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Perfect Competition
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1. Large Number of relatively small firms
2. Undifferentiated (homogenous) products
3. Low barriers to entry
2. Undifferentiated (homogenous) products
3. Low barriers to entry
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Monopolistic Competition
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1. Large number of relatively small firms
2. Differentiated products (imperfect substitutes)
3. Low barriers to entry
2. Differentiated products (imperfect substitutes)
3. Low barriers to entry
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Oligopoly
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1. Several firms produce all or most of market output
2. High barriers to entry
3. Can be homogenous or differentiated
4. Strategic interdependence, a result of several firms producing all/most of market output
2. High barriers to entry
3. Can be homogenous or differentiated
4. Strategic interdependence, a result of several firms producing all/most of market output
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Monopoly
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1. Single firm
2. Produces product with no close substitutes
3. High barrier/s to entry
2. Produces product with no close substitutes
3. High barrier/s to entry
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Price Taker
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Price is determined strictly by market forces of demand & supply (perfectly competitive model) and therefore has no market power
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Price Setter
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Has a degree of market power, or the ability to raise price without losing all sales
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Market Power
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The ability to raise price without losing all sales
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Homogenous
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Undifferentiated product
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Differentiated
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Imperfect Substitutes
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Perfect Substitutes
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The utility of product/service is identical to another
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Strategic Interdependence
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Characteristic of oligopolies, refers to the mutual interdependence of firms and their strategic behaviour (planning their actions based on guesses about what their rivals will do), in view of the expectation that what happens to the profits of one firm depends on the strategies adopted by the other firms.
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Entry Barriers
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obstacles that determine how easily a firm can enter an industry and often significantly predict industry profit potential
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General Demand Function
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Qd = f(P, M, Pr, T, Pe, N)
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General Supply Function
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Qs = f(P, Pi, Pr, T, Pe, F)
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Direct Demand Function
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Qd = f(P)
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Law of Demand
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Δ in Qd / Δ in Price must be negative
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Direct Supply Function
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Qs = f(P)
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Inverse Demand Function
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P = f(Qd) -> price is plotted on vertical axis and Qd is on horizontal axis
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Inverse Supply Function
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P = f(Qs)
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Shift of Demand
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Changes in demand caused by changes in explanatory variables OTHER THAN OWN PRICE
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Movement along the Demand Curve
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Changes in Quantity demanded caused by changes in own price
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Shift in Supply
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Changes in supply are caused by changes in any of the explanatory variables, other than own price
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Movements along the supply curve
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Changes in quantity supplied are caused by changes in own price
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Normal Good
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a good for which, other things equal, an increase in income leads to an increase in demand
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Inferior Good
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a good that consumers demand less of when their incomes increase
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substitute goods
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Products or services that can be used in place of each other. When the price of one falls, the demand for the other product falls; conversely, when the price of one product rises, the demand for the other product rises.
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Complement goods
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Two or more goods that tend to be used together. If two goods are complements, an increase in the price of one will lead to a decrease in the demand of the other.
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Equilibrium/market price and quantity
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Set Qd = Qs
Market equilibrium -> set two direct functions equal to each other and solve for price
Market Quantity -> plug price into either direct function
Market equilibrium -> set two direct functions equal to each other and solve for price
Market Quantity -> plug price into either direct function
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Excess demand/shortage
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Qd - Qs at that price
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Excess supply/surplus
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= Qs - Qd
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Price ceiling
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max price set by govt that sellers can charge for a good.
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Price Floor
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minimum price govt permits sellers to charge for a good
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What happens when ceiling price is below equilibrium?
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Shortage
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What happens when floor price is above equilibrium?
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Surplus
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When is Price indeterminate?
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When supply and demand move in the same direction during a simultaneous shift
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When is the quantity indeterminate?
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When supply and demand move in opposite directions during a simultaneous shift
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Qualitative forecast
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predicts only the direction in which an economic variable will move
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Quantitative Forecaset
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predicts both the direction and magnitude of the change in economic variables. Can only perform this when we have market demand and market supply curve equations.
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Indeterminate/ambigious
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When the direction of change depends on the relative magnitudes by which supply & demand shift
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Direct vs inverse relationship
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Direct variation suggests both move in same direction, Inverse variation suggests both move in opposite variation
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Optimization
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1. Objective function to be maximized or minimized
2. Activities or variables that determine value of objective function
3. Constraints that might restrict the values of the variables
2. Activities or variables that determine value of objective function
3. Constraints that might restrict the values of the variables
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Unconstrained optimization
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Net Benefit Maximization, Profit Maximization, Revenue Maximization
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Marginal Analysis
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Technique for solving optimization problems by changing value of variable by small amount to see if function can be improved
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Net Benefit Maximization
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NB(A) = TB(A) - TC(A)
A* is the variable that is adjusted to maximize the objective function
A* is the variable that is adjusted to maximize the objective function
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Steps for Net Benefit Maximization
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...
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Marginal Benefit vs. Marginal Cost
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Marginal Benefit -> change in total benefit caused by incremental change in activity
(MB = Δ in TB/Δ in A or dTB/dA)
Marginal cost (MC) -> change in total cost (TC) caused by an incremental change in the level of the activity.
MC = Δ in TC/Δ in A or dTC/dA (or just take the derivative of TC function)
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When do we use deltas
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when we use tables (discrete case)
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When do we use derivatives in equations?
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when we have equations (continuous case)
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TB, TC relationship to MB, MC and NB
answer
...
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When do we increase activity during a continuous case of net benefit maximization? (derivatives)
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if MB > MC (NB will rise since change in TB > change in TC)
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When do we decrease activity during a continuous case of net benefit maximization? (derivatives)
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if MB < MC
(NB will rise since TC falls by more than TB)
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What is the optimal level of activity?
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When MB = MC
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Profit Maximization
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When MR=MC f
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Elasticity (Ep) and Demand
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Measures responsiveness of consumers quantity demanded to changes in price of a good.
Ep = (Δ in Q/Δ in P) * (P/Q)
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The larger the absolute value of Ep
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The more sensitive buyers are to a change in price (more elastic) and vice versa
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How are P & Q related (Elasticity and Demand)
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Inversely related by law of demand so we would expect the own price elasticity of demand to be negative
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Why is Ep so important for a price setting firm?
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All price setting firms face a downward sloping firm demand curve, so if they raise their prices, they will lose some sales
TR = P(Q) * Q
P(Q) = firms inverse demand curve
TR = P(Q) * Q
P(Q) = firms inverse demand curve
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What does Ep tell us?
answer
If firms raise P, quantity demanded will fall.
Impact on TR will depend on the relative strength of the two effects (price effect vs quantity effect)
Ep tells us which effect is stronger
Impact on TR will depend on the relative strength of the two effects (price effect vs quantity effect)
Ep tells us which effect is stronger
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When is Ep = % Change in Q/% Change in P used vs Ep = (Change in Q/Change in P) * (P/Q)
answer
First formula used to answer "What If" questions (ex: what would be the % change in Qd due to a given % change in P?)
Second formula just used to calculate Ep and is derived from the first.
Second formula just used to calculate Ep and is derived from the first.
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What factors affect Own Price Elasticity of Demand?
answer
1. availability of substitutes for a good
2. length of time consumers have to adjust to a change in price
3. percentage the item takes in the budget
2. length of time consumers have to adjust to a change in price
3. percentage the item takes in the budget
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if | %ΔQ/ %ΔP | > 1
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Demand is elastic
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If | %ΔQ/%ΔP | = 1
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Demand is unit elastic
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If | %ΔQ/%ΔP | < 1
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Demand is inelastic
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Total Revenue
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TR = P * Q
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Price effect
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Effect on total revenue of changing price, holding output constant
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Quantity effect
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Effect on total revenue of changing output, holding price constant
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What happens to TR when demand is elastic?
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TR will increase when price decreases since % Δ in Q > % Δ in P
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What happens to TR when demand is unit elastic?
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TR will not change when price decreases since % Δ in Q = % Δ in P (offsetting effects)
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What happens to TR when demand is inelastic?
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TR will decrease when price decreases since % Δ in Q < % Δ in P and vice versa
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Marginal Revenue
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Δ in total revenue per unit Δ in quantity
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What can be used in place of the slope of the Total Revenue Curve?
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Marginal Revenue because it is the derivative of TR with respect to Q
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How to derive MR from inverse demand?
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Double slope and keep the same intercept as inverse demand
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How can the relation between MR, P & Elasticity be expressed as?
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MR = P(1+1/Ep)
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If Ep is elastic then MR ....
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MR > 0
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if Ep is inelastic then MR ...
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MR < 0
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When demand is elastic (above the midpoint), MR is ______ and slope of TR is _______
answer
MR > 0 and slope of TR is positive
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When demand is inelastic (below the midpoint), MR is _______ and slope of TR is _____
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MR < 0 and slope of TR is negative
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Income Elasticity (Em)
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measures responsiveness of Qd to income changes
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Cross-price elasticity, (Exy)
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measures responsiveness of Qd of good X to changes in price of good Y, all else constant
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How do you know if a good is a substitute based off general demand function?
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If an increase in PR causes sales to rise, the goods are substitutes and d is positive.
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How do you know if a good is a complement based off general demand function?
answer
If an increase in PR causes sales to fall, the
two goods are complements and d is negative.
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What does a perfectly competitive firm set equilibrium at?
answer
MR = MC
In order to maximize profits in a perfectly competitive market, firms set marginal revenue equal to marginal cost
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What does Profit Maximizing look like in a Perfectly Competitive Market
answer
-> MR = MC
-> MR = Price
-> MC = Price
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