micro test 3

Marginal cost pricing:

A price, set by a regulator of a natural monopoly, equal to marginal cost at the corresponding quantity demanded.

Public good:

A public good has two characteristics. First, it is difficult or impossible to exclude non-buyers from consuming the good. Second, consumers can consume a public good without interfering with others' consumption of the same good.

Common resource:

A resource that can be consumed by only one producer or consumer at a time and is found in environments in which it is difficult to exclude nonpaying users.

Oligopoly:

An industry with few producers, high entry barriers, and each one has market power. They compete on either price or quantity and may charge the same or different prices.

Monopolistic competition:

An industry with many competitors, all producing slightly different products.

Suppose regulators of a natural monopoly want to regulate prices such that the monopoly will earn normal profits. The regulator should set prices equal to ________.

Average cost

A profit-maximizing firm facing economies of scale that is subject to average cost pricing regulation will produce ______________ from the standpoint of economic efficiency and ______________ economic profits.

Too little; not earn

Winner-take-all markets:

Top performers earn high income, while others, who may be almost as good, earn significantly less.

Summarize the profit-maximizing decision.

produce at the quantity where the marginal revenue equals marginal cost.

Why would firms that propose mergers claim that a merger will make them more efficient and lower their costs? How does this influence the decision by the Federal Trade Commission and Department of Justice to approve the merger?

the possibility of having a lower price and higher quantity of output produced after the merger is formed. It will make the merger approved

What would a group of competing firms, perhaps trucking firms or airlines, do if they could influence the regulation of their industries?

they would obviously prefer higher prices and producing amounts that maximize profits. In addition, firms may try to prevent price competition and entry into the industry in order to protect economic profits.

Why do we need antitrust laws? What is the goal of antitrust laws?

to maintain competitive markets that provide the lowest prices and most efficient level of output.

At the Fisherman's Wharf in San Francisco, there are a lot of seafood vendors. Suppose that there are twenty vendors selling steamed crab. If Tommy's crab shack sells 100 steamed crabs per day for $20 each, how much economic profit will Tommy earn in the long run? (Assume that the seafood vendors are operating in a monopolistically competitive market.)

0,In a monopolistically competitive industry long run profits are always zero.

Market failure:

A condition wherein private markets do not produce an economically efficient allocation of resources.

Compensating differential:

A difference in the wages of jobs with similar skill requirements when the cause is that something about the position makes it less attractive than alternative positions.

Natural monopoly:

A firm that can produce at a lower average cost per unit of output than a number of smaller firms producing a similar amount of total output.

Predatory pricing:

A firm that lowers prices with the purpose of driving competitors out of a market, increasing its own market power, and eventually reducing output and raising prices is engaging in predatory pricing.

Concentration ratio:

A four-firm concentration ratio is the percentage of industry sales sold by the four largest firms in the industry. Other similar measures that indicate the degree of market power and competitiveness are often used.

Private good:

A good and service that can be consumed by only one person at a time. It is also possible to exclude non-buyers from consuming the goods.

Cartel

A group of producers agreeing to act in concert with one another.

Labor union:

A group of workers who have organized in an effort to increase wages and improve working conditions.

Summarize in your own words what a monopolistically competitive market is and what is important about that type of market structure.

A market that is monopolistically competitive will have many firms; a variety of types of products, each one slightly different; relatively easy entry and exit; and lots of information among buyers and sellers. Given that entry and exit is relatively easy, there will not be economic profits for firms in the long run. However, firms will produce where marginal costs are less than prices, and thus less than an allocatively efficient amount of output will be produced.

Why are the cartel's profit-maximizing price and quantity similar to the monopoly price and quantity?

A monopoly maximizes its profits if it produces where marginal cost equals marginal revenue. Because a monopoly is the only firm in an industry, it is producing where industry profits are maximized.

Payoff Matrix:

A payoff matrix is usually a two-by-two table with two actors or players. Each player will have a set of actions that will result in different payoffs. Each player's payoff is dependent on both players' course of action.

Can you remember why a perfectly competitive firm faces a perfectly elastic demand curve?

A perfectly competitive firm will not influence the price of the goods. Market supply and demand will determine the equilibrium price and equilibrium quantity for the whole market. For any single perfectly competitive firm, raising price will mean that all consumers will buy their products from someone next door. From a graphing perspective, we will have a horizontal demand curve.

Average cost pricing:

A price, set by a regulator of a natural monopoly, equal to average cost at the corresponding quantity demanded.

Can you summarize the final outcome of a monopolistically competitive firm in the short run?

Average cost will not be at a minimum. Marginal cost will be less than price. Economic profits can be earned (in the short run). Average costs at each level of output (with one exception) will be as low as possible, as firms are forced through competition to use the best technology and least expensive inputs.

A firm engaged in predatory pricing will set its price in which of the following ways?

Below the average cost to drive out competition and then increase price

Derived demand:

Demand that is derived from the demand for something else. The demands for inputs into the production process are derived from the demand for the goods and services that they produce.

Tony's Gas Station and Robert's Gas Station are the only two gas stations in a small town of Westville. If Tony and Robert collude to earn more profits, which of the following would be true?

Each limit the amount of gasoline available and raise prices

Is the demand curve facing one of the firms in a cartel more elastic or less elastic than market demand? Why?

Elastic, because the change in price would change the amount of customers they get

Mergers can sometimes be socially beneficial if they do which of the following?

Enhance the quality of the products

In the long run, a monopolistically competitive firm will produce where price _________.

Equals average cost and is greater than the marginal cost

Social benefit:

External benefits plus private benefits.

Social cost:

External costs plus private costs.

Can you explain why prices below average variable costs or below marginal cost might be predatory pricing?

Firms would not produce a level of output where price is below marginal cost or where price is below variable average cost if they are profit-maximizing in the short run.

In your own words, explain the economic role of government in a market economy.

Governments can serve to increase efficiency in markets with external costs or external benefits by introducing taxes or subsidies to producers (or consumers).

For a product with external costs, the social cost curve lies above the market supply curve. Explain why that is the case.

If one curve lies above another, then the marginal costs depicted in the higher curve exceed the marginal costs depicted in the lower curve at any given quantity of production.

If the marginal cost is zero, how much of a good should be produced? Or how many customers should be allowed or encouraged to consume the good? Why?

If there is no marginal cost of producing additional quantities, and if consumers derive any marginal benefit from the good at all, then the allocatively efficient quantity of production is "as much as possible" and as many consumers as possible should consume the good.

How does a monopoly choose its price and output? How does this compare to the price and output in a competitive industry? Which one benefits consumers more?

Just like any other firm, the monopoly is assumed to maximize its profits by setting marginal revenue equal to marginal cost and producing at that level of output while setting the price as high as possible on the demand curve at that level of output.

Antitrust law:

Legislation that restricts deliberate formation of monopolies and prevents firms from engaging in anticompetitive practices.

A monopolistically competitive firm in the long run will produce an amount that is_______ the quantity where average cost is at a minimum and charge a price that is______ marginal cost.

Less than; greater than

Once a government has introduced a proper (that is, economically efficient) policy to address the market failure, the price of a good that has external benefits will be ______________ than its free market price and the price of a good that has external costs will be ______________than its free market price.

Lower; higher

Demand curves in competitive markets represent which of the following?

Marginal benefit to consumers

Regulators of a natural monopoly concerned most with economic efficiency will set prices equal to ________.

Marginal cost

Supply curves in competitive markets represent which of the following?

Marginal costs of production

A large number of firms in Biergarten sell flavored beer. However, each firm faces a downward-sloping demand curve. The market for flavored beer is _________.

Monopolistically competitive

In which of the following markets do sellers have the highest profit level?

Monopoly

Suppose that the Peached Tortilla is one of ten food trucks in the town of Happyville, and every food truck is earning substantial economic profits. What is likely to happen in the long run?

New food trucks will enter the market and gradually all food trucks will earn zero economic profits.

Can you suggest one possible part of an antitrust law that would enhance efficiency? Suggest something other than simply making single powerful companies illegal. What might be a cost of such a law?

One obvious answer is to prevent mergers. A second might be to make price agreements among companies illegal. The costs of such laws include the administrative costs, but more important in the case of mergers is the prevention of some mergers that might increase competition or lower costs or enhance quality of the output.

In which of the following markets do sellers act as price takers?

Perfect competition

Assume that average costs are the same for all firm sizes and types of market structure. Assume that oligopolies compete a bit with one another. Which of the following represents the likely ranking of prices, from low to high, in the long run?

Perfect competition, monopolistic competition, oligopoly, monopoly.

A monopolistic competitive firm will incur loss if which of the following is true?

Price is lower than average total cost

How would you classify television broadcasts?

Public goods

Common resources are used too ______________ for economic efficiency because the marginal cost of using the resource is ______________ than if the resources were private goods.

Quickly; lower

Suppose that a local Italian restaurant is operating in a monopolistically competitive environment and is maximizing its profit. The price of spaghetti with meat sauce is $10 and the average total cost is $7. Based on this information, the firm is operating in the ______ and we can expect______.

Short-run; firms to enter the market

In efforts to increase economic efficiency, governments should ______________ goods with external benefits.

Subsidize

Fishing, as an industry, is in trouble around the world due to declining fish populations. Some countries are subsidizing their fishing industries in order to assist them. What do you think of that as a policy to aid fishermen?

Subsidizing fishing industries is exactly the wrong thing to do as it encourages more fishing, thereby worsening the fish population problem.

In efforts to increase economic efficiency, governments should ______________ goods with external costs.

Tax

Wages:

The amount paid workers, usually including fringe benefits such as health insurance, retirement, and vacation.

External benefit:

The benefits received by individuals other than the producer or consumer.

Explain why the efficient amount of production in a competitive market with external benefits is greater than the equilibrium market quantity.

The benefits, derived from the marginal social benefit curve, are higher than the supplier's costs at that point, derived from the supply curve. The market should produce more of this good - and keep producing as long as the social benefit exceeds the cost.

What if new methods of distributing movies online to personal computers are created? A number of companies are offering the service. The company that produces the dominant operating system enters the market by creating its own built-in software. It is automatically included as part of its operating system and does not create a separate, identifiable charge. Other movie software can still be used and is compatible. What difference does it make if other movie software is no longer compatible? If the dominant operating system company is guilty of violating antitrust law, what is the proper remedy?

The company has a monopoly in operating systems, perhaps because it is an effective system. The advantages to users are that it is widely used and there are many applications. However, to expand the monopoly to another product does not make sense. The firm should not be allowed to provide the movie distribution system as part of its operating system.

Suppose a company produces a computer operating system that the vast majority of personal, educational, and businesses users purchase. Should antitrust law be used to divide the company into smaller divisions that would compete with one another?

The company has grown into a monopoly because it is doing what consumers demand. It may well earn economic profits for some time and may produce at less than an economically efficient output. The trade-off is the provision of a new effective product with the possibility that for some time the firm may not offer the product at an economically efficient price or output level.

Consider a profit-maximizing firm with significant economies of scale that is subject to marginal cost pricing regulation. The regulation will produce ______________ production from the standpoint of economic efficiency and the firm will ______________ economic profits.

The correct amount; not earn

External cost:

The costs of producing a good or service that are borne by individuals other than the producer or consumer.

What can you say about the equilibrium quantity of production for a market with external costs?

The equilibrium market quantity is too high and the equilibrium market price is too low, relative to the efficient point.

What can you say about the equilibrium quantity of production and the equilibrium price for a market with external benefits?

The equilibrium market quantity is too low, and the equilibrium market price is too low, relative to the efficient level of production.

Human capital:

The factors such as experience, skills, education, and work habits that affect the value of a worker's marginal product.

Marginal revenue product of labor:

The increase in revenue resulting from the hiring of one additional worker.

The purpose of government regulation of natural monopolies is to do which of the following?

To allow monopolies to exist when they can produce at lower costs

Suppose two firms want to merge in order to save costs. Charter Communications and Time Warner Cable are recent examples in the cable TV and broadband internet industry. Also suppose that they will be able to lower costs of providing services by 30 percent. Should antitrust law stop the merger? Why or why not? Should Ford and BMW merge? Should CNN and Fox News?

The issues are the cost savings versus the increased market power that can be used by the resulting merged company. The analysis of the trade-offs is not easy to make. Clearly, there are gains and increased technical efficiencies from this type of merger. However, if the merger significantly decreases competition and makes an implicit or explicit cartel a much more likely outcome, allocative efficiency will suffer.

Marginal social benefit:

The marginal benefit of consumption from society's point of view.

Marginal social cost:

The marginal cost of production from society's point of view.

Is marginal revenue facing a single firm in the cartel different than the marginal revenue curve facing the whole market? Which is higher and why?

The marginal revenue for the individual firm includes the marginal revenue for the entire industry plus some additional revenue that it takes away from the other existing firms.

Will the monopolistically competitive firm tend to have a more elastic or less elastic demand than a monopoly? Explain why.

The monopolistically competitive firm will have a more elastic demand than a monopoly because there will likely be more close substitutes. A monopoly has fewer substitutes and no close substitutes.

Summarize, in your own words, the economic model of oligopolistic behavior.

The moral of the story is that oligopolistic industries will benefit from agreements to price and produce like monopolies. If they are able to do that, they will be able to maximize profits for all firms together, that is, for the entire industry.

Real wages:

The nominal wage adjusted for the effects of inflation.

Demand for labor:

The quantity of labor demanded at each wage rate. Derived from the marginal revenue product at each level of employment.

Supply of labor:

The quantity of labor that workers are willing to supply at each wage level.

Assume a firm creates an effective new software application (the so-called "killer" application). Sales of the application increase rapidly and soon the firm is a large, profitable monopoly. Should antitrust law be used to change the market outcome? Why or why not?

The rewards of the new application function as an incentive for firms to create new products - the "killer" applications. However, the reason the applications are called "killer" is that the competition will be killed. The conflict, in this case, is that the market is working to encourage innovation, but once the monopoly is created, the outcome will not be economically efficient.

Nominal wages:

The wages workers are paid without adjusting for inflation.

What should antitrust law do when two major firms representing substantial portions of a market propose to merge? The firms argue that combining the two firms will allow the firms to provide the same total services at lower cost and improve the quality more rapidly with the combined research and development division.

There are advantages of the lower costs, but the disadvantage is the increased likelihood of higher prices and lower output. The answer ultimately depends upon how easy entry is and how much competition remains in the industry.

What is the rationale to use in setting price, if the firms in the entire industry are acting together?

We would maximize the profit for one firm within any industry structure. For firms operating in an oligopoly industry structure, setting marginal revenue equal to marginal cost will achieve that goal of maximizing profits for the industry.

The economically efficient amount of pollution will be zero when which of the following is true?

When costs of pollution are greater than the marginal costs of pollution reduction at all levels of pollution.

Explain what will happen to economic efficiency when two firms agree to set prices and produce a mutually agreeable level of output.

When firms agree to set prices and produce a mutually agreeable level of output, economic efficiency will likely be reduced. We know this because firms wouldn't bother trying to agree on a price unless they were trying to increase it. They can only increase price by also agreeing to produce less. If they were willing to produce more at a lower price without the agreement, we know that the marginal cost of those units would be less than the marginal benefit (the price consumers were willing to pay), so economic efficiency falls.

Compare the outcomes (prices, outputs, profits, and economic efficiencies) of a competitive market and one in which the producers are able to act and set prices as though they were a monopoly. What would antitrust law try to accomplish?

When markets are competitive, firms accept the market price and will produce more, putting downward pressure on price until price is equal to each firm's marginal cost. If marginal cost is above average total cost, firms will enter, increasing supply until price is equal to the minimum of average cost. If price is equal to average total cost, economic profits are zero.

The reason to regulate a natural monopoly is that a natural monopoly ______________ produce an economically efficient amount of output, ______________ charge a higher price than the perfectly competitive industry, and ______________ have lower average costs than a perfectly competitive industry.

Will not; may; will

Compare the levels of economic profits in a long-run equilibrium for a perfectly competitive firm, a monopoly, a monopolistically competitive firm, and an oligopoly. Economic profits will most likely be:

Zero in perfect competition and monopolistic competition, perhaps positive in a monopoly and perhaps positive in oligopoly

Can you give some examples of situations in which markets may not be efficient?

a market with a monopoly supplier

What will happen in the monopolistically competitive industry if fixed cost decrease?

economic profits will increase.

What will happen in the monopolistically competitive industry if variable costs increase?

firms will reduce production.

What will happen in the monopolistically competitive industry if demand increases?

in the short run marginal revenue will rise. Firms will increase output since marginal revenue exceeds marginal cost. Economic profits will rise in the short run, new firms will enter, and this will lower demand for each firm's output; thus, profits will go down again.

Why would there ever be doubt about using antitrust law to force monopolistic or oligopolistic markets to be competitive?

it could make prices go up