity
(should equal the price if you charge everyone the same price)
What are fixed costs and variable costs?
Fixed costs –> don’t vary with changes in output (ex. rent, contract salaries, insurance payments)
Variable costs –> change with changes in output (ex. wages, cost of material inputs)
What are the equations for AFC, AVC, and ATC
AFC = TFC / Q
AVC = TVC / Q
ATC = AFC+AVC (= TC/Q)
What is the equation for the marginal cost?
Change in TC / change in Q
If the average cost is rising, the marginal cost must be ______ the average cost
ABOVE
If the average cost is falling, the marginal cost must be _______ average cost
BELOW
What’s the equation for average cost?
Total cost (fixed and variable) / quantity
The U-shape of the average cost curve is a result of which two factors?
- the spreading of fixed costs
- as you produce more and more, the fixed costs get spread over more and more units - the rising variable costs
- reflect emerging inefficiencies
ex. diminishing marginal product - reducing productivity of workers
ex. rising input costs per unit (paying workers overtime)
What is the profit margin? What would it look like on the graph?
Price - average cost
OR
Average revenue - average cost
On the graph your profit margin is the gap between your firm’s demand curve and its average cost curve (there’s profit when the demand (or average revenue) lies above the average cost curve)
What is the equation for profit?
What area is it on a graph?
(P - ATC) x Q
OR
TR - TC
On a graph, it is the rectangle between the demand curve and the ATC curve
What is the rational rule for entry?
Enter a market if you expect to earn a positive economic profit, which occurs when the price exceeds your average cost
What is the rational rule for exit?
Exit a market if you expect to earn a negative economic profit, which occurs when the price is less than your average cost
What are the two things that happen to your demand curve when new competitors enter the market?
Your firms demand curve shifts left (you lose customers)
Your demand curve becomes flatter (more elastic because loss of market power)
What are the two things that happen to your demand curve when existing competitors EXIT the market
Your firms demand curve shifts right (you gain customers)
Your demand curve gets steeper (more inelastic because you gained market power)
In the long run, entry and exit stops until economic profits are ______
zero
On a graph, what do the average cost and demand curves look like when entry to the market is happening
When demand crosses average cost (is going through it), there is economic profit and entry will happen
________ ________ are the dominant factor determining prices in the long run
Average costs
What are the two things that happen in the long run when there is free entry and exit
- economic profit will be eliminated (at zero)
- price will equal average cost
What are the four strategies for creating barriers to entry?
- demand-side strategies
- supply-side strategies
- regulatory strategies
- entry deterrence strategies
How do firms use demand-side strategies?
- Switching costs (ex. all the chargers and data with iphones)
- Eard goodwill to keep your customers loyal
- Develop network effects (use tik tok because everyone’s on tik tok)
How do firms use supply-side strategies?
- Develop cost advantages
- learning by doing (you have more experience)
- mass production
- research and development (develop new products and cut your costs)
- leverage relationship with suppliers to get a better deal
- limit access to key inputs
How are regulatory strategies used as a barrier to entry?
- Patents, copyrights, and trademarks
- incentivizes innovation - Regulations make it hard for new businesses to start
- Compulsory government licenses can limit competition
Describe entry deterrence strategies
Goal –> convince rivals that your will crush them
- build excess capacity to signal you’re ready to fight
- show off financial resources - show that you cant survive a fight
- Brand proliferation eliminates profitable niches for rivals (ex. excessive types of cereal from only a few companies)
- Have a reputation for fighting
Price differences arise from differences in _________ ____ ______ , not in differences in cost
willingness to pay
What are the 3 necessities to make price discrimination feasible?
- your business has market power
- you can prevent resale
- you can target the right prices to the right customers
What does perfect price discrimination take away?
Takes away consumer surplus
What happens to economic surplus under price discrimination?
Creates lots of additional producer surplus
Adds a little additional consumer surplus
What is perfect price discrimination?
Charging each consumer their exact willingness to pay
What are hurdles and what are some examples
People who are more price sensitive are willing to jump the hurdle in order to get the lower price
ex. clipping coupons, waiting in line for theatre tickets
What is the main strategy of group pricing
Charge higher prices to group that are more insensitive to price and those who value your product more
Charge lower prices to groups that are more price sensitive
What is a quantity discount?
When the per-unit price is lower when you buy a larger quantity
ex. buy one get one half off
What is bundling as a quantity discount?
Selling different goods together as a package - sold for lower price than if you bought them separately
* companies often bundle something you like with something you don’t really want or need
What are some different hurdle options?
Alternative versions and timing, fluctuating prices, haggling, extra hassle, bad service, imperfect goods, quantity discounts, and bundling
What are the equations for the profit margin?
Price - average cost
Average revenue - average cost
If you’re producing a quantity where MC = P, then profit can be increased when production _____________
decreases
in a perfectly competitive market, what is MR equal to?
price
