Unit 4 - Imperfect competition

Question 1

Four market model

Answer 1

Pure competition involves a very large number of firms producing a standardized product and there is easy entry and exit.

Pure monopoly is a market structure in which one firm is the sole seller of a product or service and the entry of additional firms is blocked.

Monopolistic competition consists of a relatively large number of sellers producing differentiated products.

Oligopoly involves only a few sellers of a standardized or differentiated product.

Question 2

Characteristics of pure monopoly

Answer 2

• One large firm
• unique products
• High barriers
• Price makers

Question 3

What is a natural monopoly?

Answer 3

One firm can produce the socially optimal quantity at the lowest cost due to economies of scale.

If MR = MC it is unregulated.
Socially optimal (no DWL) - where price hits MC
Fair return (no eceonomic profit) - where price hits ATC

Question 4

Dead-weight loss for monopoly

Answer 4

Question 5

Price discrimination

Answer 5

Price discrimination is defined as charging different buyers’ different prices when such price differences are not justified by cost differences.

Conditions:
- Pricing power
- Market segregation
- No resale

Question 6

Characteristics of oligopoly

Answer 6

• A few large producers
• Identical or differentiated products
• High barriers of entry
• Price maker
• Mutual interdependence - firms use strategic pricing

Question 7

Game theory

Answer 7

• Strategic pricing behavior refers to how a firm’s decisions are based on the actions and reactions of rivals.
• Mutual interdependence: each firm’s profit depends on its own pricing strategy and that of its rivals.
• Collusion: cooperation with rivals can benefit the firm.
• Incentive to cheat: cheating can result in more revenues for the cheater.

Question 8

Kinked demand

Answer 8

The kinked-demand model is used for noncollusive oligopolies to explain their behaviors and pricing strategies. Since the firms do not collude, none of the firms know with certainty what their rivals are going to do. However, the firms assume that their rivals will match any price reductions in an effort to maintain their customers. On the other hand, it is reasonable to assume that if a firm raises its price, its rivals will ignore the price change in an effort to steal customers from the firm raising its price.
- Noncollusive Oligopoly.
- Uncertainty about rivals reactions, rivals match any price change or ignore it
- Assume combined strategy, match price reductions, ignore price increases.

Question 9

Monopolistic competition

Answer 9

• Large number of sellers
• Differentiated products
• Low barriers of entry
• Some control of price

Same as monopoly but ATC moves up in the long run.

Question 10

If oligopolistic firms facing similar cost and demand conditions successfully collude, price and output results in this industry will be most accurately predicted by which model?

Answer 10

Pure monopoly model (cartel)