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Econ Ch. 9
Terms in this set (42)
Imperfectly Competitive Industry
An industry in which single firms have some control over the price of their output
**Imperfect competition does not mean that NO competition exists in the market. Firms can differentiate their products, advertise, improve quality, market aggressively, cut prices and so on...
**The competition is not "perfect in the sense that all firms are not forced to charge the same price
An imperfect competitive firm's ability to raise price without losing all of the quantity demanded for its product
An Industry with a single firm that produces a certain product for which:
1) There are NO close substitutes
2) Significant barriers to entry exist to prevent other firms from entering the industry to compete for profits
No Close Substitutes
Without close substitutes, a monopolist can raise its prices without fear of consumers switching product; this gives the monopolist power over the price --> the fewer substitutes there are, the LESS elastic the demand is and the more POWER the monopolist has
Defining Industry Boundaries
The ease with which consumers can substitutes for a product limits the extent to which a monopolist can exercise market power; the more BROADLY a market is defined, the more difficult it becomes to find substitutes
Barriers to Entry
Something that PREVENTS new firms from entering and competing in imperfectly competitive industries
In order to maintain market power, the monopolist must be able to prevent other firms from entering this industry; if other firms enter, it is no longer a monopoly
Barrier give monopolists positive profits
Types of Barriers of Entry
1) Government Franchising or Licensing
3) Grants exclusive use of patented product to its inventor for a limited period of time
3) Economies of scale or other cost advantages
4) Ownership of a scarce factor of production
Monopoly: Marginal and Total Revenue
*From Points A to B is Elastic, Point B is Unit Elastic, and Point B to C is Inelastic
*A monopoly will NEVER choose a quantity with negative marginal revenue; it will always choose to be on the ELASTIC portion of its demand curve
Monopoly and Profit Maximization
* To maximize profits, monopolists choose QUANTITY such that MR=MC
*Price is always determined by the demand curve at that quantity
*Monopolists will choose Q, then will charge as much as they can given that Q
*Under perfect competition, a firm would choose quantity such that MR=MC (or P=MC since P=MR under perf. competition) to MAXIMIZE PROFIT
Price and Output Decisions in Pure Monopoly Markets
*All firms, including monopolies, raise output as long as marginal revenue is greater than marginal cost
*Any positive difference between marginal revenue and marginal cost can be thought as marginal profit
*The profit-maximizing level of output for a monopolist is the one at which marginal revenue equals marginal cost MR=MC or P=MR
The Sad Monopolist (negative profit monopolist)
If ATC is than where MR and MC intersect
Zero Profit Monopolist
Tangent Point of Demand and ATC
The Stupid Monopolist
Example: Chester Carlson invented the photocopier, but he did not have the facilities to produce it. He peddled the idea to a number of firms to get them to produce it.
IBM turned him down because Arthur D. Little consulting told them total national demand for too low to support the investment. So, they passed up the chance, as did GE and others...oops.
Chester went off and created the Xerox Company which was a very successful monopolist for years (others have since entered the market).
NOTE: Today the average American worker makes 10,000 copies a year.
Monopoly and the Supply Curve
*A monopoly firm has no supply curve that is independent of the demand curve for its product
Monopoly and the Supply Curve
*A monopoly has NO supply curve that is independent o the demand curve for its product
*A monopolist sets both PRICE and QUANTITY and the amounts of output that it supplies depends on both its marginal cost curve and the demand curve that it faces
Monopoly vs. Perfect Competition
*Compared to the perfectly competitive equilibrium, monopolists choose a lower quantity and charge a higher price
*By raising price and cutting quantity, monopolists steal surplus from consumers
*Some of this surplus goes to firms as "producer surplus" and some is lost completely (dead weight loss)
Perfect Competition Point
Where P=MC and Price Monopoly is @ PM which is above the MC price
*Monopolies might lower their prices to decrease DWL
*DWL can be both less or more than what we draw if resources were used to achieve this monopoly power in the first place
*Called "rent seeking"
Mopolies cause DWL because...
ATC MUST be above the demand curve at some point in order to continue operating.
Long run look at ATC and at short run look at variable cost
Why are monopolies bad?
1) Result in quantity less than the optimal PC quantity (and price higher than PC pride) - causes DWL
2) Monopolies do not have as much incentive to cut costs; to begin with, mopolist do not operate the the minimum of ATC like PC firms do (in the long run)
3) Monopolies often spend resources to keep their power (rent seeking) and may do other bad things to keep power
*PC firms have a big incentive to cut costs; if one firm can cut costs, that firm can earn big positive profits while other firms still earn zero profit
*The cost cutting firm can still charge the market price but faces lower costs than other firms
*While monopolies can earn MORE profit by cutting costs, the benefits are not as large as they would be for a PC firm.
*Empirical evidence suggests that monopolies do not try to cut costs as much as other, more competitive firms.
Monopolists get lazy
*Once a patent runs out, other companies can come into the market and produce a better version
*An Industry that realizes such large economies of scale in producing its product that single-firm production of that good or service is most efficient
*Classic examples of natural monopolies: Public utilities, gas, electricity, etc...
*Charging different prices to different buyers
Perfect Price Discrimination
*Occurs when a firm charges the maximum amount that buyers are willing to pay for each unit. Also called "First Degree" price discrimination
Natural Monopolies exist because of
Economies of Scales
Price Discrimination and Consumer Surplus
Remember our Gatorade example:
What if the 7-11 owner could charge you $4 for the first Gatorade, $2 for the second, and $1 for the third?
Then he could make $7 off of you rather than $3 (what he earned by charging you $1 each for all 3)
By doing this, he could take ALL your consumer surplus
Second Degree Price Discrimination
*Occurs when firms charge different prices based on unobservant consumer attributes
*By pricing in strategic ways, firms let consumers "self-select" into groups based on their willingness to pay
Ex: Quantity discounts or Costco or Sam's Club- these firms extract some consumer surplus by charging membership fees that allow you to buy large quantities for cheaper prices
Third Degree Price Discrimination
*Occurs when firms charge people different prices based on observable consumer attributes
*These factors may indicate, in some way, the consumers' willingness to pay
*Ex: Cheaper movie tickets for students or seniors; firms know that these groups have less income so they have a different demand curve than working people
Price and Output Decisions for a monopolistically competitive firms
*It turns out that the monopolistically competitive firm's problem looks just like the monopolist's problem
*The solution is the same, choose Q where MR=MC and price off the demand curve, but this demand curve is for just one firm, not the whole market
*Basically a M-comp firm acts as a monopolist of its particular "version" of the product
Monopolistic Competition vs Monopoly
*3 features distinguish monopolistic competition from monopoly and oligopoly
1) Firms cannot influence the market price by virtue of their size
2) Good (but not perfect) substitutes exist
3) There is unrestricted entry and exit (so on average, firms in a monopolistically competitive industry will earn zero profits in the long run
Ex: Pizza places in NYC
A strategy that firms use to achieve market power
*Monopolistic competitive firms achieve whatever degree of market power they have through product differentiation, in order to be chosen over competitors, products must have distinct positive identities in the mind of consumers.
Types of products differentiation
1) Types of product differentiation= Physical differences (appearance), Location = Spatial differentiation, Services, Product image = promotion, advertising, marketing, packaging
Note: Whether differences actually exist is irrelevant, what is important is that consumers THINK differences exist
Price and output determination in monopolistic competition (Product differentiation and demand elasticity)
Although the demand curve faced by a monopolistic competitor is likely to be less elastic than the demand curve faced by a perfectly competitive firm, it is likely to be more elastic than the demand curve faced by a monopoly
A monopolistically competitive firm will produce where ___ and will on average have ____profits in the long run
more firms will enter if we have positive average and the answer is always MR=MC
A form of industry (market) structure characterized by a few dominant and interdependent firms.
**Most importantly, the behavior of any one firm in an oligopoly depends to a great extent on the behavior of others (this is what we mean by "interdependent").
Basically, the oligopolists band together to act as one big monopolist.
The behavior of any given oligopolistic firm depends on the behavior of the other firms in the industry comprising the oligopoly.
Characteristics of Oligopolies
Products may be homogeneous or differentiated.
Oligopolistic industries often have significant barriers to entry (usually cost related but could be legal).
When those barriers to entry come in the form of economies of scale, the oligopoly is sometimes called a "natural oligopoly" (remember natural monopolies?)
The act of working with other producers in an effort to limit competition and increase joint profits.
A group of firms that gets together and makes joint price and output decisions to maximize joint profits.
Collusion occurs when price- and quantity-fixing agreements among producers are explicit. Tacit collusion occurs when such agreements are implicit
**Watching what other companies are doing and copy them
**The colluding oligopoly will face market demand and produce only up to the point at which marginal revenue and marginal cost are equal (MR=MC) and price will be set above marginal cost
THIS SET IS OFTEN IN FOLDERS WITH...
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