Micro Econ Test #3
Good ****ing Luck
Terms in this set (37)
System of market structure is based on two dimensions
1) the number of firms in the market (one, few, or many)
2) whether the goods offered are identical or differentiated
Different but considered at least somewhat substitutable by consumers (coke vs pepsi)
many firms each sell an identical product
all market participants are price-takers - when there is enough competition, competition is what economists call "perfect" eery firm is a price-taker.
When the number of competitors is large it doesn't even make sense to identify rivals and engage in aggressive competition bc each firm is too small within the scope of the market to make a significant difference.
single firm sells a single undifferentiated product
a few firms more than one but not a large number sell products that may be either identical or differentiated
many firms each sell a differentiated product (producers of economic textbooks)
a firm whose actions have no effect on the market price of good or service it sells
Perfectly competitive industry- industry in which firms are price-takers
A consumer whose actions have no effect on the market price of the good or service he/she buys.
market price is unaffected by how much or little of the good the consumer buys.
Perfect Competition Graph
Demand curve is horizontal.
if firm charged more than the market price, buyers would go to any of the many alternative sellers of the same produt.
For an industry to be perfectly competitive;
two necessary conditions
1) it must contain many firms none of whom have a large market share (fraction of the total industry output accounted for by that firms output)
Thousands of wheat farmers, none of whom account for more than a tiny fraction of total wheat sales.
-Assume that firms are price-takers only when they are numerous and relatively small
2) if consumers regard the products of all firms as equivalent - standardized product
Standardized Product -(commodity) when consumers regard the products of different firms as the same good
Wheat is standardized; one farmer cannot increase the price for his/her wheat w/o losing all sales to other wheat farmers.
Free Entry and Exit
It is easy for new forms to enter the industry or for firms that are currently in the industry to leave.
When there are no obstacles to entry into or exit from an industry we say that the industry has free entry and exit
firm that is the only producer of a good that has no close substitutes. An industry controlled by a monopolist is known as a monopoly.
Barrier To Entry
To earn economic profits, a monopolist must be protected by a barrier to entry - something that prevents other firms from entering the industry
Four Barriers to Entry:
1) Control of a scarce resource or input: a monopolist that controls a resource or input crucial to an industry can prevent other firms (De Beers Diamonds)
2) Economies of Scale: Larger firms are more profitable and drive out smaller ones. Established firms have a cost advantage over any potential entrant-potent barrier to entry.
monopoly created and sustained by economies of scale is called a natural monopoly exits when economies of scale provide a large cost advantage to a single firm that produces all of an industries output
(Water, Gas, Electricity, Local land-line phone service, cable television)
3) Technological Superiority: advancement, in certain high-tech industries, technological superiority is not a guarantee of success against competitors.
4) Government Created Barriers: monopoly protected by government-created barriers. Patents: gives an inventor a temporary monopoly in the use or sale of an invention Copyright: gives the creator of a literary or artistic work the sole right to profit from that work.
only a few firms is known as an oligopoly; a producer in such is known as a oligopolist.
Oligopolists compete with each other for sales. They know their decisions about how much to produce will affect the market price. Have some market power.
Imperfect Competition: when no one firm has a monopoly but producers nonetheless realize that they can affect market prices. (oligopoly and monopolistic competition)
Examples: Three firms Chiquita, Dole, and Del Monte which own huge banana plantations in central america control 65% of world banana exports.
Most cola beverages are sold by coca-cola and pepsi.
Is it an oligopoly or not? (!!!!!!!)
Concentration ratios: measure the percentage of industry sales accounted for by the "X" largest firms, for example the four-firm concentration ratio or the eight-firm concentration ratio.
Herfindahl-Hirschman Index: is the square of each firms share of market sales summed over the industry. It gives a picture of the industry market structure.
Monopolistic Competition (2)
Some market power; has some ability to set own price. But exactly how high the price can be set is limited by the competition it faces from other existing and potential firms that produce close, but not identical products.
Market structure in which there are many competing firms in an industry each firm sells a differentiated product, and there is free entry into and exit from the industry in the long run. (restaurant and gas station industries)
Monopolistic Competition Explained
1) Large Numer: many firms (does not look like a monopoly or an oligopoly where each firm has only a few rivals) istead each seller has many competitors. many vendors in a big food court, many gas stations along a major highway, many hotels at a popular beach resort.
2) Differentiated Products: each firm has a product that consumers view as somewhat distinct from the products of competing firms (different styles/types, locations, levels of quality) at the same time consumers see these products as close substitutes.
3) Free entry and exit in long run
differs from 3 market structures
Perfect Competition: firms have some power to set prices
Monopoly: firms face some competition
Oligopoly: there are many firms and free entry, which eliminates the potential for collusion
Perfect competition maximizing profit
profit is maximized by producing the quantity at which the marginal revenue of the last unit produced is equal to its marginal cost.
optimal output rule: marginal revenue=marginal cost
(or when revenue is a little higher than cost)
Price-taking firm's optimal output rule say that a price-taking firms profit is maximized by producing the quantity of output at which the market price is equal to the marginal cost of the last unit produced.
in a price-taking firm marginal revenue is equal to market price; price taking firm cannot influence the market price by its at ions.
marginal revenue=price=demand perfectly elastic.
should producer produce at all? if yes, next question is how much? : maximizing profit by question, by choosing quantity of output at which marginal cost is qual to price. (marginal price =mc)
horizontal demand curve (MR=D=P)
When is production profitable?
(firms make their decisions with the goal of maximizing economic profit-measure based on the opportunity cost of resources used by the firm)
(implicit costs; forgone explicit costs; actually paid)
always based on economic profit!
Whether the market price is more or less than the farms minimum average total cost.
Profit= total revenue-total cost
If firm produces a quantity at which...
TR > TC - Profit > 0 (profit)
TR=TC - Profit=0 (normal-oppurtunity cost doing as well as your next best alternative)
TR < TC - Profit < 0 (loss)
if the firm produces a quantity at which
P > ATC the firm is profitable
P=ATC, the firm breaks even
P < ATC the firm incurs a loss
1)What Q should be produced MR=MC
2) What is profit Profit=(P-ATC) * Q
Break Even Price
of a price taking firm is the market price at which it earns zero profits or (normal profit). Miniumum average total cost.
Should the Perfectly competitive firm keep producing in the short run
Price < Minimum Average Total Cost => Loss (exit in long run)
In short run can we cover some fixed cost
if PRICE greater than MIN AVC => keep producing in short run (cover some fc)
if PRICE < AVC => Shut down in short run
(can't cover all vc or fc)
SHUT DOWN PRICE: a firm will cease production in the short run if the market price falls below the shut down price, which is equal to minimum average variable cost
Whenever price falls between min atc and min avc the firm is better off producing some output in the short run. The reason is that by producing, it can cover its variable cost and at least some if its fixed cost event hough it is incurring a loss.
When is firm better off shutting down
if price is below min average variable cost in the short run, or below minimum average total cost in the long run
industry behaviors differ in the short and long run why?
Industry supply curve shows the relationship between the price of a good and the total output of the industry of as a whole.
Short Run Industry Supply Curve
Short run number of firms in an industry is fixed, there is no entry or exit.
Industry supply curve; shows the total amount of a good that all of the firms in an industry will produce at different prices.
Short run industry supply curve; shows how the quantity supplied by an industry depends on the market price, given a fixed number of firms.
Where supply and demand intersect; short run market equilibrium; the quantity supplied equals the quantity demanded.
(Long run different bc firms can enter and exit market)
The Long Run Industry Supply Curve
long-run market equilibrium; when the quantity supplied equals the quantity demanded, given that sufficient time has elapsed for entry into and exit from the industry to occur.
(All existing and potential producers have fully adjusted to their optimal long-run choices; as a result, no producer has an incentive to either exit or enter the industry)
-The price is equal to marginal cost in a long-run equilibrium in perfect competition.
-The total cost of production is minimized when a competitive industry is in a long-run equilibrium.
-In long-run equilibrium, the market price equals minimum average total cost.
In a perfectly competitive industry with free entry and exit each firm will have zero economic profits in long run equilibrium.
Long run market equilibrium of a perfectly competitive industry is efficient; no mutually beneficial transactions go unexploited
In long run, firms will enter the industry whenever existing firms are making a profit, that is whenever the market price is above the break-even price.
When additional farms enter the industry the quantity supplied will increase. The short-run industry supply curve will shift to the right which will alter the market equilibrium and result in a lower market price.
Existing farms will respond to the lower market price by reducing their output but the total industry output will increase because of the large number of firms in the industry
-When new firms enter supply increases, price decreases, quantity increases, continues till profit=0 (no incentive for firms to enter or exit)
Production and Efficiency in Long-run Equilibrium
1) in a perfectly competitive industry in equilibrium, the value of marginal cost is the same for all firms. (all firms produce the quantity of output at which marginal cost equals market price, and as price takers they all face the same market price)
2) with free entry and exit, each firm will have zero economic profit in the long run equilibrium. Each firm produces the quantity of output that minimizes its average total cost.
3) long-run market equilibrium of a perfectly competitive industry is efficient: no mutually beneficial transactions go unexpoloited. (market price matches all consumers willing to pay at least the market price with all sellers who have a cost of production that is less than or equal to the market price)
long run equilibrium; efficient; costs are minimized; every consumer willing to pay the cost of producing the good it gets.
downward sloping marginal revenue & download sloping demand.
sole supplier of its good.
to sell more output, it must lower the price; by reducing output it raises the price.
increase in production by a monopolist has two opposing effects on revenue:
quantity effect: one more unit is sold, increasing total revenue by the price at which the unit is sold
Price effect: in order to sell that last unit, the monopolist must cut the market price on all units sold. this decreases the total revenue.
The quantity effect dominates the price effect when total revenue is rising, the price effect dominates the quantity effect when total revenue is falling.
at low levels of output, the quantity effect is stronger than the price effect as the monopolist sells more it has to lower the prie on only very few units so the price effect is small. As output rises total revenue actually falls. This reflects that at high levels of output the price effect is stronger than the quantity effect as the monopolist seeks more, it now has to lower the price on many units of output making th price effect very large.
Monopolist profit-maximizing output and price
if marginal revenue exceeds marginal cost, the company increases profit by producing more; if marginal revenue is less than marginal cost, the company increases profit by producing less.
MR=MC (at the monopolists profit maximizing quantity of output)
Monopolists marginal revenue is influenced by the price effect, so that marginal revenue is less than the price
P > MR=MC at the monopolists profit maximizing quantity of output.
Monopolist produces less than competitive industry.
Compared to a competitive industry a monopolist:
produces smaller quantity
charges a higher price
earns a profit
perfect competition and monopoly
perfectly competitive industry can have profits in the short run but not in the long run. (long run P=Min ATC)
In the short run price can exceed average total cost, allowing for a perfectly competitive firm to make a profit. In long run any profit in a perfectly competitive industry will be competed away as new firms enter the market.
While monopoly can earn a profit or a loss in the short run, barriers to entry make it possible for a monopolist to make positive profits in the long run.
A monopolist who charges everyone the same price is known as a single-price monopolist.
Others sell the same good to different costumers for different prices; which is price discrimination.
price discrimination takes place under oligopoly and monopolistic competition as well as monopoly.
does not happen under perfect competition.
(captures all consumer surplus)
two groups of consumers differ in their sensitivity to price - that a high price has a larger effect in discouraging purchases by students than by business travelers.
As long as different groups of costumers respond differently to the price, a monopolist will find that it ca capture more consumer surplus and increase its profit by charging different prices.
Perfect Price Discrimination
when a monopolist charges each consumer his or her willingness to pay-the maximum that the consumer is willing to pay.
the entire surplus is captured by the monopolist in the form of profit.
-the greater the number of different prices charged, the closer the monopolist is to perfect price discrimination.
the greater the number of prices the monopolist charges, the lower the lowest price, that is some consumers will pay prices that approach marginal cost.
the greater the number of prices the monopolist charges, the more money extracted from consumers.
common techniques for price discrimination:
advance purchase restrictions: prices are lower for those who purchase well in advance. this separates those who are likely to shop for better prices from those who won't.
volume discounts: often the price is lower if you buy a large quantity. this separates those who plan to buy a lot and so are likely to be more sensitive to price from those who don't.
two part tariffs: in a discount club like costco or same club (monopolistic competitors), you pay an annual fee (the first part of the tariff) in addition to the price of the items you purchase (the second part of the tariff) so the full price of the first item you buy is in effect much higher than that of subsequent items, making the two part tariff behave like a volume discount.
when a single, medium level price is replaced by a high price and a low price some consumers who were formerly priced out of the market will be able to purchase the good. the price discrimination increases efficiency because more of the units for which the willingness to pay (determined by height of the demand curve) exceeds the marginal cost are produced and sold.
PD that creates serious concerns about equity is likely to be prohibited - for example an ambulance service that charges patients based on the severity of their emergency.
characterized by INTERDEPENDENCE; a relationship in which the outcome (profit) of each firm depends on the actions of the other firms in the market.
outcome for each seller depends on the behavior for others. Firms must observe and predict the behavior of other firms.
an industry which there are only two firms - a duo ply- and each is known as a duoplist.
Sellers engage in collusion when they cooperate to raise their joint profits. A cartel is a group of producers that agree to restrict output in order to increase prices and their joint profits. (OPEC)
cartel made up of governments rather than firms.
cartels among firms are illegal.
What oligopolists do effect the decisions of everyone else.
The incentive to cheat motivates the firms to produce more than the quantity that maximizes their joint profits rather than limiting output as a true monopolist would.
producing an additional unit of a good has two effects:
a positive quantity effect; one more unit sold, increasing total revenue by the price sat which that unit is sold
a negative price effect; in order to sell one more unit, the monopolist must cut the market price on all units sold. > (reason marginal revenue for a monopolist is less than market price)