71 terms

Managerial Economics Exam 2: Chapter 8


Terms in this set (...)

Perfect Competition
No market power.
Market power.
Monopolistic Competition
Make power with some competition.
Total revenue - total cost
Decision Making Framework
Goal: Maximize economic profits.

1. Costs
2. Price it can charge for its output.
Perfect Competition
Many buyers and sellers.

Homogeneous, identical, products of different firms.

Perfect information on both sides of market, supply and demand.

Free entry and exit of firms.
Marginal Revenue
Change in total revenue resulting from a one unit change in output.
Perfect Competition
These firms are price takers mean that the price equals marginal revenue.

Market determines price.
Perfect Competition
Short-run: firms may earn profits or losses.

Long-run: Entry and exit forces profits to zero.
Perfect Competition: Manager Considerations
1. Importance of product differentiation.

2. Sustainable advantage.
Profit Maximization
Occurs at the quantity of output at which marginal revenue equals marginal cost and marginal cost is increasing.
Increase Quantity
When marginal revenue > marginal cost then ___________ quantity.
Decrease Quantity
When marginal revenue < marginal cost then ___________ quantity.
Short Run
Period of time over which some factors of production are fixed.

To maximize profits in the ______ _______, managers must take as given the fixed inputs/costs and determine how much output to produce by changing the variable inputs.
The demand curve for a competitive firm's product is a _____________ line at the market price. This is the competitive firm's marginal revenue. Df=P=MR.
Refers to a short-run decision not to produce anything during a specific period of time because of current market conditions.
Refers to a long-run decision to leave the market.
Sunk Costs
Costs that have already been committed and cannot be recovered. Can be very similar to fixed costs.
Short Run
The firm shuts down in the _______ _______ if the revenue it can get from producing is less than the variable cost of production.
Short Run Shutdown
Variable Costs
The firm continues to produce as long as it can earn enough revenue to cover its _________ _________ and have some revenue left over to start paying off some of its fixed costs.
Shutdown Decision Rule
A profit-maximizing firm should continue to operate, sustaining short-run losses, if its operating loss is less than its fixed costs.

Operating results in a smaller loss than ceasing operations.
Average Variable Cost
The portion of the marginal cost curve that lies above the __________ __________ __________ is the perfectly competitive firm's short run supply curve.
Long Run Enter
Perfectly Competitive
Firms will enter the industry if:
Perfectly Competitive
If firms enter in a ___________ __________ market then supply increases and price decrease down to where profits = 0.
Economic Profits/Losses
_________ __________ are the signal for firms to enter or exit in the perfectly competitive market.
Long Run Competitive Equilibrium
In the short run and the long run, perfectly competitive firms produce an output level at which P=MC.

In the long run, this price is forced also to be where P=Min of LR ATC.
Market Supply
Equals the sum of the quantities supplied by the individual firms in the market.
1. Sole seller of a product.

2. The product it sells does not have close substitutes.
A market in which single firm serves an entire market for a good that has no close substitutes.

Sole seller of a good in a market gives that firm greater market power than if it competed against other firms.
Barrier to Entry
The fundamental cause of a monopoly is the presence of some type of _________ ____ _______.
Barrier to Entry: 3 Main Sources
1. Ownership of a key natural resource.

2. The government gives a single firm the exclusive right to produce some good.

3. Cost of production make a single producer more efficient than a large number of producers. Economies of scale or scope: natural monopoly.
Government-Created Monopolies
Governments may restrict entry by giving a single firm the exclusive right to sell a particular good in certain markets.

Ex: Patent and copyright laws.
Natural Monopoly
An industry is a ___________ ___________ when a single firm can supply a good or service to an entire market at a smaller average cost than could two or more firms. Arises when there are strong economies of scale over the relevant range of output.
Sole producer.

Faces downward-sloping demand curve.

Price maker.

Reduces price to increase sales.
Competitive Firm
One of many producers.

Faces a horizontal demand curve.

Price taker.

Sells as much or as little at same price.
TR = P x Q

MR = change in TR/change in Q
Less Than
A monopolist's marginal revenue is always ________ _______ the price of its good because:

The demand curve faced by the monopoly for its product is downward sloping.

When a monopoly drops the price to sell one more unit, the revenue received form previously sold units also decreases.
Maximizes Profit
A monopoly (like all firms) ___________ ________ by producing the quantity at which marginal revenue equals marginal cost and the slope of MC > slope of MR.
Demand Curve
The ________ _________ determines the maximum price a monopoly can charge to sell that quantity to consumers.
A ____________ may earn positive economic profits, which in the presence of barriers to entry prevents other firms from entering the market to reap a portion of those profits.
Markup Rule
More elastic the demand, lower markup.

Less elastic the demand, higher markup.
Welfare Cost of a Monopoly
In contrast to a competitive firm, the monopoly charges a price above the marginal cost.

From the standpoint of consumers, this high price makes monopoly undesirable.

However, from the standpoint of the owners of the firm, the high price makes monopoly very desirable.
Deadweight Loss
Because a monopoly sets its price above marginal cost, it places a wedge between the consumer's willingness to pay and the producer's cost. This wedge causes the quantity sold to fall short of the social optimum.

The consumer and producer surplus that is lost due to the monopolist charging a price in excess of marginal cost.
Governments Response to Monopolies
1. Making monopolized industries more competitive through anti-trust laws.

2. Regulating the pricing behavior of monopolies.

3. Turning some private monopolies into public enterprises.

4. Doing nothing at all.
Antitrust Laws
Are a collection of statutes aimed at curbing monopoly power.

Give government various ways to promote competition.
-prevent mergers
-break up companies
-prevent companies from performing activities that make makes less competitive
Sherman Antitrust Act
1980: Reduced the market power of the large and powerful trusts of that time period.
Clayton Act
1914: Strengthened the government's powers and authorized private lawsuits.
Natural Monopoly
Rather than regulating a _________ ____________ that is run by a private firm, the government can run the monopoly itself.

Ex: the U.S. Postal Service
A firm that is the sole seller in its market.

Faces a downward-sloping demand curve for its product.

Marginal revenue is always less than the price of its good.

Maximizes profit by producing the quantity at which marginal cost and marginal revenue are equal.

Its price exceeds its marginal revenue, so its price exceeds marginal cost.

Profit-maximizing level of output is below the level that maximizes the sum of consumer and producer surplus.

Inefficiencies can be addressed with antitrust laws, regulation of prices, or by turning it into a government run enterprise.
Imperfect Competition
Refers to those market structures that fall between perfect competition and pure monopoly such as monopolistic competition and oligopoly.
Two Types of Imperfectly Competitive Markets
1. Monopolistic Competition

2. Oligopoly
Monopolistic Competition
Many firms selling products that are similar but not identical, typically engaging in non-price competition.
Only a few sellers, each offering a similar or identical product to the others, where the actions of one firm influences the others.
Monopolistic Competition
Markets that have some features of competition and some features of monopoly.

Many sellers.

Some product differentiation between firms but the output of different firms are viewed as close substitutes by consumers.

Free entry and exit of firms.

Lots of non-price competition.
Many Sellers
There are many firms competing for the same group of customers.
Product Differentiation
Each firm produces a product that is at least perceived to be slightly different from those of other firms.

Rather than being a price taker, each firm faces a downward-sloping demand curve for its particular brand of the product.
Monopolistic Competition: Firms entering in the long run.
Increases the number of products or brands offered.

Reduces the demand faced by firms already in the market.

Incumbent, existing, firms' demand curves shift to the left.

Demand for the incumbent firms' products fall, and their profits decline.
Monopolistic Competition
Have market power that permits pricing above marginal cost

Level of sales depends on the price it sets.

The presence of other brands in the market makes the demand for your brand more elastic than if you were a monopolist.

Free entry and exit impacts profitability in the long run.

More limited market power than monopolies.
Implications of Product Differentiation
The differentiated nature of products in monopolistically competitive markets implies that firms in these industries must continually convince consumers that their products are better than or different from their competitors and/or maintain a cost advantage in production.
Monopolistic Competition
The good to consumers:
-Product variety

The bad to society:
-P > MC
-Excess capacity

The ugly to managers:
-P = ATC > minimum of average costs
- Pressures for zero profits in the long run
When firms sell differentiated products and charge prices above marginal cost, each firm has an incentive to __________ in order to attract more buyers to its particular product as well as to increase brand loyalty.

Typically takes up between 10 and 20 percent of a firm's revenue.
Advertising Critics
Argue that firms do this in order to manipulate people's tastes (lower price elasticity of demand - increase brand loyalty).

They also argue that it impedes competition by implying that products are more different than they truly are.
Advertising Defenders
Argues that it provides information to consumers.

Argues that it is another form of competition by offering a greater variety of products and prices.
Brand Names
Critics argue that _______ ________ cause consumers to perceive differences that do not really exist.

Defenders have argued that _______ ________ may be a useful way for consumers to ensure that the goods they are buying are of high quality.
-providing information about quality.
-giving firms incentive to maintain high quality.
Manipulative- increase D and decrease Ed/increase brand loyalty

Informative- increase D and increase Ed
Optimal Advertising
Advertise to the point where the additional revenue generated from advertising equals the additional cost of advertising.
Perfectly Competitive
Firms operating in a __________ ____________ market take the market price as given.

-Produce output where P = MC.
-Firms may earn profits or losses in the short run.
-But, in the long run, entry or exit forces profits towards zero.
A ____________ firm, in contrast, can earn persistent profits provided that source of monopoly power is not eliminated.
Monopolistically Competitive
A ____________ ___________ firm can earn profits in the short run, but entry by competing brands will tend to erode these profits over time.