nonrival goodConsumption of the good by one consumer does not reduce the quantity available for consumption by others.nonexclusive goodOnce the good is produced, no consumer can be excluded from its consumptionmonopolyA market with a single producer selling a good that does not have any substitutes. Hence, any consumer with a preference for the good must buy from the monopolistmonopolistic competitionA market structure characterized by a large number of buyers and sellers, full information and free entry and exit but with each seller specializing in a differentiated (not homogenous) goodperfect oligopolyAn oligopolistic market where all firms sell a homogeneous good.monopolistic oligopolyAn oligopolistic market where all firms sell a slightly differentiated good.Why, in the case of a monopolist, is marginal revenue at any output less than output price?Remember, we know that MR = PX (1 - 1/ε). Since elasticity is always positive, MR less than PX must always hold. Under perfect competition, elasticity is infinite, and hence MR = PX.How would your diagrams change if the firm were loosing money, i.e., had negative profit?If the firm were losing money, the Short-Run-Average-Cost (SRAC) curve would lie entirely above the demand curve.Explain why a monopolist maximizes its long-run profit by producing that output for which marginal revenue equals long-run marginal cost.profit is the difference between total revenue and total cost; therefore in the long-run, profit is maximized where the additional revenue from producing (and selling) an extra unit of output (the Marginal Revenue), is exactly equal to the cost of producing an extra unit of output (the Marginal Cost).Can the profit-maximizing monopolist produce an output that lies in the inelastic portion of the demand curve it faces? Why or why not?No it cannot. This is because marginal revenue is negative in the inelastic portion of the demand curve it faces. Given that marginal cost is always positive and profit maximization occurs at the equality of marginal revenue and cost, producing in the elastic portion of the demand curve is not an option.Does long-run profit maximization by a monopolist imply that it must produce at the minimum point of its long-run average cost curve? Why or why not?No. All of the cost-curves (total, marginal and average) are already derived from a cost-minimization procedure. Profit maximization occurs at the equality of marginal revenue and marginal cost. This may, or may not, occur at the minimum point of the long-run average cost curveHow does the presence of monopoly create market failure and rule out Pareto optimality (efficiency)?The key point here is that market price is no longer equal to marginal cost under monopoly. Price is greater than marginal cost and profits are maximized at the equality of marginal revenue (lower than price) and marginal cost. Recall that Pareto optimality in general requires the ratio of marginal costs to be equal to the ratio of marginal rates of substitutions and this holds under perfect competition because the MRS of consumers as well as the ratio of marginal costs equals the output price ratios. If we have monopoly in even one output market, this condition will not hold and Pareto optimality will not be achieved.Why doesn't the abnormal profit of a monopolist, unlike that of the perfect competitor, reduce to zero in the long run?Abnormal profits were competed away under perfect competition because we assumed free entry and exit and an infinite number of firms capable of producing a single homogenous good. In a monopoly, we assume there is only a single firm capable of producing a good that is nonsubstitutable. Hence, whatever abnormal profits accrue to the firm is retained.Explain how price regulation of a monopoly can reduce the social cost (deadweight loss) of monopoly.The government can set a price ceiling below the profitmaximizing price of the monopolist. This will also induce the monopolist to produce a higher output than she otherwise would and thus the social cost is reduced.How do the demand curves facing the perfectly competitive firm, the monopolist, and the monopolistically competitive firm differ? Explain why these differences arise.Perfectly competitive firm - horizontal, perfectly elastic demand curve since the firm has no market power.
Monopolist - demand curve is downward sloping and identical to the market demand curve since there is only one seller.
Monopolistically competitive firm - demand curve is downward sloping (like the monopolist) but NOT identical to the market demand curve (unlike the monopolist). The demand curve now depends on the market share of the firm, which is competitively determined.In the long run, how do price and output compare for a perfectly competitive firm and a firm with the same cost curves in a monopolistically competitive environment?The output will be higher and the price will be lower for a perfectly competitive firm as compared to a monopolistically competitive firm iff we assume the following -
i) We are dealing with an industry with a large number of firms that can be organized either as a perfectly competitive industry or as a monopolistically competitive industry
ii) The firms in the industry are all identical.In what sense does the firm in an oligopoly situation face uncertainty?In an oligopoly, firms are strategically interdependent. In other words, the actions of one firm affect the quantity and price that other firms can sell and charge. Thus, the demand curve facing a firm cannot be decided unambiguously and it is in that sense that firms face uncertainty.How do the oligopoly models of price leadership by a dominant firm, a cartel, and the kinked demand curve get around this uncertainty?Price leadership model assumes 1) Homogeneous goods, 2) There is one dominant firm and other firms follow and 3) The dominant firm sets the price and then allows other firms to sell whatever they can at that price.
Cartel assumes 1) Homogeneous good and 2) All firms band together to act as a monopoly and maximize the aggregate profit of all firms.
Kinked demand curve model assumes - 1) Differentiated good 2) Each firm faces two demand curves - one showing the situation where all other firms follow and the other showing the situation where no other firm follows 3) The two demand curves facing the firm intersect at the prevailing market price and 4) All other firms follow price cuts but no other firm follows price hikes.In the price-leadership-by-a-dominant-firm model a. After the dominant firm sets the market price, what is the output-supply behavior of the remaining firms in the industry?Once the dominant firm sets the market price, the outputsupply of the remaining firms can be read off from the ΣMCi curve. This is because all other firms behave as perfectly competitive firms and thus the summation of the marginal costs of individual firms gives us the market supply (excluding the dominant firm) once the market price is setIn light of the supply behavior of the remaining firms, how is the demand curve facing the dominant firm calculated?In light of the supply behavior of the remaining firms, the demand curve facing the dominant firm becomes the difference between the market demand at a particular price and the output supplied by all other firms at that price.How does the presence of monopolistic competition or oligopoly create market failure and rule out Pareto optimality (efficiency)?Again, the key point here is that market price is no longer equal to marginal cost under either monopolistic competition or oligopoly. Price is greater than marginal cost and profits are maximized at the equality of marginal revenue (lower than price) and marginal cost. Recall that Pareto optimality in general requires the ratio of marginal costs to be equal to the ratio of marginal rates of substitutions and this holds under perfect competition because the MRS of consumers as well as the ratio of marginal costs equals the output price ratios. If we have monopolistic competition or oligopoly in even one output market, this condition will not hold and Pareto optimality will not be achieved.How does the presence of an externality create market failure and rule out Pareto optimality (efficiency)When we have an externality, the relevant costs to consider are the MSC and the MSB. The equality of MSC and MSB is the condition for Pareto Optimality. However, since externalities do NOT flow through the market, individual agents acting in the market take into account only private costs and benefits. Hence, even if we have perfect competition and Px = MC holds, Pareto efficiency is not achieved.Explain why, in a market with a. negative externality, too much output (more than the efficient amount) is produced and sold.Assuming MEB = 0 and MEC > 0, under negative externality, MSC > MC. Private agents produce where Px = MC. However, to be socially efficient, the MEC should be taken into account and the output should be lower than what private producers end up producing.. Explain why, in a market with positive externality, too little output (less than the efficient amount) is produced and sold.If you use a diagram in your answer, make that diagram large and label all axes, curves, and points.Assuming MEC < 0 and MEB = 0, under positive externality, MSC < MC. Private agents produce where Px = MC. However, to be socially efficient, the negative MEC should be taken into account and the output should be higher than what private producers end up producing.Describe two methods for correcting the inefficiencies caused by the presence of an externality in a marketThe two methods are - 1) Taxes for negative externalities and Subsidies for positive externalities (often called Pigouvian taxes and subsidies after the economist A.C.Pigou).
2) Cap and Trade or a system of tradable pollution permits.How does the presence of a public good generally create market failure and rule out Pareto optimality (efficiency)?Given that public goods are non-rival and non-exclusive, no one has any incentive (or willingness) to pay for the good. Hence there is no market for the good, which creates a market failure and effectively rules out any possibility of achieving Pareto optimalityAssuming we know the willingnesses to pay of all individuals for a public good, explain how one could calculate the efficient amount of that good to produce. If you use a diagram in your answer, make that diagram large and label all axes, curves, and points.One could first add up the willingness to pay (WTP) of different consumers by vertically adding up their demand curves. The intersection of the aggregate WTP curve and the marginal cost curve could give us the efficient amount of the good to be produced. (A diagram is not really necessary for this question).Describe two difficulties in obtaining individuals' willingnesses to pay for a public good with any degree of accuracy. In practice, how do we actually determine the amount of a public good to produce?The two difficulties are - 1) Free-Riding Problem - Since no one can be excluded from consuming the good once it is made available, no one has any incentive to reveal their true WTP.
2) Drop-in-the-Bucket Problem - Since the actual cost of public good provision is very high, the contribution of each individual can only ever be a drop-in-the-bucket. These leads individuals to believe that their contribution to the public good does not matter and that the good will be provided regardless.
In practice, we try to determine WTP either directly through voting, or we let elected representatives make decisions about public goods on behalf of the general public.
