week 7 (GPT) Flashcards
What are the main features of perfect competition?
Many buyers and sellers,
identical products,
firms are price takers,
free entry and exit,
no externalities.
What does it mean to be a price taker?
A firm that cannot set its own price and must accept the market price.
What is market power?
The ability of a firm to influence the price of a good or service.
What is a monopoly?
A market with only one dominant firm, which has significant market power.
Why does a monopolist face a downward-sloping demand curve?
Because to sell more, it must lower the price, unlike a firm in perfect competition.
Why does marginal revenue lie below the demand curve in monopoly?
Because lowering price to sell one more unit reduces revenue on all previous units.
Where does a monopoly maximize profit?
Where marginal revenue (MR) equals marginal cost (MC).
How does a monopoly choose price?
It uses the demand curve to set price at the quantity where MR = MC.
What is the result of monopoly pricing on output?
Monopolies restrict output below the socially optimal level.
What is deadweight loss in monopoly?
lost value to society when a market doesn’t produce at the efficient level, meaning some buyers and sellers miss out on gains from trade.
What is allocative efficiency?
The point where price equals marginal cost (P = MC), representing optimal output for society.
Why do monopolies cause allocative inefficiency?
Because they set P > MC, underproducing the good.
What is a natural monopoly?
A monopoly that exists due to economies of scale making it most efficient for one firm to serve the market.
Why do natural monopolies have decreasing average total cost?
Because high fixed costs are spread over more output, lowering ATC.
What is marginal cost pricing?
A regulation method where the monopoly must set price equal to marginal cost (P = MC).
What is the downside of marginal cost pricing in natural monopoly?
It can cause losses since price may fall below average total cost.
What is average cost pricing?
A regulation where the firm sets price equal to average total cost to earn normal profit.
What is the effect of average cost pricing?
It reduces price and increases output while allowing the firm to break even.
What is price discrimination?
Charging different prices to different consumers for the same product.
What is first-degree price discrimination?
Charging each customer their exact maximum willingness to pay (reservation price).
What is the result of first-degree price discrimination?
No consumer surplus remains; all surplus goes to the firm.
What is second-degree price discrimination?
Charging different prices based on quantity or bundle (e.g. bulk discounts, loyalty cards).
What is third-degree price discrimination?
Charging different prices to different groups based on observable traits (e.g. students, seniors).
How does price discrimination affect output and efficiency?
It increases output and can reduce deadweight loss compared to single-price monopoly.
Why is price discrimination common in transport or entertainment?
Because it’s easy to separate consumers by age, income, or usage (e.g. student fares, senior discounts).
What does the demand curve look like for a firm in perfect competition?
Perfectly horizontal, reflecting that the firm is a price taker.
What does the demand curve look like for a monopoly?
Downward-sloping, because the firm has market power.
How does marginal cost curve typically behave in a natural monopoly?
It is flat or gently upward-sloping due to low variable costs.
What is the relationship between demand and marginal revenue in monopoly?
MR falls twice as steeply as demand.
Why can’t a monopoly set both price and quantity independently?
Because setting one determines the other based on the demand curve.
How is profit shown on a monopoly graph?
As the vertical difference between price and ATC, multiplied by quantity.
How is deadweight loss shown on a monopoly graph?
As the triangle between demand and MC between monopoly and socially optimal output.
Why might the government regulate a monopoly?
reduce prices,
increase output,
improve social welfare.
What are the two main regulation methods for monopolies?
Marginal cost pricing and average cost pricing.
What are the risks of regulating monopolies too strictly?
It may cause the firm to operate at a loss, discouraging investment or service.
Why does average cost pricing allow a monopoly to survive?
Because it lets the firm cover both fixed and variable costs while limiting excess profit.
