Tutorial 1-4 Flashcards

Question

What is **firm-level price elasticity of demand**?

Answer 1

= **percentage change** in a **firm’s quantity demanded** per percentage change in **price** when t**hat firm change**s its price but **other competing firms do not**

Answer 2

- Determines **perceived benefits** from a **price cut** aimed at **stealing business from competitors** - Shapes **industry profitability** by influencing the **likelihood of destabilizing price-cutting** behavior by firms

Answer 3

- Output **expansion** of a firm .--> market price **reduction** --> **lower** sales revenue of **rivals** - Effect occurs **in oligopoly markets** - **One firm expands** its output **which leads to a market-wide** **reduction** in **price** and to a **destruction** of **profits for the industry**

Answer 4

**Each** firm **seeks to maximize its own profit** rather **than total industry profit**

Answer 5

- result: **greater** is the **divergence** between the **Cournot** **equilibrium** and the **collusive** **outcome** - **number** of firms **increases**, competitive **pressure** -> **foreces firms** to **produce** more and **reduce** prices - this **price reduction** leads to the r**evenue destruction effect** **Divergence** the price level between **under collusion** and **cournot** get **larger**

Answer 6

- The **smaller** a firm’s **share of industry sales**, the **greater** is the **divergence** between **private gain** and the **revenue destruction effect** - for **smaller** firms the **private** gain from **reducing prices** (increased market share + revenue) is **greater** compared to the **revenue destruction effect**

Answer 7

**Relationship**: Prices tend to be **higher** in **concentrated** markets Industry with **high concentration ratio:** - **Total** industry **output** and **price are closer** to the **levels** that would **be chosen** by a **profit-maximizing monopolist** - **Tacit** **collusion** is **more successful** with a small number of sellers (**tacit** = situation where firms **indirectly** coordinate actions) - **Divergence** between a firm’s **private** gain and the revenue **destruction** effect from output expansion is **small**

Answer 8

**Influencing factors:** - **Regulation** - **Product** differentiation - **Nature** of sales transactions - **Concentration** of buyers

Answer 9

- Marginal costs = marginal revenues - Firms **do not earn** an economic profit - Firms **only earn** returns on their **factors of production** - Production **efficiency** allows firms to **expand** output and **gain market share** --> increases **total returns to the factors** (but still not allows to earn an economic profit)

Answer 10

**Oligopoly and monopoly markets** - Firms earn e**conomic profit**s in **excess** of their **factor costs** - Efficiency **lowers** production **costs** and **allows for an increase** in **output quantity** and **market share** - **Higher outpu**t quantity **increases** the economic **profit earned** by a firm

Answer 11

- **Efficiency** is **important** in **all** market **structures** - It **can be** argued that **efficiency is less important** in **oligopolies and monopolies** - as firms **earn economic profits** in **excess** of their **factor costs** - However, **all** **firms** seek to **maximize** profits - -> profit maximization is **obtained by producing a greater quantity** at a point where the **firm’s marginal cost equals its marginal revenue**

Answer 12

**Oligopoly** - **Reduction** in market **price** is **shared** among **all** firms in the market - **Output** expanding **firm** **does not** bear the **full burden** of **revenue destruction** **Monopoly** - **Output** expanding **firm** **incurs entire amount of revenue destruction** - **Monopolists** are **less likely** **than** oligopolists** to **expand** output

Answer 13

**“Monopolistic”** - Monopolistic competitors **produce** products that are **slightly differentiated** - Monopolistic competitors can **earn economic** profits by **advertising** the **differences** in their products - -->**Make products** seem **unique (“monopolistic”)**

Answer 14

**Competitive”** - Relatively **low barriers** to entry - **New** entrants **reduce individual** market shares - Economic **profits** are **eliminated** in the l**ong-run** - **Monopolistic competitors** become “**price**-**takers**” (not **unlike** perfect competitors) - and earn **only** returns on their **factors of production**

Answer 15

1. **Product differentiation** – **Bertrand** model: two firms sell identical products – **reality**: firms often sell **differentiated** products, i.e. undercutting the rival’s price **does no**t guarantee total market demand 2. **Dynamic competition** – **Bertrand** model: firms compete in o**ne period only**, i.e. price is chosen once and for all (static nature) – **reality**: firms **dynamically** compete **over** multiple periods, i.e. undercutting a rival’s price **may cause the rival to lower its price too**, possibly initiating a price war (threat of retaliation) 3. **Capacity constraints** – **Bertrand** model: no capacity constraints – **reality**: firms often have **capacity constraints** and may **not** be able to satisfy **total market** demand – even if they receive it by **undercutting** the rival’s price

Answer 16

- **Presence of capacity constraints**: Is there **unlimited** **capacity** or **do firms face some sort** of restrictions? - **Short-term adjustability of prices:** Can firms **easily** **change** their **prices** or are **they costly and complex** to adjust

Answer 17

**Quantity competition:** - Do **firms in** an industry **stick to a particular quantity** and sell this quantity **at any price?** --> implies **quantity** competition - Appropriate model choice in case of **limited capacities, even if firms are price setters**

Answer 18

**Price competition:** - **Do** firms in an industry **stick to a particular price** and **sell any quantity** at this price? --> implies **price** competition Appropriate model choice - in case of **unlimited capacit**y or - when **prices** are **more difficult** to **adjust** in the **short run** than **quantities**

Answer 19

**Oil refining:** - firms decide **how much to sel**l up to a **capacity constraint** and this **determines** the price - few firms in the market, large fixed costs to enter --> **Cournot model** **Insurance:** - **diverse field** of players with many large companies - capacity constraints are **not a major issue** as insurance supply **depends** on the **number** of employees involved (labor) -->**Bertrand model**

Answer 20

**Farmer markets:** - large number of suppliers who **have to decide how much** to supply **each** year - total supply (crop) determines market price -->**Cournot model** **Cleaning services:** - **mainly labor-based** industry with a **large** number of **independent** suppliers plus some larger companies - labor supply is **fairly flexible** -->**Bertrand model**

Answer 21

Relation in optimal monopoly pricing: **the statement is true** - the **greater e(more elastic**) the **lower monopoly power** and in turn monopoly profits **P - MC/P = 1/elasiticy** - with p = price, MC = marginal cost and ɛ = demand elasticity - The **greater the value of ɛ,** the **lower** the value of **(p – MC)** and the **lower** the **monopoly profits** - **Very elastic demand** --> monopoly profits at c**ompetitive level**

Answer 22

- An **elasticity of 10** implies that AT&T’s demand is **very elastic** - - **Market power** is a firm’s **ability** to **raise** price **above** marginal cost and **earn** a positive profit - The **more elastic** the **demand**, the **lower** is a firm’s market **power** --> here: **no significan**t market power for AT&T

Answer 23

- **"Attribute Dependency"** is when **one attribute** or variable **depends** on the status of **another attribute/variable**

Answer 24

**Cross-price elasticity of demand between two products** - Measures the percentage change in demand for good Y that results from a 1% change in price of good X - Allows to **identify substitutes** - The **higher the cross-price elasticity**, the **more readily consumers substitute** between **two goods when the price of one good is increased**