Microeconomics Chapter 11

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

Demand facing a single firm is more elastic. This is because a small decrease in price will not only attract more buyers (movement along the market demand curve) but it will also attract buyers from the other members of the cartel who are charging a higher price.

What is similar and what is different between the automobile industry and restaurant industries?

There are far more competitors in the restaurant industry than in the automobile industry. This is likely due to the barriers to entering the automobile industry compared to opening a new restaurant. There are much larger economies of scale in the automobile production compared to the production of a meal. Both industries produce goods that are unique when compared to a competitor's product.

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

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

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.

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

​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 long run, new firms will enter, and this will lower demand for each firm's output; thus, profits will go down again.

What might happen if one firm lowers its price?

​If one firm lowers it price it will likely attract new customers and attract some existing companies' customers away.

What incentives does Ford have to lower prices? What happens to all of the firms? What are the incentives and what might happen as a result?

​Profits will increase for Ford if it can lower prices and get away with it, that is, not have General Motors also lower prices. The same is true for General Motors. However, when Ford lowers prices, General Motors will find its profits falling rather dramatically as customers switch to Ford. To protect itself, General Motors may well lower prices in response to the initial cut by Ford. The end result is that both companies end up earning less than they could have earned if they all kept their higher prices.

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 include the marginal revenue for the entire industry plus some additional revenue that is take 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. The greater number of substitutes will cause elasticity to increase. It is easier for individuals to switch to consuming other goods when prices rise.

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. However, there is always the incentive to "cheat" on the agreement. A firm that lowers its prices will do so to increase its own production and profits. However, other firms will match the decreases. That cheating on the original attempts to maximize industry profits will result in lower profits, lower prices, and greater quantities for all firms together than the monopoly level of profits, prices, and quantities.

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.

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 low as possible, as firms are forced through competition to use the best technology and least expensive inputs. The exception is that firms may advertise or devote resources to differentiate their products in other ways. This obviously increases the cost to a level above the perfectly competitive costs.

Cartel

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

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 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.

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.

Summarize the profit-maximizing decision.

​To maximize profit, we need to produce at the quantity where the marginal revenue equals marginal cost. This is same decision rule for monopolies.

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. Thus, a small group of firms would want to produce the same level of output and price as a monopolist if total industry profits are to be maximized.

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

If fixed costs fall, economic profits will increase. No change will be made in the short run. However, the economic profits will attract competitors and the increased competition will force prices down. If fixed costs rise, the eventual outcome will be firms exiting from the industry.

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

If variable costs increase, firms will reduce production. Since average costs increased, firms will be making economic losses. In the long run, some firms will leave the industry. Demand for each remaining firm's output will increase. The likely result will be an increase in price. It is more difficult to tell about quantity.