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The Firm and Market Structures
Terms in this set (57)
What is perfect competition?
Many firms produce identical products and competition forces them to all sell at market price
What is monopolistic competition?
Each firm differentiates its products and prices are not identical because of perceived differences among competing products. Low barriers to entry. Demand is downward sloping.
Example is the market for toothpaste.
What is an oligopoly?
A market where there are only a few firms competing. Firms and competitors are interdependent.
Example is the automobile market.
What is a monopoly?
A single seller of a product with no close substitutes. High barriers to entry.
What is a natural monopoly?
A natural monopoly is a monopoly in an industry in which it is most efficient (involving the lowest long-run average cost) for production to be permanently concentrated in a single firm rather than contested competitively.
Example is utilities.
What happens when privately owned companies are given monopoly power?
Often regulated by the government
Characteristics of the 4 market structures (picture)
What is marginal revenue equal to under perfect competition?
Marginal revenue is equal to price because all additional units are assumed to be sold at the same (market price)
Under perfect competition (price taker), how does a firm maximize profits in the short run?
Produce and sell the quantity for which MR = MC or produce where total revenue exceeds total cost by the maximum amount
In a perfectly competitive market, can firms earn economic profit in the long run?
No because the assumption is that new firms will enter the industry to earn economic profits, increasing market supply and eventually reducing market price so that it just equals firms' ATC
In a perfectly competitive market, what is the equilibrium point?
The point where P = MR = MC = ATC
What is the short run supply curve for a firm?
It is its MC line above the AVC curve
How does a short run demand increase affect the firm's equilibrium output?
It will increase equilibrium price leading to a higher output level and an economic profit in the short run
How will a permanent change in demand affect long run equilibrium?
Shifts demand of industry demand to the right and increases price and quantity temporarily. Then more firms will enter and it will shift price back down and quantity produced of the firm back to normal.
What are some characteristics of monopolistic competition?
Large number of independent sellers, differentiated products, firms compete on price, quality, marketing, and low barriers to entry
What is the shape of the demand curve of firms in monopolistic competition?
Downward sloping and highly elastic demand curve
Under monopolistic competition, can a firm make economic profit in the short run?
Yes. Profit is maximized where MR = MC. If they charge a price higher on demand curve higher than ATC, they will make economic profit.
Under monopolistic competition, can a firm make economic profit in the long run?
No. Entry of new firms seeking economic profit will shift demand curve down to where it equals ATC.
What is the difference between output graphs of monopolistic competition and perfect competition?
Monopolistic competition has a downward sloping demand curve and can produce at a price greater than MC.
Why is product innovation necessary in monopolistic competition?
Firms that bring new products to the market are confronted with less elastic demand curves, enabling them to increase price and earn economic profits
How high are advertising expenses for firms in monopolistic competition?
Yes, to create perception of differences between products. Higher than advertising expenses for monopolies and perfect competition.
Explain the kinked demand curve.
Used for oligopolies. Each firm believes that an increase in a product price will not be followed by its competitors (more elastic), but a decrease in price will (less elastic).
What is the profit maximizing point of a kinked demand curve?
The price at which the kink is located
What is a shortcoming of the kinked demand curve model?
How to determine the market price (where the kink is located) is outside the scope of the model
What is the Courtnot model?
Consists of an oligopoly of 2 firms with identical and constant marginal costs of production. Firms simultaneously determine their quantities each period and these quantities will change until they are equal
What is Nash equilibrium?
A Nash equilibrium is reached when the choices of all firms are such that there is no other choice that makes any firm better off
Describe a prisoner's dilemma type game for 2 firms.
Each firm agrees to charge a high price but may cheat to charge a low price. Nash equilibrium is if both firms cheat since it is the only combination from which neither firm can unilaterally change is action to improve profits.
What is the dominant firm model?
Final model of oligopoly where there is a single firm that has a significantly larger market share because of its greater scale and lower cost structure. The dominant firm controls the price and the competitive firms take this market price as given.
Under the dominant firm model, at which points are profits maximized
The dominant firm will maximize where MC = MR, but at the point on the demand curve.
The competitive firm will maximize profits where marginal cost equals the price SET BY DF
What are the 2 pricing strategies for monopolies?
Single price and discrimination
Monopolists will expand output until what point?
Until marginal revenue equals marginal cost
Do monopolists charge the highest price possible?
No because monopolists want to maximize profit not price
Where must the demand curve lie for a monopoly in order to ensure a profit?
It must lie above the ATC curve at the optimal quantity so that price > ATC.
How do you calculate economic profit?
(P - ATC) x Q
What is price discrimination?
The practice of charging different consumers different prices
What must be true about the seller for price discrimination to work?
1. Downward sloping demand curve
2. Have at least 2 identifiable groups of customers with difference price elasticities of demand for the product
3. Be able to prevent the customers from buying at the low price and reselling at the high price
What is the effect on profit and deadweight loss of price discrimination?
Increases profit and decreases deadweight loss
Why does price discrimination increase profit?
The firm gains customers with inelastic demand while still providing goods to customers with more elastic demand
Under perfect competition, the efficient quantity is the one fro which what is maximized?
Consumer surplus and producer surplus is maximized
What does a monopoly create relative to perfect competition?
Deadweight loss because they produce at quantities that do not maximize the sum of consumer and producer surplus
What are the 2 forms of regulation for natural monopolies?
Average cost pricing and marginal cost pricing
What is average cost pricing?
Forces monopolists to reduce price to where a firm's ATC intersects the market demand curve. Ensures that the monopolist has a normal profit where P = ATC.
What is marginal cost pricing (also called efficient regulation)?
Forces the monopolist to reduce price to the point where the firm's MC curve intersects the market demand curve.
What does marginal cost pricing do to a monopolist's profit. What does the government do as a result?
It causes the monopolist to incur a loss because price is below ATC. The government provides a subsidy so the firm can have normal profit.
What is a firm's short-run supply function under perfect competition?
It is its marginal cost curve above its average variable cost curve.
What is the optimal pricing strategy under perfect competition?
Profits are maximized by producing where MC = MR. MR also equals price so MC = MR = P.
What is the optimal pricing strategy under a monopoly?
Profits are maximized by producing where MC = MR. Price is greater than MR and MR because the demand curve is downward sloping.
What is the optimal pricing strategy under a monopolistic competition?
Profits are maximized by producing where MC = MR. Similar to a monopoly price is greater than MR and MR because the demand curve is downward sloping.
What is the optimal pricing strategy under an oligopoly with a kinked demand curve?
Firms produce where MR = MC. MR curve however is discontinuous so for many cost structures, the optimal quantity is the same
What is the optimal pricing strategy under an oligopoly with a collusion strategy?
If all producers agree to share the market to maximize profits, they will produce at a quantity where MC = MR and charge the price from the industry demand curve at which that quantity can be sold.
What is the optimal pricing strategy under an oligopoly under the dominant firm model?
Assume that one firm has the lowest cost structure and largest market share. This dominant firm will maximize profit by producing where MR = MC and charge the price on its firms demand curve for that quantity. Other firms in the market will have to take that price.
What is the optimal pricing strategy under an oligopoly under the Game Theory?
The long run outcome is indeterminant and we can only say the price will be between monopoly and perfect competition price (marginal cost)
What is the N-firm concentration ratio?
Calculated as the sum or the percentage market shares of the large N firms in the market.
What is a limitation of the N-firm concentration ratio?
May be insensitive to mergers of two firms with large market shares
What is the Herfindahl-Hirschman Index (HHI)?
Calculated as the sum of the squares of market shares of the largest firms in the market.
What is a limitation to both the N-firm concentration ratio and the HHI?
Doesn't take into consideration barriers to entry. A firm with high market share may not have much power if barriers to entry are low.
Characteristic of the 4 market structures (picture)
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