1B03 - Microeconomics
Two characteristics of monopolistic competition
- As in a monopoly: P > MC, MR = MC, MR < P since D is downward sloping - As a competitive market: P = ATC in LR equilibrium, free entry & exit drive economic profit to 0
Private Goods
- Both excludable and rival - Ex. Donut
In SR, loss for monopolistic firm...
- Decrease the number of products offered - Increases demand faced by remaining firms (Shifts demand of remaining to the right and increases remaining firm's profits)
Product Differentiation
- Each firm's product is at least slightly different from another firm - Ex. McDonald's and Harvey's sell burgers but they taste different *Note: Price must be around the same
Club Goods (formerly natural monopoly goods)
- Excludable but not rival - Ex. Cable TV
*OLIGOPOLY*
- Fewer sellers, big firms, homogenous/nearly identical products - Interdependence between firms - Big oil companies, soft drink market, sugar
Minimum wages
- Goal of government to ensure at least a certain wage for workers - Must be able equilibrium wage (a wage floor)
Changes in supply of other factors
- If MP changes, curve will shift - Ex. decrease supply of plastic = decrease in water bottles = decrease MP & D_L shift left * Note: Only shifts labour demand
Constant cost industry
- If input price do does not increase as market output increases, firms' costs will not change - min ATC & min LRAC will not change regardless of how much they produce - Market supply will be a horizontal line @ P = min LRAC
Advertising
- Increases competition by offering a greater variety of products and prices - People will think a firm has a quality product if they have a good advertisement because it costs a lot of money - Ex. Superbowl commercials
In SR, profit for monopolistic firm..
- Increases the number of products offered - Decreases the demand faced by firms already in the market (Existing firms: D shifts left & profits fall)
Excludability
- Prevent someone from enjoying or using the good - Ex. You can't have a candy bar unless someone gives you one or sells you one
Supply of Labour
- Reflects worker's opportunity costs - Less leisure time = more hours of wages (vise versa) - Higher wage, more expensive leisure becomes, and more work hours/less leisure an individual is willing to supply
Common Resources
- Rival but not excludable - Ex. Fish in the oceans * Note: Our enjoyment of and possible overuse/misue of these resources can diminish others' ability to enjoy them (Ex. Every time we drive we take up part of the road from others)
Increase in supply of labour
- Surplus of labour - Downwards pressure on wages - Firms can hire more workers - Diminishing MP - Lower value of MP - Gives new equilibrium
Critics argues that minimum wage causes...
- Unemployment increase - Encourages teens to drop out of school - Prevents unskilled workers form getting on-the-job training - Isn't high enough to relieve poverty of working poor
Brand names
- Useful way for consumers to ensure that the goods they are buying are of high quality
Change in attitudes
- When an individual personally feels like they need to contribute or not contribute - Ex. women wanting to work outside the home = increase labour supply * Note: Only shifts labour supply
Immigration
- Workers moving from region to region
Cartel
A group of firms acting in unison
Prisoner's Dilemma
A particular "game" between 2 captured prisons that illustrates why cooperation is difficult to maintain even when it is mutually beneficial
Nash Equilibrium
A situation in which economic actors interacting with one another each choose their best strategy given the strategies that all the others have chosen (always result in suboptimal outcome) ** ALWAYS SUBOPTIMAL ** * Note: If both firms stuck with the original agreement in the first place, they would be making more profit instead of cheating between each other
Business-stealing externalities
Other firms lose customers and profits from entry of new firms, therefore entry imposes a negative externality on existing firms
Game Theory
Study of how people behave in strategic situations
Market Supply
Sum of the quantities supplied by individual firms in a market.
The government solves this by...
Taxing each resident an amount not exceeding the value they place on the event/good *Note: However, people of the city get taxed but someone from another city can come and enjoy the event/good for free
Average revenue
Tells us how much revenue a firm receives for the typical unit sold
Oligopoly would look more like a competitive market if...
The number of sellers increase
Changes in P of goods
*- D_L = D_VMPL = P x MP_L - If P increases, D_L increases, shifts right - If P decreases, D_L decreases, shifts left* * Note: Only shifts labour demand
Equation for average revenue
*AR = TR/Q = PQ/Q = P*
Equation for marginal revenue
*MR = ∆TR/Q* (For perfectly competitive firms: MR = P) *Note: MR is the slope or TR
Relationship between marginal revenue and marginal cost
*MR > MC, firm should increase quantity (Producing one more good will add more to TR than TC, at Q1) MR < MC, firm should decrease quantity (Producing that good adds more to TC than TR, at Q2) MR = MC, profit max at that quantity*
Relationship between output effect and price effect
*OE > PE = increase production PE > OE = decrease production*
Firm will exit an industry
*P < min ATC or TR < TC* * Note: In the long run, everything is variable cost
Firm will shutdown in SR
*P < min AVC* (Variable costs cannot be covered by revenue; as long as price is above min AVC, firm will produce) *Note: Only fixed costs are still paid for.
When a perfect competition produces
*P = MR = MC* *Note: P is the demand curve
Firm will not enter nor exit an industry
*P = min ATC (LR equilibrium)*
Relationship between P and ATC
*P > ATC, firm makes positive economic profit P < ATC, firm makes negative economic profit (loss) P = ATC, firm makes 0 economic profit (considered normal economic profit)* *Note: Demand and ATC are tangent curves to each other
Output Effect
*P > MC = selling more output increases profit*
Firm will enter an industry
*P > min ATC*
Equation for coupon payment (annual payment)
*PV = C/(1 + i) + C/(1 + i)^2 + ... + (C + X)/(1 + i)^t*
Equation for present value
*PV = X/(1 + i)^t* X = amount you want to receive in period t t = amount of time i = prevailing interest rate
Relationship between PV and BS
*PV > BS = more firms are desirable (too little firms) BS > PV = fewer firms are desirable (too many firms)*
Competitive firm's demand curve
*Perfectly elastic (P = AR = MR = D)*
Relationship between monopoly, oligopoly, and perfect competition
*Pm > Po > Pc Qc > Qo > Qm*
Equation for a competitive firm's profit in the SR
*Profit = (P - ATC) x Q* * Note: True for all firms
Equation for profit
*Profit = TR - TC* * Note: The larger the distance between TR and TC, the higher profit will be
Relationship between total revenue and total cost (losses & profits)
*TC > TR = losses TR > TC = profit max*
Equation for TR, AR, and MR in a monopoly
*TR = PQ AR = P = TR/Q MR = ∆TR/∆Q*
Equation for total revenue
*Total revenue = Price x Quantity (TR = PQ)* * Note: Price would be a given value b/c firms are price takers
Equation for value of marginal product of labour
*VMPL = W = P x MP_L* VMPL = MR of the last worker hired in addition to TR W = Their wage; the MC of the last worker hired in addition to TC P x MP_L = A firm hires labour where MR_L = MC_L to max. profit
Firm may stop hiring when...
*W = VMPL (because they want to max. profit)* Additional cost of hiring the labour = additional revenue the labour generates
Equation for rental price of capital
*r = P x MP_k* P = selling P of good MP_k = Amount of captial
Free Rider
- A person who receives the benefit of a good but avoids paying for it - Ex. A fireworks show (someone can watch from their balcony)
Technological change (not those that replace labour)
- Advances = Increase in MP_L = Increase D_L * Note: Only shifts labour demand
Long Run Exit & Entry
- All costs are variable; therefore ATC (including any SR fixed costs) come into play - Firm will want to exit completely if revenue earned is consistently less than its costs
Collusion
- An agreement among firms in a market about quantities to produce or prices to change. - Tacit collusion is most common (no formal agreements) Note: Illegal by Canada's Competition Act
Increasing cost industry
- Industry output increases, demand for input increases - Input sellers may increase input prices => Raises production costs of final goods - Increase in P is required to cover increase in costs and increase in market Q supplied
*PERFECTLY COMPETITIVE MARKETS*
- Many buyers & sellers, goods are homogenous (identical), and firms can freely enter & exit the market (no barriers, such as patents) - Ex. convenience stores
*MONOPOLISTIC COMPETITION*
- Many sellers, free entry & exit (no barriers) - Ex. restaurants, most retailers
Monopolistic competition
- Many sellers, free entry & exit (no barriers) - Ex. restaurants, most retailers
*FACTOR MARKETS* Demand of Labour
- Market perfectly competitive - Firm has no control over wages (determined by market S & D) - A worker's contribution to TR is their MP
Public Goods
- Neither excludable nor rival - Ex. Lighthouse
Rivalry
- One person's use of the good diminishes the ability of another person to use it - Ex. If I'm eating a candy bar, you can't eat the same one
Changes in alternative opportunities
- When another job has better wages but similar job characters - Ex. wages of apple pickers increase, some cherry pickers would switch * Note: Only shifts labour supply
3 important public goods
1) National Defence 2) Research 3) General Knowledge
Four sources of barriers to entry in monopoly
1) Single firm owns a key resource that no other firm can access or have a close substitute for. 2) Government gives on firm the exclusive right to produce or sell some good. 3) Industry is a natural monopoly. 4) Monopoly by good management (driving out competition).
Excess capacity
A level of quantity where ATC is above min ATC (unlike perfectly competitive firms)
Dominant Strategy
Best strategy for a player to follow regardless of strategies chosen by the other players. (Result is suboptimal Nash equilibrium)
Cheating
Breaking the agreement, each would see the potential to increase their profits
Marginal revenue
Change in total revenue from an additional unit sold
Predatory Pricing
Charging too low prices hoping to drive out competitors; can lead to price wars which benefit consumers
When P = MC, you have a....
Competitive firm
Firms may charge higher P in market segment with more inelastic demand
Consumers are less flexible and less able to shop around and look for alternatives (ex. business vs. vacation flyers)
Product-variety externalities
Consumers like new products, therefore entry of new firm = positive externality on consumers
Firm hires workers when...
Contribution > Cost
Sunk costs
Costs that have already been committed and cannot be recovered
Third Degree Price Discrimination (Ordinary PD)
Firm can distinguish between different markets for its good (ex. Movie tickets, bus fares, discount coupons, quantity discount, ladies' nights at bars, ect)
If ATC is above demand curve...
Firm will make losses (will not enter market) * Note: If demand curve moves, so does that MR curve
Regulation
Government agencies can regulate the prices a monopoly may charge (set P = ATC or P = MC); if they lose money, government should subsidize firm
Public Ownership
Government can run the monopoly itself (may not be efficient)
Monopoly would do nothing
If inefficiency is small, government may stay out of it
Tying
In order to purchase monopoly good, you must purchase another competitive good at the same time
A monopolistically competitive firm will resemble a perfect competition....
In the long run
A monopolistically competitive firm will resemble a monopoly....
In the short run
Price Effect
Increase production = increase market quantity = reduces market price and reduces profit on all units sold
Competitive Law
Legislation to prevent mergers that would make the market less competitive
Perfect Price Discrimination (1st degree PD)
Monopolist knows exactly the willingness-to-pay of each customer, it will charge each customer a different price (ex. accountants)
When P > MC, you have a...
Monopolistically competitive firm *Note: An extra unit sold at the going price means more profit for the monopolistically competitive firm (adds more to TR than it does to TC)
Duopoly
Oligopoly with only two members
*MONOPOLY*
One seller of product, no close substitutes, firm is a price setter ** ALWAYS BEST **
Pay-off Matrix
Payoffs can be negative (minimize) or positive (maximize); depends on the other person's decision on action (ex. jail time)
Competitive equilibrium level when...
Price approaches marginal cost & quantity produced approaches socially efficient
Resale Price Maintenance
Requiring a retailer to sell a good at a certain price determined by the wholesaler
Public Discrimination
Selling the same good at different prices to different customers, even though the costs are the same (not possible in competitive markets)
Present value
The amount of money needed today to produce a given amount of money at a specified future date, accounting for prevailing interest rates *Note: Firm will choose investment that has the highest present value.
Competitive firm's SR supply curve
The portion of the MC curve that lies above min AVC
Inefficiency of monopoly is due to...
Too little quantity traded (Can be measured by DWL; DWL in total surplus in market) *Note: To calculate, find monopoly's profit (MR = MC) and graph. Then use (b x h)/2. Remember that profit is on the demand curve.
The purchase price
What a person pays to own an input indefinitely
The rental price
What a person pays to use an input for a limited period of time (e.g., leasing equipment)
