question
market structures
answer
pure competition: price taker
number of firms-very large #
type of product-standardized
control over price-none
condition of entry-very easy
examples: agriculture
monopolistic competition
number of firms-many
type of product-differentiated
control over price-some, but with narrow limits
condition of entry-relatively easy
examples: retail trade
oligopoly
number of firms-few
type of product-standardized or differentiated
control over price-limited by mutual interdependence
condition of entry-difficulty
examples: automobiles, appliances
monopoly
number of firms-1
type of product-unique, no close substitutes
control over price-considerate
conditions of entry-impossible
examples: local utilities
number of firms-very large #
type of product-standardized
control over price-none
condition of entry-very easy
examples: agriculture
monopolistic competition
number of firms-many
type of product-differentiated
control over price-some, but with narrow limits
condition of entry-relatively easy
examples: retail trade
oligopoly
number of firms-few
type of product-standardized or differentiated
control over price-limited by mutual interdependence
condition of entry-difficulty
examples: automobiles, appliances
monopoly
number of firms-1
type of product-unique, no close substitutes
control over price-considerate
conditions of entry-impossible
examples: local utilities
question
standardized vs differentiated
answer
standardized: identical products
differentiated: unique products, must involve in non price competition
differentiated: unique products, must involve in non price competition
question
pure competition in short run (demand)
answer
demand: affects revenue--firm must accept price determined by market
*demand curve in pure competition/short run= perfectly elastic b/c firm can sell as much output as it wants
*demand curve=marginal revenue=average revenue line
*TR=upsloping--b/c each additional unit increases TR
*MR and AR= coincides with demand curve--b/c product price is constant
*demand curve in pure competition/short run= perfectly elastic b/c firm can sell as much output as it wants
*demand curve=marginal revenue=average revenue line
*TR=upsloping--b/c each additional unit increases TR
*MR and AR= coincides with demand curve--b/c product price is constant
question
average revenue
answer
AR= TR/Q (revenue per unit)
question
total revenue
answer
PxQ (total number of $ received by a firm from sale of product)
question
marginal revenue
answer
∆TR/∆Q
question
profit maximization in short run
answer
Total Revenue-Total Cost approach
Marginal Revenue=Marginal Cost approach
*used to maximize profits/minimize losses
Marginal Revenue=Marginal Cost approach
*used to maximize profits/minimize losses
question
total economic profit
answer
(P-ATC)xQ
question
should we produce this product in short run?
answer
yes= if firm can earn economic profit
question
total cost in short run reflects
answer
diminishing returns
(0 to 4): increasing at a decreasing rate
(5 +): increasing rate b/c diminishing returns set in and efficiency falls
(0 to 4): increasing at a decreasing rate
(5 +): increasing rate b/c diminishing returns set in and efficiency falls
question
breakeven point/normal profit
answer
TR=TC
question
marginal revenue=marginal cost approach
answer
what company wants: MR > MC
firm will maximize profits/minimize losses by producing the output at which MR=MC, provided that price is greater than/equal to min AVC
firm will maximize profits/minimize losses by producing the output at which MR=MC, provided that price is greater than/equal to min AVC
question
if MR is not greater than/equal to min AVC
(P=MR=minAVC)
(P=MR=minAVC)
answer
shutdown
(shutdown point)
(shutdown point)
question
we can substitute P for MR because
answer
P=MR in a purely competitive setting
question
min ATC>price>min AVC
answer
loss minimizing case: firm will still produce b/c loss is less than firm's fixed costs
question
marginal cost curve is the same as a pure competitor's supply curve b/c
answer
a pure competitor equates price to marginal cost
question
pure competitive short run equilibrium
answer
total-supply data must be compared to total-demand data
*use TR-TC method or (P-min ATC)xQ to determine if equilibrium price is profitable
*use TR-TC method or (P-min ATC)xQ to determine if equilibrium price is profitable
question
pure competition in short run vs pure competition in long run
answer
entry/exit of firm can only happen in long run
question
profit maximization in long run for pure competition
answer
assumptions:
entry/exit only--ignore short-run adjustments
identical costs=all firms in industry have identical costs
constant-cost industry=entry/exit doesn't affect resource price or location of ATC curves of individual firms
entry/exit only--ignore short-run adjustments
identical costs=all firms in industry have identical costs
constant-cost industry=entry/exit doesn't affect resource price or location of ATC curves of individual firms
question
after long-run adjustments are completed in a purely competitive industry
answer
product price=minimum ATC
question
price > min ATC
answer
economic profit, new firms will enter industry
will increase supply, until price is brought back to equality with minimum ATC
will increase supply, until price is brought back to equality with minimum ATC
question
min ATC > price
answer
economic loss, firms will exit industry
will decrease supply, until price brought up to equality with minimum ATC
will decrease supply, until price brought up to equality with minimum ATC
question
entry of firms
answer
eliminates economic profits
question
exit of firms
answer
eliminates economic losses
question
long-run supply curve in pure competition
answer
changes in number of firms will have costs on individual firms in industry
question
long-run supply curves for constant-cost industry
answer
no shift of ATC curves b/c industry expansion/contraction will not affect resource prices/production costs
supply curve=horizontal line
supply curve=horizontal line
question
long-run supply curves for increasing-cost industry
answer
ATC shifts upwards as firms enter/industry expand
entry of new firms=higher than eq price
upsloping suppy curve
entry of new firms=higher than eq price
upsloping suppy curve
question
long-run supply curves for decreasing-cost industry
answer
firms experience lower costs as their industry expands
downsloping supply curve
downsloping supply curve
question
constant-cost industry:
answer
when firms enter/exit industry, there is no effect on the prices the industry must pay and no effect on production costs
question
increasing-cost industry
answer
when firms enter/exit industry, raises the prices the industry must pay for resources, thus increasing production costs
question
decreasing-cost industry
answer
when firms enter/exit industry, lowers the prices the industry must pay for resources, thus decreasing production costs
question
long-run equilibrium for pure competitor: efficient allocation of resources
answer
P=MC=min ATC
*productive: P=min ATC, industry is using most efficient technology charging at the lowest price/producing the greatest output consistent with last unit
*allocative: P=MC, society allocated its scarce resources in accordance to consumer preferences (sum of consumer surplus/producer surplus are maximized)
*productive: P=min ATC, industry is using most efficient technology charging at the lowest price/producing the greatest output consistent with last unit
*allocative: P=MC, society allocated its scarce resources in accordance to consumer preferences (sum of consumer surplus/producer surplus are maximized)
question
allocative efficiency occurs in long-term equilibrium
answer
at market equilbrium
question
consumer surplus
answer
difference b/t max prices that consumers are willing to pay for a product and market price of a product
*below demand curve, above market price
*below demand curve, above market price
question
producer surplus
answer
difference b/t min prices that producers are willing to accept for a product and market prices of a product
*above supply curve, below market price
*above supply curve, below market price
question
what we want: consumer surplus= producer surplus
answer
if sum of surpluses < Qe= sum of consumer/producer surplus would be less than that shown
if sum of surpluses> Qe=a deadweight loss would subtract from combined consumer/producer surplus
if sum of surpluses> Qe=a deadweight loss would subtract from combined consumer/producer surplus
question
profit incentives/creative destruction
answer
create incentives to: make profits in short run, new products destroy market power of monopoly
question
imperfect competition
answer
any other market structure other than pure competition
*all engage in nonprice competition
*all engage in nonprice competition
question
pure monopoly
answer
price maker
question
barriers of entry in pure monopoly
answer
1) economies of scale--declining ATC with added firm size
*when long-run ATC is declining, only a single producer can produce any particular amount of output with min ATC
*small firms cannot realize economies of scale--protects monopolist from competition
2) patents/licenses
3) use of private property (i.e. control of a essential resource) to prevent rival firms from entering industry
4) pricing--slashing them, stepping up advertising= in order to squash entrant from entering industry--where the firm cannot realize economies of scale if it enters
*when long-run ATC is declining, only a single producer can produce any particular amount of output with min ATC
*small firms cannot realize economies of scale--protects monopolist from competition
2) patents/licenses
3) use of private property (i.e. control of a essential resource) to prevent rival firms from entering industry
4) pricing--slashing them, stepping up advertising= in order to squash entrant from entering industry--where the firm cannot realize economies of scale if it enters
question
natural monopoly
answer
lowest-average-cost advantage would accrue to monopolist profit and not consumer lower prices
*when the most efficient number of firms in the industry is one
*when the most efficient number of firms in the industry is one
question
demand in a pure monopoly
answer
assumptions:
-barriers of entry secures the firm's ownership
-firm: single-price monopolist--charges same price for all units of output
MR: positive, TR: increasing at a decreasing rate
TR at maximum when MR=0
TR decreases when MR=negative
-barriers of entry secures the firm's ownership
-firm: single-price monopolist--charges same price for all units of output
MR: positive, TR: increasing at a decreasing rate
TR at maximum when MR=0
TR decreases when MR=negative
question
pure competitive seller vs pure monopolist seller
answer
pure competitor: perfectly elastic horizontal demand curve, price taker, MR: constant and equal to product price
pure monopolist: demand curve=market demand curve b/c monopoly is the industry, price taker
-downsloping demand curve
pure monopolist: demand curve=market demand curve b/c monopoly is the industry, price taker
-downsloping demand curve
question
marginal revenue is less than price in a pure monopoly b/c
answer
downward sloping demand curve is fixed, pure monopolist can only increase sales by charging a lower price, AND:
lower price applies to all prior units of output of an extra unit of output
lower price applies to all prior units of output of an extra unit of output
question
monopolist sets price in elastic region of demand
answer
TR test: 3rd implication for demand
when demand is elastic: price will decrease, TR will increase
when demand is inelastic: price will decrease and so will TR
when demand is elastic: price will decrease, TR will increase
when demand is inelastic: price will decrease and so will TR
question
D>MR in pure monopoly b./c
answer
monopolist must decrease price to sell more output
question
monopolist won't set price in inelastic region when TR is decreasing b/c
answer
MC=positive, MR=negative
question
price determination
answer
cost data: has same cost structure as a pure competitive firm
MC=MR--monopolist seeks to maximize total profit
MC=MR--monopolist seeks to maximize total profit
question
why is there no supply curve in a pure monopoly?
answer
because Price>MR, therefore there is no single, unique price associated with each level of output
question
monopolist seeks to maximize TOTAL profit and NOT PER UNIT profit
answer
...
question
Steps to determine profit-maximizing output, price and economic profit (if any) in a pure monopoly
answer
1) determine output at which MR=MC
2) extend vertical line from MR=MC point to demand curve to determine price
3) determine economic profit in 2 ways:
TR-TC
(P-ATC)xQ
2) extend vertical line from MR=MC point to demand curve to determine price
3) determine economic profit in 2 ways:
TR-TC
(P-ATC)xQ
question
economic profit persists in long run of pure monopoly b/c
answer
barriers of entry
and no entrants increase supply to drive down price and eliminate economic profit
and no entrants increase supply to drive down price and eliminate economic profit
question
loss minimizing in monopoly
answer
min ATC>P>min AVC
*must obtain a normal profit to persist in long run
*must obtain a normal profit to persist in long run
question
pure monopoly and efficiency
answer
inefficient b/c output is less than that required for minimum ATC because P>MC
inefficiency:
*MR is below D curve
*output is lower (Qm is preferred over Qc) and price is higher Pm rather than Pc)
inefficiency:
*MR is below D curve
*output is lower (Qm is preferred over Qc) and price is higher Pm rather than Pc)
question
monopolist yields no allocative efficiency nor productive because
answer
market exceeds marginal cost (for allocative)
market (Qm/Pm) exceeds min ATC (Qc/Pc) (for productive)
market (Qm/Pm) exceeds min ATC (Qc/Pc) (for productive)
question
income transfer
answer
monopoly transfers income from consumer to owners of a monopoly
*income received by owners; revenue -- b/c monopoly has market power and can increase price with same costs
(Pm-Pc) x Q= total amount of income
*what a consumer loses, the monopoly gains
(Qc-Qm)= deadweight loss= society loses total net benefits that aren't produced
*income received by owners; revenue -- b/c monopoly has market power and can increase price with same costs
(Pm-Pc) x Q= total amount of income
*what a consumer loses, the monopoly gains
(Qc-Qm)= deadweight loss= society loses total net benefits that aren't produced
question
why sometimes costs have complications/not identical in pure monopoly
answer
1) x-inefficiency: when a firm produces output at a higher cost than it is necessary to produce it
(ATCx and ATCx1 are being produced above ATC/ATC1 curve)
2) economies of scale: market demand may not be sufficient to support a large number of competing firms, each producing MES
3) rent seeking behavior: an activity designed to transfer income/wealth to a particular firm/supplier at someone's or society's expense
rent-seeking expenditures: add nothing to firm's output, but clearly increases its costs/less efficient
4) technological advance: in very long run--firms can produce their costs through discovery/implementation of new technology
*but little incentive to be technologically progressive unless it uses it as one of its barriers of entry into the industry
(ATCx and ATCx1 are being produced above ATC/ATC1 curve)
2) economies of scale: market demand may not be sufficient to support a large number of competing firms, each producing MES
3) rent seeking behavior: an activity designed to transfer income/wealth to a particular firm/supplier at someone's or society's expense
rent-seeking expenditures: add nothing to firm's output, but clearly increases its costs/less efficient
4) technological advance: in very long run--firms can produce their costs through discovery/implementation of new technology
*but little incentive to be technologically progressive unless it uses it as one of its barriers of entry into the industry
question
simultaneous consumption
answer
a product's ability to satisfy a large number of consumers at the same time
*MCs are so low that ATCs decline as the number of consumers increase
*MCs are so low that ATCs decline as the number of consumers increase
question
network effects
answer
are present when the value of a product to each user, including existing users, increase as total number of users rises
*may drive a market toward monopoly b/c consumer tends to choose standard products that everyone else is using
*may drive a market toward monopoly b/c consumer tends to choose standard products that everyone else is using
question
overall: monopolists can change higher-than competitive prices that result in an underallocation of resources to the monopolized product
answer
solutions: ignore it, regulate it, sue it with antitrust laws
question
price discrimination
answer
practice of selling a specific product at more than one price when price differences are not justified by cost differences
3 forms: 1-charging each customer max price he/she willing to pay
2-charging each customer 1 price for first units and even less for subsequent units (buy 1 get 1 50% off)
3-charging some customers 1 price and others another
3 forms: 1-charging each customer max price he/she willing to pay
2-charging each customer 1 price for first units and even less for subsequent units (buy 1 get 1 50% off)
3-charging some customers 1 price and others another
question
price discrimination is possible when
answer
firm has monopoly power, market segmentation, no resale
(ex): movie theaters, golf courses, railroad/student discounts
(ex): movie theaters, golf courses, railroad/student discounts
question
regulated monopoly
answer
natural monopolies are subject to regulation
*will allow monopoly to break even but will not fully correct underallocation of resources
*will allow monopoly to break even but will not fully correct underallocation of resources
question
socially optimal price
answer
P=MC
the regulated price Pr where it achieves allocative efficiency
the regulated price Pr where it achieves allocative efficiency
question
fair-price return
answer
P=min ATC
the price that would allow regulated monopoly to earn normal profit
the price that would allow regulated monopoly to earn normal profit
question
problems of regulation
answer
P=MC--will achieve allocative efficiency, but firm will suffer losses
P=min ATC
allows monopolist to cover costs, but resources are still underallocated
P=min ATC
allows monopolist to cover costs, but resources are still underallocated
question
monopolistic competition
answer
see characteristics above
question
4-firm concentration ratio
answer
> 40%= oligopoly
< 40%= monopolistic competition
*expressed as %
*not that accurate
output of 4 largest firms/total output in industry
< 40%= monopolistic competition
*expressed as %
*not that accurate
output of 4 largest firms/total output in industry
question
Herfindahl index
answer
(%s1)^2+(%s2)^2+(%s3)^2+...+(%sq)^2
*sum of squared % market shares of individual firms in industry
>1000 (oligopoly)
10,000= monopoly
<1000 (monopolistic competition)
*closer to 0=more competitive, closer to 10000=more monopolistic
*more accurate, but not clear way to determine type of market power
*sum of squared % market shares of individual firms in industry
>1000 (oligopoly)
10,000= monopoly
<1000 (monopolistic competition)
*closer to 0=more competitive, closer to 10000=more monopolistic
*more accurate, but not clear way to determine type of market power
question
demand curve for monopolistic competition
answer
highly elastic for monopolistically competitive seller
MR=MC--to maximize profits/minimize losses
P<minATC= economic profit/short run profits
P=min ATC= long run equilibrium
P>min ATC=short run losses
MR=MC--to maximize profits/minimize losses
P<minATC= economic profit/short run profits
P=min ATC= long run equilibrium
P>min ATC=short run losses
question
profit maximizing, loss minimizing, long run= normal profit
answer
same steps seen in monopoly
question
monopolistic competition--theoretically vs realistically
answer
theoretically: normal profit is the only profit in long run
realistically: monopolistic competition can earn economic profit in long run because products are differentiated
realistically: monopolistic competition can earn economic profit in long run because products are differentiated
question
monopolistic competition/efficiency
answer
neither productive/allocative efficiency occurs/exists in long run equilibrium
P>min ATC (underallocation of resources, no productive efficiency)
P>MC (allocative inefficiency)
P>min ATC (underallocation of resources, no productive efficiency)
P>MC (allocative inefficiency)
question
excess capacity
answer
gap between min ATC output/profit maximizing output
*too many firms each supplying too little
*too many firms each supplying too little
question
product variety in monopolistic competition
answer
helps firms stay above competitors/keep economic profit/inhibit loss
*although product differentiation will add to firm's costs, it can increase demand for product
benefits: helps maintain economic profit, advantageous to consumer
drawbacks: juggles 3 factors--product, price, advertising to maximize profits
*although product differentiation will add to firm's costs, it can increase demand for product
benefits: helps maintain economic profit, advantageous to consumer
drawbacks: juggles 3 factors--product, price, advertising to maximize profits
question
oligopoly
answer
see characteristics above
question
mutual interdependence
answer
change of price in one firm will affect firms in entire industry
question
mergers
answer
oligopolies are known for this: increases market share, allows for new firms to achieve greater economies of scale, and allows for more monopoly power-- more control over industry
question
oligopolies also use 4-firm concentration ratio/herfandahl index but with shortcomings:
answer
1) localized markets: concentration ratios=nationwide, so oligopolies can exist locally and have low ratios
2) interindustry competition: competition b/t 2 products associated in different industries
*concentration ratios can disguise interindustry competition
3) world trade: they do not account for import competition of foreign competitors
2) interindustry competition: competition b/t 2 products associated in different industries
*concentration ratios can disguise interindustry competition
3) world trade: they do not account for import competition of foreign competitors
question
game theory
answer
oligopoly behavior has the characteristics of certain games of strategy --best way to play depends on how opponent plays
question
incentives to cheat in game theory
answer
both are tempted to cheat in collusion because one can earn more profits while hurting the other company/competitor
*lucrative/costly to other firm affected
*lucrative/costly to other firm affected
question
3 oligopoly models
answer
1- kinked demand theory
2- collusive pricing
3- price leadership
2- collusive pricing
3- price leadership
question
why not a single model?
answer
oligopolies are diverse: tight--2/3 dominating firms, loose--5/7 firms, could be differentiated/standardized products, those who collude/independent action, strong vs weak barriers to entry
question
kinked-demand theory
answer
noncollusive oligopoly
*kinked feature/MR break b/c rivals usually ignore price increase of a firm, but match when price decreases
*no change in price/quantity
*decrease in price=D-inelastic=decrease in TR
*increase in price=D-elastic=increase in TR
*kinked feature/MR break b/c rivals usually ignore price increase of a firm, but match when price decreases
*no change in price/quantity
*decrease in price=D-inelastic=decrease in TR
*increase in price=D-elastic=increase in TR
question
rivals' assumptions
answer
match price changes (why D1/M1 are so steep): inelastic because other rivals really don't have a choice
*must change price so the firm that does change doesn't get upperhand
ignore price changes (why D2/M2 look so flat): elastic
*if price increases: firm that changes loses customers
*if price decreases: firm that changes gains customers
BUT because of product differentiation: customers may be willing/able to pay higher price for the firm that changes its price
*must change price so the firm that does change doesn't get upperhand
ignore price changes (why D2/M2 look so flat): elastic
*if price increases: firm that changes loses customers
*if price decreases: firm that changes gains customers
BUT because of product differentiation: customers may be willing/able to pay higher price for the firm that changes its price
question
why prices are generally stable in noncollusive oligopoly
answer
demand side: oligopolist believes it cannot improve its TR by changing price
cost side: costs can vary, but firm will have no reason to change its price/quantity
cost side: costs can vary, but firm will have no reason to change its price/quantity
question
criticisms of kinked-demand
answer
doesn't explain how price gets at Po= only explains why oligopolists stick with inflexible price
*kinked demand is not as rigid as it implies--if macroeconomy=unstable--price change/price war
*kinked demand is not as rigid as it implies--if macroeconomy=unstable--price change/price war
question
cartels/collusions
answer
can increase profits, reduce uncertainty, prohibit entry of new firms
collusion: a situation in which firms act together and in agreement to fix prices
*acts as a pure monopolist
cartel: countries band together and set prices/output of the same industry
collusion: a situation in which firms act together and in agreement to fix prices
*acts as a pure monopolist
cartel: countries band together and set prices/output of the same industry
question
obstacles to collusion
answer
demand/cost differences: difficult to agree on price
# of firms: if too large--hard to agree
cheating
recession: slumping markets increase cost, huge excess capacity production--price war may ensue
legal action/antitrust laws
# of firms: if too large--hard to agree
cheating
recession: slumping markets increase cost, huge excess capacity production--price war may ensue
legal action/antitrust laws
question
price leadership model
answer
cooperating prices without engaging in outright collusion
*based on formal meetings/secret agreements
*many firms follow the biggest firm in industry
[breaks down when there's a price war]
*based on formal meetings/secret agreements
*many firms follow the biggest firm in industry
[breaks down when there's a price war]
question
leadership tactics
answer
1-infrequent price changes: doesn't change much
2-communication
3-limit pricing: to discourage new entrants
*when price < profit max level--so that new firms cannot cover costs
2-communication
3-limit pricing: to discourage new entrants
*when price < profit max level--so that new firms cannot cover costs
question
oligopolies and advertisingq
answer
doesn't compete based on price, but on product development/advertising
*harder to duplicate than price cuts
*can produce more permanent gains in market share
positive effects of advertising:
-low cost means (media advertising)
-diminishes monopoly, stimulates competition
-greater efficiency
-increases sales/output=advertising minimizes long run ATCs by enabling firms to obtain economies of scale
negative effects:
-can manipulate, confuse, persuade consumers to alter their preferences
-misleading/extravagant
-conveys little/no information on price/quality
-self-cancelling: inefficient b/c no one gains sales
-brand loyalty
-inferior product may be just as good as superior product
*harder to duplicate than price cuts
*can produce more permanent gains in market share
positive effects of advertising:
-low cost means (media advertising)
-diminishes monopoly, stimulates competition
-greater efficiency
-increases sales/output=advertising minimizes long run ATCs by enabling firms to obtain economies of scale
negative effects:
-can manipulate, confuse, persuade consumers to alter their preferences
-misleading/extravagant
-conveys little/no information on price/quality
-self-cancelling: inefficient b/c no one gains sales
-brand loyalty
-inferior product may be just as good as superior product
question
oligopoly and efficiency
answer
P>min ATC= productive inefficiency
P>MC=allocative inefficiency
*argument that oligopolies are less desirable than pure monopolies b/c they're not regulated by gov
what keeps oligopolies in check:
-increased foreign competition/increased rivalry
-limit pricing: consumers benefit from low prices, even though suppliers are slashing their prices below the profit max level
-technological advance: economic profit can finance research/development
P>MC=allocative inefficiency
*argument that oligopolies are less desirable than pure monopolies b/c they're not regulated by gov
what keeps oligopolies in check:
-increased foreign competition/increased rivalry
-limit pricing: consumers benefit from low prices, even though suppliers are slashing their prices below the profit max level
-technological advance: economic profit can finance research/development
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