a market structure in which barriers to entry are low and many firms compete by selling similar, but not identical, products. These firms differ from perfectly competitive firms in two major ways: 1) they charge a price greater than marginal cost, and 2) they do not produce at minimum average total cost.
___ ___ is always equal to price. This is true for firms selling in any of the four market structures of perfect competition, monopolistic competition, oligopoly, and monopoly.
The situation in which an increase in the price of one input will increase a firm's production costs and reduce its level of output, thus reducing the demand for other inputs; conversely for a decrease in the price of the input.
after a price increase, each unit sold sells at a higher price, which tends to raise revenue
marginal revenue curve
every firm that has the ability to affect the price of the good or service it sells will have a ___ ___ ___ that is below its demand curve.
monopoly maximizing profit
all firms use the same approach to max profits: They produce where 'marginal revenue' is equal to 'marginal cost'. A monopolistically competitive firm produces where P>MR, unlike a perfectly competitive firm. So a monopolistically competitive firm will maximize profits where P>MC.
monopolistically competitive profits
in the short run, the profits made by a firm attract additional firms to enter the market, shifting the demand curve closer to the ATC curve, negating profits. In the long run, the demand curve becomes tangent to the average cost curve, P=ATC, the firm breaks even, and no longer earns an economic profit. Therefore, in the long run, monopolistically competitive firms will experience neither economic profits nor economic losses.
is zero economic profit inevitable in the long run?
This result holds only if the firm stands still and fails to find new ways of differentiating its product or fails to find new ways of lowering the cost of producing its product. To stay one step ahead of its competitors, a firm has to offer consumers goods or services that they perceive to have greater value than those competing firms offer.
excess capacity under monopolistic competition
a perfectly competitive firm maximizes profit where price equals marginal cost, the minimum point of its average total cost curve. Whereas the profit-maximizing level of output for a monopolistically competitive firm comes at a level of output where price is greater than marginal cost, and the firm is not at the minimum point of its average total cost curve. A monopolistically competitive firm has 'excess capacity': If it increased its output, it could produce at a lower average cost.
monopolistic competition inefficiency
efficiency entails having both productive and allocative efficiency. For productive efficiency to hold, firms must produce at the minimum point of ATC, and for allocative efficiency to hold, firms must charge a price equal to marginal cost. Both are achieved in a perfectly competitive market, but economists debate whether monopolistically competitive markets being neither productively nor allocatively efficient results in a significant loss of well-being to society in these markets compared with perfectly competitive markets.
how consumers benefit from monopolistic competition
the only difference between the monopolistically competitive firm and the perfectly competitive firm is that the demand curve for the monopolistically competitive firm slopes downward, whereas the demand curve for the perfectly competitive firm is a horizontal line. The demand curve for a monopolistically competitive firm slopes downward because the good or service the firm is selling is differentiated from the goods or services being sold by competing firms. The perfectly competitive firm is selling a good or service identical to those being sold by its competitors. A key point to remember is that 'firms differentiate their products to appeal to consumers'.
the actions of a firm intended to maintain the differentiation of a product over time
a market structure in which a small number of interdependent firms compete.
A measure of market power - the percentage of all sales that is accounted for by the four or eight largest firms in the market. Most economists believe that a four-firm ratio greater than 40% indicates that an industry is an oligopoly.
barriers to entry
anything that keeps new firms from entering an industry in which firms are earning economic profits. New firms will enter industries where existing firms are entering economic profits, but new firms often have difficulty entering an oligopoly. Three barriers to entry are 1) economies of scale, 2) ownership of a key input, 3) and government-imposed barriers.
economies of scale
barrier to entry; the situation when a firm's long-run average costs fall as it increases output. The greater this effect, the smaller the number of firms that will be in the industry. 1) If ___ _ ___ are relatively unimportant in the industry, the typical firm's long-run average cost curve will reach a minimum at a level of output that is a small fraction of total industry sales. The industry will have room for a large number of firms and will be competitive. 2) If ___ _ ___ are significant, the typical firm will not reach the minimum point on its long-run average cost curve until it has produced a large fraction of industry sales. Then the industry will have room for only a few firms and will be an oligopoly.
ownership of a key input
barrier to entry; if production of a good requires a particular input, then control of that input can be a barrier to entry.
barrier to entry; firms sometimes try to convince the government to impose barriers to entry. Many large firms employ lobbyists to convince state legislatures and members of Congress to pass laws favorable to the economic interests of the firms. Examples of these barriers include: patents, licensing requirements, and barriers to international trade.
the study of how people make decisions in situations in which attaining their goals depends on their interactions with others; in economics, the study of the decisions of firms in industries where the profits of each firm depend on its interactions with other firms. Games share three characteristics: 1) rules, 2) strategies, and 3) payoffs
actions taken by a firm to achieve a goal, such as maximizing profits. In business situations, the rules of the "game" include not just laws that a firm must obey but also other matters beyond a firm's control - at least in the short run - such as its production function. The 'payoffs' are the profits a firm earns as a result of how its strategies interact with the strategies of other firms.
a table that shows the payoffs that each firm earns from every combination of strategies by the firms.
game - price competition between two firms: in an oligopoly with two firms, Apple and HP for example, The two firms have to decide whether to charge $1,200 or $1,000 for their computers, which price will be more profitable depends on the price the other firm charges. If Apple and HP both charge $1,200 for their computers, each firm will make a profit of $10 million per month. If Apple charges the lower price of $1,000, while HP charges $1,200, Apple will gain many of HP's customers. Apple's profits will be $15 million, HP's only $5 million. Similarly, if HP charges $1,000, while Apple is charging $1,200, Apple's profits will be only $5 million, while HP's profits will be $15 million. If both firms charge $1,000, each will earn profits of $7.5 million per month (charging $1000 is the dominant strategy for both firms).
an agreement among firms to charge the same price or otherwise not compete. Clearly, firms would be better off if they both charge the high price within a duopoly, one possibility to ensure this action is to get together and collude by agreeing to charge the higher price. Unfortunately, for firms, this is against the law in the US.
a strategy that is the best for a firm, no matter what strategies other firms use. The situation, where both firms elect to take the ___ ___ the result is an equilibrium because each firm is maximizing profits, given the price chosen by the other firm.
a situation in which each firm chooses the best strategy, given the strategies chosen by other firms.
an equilibrium in a game in which players cooperate to increase their mutual payoff.
an equilibrium in a game in which players do not cooperate but pursue their own self-interest.
a game in which pursuing dominant strategies results in noncooperation that leaves everyone worse off. Generally in markets, firms are playing a 'repeated game'. In a repeated game, the losses from not cooperating are greater than in a game played once, and players can also employ retaliation strategies against those who don't cooperate. As a result, we are more likely to see cooperative behavior.
a form of implicit collusion in which one firm in an oligopoly announces a price change and the other firms in the industry match the change. The offer to match prices is a good enforcement mechanism because it guarantees that if either store fails to cooperate and charges the lower price, the competing store will automatically punish that store by also charging the lower price.
a group of firms that collude by agreeing to restrict output to increase prices and profits
in many business situations, one firm will act first, and then other firms will respond. We use ____ ___ to analyze two business strategies: deterring entry and bargaining between firms
a diagram that describes the possible moves in a game in sequence and lists the payoffs that correspond to each possible combination of moves. Utilized to figure the correct action to deter another firm from entering the market.
a firm that is the only seller of a good or service that does not have a close substitute.
Entry blocked by government action
barrier to entry; in the US, government blocks entry in two main ways: 1) by granting a 'patent' or 'copyright' to an individual or a firm, giving it the exclusive right to produce a product. 2) or by granting a firm a 'public franchise', making it the exclusive legal provider of a good or service.
gives a firm the exclusive right to a new product for a period of 20 years from the date the product is invented. `
a government-granted exclusive right to produce and sell a creation.
a government designation that a firm is the only legal provider of a good or service.
Control of a key resource
barrier to entry; another way for a firm to become a monopoly is by controlling a key resource. This happens infrequently because most resources, including raw materials such as oil or iron ore, are widely available from a variety of suppliers.
a situation in which economies of scale are so large that one firm can supply the entire market at a lower average total cost than can two or more firms. In this case, there is really "room" in the market for only one firm.
how does a monopoly choose price and output?
like every other firm, a monopoly maximizes profit by producing where marginal revenue equals marginal cost. A monopoly differs from other firms in that 'a monopoly's demand curve is the same as the demand curve for the product'. For example, the demand curve for wheat is very different from the demand curve for the wheat produced by any one farmer. If, however, one farmer had a monopoly on wheat production, the two demand curves would be exactly the same.
monopolies marginal revenue
firms in perfectly competitive markets - such as a farmer in the wheat market - face horizontal demand curves. They are 'price takers'. All other firms, including monopolies. are 'price makers'. If price makers raise their prices, they will lose some, but not all, of their customers. Therefore, they face a downward-sloping demand curve and a downward-sloping marginal revenue curve as well. Let's review why a firm's marginal revenue curve slopes downward if its demand curve slopes downward. When a firm cuts the price of a product, two things happen: 1) it sells more units of the product, and 2) it receive less revenue from each unit than it would have received at the higher price.
profit maximization for a monopoly
the profit maximizing quantity and price, for a monopoly occur where Marginal Cost intersects Marginal Revenue. As long as the marginal cost of selling one more of the product is less than the marginal revenue, the firm should sell additional products because it is adding to its profits. Even though a monopoly is earning economic profits, new firms will not enter the market, and thus the company will be able to continue to earn economic profits, even in the long run.
comparing monopoly and perfect competition
a perfectly competitive market is economically efficient; equilibrium in a perfectly competitive market results in the greatest amount of economic surplus, or total benefit to society, from the production of a good or service. But what happens to economic surplus in a monopoly? We know that the monopoly will maximize profits by producing where marginal revenue equals marginal cost. To do this, the monopoly reduces the quantity of televisions that would have been produced if the industry were perfectly competitive and increases the price. Conclusion: A monopoly will produce less and charge higher price than would a perfectly competitive industry producing the same good.
measuring the efficiency losses from monopoly
a monopoly produces the profit-maximizing level of output but fails to produce the efficient level of output from the point of view of society. A monopoly causes three things: 1) a reduction in consumer surplus, 2) an increase in producer surplus (both due to increased prices), 3) and a deadweight loss, which represents a reduction in economic efficiency.
how large are the efficiency losses due to monopoly?
there a relatively few monopolies, so the loss of economic efficiency due to monopoly must be small. However, many firms have market power, and influence the price. The only firms that do not have market power are firms in perfectly competitive markets, which must charge price equal to marginal cost. Because few markets are perfectly competitive, 'some loss of economic efficiency occurs in the market for nearly every good or service'. The loss of economic efficiency is small primarily because true monopolies are very rare. In most industries, competition keeps price much closer to marginal cost than would be the case in a monopoly. The closer price is to marginal cost, the smaller the size of the deadweight loss.
the ability of a firm to charge a price greater than marginal cost.
market power and technological change
some economists have raised the possibility that the economy may actually benefit from firms having market power; arguments made that economic progress depends on technological change in the form of new products. Because firms with market power are more likely to earn economic profits than are perfectly competitive firms, they are also more likely to carry out research and development and introduce new products. In this view, the higher prices firms with market power charge are unimportant compared with the benefits from the new products these firms introduce to the market.
antitrust laws and enforcement
after the Sherman Act passed, prohibiting trusts and collusive agreements, trusts disappeared, but the term antitrust laws has lived on to refer to the laws aimed at eliminating collusion and promoting competition among firms.
laws aimed at eliminating collusion and promoting competition among firms.
regulating natural monopolies
if a firm is a natural monopoly, competition from other firms will not play its usual role of forcing price down to the level where the company earns zero economic profit. As a result, local or state regulatory commissions usually set the prices for these monopolies, such as firms selling natural gas or electricity. We can measure the additional benefit consumers receive from the last unit by the price, and we can measure the additional cost to the monopoly of producing the last unit by marginal cost. Therefore, to achieve economic efficiency, regulators should require that the monopoly charge a price equal to its marginal cost.
a price strategy, designed to increase economic profits for a firm, involves firms setting different prices for the same good or service. A firm can increase its profits by charging a higher price to consumers who value the good more and a lower price to consumers who value the good less.
buying a product in one market at a lower price and reselling it in another market at higher price. The profits received from engaging in this are referred to as ___ profits.
the costs in time and other resources that parties incur in the process of agreeing to and carrying out an exchange of goods or services. The 'law of one price' holds exactly only if these costs are zero. As we will soon see, in cases in which it is impossible to resell a product, the law of one price will not hold, and firms will be able to practice price discrimination. Apart from this important qualification, we expect that arbitrage will result in a product selling for the same price everywhere.
The requirements for successful price discrimination
a successful strategy of price discrimination has three requirements: 1) a firm must possess market power, 2) some consumers must have a greater willingness to pay for the product than other consumers, and the firm must be able to know what prices customers are willing to pay, 3) the firm must be able to divide up - or segment - the market for the product so that consumers who buy the product at a low price are not able to resell it at a high price. In other words, price discrimination will not work if arbitrage is possible.
price discrimination in the airline industry
the airlines go well beyond a single leisure fare and a single business-fare in their pricing strategies. Although they ordinarily charge high prices for seats that they expect won't sell at existing prices. This practice of continually adjusting prices to take into account fluctuations in demand is called 'yield management'.
perfect price discrimination
Occurs when a firm charges the maximum amount that buyers are willing to pay for each unit. In this situation, because the firm can now charge each consumer the maximum each consumer is willing to pay, its marginal revenue from selling one more unit is equal to the price of that unit. Therefore, the monopolist's marginal revenue curve becomes equal to its demand curve, and the firm will continue to produce up to the point where price is equal to marginal cost. Two key results of this extreme price discrimination: 1) profits increase and 2) consumer surplus decreases.
price discrimination over time
with this strategy, firms charge a higher price for a product when it is first introduced and a lower price later. After the demand of the 'early adopters' was satisfied, the companies reduced prices to attract more price-sensitive customers. Book publishers routinely use price discrimination across time to increase profits, hardcover editions of novels have much higher prices and are published months before paperback editions.
can price discrimination be illegal?
Congress passed antitrust laws to promote competition. Price discrimination may be illegal if its effect is to reduce competition in an industry.
Psychological pricing technique based on the principle that prices ending in odd numbers ($5.99) communicate a bargain and prices ending in even numbers ($6.00) communicate quality. Surveys show that 80-90% of the products sold in supermarkets have prices ending in "9" or "5" rather than "0".
many firms use this, which involves adding a percentage markup to average cost. With this pricing strategy, the firm first calculates average cost at a particular level of production, usually equal to the firm's expected sales. It then increases average cost by a percentage amount, say 30%, to arrive at the price. Economists conclude that using cost-plus pricing may be the best way to determine the optimal price in two situations: 1) when marginal cost and average cost are roughly equal and 2) when the firm has difficulty estimating its demand curve.
a situation in which consumers pay one price (or tariff) for the right to buy as much of a related good as they want at a second price. For example, many golf and tennis clubs require members to buy an annual membership in addition to paying a fee each time they use the golf course or tennis court. The outcome of a firm using an optimal two-part tariff: 1) because price equals marginal cost at the level of output supplied, the outcome is economically efficient, and 2) all consumer surplus is transformed into profit.
factors of production
labor, capital, natural resources, and other inputs used to produce goods and services.
the demand for a factor of production; it depends on the demand for the good the factor produces. For example, Apple's demand for the labor to make iPods is derived from the underlying consumer demand for iPods. As a result, Apple's demand for labor depends primarily on two factors: 1) the additional iPods Apple can produce if it hires one more worker, 2) the additional revenue Apple receives from selling the additional iPods.
marginal product of labor
the additional output a firm produces as a result of hiring one more worker. We calculate this as the change in total output as each additional worker is hired. Because of the law of diminishing returns, this marginal product of labor declines as firm hires more workers.
marginal revenue product of labor (MRP)
the change in a firm's revenue as a result of hiring one more worker. When deciding how many workers to hire, a firm is not interested in how much output will increase as it hires another worker but in how much revenue will increase as it hires another worker. We calculate this amount by multiplying the additional output produced by the product price. When the marginal revenue product of labor is equal to the wage, the firm has maximized profits by hiring the optimal number of workers.
market demand curve for labor
similar to the market demand curve for a good is determined by adding up the quantity of the good demanded by each consumer at each price. Similarly, the market demand curve for labor is determined by adding up the quantity of labor demanded by each firm at each wage, holding constant all other variables that might affect the willingness of firms to hire workers.
factors that shift the market demand curve for labor
In constructing the demand curve for labor, we held constant all variables - except for the wage - that would affect the willingness of firms to demand labor. An increase or decrease in the wage causes 'an increase or decrease in the quantity of labor demanded', which we show by a movement along the demand curve. If any other variable other than wage changes, the result is 'an increase or a decrease in the demand for labor' which we show by a shift of the demand curve: 1) increases in human capital, 2) changes in technology, 3) changes in the price of the product, 4) changes in the quantity of other inputs, 5) changes in the number of firms in the market.
the supply of labor
because in devoting an hour to leisure we give up an hour's earnings from working, the opportunity cost of leisure is the wage. The higher the wage we could earn working, the higher the opportunity cost of leisure. Therefore, as the wage increases, we tend to take less leisure and work more (upward sloping curve). Although it is possible at very high wage levels, the labor supply curve of an individual might be backward bending, so that higher wages actually result in a smaller quantity of labor supplied. To understand why, recall the definitions of the 'substitution effect' and the 'income effect'; in the case of a wage change, the substitution effect refers to the fact that an increase in the wage raises the opportunity cost of leisure and causes a worker to devote more time to working and less time to leisure. Because leisure is a normal good, the income effect of a wage increase will cause a worker to devote less time to working and more time to leisure.
the market supply curve of labor
the market supply curve of a good is determined by adding up the quantity of the good supplied by each firm at each price. Similarly, the market supply curve of labor is determined by adding up the quantity of labor supplied by each worker at each wage, holding constant all other variables that might affect the willingness of workers to supply labor.
factors that shift the market supply curve of labor
in constructing the market supply curve of labor, we hold constant all other variables that would affect the willingness of worker to supply labor, except the wage. If any of these other variables change, the market supply curve will shift: 1) increases in population, 2) changing demographics, 3) changing alternatives
the effect on equilibrium wages of a shift in labor DEMAND
in many labor markets, increases over time in labor productivity will cause the demand for labor to increase. If labor supply is unchanged, an increase in labor demand will increase both the equilibrium wage and the number of workers employed.
the effect on equilibrium wages of a shift in labor SUPPLY
if labor demand remains unchanged, an increase in labor supply will decrease equilibrium wage but increase the number of workers employed.
explaining differences in wages
example: the marginal revenue product of baseball players is very high, and the supply of people with the ability to play Major League Baseball is low. The result is that 750 MLB players receive an average wage of $3,260,000. The marginal revenue product of college professors is much lower, and the supply of people with the ability to be college professors is much higher. The result is that the 663,000 college professors in the United States receive an average wage of $81,000, far below the average wage of baseball players.
higher wages that compensate workers for unpleasant aspects of a job. For example, if working in a dynamite factory requires the same degree of training and education as working in a semiconductor factory but is much more dangerous, a larger number of workers will want to work making semiconductors that will want to work making dynamite. As a consequence, the wages of dynamite workers will be higher than the wages of semiconductor workers, 'the price of risk'.
paying a person a lower wage or excluding a person from an occupation on the basis of an irrelevant characteristic such as race or gender. Most economists, however, believe that only a small amount of the gap between the wages of white males and the wages of other groups is due to discrimination, instead, most of the gap is explained by: 1) difference in education, 2) differences in experience, and 3) differing preferences for jobs.
the application of economic analysis to human resources issues. Analyzes the link between differences jobs and differences in the way workers are paid. Jobs have different skill requirements, require more or less interaction with other workers, have to be performed in more or less unpleasant environments, and so on. Firms need to design compensation policies that take into account these differences.