Microeconomics- Exam 2
accounting profit
total revenue minus total explicit cost
asymmetric information
two parties in a situation possess different levels of information (i.e. marriage!)
government argument against tying
tying could allow firms to expand their market power by forcing consumers to buy an unprofitable product along with another in high demand
sunk costs example (McDonalds)
used to open at 11am, did not serve breakfast, even though the fixed costs were still being spent (they thought the revenue they would have made would not have been enough to make up for the variable costs); at the time, most people ate breakfast at home Now that 15% of breakfast is eaten outside of the home, they open for breakfast
average variable cost
variable cost divided by the quantity of output
economies of scale as a cause of monopoly
when a firm's average-total-cost curve continually declines, the firm has what is called a natural monopoly
horizontal merger
when two businesses that produce and sell in the same industry merge
In the zero profit equilibrium, economic profit is ___ but accounting profit is ____
zero; positive
The metropolitan museum art used to not charge admission, but had a suggested contribution amount; by paying the full $12 suggested price, it helps offset the $34 cost of letting you enter-- what is the $12 and what is the $34 value?
$34 is the average total cost (per visitor); made up of fixed and variable costs $12 is the variable cost of keeping the museum operations going (rather than the cost of purchasing the building, etc.)
what's wrong with the HHI from chicago's point of view? (2 points)
(1) HHI does not consider foreign firms (which is particularly bad for the automobile market) (2) if it's a contestable market, you don't need a lot of firms (doesn't consider potential entrants if the market is profitable)
three important properties of cost curves
(1) Marginal cost eventually rises with the quantity of output. (2) The average-total-cost curve is U-shaped. (3) The marginal-cost curve crosses the average-total-cost curve at the minimum of average total cost.
reasons to do a horizontal merger
(1) economies of scale; consumers benefit; i.e. routes for airlines, production for cars (2) raise market share; gets rid of rival and gains market share, allowing it to have more influence on prices
differences between monopolistic and perfect competition
(1) excess capacity; monopolistically competitive firms could increase the quantity it produces and lower the average total cost, but forgo this opportunity because it would need to cut its price to sell the additional output (2) markup over marginal cost; price exceeds marginal cost because the firm always has some market power
three attributes of monopolistic competition
(1) many sellers (2) product differentiation-- sell slightly different products; instead of being a price taker, each firm faces a downward-sloping demand curve (3) free entry and exit
monopolistic competition & the welfare of society (inefficiencies)
(1) markup of price over marginal cost-- has the normal deadweight loss of monopoly pricing (2) the number of firms in the market may not be "ideal" --> the invisible hand does not ensure that total surplus is maximized under monopolistic competition
defense of resale price maintenance
(1) not aimed at reducing competition-- supplier has no incentive to discourage competition among retailers; suppliers can exert their market power through wholesale prices if they wanted to (2) legitimate goal--> incentivize stores to provide customers with a pleasant showroom and a knowledgeable sales force [without resale price maintenance, customers would take advantage of one store's service then buy the item at a discount retailer
two reasons why the long-run market supply curve might slope upward
(1) some resources used in production may be available only in limited quantities (2) firms may have different costs
oligopolist supply considerations (two effects)
(1) the output effect-- because price is above marginal cost, selling one more gallon of water at the going price will raise profit (2) price effect-- raising production will increase the total amount sold, which will lower the price of water and lower the profit on all the other gallons sold
the monopolist's profit
(P-ATC) x Q
long-run market supply curve
(a) the number of firms adjusts to ensure that all demand is satisfied at this price; (b) the long-run market supply curve is horizontal at this price
defense of brand names
-Brand names provide information about quality to consumers when it cannot easily be judged in advance of purchase -Companies with brand names have incentive to maintain high quality, to protect the reputation of their brand names
Each oligopolist continues to increase production until...
the output and price effects exactly balance
long-run equilibrium in a monopolistically competitive market
-price exceeds marginal cost (MR = MC, downward sloping demand curve) -price = average total cost (profit maximizing quantity), because free entry and exit drive economic profits to zero
three main sources of barriers to entry
1) monopoly resources (a key resource required for production is owned by a single firm) 2) government regulation (the gov gives a single firm the exclusive right to produce some good or service 3) production process (a single firm can produce output at a lower cost than can a larger number of firms)
Three general rules for profit maximization
1. If marginal revenue is greater than marginal cost, the firm should increase its output 2. If marginal cost is greater than marginal revenue, the firm should decrease its output 3. At the profit-maximizing level of output, marginal revenue and marginal cost are exactly equal
sanderson considers babysitting to be fall between chapter(s) _______________
15 & 16, depending on service differentiation and the number of teenage girls in the neighborhood
perfectly competitive market
A market that meets the conditions of (1) many buyers and sellers, (2) all firms selling identical products, and (3) firms can freely enter or exit the market
profit maximization for a monopoly
A monopoly maximizes profit by choosing the quantity at which marginal revenue equals marginal cost (point A). It then uses the demand curve to find the price that will induce consumers to buy that quantity (point B).
concentration ratio
the percentage of the market's total output supplied by its four largest firms
the inefficiency of monopoly
Because a monopoly charges a price above marginal cost, not all consumers who value the good at more than its cost buy it. Thus, the quantity produced and sold by a monopoly is below the socially efficient level. The deadweight loss is represented by the area of the triangle between the demand curve (which reflects the value of the good to consumers) and the marginal-cost curve (which reflects the costs of the monopoly producer).
Sanderson/Chicago disagreement with Mankiw on competition
Chapter 14 covers perfect competition, price-takers; (1) produce a homogeneous product, (2) there are a lot of firms in the industry --> Chicago asks "is this a contestable market?" --- even if there is only one dry cleaning service in hyde park, if it is getting very rich, someone else can come in and start offering dry cleaning services
Reading: "Coase call"
Classical Economist Perspective: No authority is in charge. The firms that make up the many links in the chain that supply a product obey market prices. However, this standard (market) model does not fit with what goes on within companies. Coase's Argument: firms are a response to the high cost of using markets. Critiques of Coase: it is difficult to specify all that is required of a business relationship, so some contracts are necessarily "incomplete." -Spot markets cover most transactions; once money is exchanged for goods, the deal is completed. -Long-term contracts that specify expectations are used for situations where parties are locked into deals that are costly to get out of (i.e. rent/leases). For many business arrangements, it is difficult to set down all that is required of each party in all circumstances. In such cases, formal contracts are by necessity "incomplete" and sustained largely by trust (i.e. employment contracts). Because market forces are softened in such a contract, it calls for an alternative form of governance: the firm. Successful economies need both the benign dictatorship of the firm and the invisible hand of the market.
examples of monopoly resources
DeBeers diamonds
Reading-- "ICC, FCC, SEC... and DC?"
Digital markets are two-sided-- they serve at least two distinct user groups (users and advertisers), providing network effects to each. Economies of scale, of scope, and of increasing returns to the possession of user data mean that such markets often "tip" at a certain point. Why not enact a Digital Competition Commission?
Reading-- "War Games"
Game theory is the study of what happens when two self-interested individuals encounter one another and take into account the actions of the other. Schelling argued that a country's best safeguard against nuclear war was to protect its weapons, not its people. A country that thinks it can withstand a nuclear war is more likely to start one-- better to show your enemy that you can hit back after a strike. The prospect of vengeful retaliation opens up many opportunities for amicable cooperation.
Reading-- "Hard bargains"
In the real world, humans often undermine the greater good by grabbing whatever goodies their position allows them. Contract Theory-- when people want to work together, individual self-interest must be kept under control. Firms overcome the uncertainty of contract-making by clever use of the bargaining power bestowed by the ownership and control of key assets, such as machines or intellectual property [...] workers agree to sell their labor to a firm even though they know the firm will suck up most of the profit. Many basic power dynamics in society boil down to a principal, who needs another (the agent) to do something for them. The principal can use contracts to shape the incentives facing the agent to better get him to direct his activities. However, it is difficult to design these contract incentives, because most jobs are made up of many different tasks, with some easier to assess than others.
When it increases the price it charges by 25%, what happens to its total revenue?
It goes to zero (it's a price taker since it's perfectly competitive! No one will buy their stuff)
Reading-- "It's Complicated"
Making sure companies compete fairly is a tricky business-- the firms being regulated know far more about their businesses than regulators. "Natural monopolies" present regulators with a problem; they do not want monopolists to gauge consumers and stifle innovation, yet they often struggle to determine the extent to which those things are happening (asymmetric information). This dilemma resembles the agency problem in economics. Tirole and Laffont borrowed from other fields to argue that rather than trying to force firms into a single form of contract, regulators should give them a choice. Either cost-plus contracts (firms with little opportunity to cut costs) or set prices (more innovative firms). The best possible solution is not always one that leads to the lowest prices-- regulator's best bet may actually be to signal its intent to be lenient over time and not choke off cost-saving innovation.
cost curves for a typical firm
Many firms experience increasing marginal product before diminishing marginal product. As a result, they have cost curves shaped like those in this figure. Notice that marginal cost and average variable cost fall for a while before starting to rise
Reading-- "Intelligent Design"
Mechanism design explores how to arrange our economic interactions so that, when everyone behaves in a self-interested manner. the result is something we all like. Mechanism-design theory aims to help the invisible hand by focusing on how to minimize the economic cost of asymmetric information. Incentive Compatibility-- the way to get as close as possible to the most efficient economic outcome is to design mechanisms in which everybody does best for themselves by sharing truthfully whatever private information they have that is asked for. Mechanism design has "incentive efficiency:" given compatible incentives, no one can do better without someone doing worse.
Reading-- "Game, Set, and Match"
Money is not essential to the market-- economics is about maximizing welfare, not GDP. But the absence of a price to allocate supply and demand makes it hard to know whether welfare is being maximized. Co-operative Game Theory has been used to streamline the national resident match program (matching med school grads with hospitals) and organ donations (New England program for kidney exchange).
monopolistic competition vs. oligopoly
Monopolistic competition= Many small firms, differentiated product, Oligopoly= Few (large) firms, strategic interactions, high barriers to entry
for a competitive firm, P =
P = MR = MC (price equals marginal cost)
for a monopoly, P
P > MR = MC (price exceeds marginal cost)
welfare with and without price discrimination
Panel (a) shows a monopoly that charges the same price to all customers. Total surplus in this market equals the sum of profit (producer surplus) and consumer surplus. Panel (b) shows a monopoly that can perfectly price discriminate. Because consumer surplus equals zero, total surplus now equals the firm's profit. Comparing these two panels, you can see that perfect price discrimination raises profit, raises total surplus, and lowers consumer surplus.
Reading-- "The Price is Right"
Price discrimination is the practice of selling the same good or service at different prices to different buyers or groups (a rational profit-maximizing strategy. In order to do so, a firm must (1) identify consumers according to their willingness to pay and (2) prevent arbitrage Examples: airlines separating out leisure and business travelers (through how long in advance tickets are purchased); movie theaters giving ticket discounts to children and senior citizens (but not for concessions!); colleges giving financial aid based on family income; hardback v. paperback not to be confused with dynamic pricing!
difference between proprietorships and corporations
Proprietorships/partnerships[?] have unlimited liability; not what I have invested in my business-- it's what do I have, period? → things go poorly, owners lose everything Corporations have limited liability, allowing for bigger scale operations/financing; if Sanderson invests in Ford Co. stocks, and things don't go well, the most he can lose is his stocks; downsides to corporations→ organization costs, political targets (high taxation)
Reading: "To Pillory and Punish-- or to Praise and Preserve?"
Society transitioned from largely self-sufficient home firms to outsourcing many goods and services, taking advantage of efficiency gains from specialization, trade, and the exploitation of comparative advantages. Ronald Coase laid out an explanation for why firms exist at all in 1937. In the 20th century, new tech allowed entrepreneurs to take advantage of economies of scale to increase productivity, expand output, and lower cost --> built what we know today as corporations. Corporations constitute under 20% of all businesses but account for more than 80% of sales and employment in the U.S. "The social responsibility of business is to increase its profits" (Milton Friedman)
Reading-- "Prison Breakthrough"
The Nash Equilibrium describes a stable outcome that results from people or institutions making rational choices based on what they think others will do. In this circumstance, no one is able to improve their own situation by changing strategy: each person is doing as well as they possibly can, even if that does not mean that the optimal outcome for society. Every game with a finite number of players and options has at least one nash equilibrium. What is best for the individual can be disastrous for the group (i.e. prisoner's dilemma). Helped economists understand how self-improving individuals can lead to self-harming crowds. Economists just had to make sure that every individual faced the best incentives possible. (i.e. national match for med students)
examples of natural monopolies
Water, electricity, police and fire protection, legal and justice services, currency regulation
Reading: "Why do Firms Exist?"
Why have these "islands of conscious power" (firms) survived in the surrounding "ocean of unconscious cooperation" (markets)? Coase's central insight was that firms exist because going to market all the time can impose heavy transaction costs. A firm is essentially a decide for creating long-term contracts when short-term contracts are too bothersome. Coase also pointed out that growing firms impose transaction costs of their own, which tend to rise as they grow bigger-- the proper balance between hierarchies and markets are constantly recalibrated by the forces of competition. Resource-based theory of the firm: management theorists argue that activities are conducted within firms not only because markets fail, but also because firms succeed. They can marshal a wide range of resources that markets cannot access (companies can organize production, create knowledge, and make long-term bets on innovations that redefine markets rather than merely satisfy demand). Coase's theory of "market failure" needs to be complemented by a theory of "organizational advantages."
how do grocery stores price discriminate?
buy one get one free deals (quantity change) and frequent buyer points
Reading: "Mr Watson, are you there?"
Yahoo's CEO told her employees that they would no longer be permitted to work from home. This is a case of asymmetric information, or situations in which one party in a transaction, whether it be employer or employee, is more well-informed than the other or posses private information that he or she may not want to divulge. In adverse-selection situations, a sample of products or people may not be representative of the population as a whole. The tendency of an imperfectly monitored employee to blow off work brings off moral-hazard and principal-agent problems, as well as questions of how to align incentives to ensure that the worker is acting in the best interests of the employer/firm. Sometimes compensation can be structured-- piece-rate pay, performance bonuses, tips-- to address principal-agent and moral-hazard problems.
If there isn't anything preventing someone from entering the market (low barriers to entry), Chicago considers it...
a contestable market
sunk cost
a cost that has already been committed and cannot be recovered
market power alters the relationship between...
a firm's costs and the price at which it sells its product
quantity discounts
a form of price discrimination because the customer pays a higher price for the first unit bought than for the twelfth; successful because a customer's willingness to pay for an additional unit declines as the customer buys more units
cartel
a group of firms acting in unison
exit
a long-run decision to leave the market (firm does not have to pay any costs at all-- fixed or variable)
monopolistic competition
a market structure in which many companies sell products that are similar but not identical (each firm has a monopoly over the product it makes, but many other firms make similar products that compete for the same customers) --> (i.e. novels, movies)
oligopoly
a market structure in which only a few sellers offer similar or identical products (i.e. tennis balls, cigarettes)
competitive market
a market with many buyers and sellers trading identical products so that each buyer and seller is a price taker
natural monopoly
a monopoly that arises because a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms
prisoner's dilemma
a particular "game" between two captured prisoners that illustrates why cooperation is difficult to maintain even when it is mutually beneficial
principal agent problem
a problem caused by an agent pursuing his own interests rather than the interests of the principal who hired him how does the principal (owner, boss, etc.) get the agent (employee, student, etc.) to do what he or she wants them to do?
shutdown
a short-run decision not to produce anything because of current market conditions (firm still has to pay its fixed costs)
nash equilibrium
a situation in which economic actors interacting with one another each choose their best strategy given the strategies that all the other actors have chosen
dominant strategy
a strategy that is best for a player in a game regardless of the strategies chosen by the other players (confess!)
Because a monopoly is the sole producer in its market, it can alter the price of its good by...
adjusting the quantity it supplies to the market (its demand curve is the market demand curve; the market demand curve provides a constraint on a monopoly's ability to profit from its market power)
when economists speak of a firm's cost of production, they include...
all the opportunity costs of making its output of goods and services
if a monopolist could perfectly price discriminate, they would sell at prices...
all the way to MC = D (marginal cost) like a competitive firm! this is would constitute an efficient allocation
Nuance to amazon antitrust case
amazon doesn't do harm to customers; amazon's prices aren't too high! they do control markets and make it difficult for competitors to enter the industry though)
economist's issue with amazon's pricing
amazon's price elasticity of demand was -0.5; amazon is buying and selling in the inelastic portion of their marginal revenue curve --> not maximizing profit! (prices were way too low)
if we say a monopoly has market power, we are referring to... in the case of natural monopolies...
an action/effort to secure an advantage; the advantage is natural; the larger the firm is, the cheaper it is to produce
collusion
an agreement among firms in a market about quantities to produce or prices to charge (firms would ideally agree on the monopoly outcome to maximize profit)
when the demand for a good increases, the long-run result is...
an increase in the number of firms and in the total quantity supplied, without any change in price
price takers
buyers and sellers in a competitive market that must accept the price that the market determines
as the number of sellers in an oligopoly grows larger...
an oligopolistic market looks more and more like a competitive market. the price approaches marginal cost, and the quantity produced approaches the socially efficient level
examples of prisoner's dilemma
arms race; common resources (i.e. pool of oil)
price elasticity of demand for monopolies
around -1.5 (with very few substitutes!)
Whenever marginal cost is greater than average total cost...
average cost is rising
Whenever marginal cost is less than average total cost...
average total cost is falling
why is price discrimination a rational strategy for the profit maximizing monopolist?
by charging different prices to different customers, a monopolist can increase its profit (allows firm to separate customers according to their WTP)
the fundamental cause of monopoly is...
barriers to entry: A monopoly remains the only seller in its market because other firms cannot enter the market and compete with it
in the long run equilibrium of a competitive market with free entry and exit, firms must...
be operating at their efficient scale
product-variety externality
because consumers get some consumer surplus from the introduction of a new product, entry of a new firm conveys a positive externality on consumers (monopolistic competition)
the monopolistically competitive firm in the short run
because its product is different from those offered by other firms, it faces a downward-sloping demand curve; also follows monopolist's rule for profit maximization (chooses to produce the quantity at which marginal revenue = marginal cost & then uses the demand curve to find the price at which it can sell that quantity)
business-stealing externality
because other firms lose customers and profits from the entry of a new competitor, entry of a new firm imposes a negative externality on existing firms (monopolistic competition)
output effect (oligopoly)
because price is above marginal cost like monopoly, selling one more unit at going price will raise profit
where most firms lie scale from chapter 14 > 16 > 17 > 15
bernie/liz/aoc would say most firms lie past 15 mankiw would say most firms land between 16 & 17 (14 = price takers; 15 = monopolies; 17 = price searchers, oligopolies)
nash equilibrium in prisoner's dilemma
both confess! cooperation between the two prisoners is difficult to maintain, because cooperation is individually irrational
marginal cost (formula)
change in total cost / change in quantity
deadweight loss associated with monopoly pricing
competitive markets allocate resources more efficiently than monopoly markets; DWL is created as a triangle, with vertices at the intersection of marginal cost and demand (Qc), monopoly price (Pm), and the intersection of marginal revenue and marginal cost (determining profit maximizing monopoly quantity)
____________ are the primary beneficiaries in competitive markets; i.e. new discoveries, advantages, illegal immigration
consumers (for immigration-- cheaper, productive labor --> lower prices)
consumers benefit most in/from ___________ markets
contestable
diseconomies of scale can arise because of...
coordination problems that are inherent in any large organization
fixed costs
costs that do not vary with the quantity of output produced (incurred even if the firm produces nothing at all)
variable costs
costs that vary with the quantity of output produced
U.S. post office shredding typo stamps
decided to shred most of them then sell/auction the rest to stamp collectors; wanted to shred so many that they can reach a unitary marginal revenue (E = -1)
not everything that has different prices is price discrimination!
dynamic/surge pricing is only responding to changes in demand (i.e. disney's summer ticket prices)
Cats are almost 100x as heavy as a mouse, with 100x as many cells; it's metabolic rate is only 32x as much as a mouse (needing only about 32x as much energy to sustain itself). What does this have to do with economics?
economies of scale
source of natural monopoly's market power
economies of scale
retailers bottling their own milk, threatening small dairy farmers, is an example of
economies of scope
how an economist vs. accountant views a firm
economists include all opportunity costs when analyzing a firm, whereas accountants measure only explicit costs therefore, economic profit is smaller than accounting profit
if firms in a market are profitable, then new firms will have an incentive to...
enter the market (increasing the quantity of the good supplied, driving down profits and prices)
if firms in the market are making losses, then some existing firms will...
exit the market (reducing the number of firms, decreasing the quantity of the good supplied and driving up prices/profits)
the invisible hand guides markets to allocate resources only when markets are competitive, and markets are competitive only when...
firms in the market fail to cooperate with one another
vertical merger
firms in the same industry but different phases of production (i.e. shoe manufacturing & distribution)-- economists have no problem with these as you don't gain market power from merging
the long run: market supply with entry and exit
firms that remain in the market must be making zero economic profit (if the price of the good equals the average total cost of producing the good)
average fixed cost
fixed cost divided by the quantity of output
demand curves for a competitive firm are ___________ & _______________, while demand curves fir monopoly firms are _______________
flat, horizontal; slanted down
skepticism over predatory pricing
for a price war to drive out a rival, prices have to be driven below cost; the predator ends up suffering more than the prey (bears all the losses of cutting prices)
a market price below the minimum of the average total cost...
generates losses, leading to exit and a decrease in the total quantity supplied
a market price above the minimum of the average total cost...
generates profit, leading to entry and an increase in the total quantity supplied
what government anti-trust interventions is sanderson cool with?
going after companies involved in price fixing and collusion
economies of scale often arise because...
higher production levels allow specialization among workers, which permits each worker to become better at a specific task
the long-run market supply curve is _______ at the minimum of average total cost
horizontal; (entry and exit can cause the long-run market supply curve to be perfectly elastic)
a firm is a monopoly if...
it is the sole seller of its product and if its product does not have close substitutes
economic profit
total revenue minus total cost, including both explicit and implicit costs
auction theory
how to design auctions
marginal costs example (family visiting from new york)
if Sanderson has two groups of people coming to visit him in Chicago from New York; he expects the family of four to drive, while the individuals will fly (marginal cost of buying one more ticket is far more than adding one more person into a car)
if marginal revenue is greater than marginal cost, the firm can increase profit by...
increase profit by increasing production
implicit costs
input costs that do not require an outlay of money by the firm (opportunity costs! i.e. income an entrepreneur would have earned if they worked for another business rather than starting their own; the opportunity cost of the financial capital that has been invested in the business)
explicit costs
input costs that require an outlay of money by the firm (cost of ingredients, wages, etc.)
why does price discrimination raise economic welfare?
it can eliminate the inefficiency inherent in monopoly pricing
why are there no graphs in mankiw's chapter 17? (oligopolies)
it is too difficult to draw demand curves for oligopolies, as the behavior of these firms depend on one another --> strategic decision-making & possibility of collusion
A monopolist's marginal revenue is always...
less than the price of its good (because monopolies face a downward demand curve)
the monopolist produces...
less than the socially efficient quantity of output (the socially efficient output is found where the demand curve and marginal cost-curve intersect)
a firm maximizes profit by producing the quantity at which...
marginal cost = marginal revenue
monopolist produces where ___________; competitive firms produce where _________________
marginal cost = marginal revenue (MC = MR); marginal cost = demand
market power is relative to...
market size (uchicago has very little market power, given how huge the higher education market is)
markets have imperfections, but so do governments; mankiw argues that imperfect _____________ are more effective
markets
if HHI < 1,000
merge away!
what rockefeller actually did
merge! rockefeller really just bought out competitors
reasoning for a monopoly to engage in price discrimination
monopolist is upset because there are people willing to pay even more (above Pm in demand curve) and people are willing to pay less than the set price, but more than the marginal cost --> lets them capture these consumers
the oligopoly price is less than the ___________________ but greater than the _______________
monopoly price; competitive price (which equals marginal cost)
marginal revenue for monopolies: the output effect
more output is sold, so Q is higher, which tends to increase total revenue
sanderson considers k-12 education to be an example of a(n) ______________
oligopoly; because there's a captive market (only school(s) in your neighborhood)
examples of government created monopolies
patent and copyright laws (promote creative activity but eliminate competitive pricing)
demand is _______ ___________ in a perfectly competitive market, so an increase in quantity supplied results in ____________ for a firm
perfectly elastic; an increase in revenue for a firm! produces until marginal cost = total revenue
the process of entry and exit ends only when...
price and average total cost are driven to equality
Whereas a competitive firm is a price-taker, a monopoly firm is a...
price maker
issue with mankiw: firms aren't "price-makers," they are _________ _________
price searching (looking for the optimal price!)
profit (formula)
profit = (P - ATC) x Q
graphs: firm with profits & firm with losses
profit as the area between price and average total cost
if price is below average total cost,
profit is negative, which encourages some firms to exit
if price is above average total cost,
profit is positive, which encourages new firms to enter
price effect (oligopoly)
raising production will increase the total amount sold, which will lower the price of water and lower the profit on all the other gallons sold
Why do competitive firms stay in business if they make zero profit?
recall that profit equals total revenue minus total cost (including all of the opportunity costs of the firm-- i.e. time and money devoted to the business) in the zero-profit equilibrium, the firm's revenue must compensate the owners for these opportunity costs
if marginal revenue is less than marginal costs, a firm can increase profit by...
reducing production
controversies over antitrust policy
resale price maintenance, predatory pricing, tying
if the price effect is larger than the output effect...
the oligopolist will not raise production (in this case, it's actually profitable to reduce production)
why economists don't like the rockefeller "predatory pricing" theory
returning entrants can come back when prices go back up; standard oil would lose too much of their own money in the process of driving competition that can just come back
HHI (Herfindahl-Hirschman Index)
takes the share of the top four firms and squares them; measure of market concentration used by the US justice department in antitrust suits
total revenue
the amount a firm receives for the sale of its output (quantity of output x price per unit of output)
price discrimination
the business practice of selling the same good at different prices to different customers
marginal revenue
the change in total revenue from an additional unit sold
who were the primary beneficiaries of the slave trade?
the consumers of what the slaves made-- europeans who traded with the Southern U.S.
average total cost tells us...
the cost of a typical unit of output, if total cost is divided evenly over all the units produced
monopolies don't have supply curves because...
the firm sets the price at the same time as it chooses the quantity to supply (this decision is impossible to separate from the demand curve it faces)
why does the HHI square firms' market shares?
the firm that has 20% market share has 4x more market power than one with a 10% share
marginal firm
the firm that would exit the market if the price were any lower (this firm owns zero profit, but firms with lower costs earn positive profit)
marginal product
the increase in output that arises from an additional unit of input
marginal cost
the increase in total cost that arises from an extra unit of production
marginal cost tells us...
the increase in total cost that arises from producing an additional unit of output
for any given price, the competitive firm's profit maximizing quantity of output is found by looking at...
the intersection of price with the marginal cost curve
the monopolist's profit maximizing quantity of output is determined by...
the intersection of the marginal-revenue curve and the marginal-cost curve
conglomerate merger
the joining of firms in completely unrelated industries (i.e. fisher price and quaker oats)-- nobody cares about these
the larger the number of firms (in an oligopoly scenario)...
the less concerned each oligopolist is on their own impact on the market price
Because firms can enter and exit more easily in the long run than in the short run...
the long-run supply curve is typically more elastic than the short-run supply curve
Because the firm's marginal cost curve determines the quantity of the good the firm is willing to supply at any price...
the marginal cost curve is also the competitive firm's supply curve
corollary to the relationship between average total cost and marginal cost
the marginal-cost curve crosses the average total cost curve at its minimum
total cost
the market value of the inputs a firm uses in production
if HHI > 2,500
the merger will not be approved
why do oligopolies have trouble maintaining monopoly profits?
the monopoly outcome is jointly rational, but each oligopolist has an incentive to cheat (producing more is the dominant strategy, because it leads to more profit regardless of whether the other firm honors their end of the bargain or not)
if the output effect is larger than the price effect...
the oligopolist will increase production
a competitive firm's short-run supply curve is...
the portion of its marginal cost curve that lies above average variable cost
the competitive firm's long-run supply curve is...
the portion of its marginal-cost curve that lies above average total cost
marginal revenue for monopolies: the price effect
the price falls, so P is lower, which tends to decrease total revenue (when a monopoly increases production by one unit, it must reduce the price it charges for every unit it sells, and this cut in price reduces revenue on the units it was already selling)
a firm exits the market if (price)
the price of its good is less than the average total cost of production (if P < ATC)
for all types of firms, average revenue equals...
the price of the good
an operating firm has zero profit only if
the price of the good equals the average total cost of producing that good
an entrepreneur enters the market if
the price of the good exceeds the average total cost of production (if P > ATC)
a firm shuts down if (price)
the price of the good is less than the average variable cost of production (P < AVC)
arbitrage
the process of buying a good in one market at a low price and selling it in another market at a higher price to profit from the price difference
economies of scale
the property whereby long-run average total cost falls as the quantity of output increases
diseconomies of scale
the property whereby long-run average total cost rises as the quantity of output increases
constant returns to scale
the property whereby long-run average total cost stays the same as the quantity of output changes
diminishing marginal product
the property whereby the marginal product of an input declines as the quantity of the input increases
efficient scale
the quantity of output that minimizes average total cost
economies of scope
the range of activities in which a firm is engaging; uchicago's operating scope is how many majors, research programs, & schools we offer
production function
the relationship between quantity of inputs used to make a good and the quantity of output of that good
a firm exits the market if (revenue)
the revenue it would get from producing is less than its total costs (if TR < TC)
a firm shuts down if (total revenue)
the revenue that it would earn from producing is less than its variable costs of production (TR < VC)
industrial organization
the study of how firms' decisions about prices and quantities depend on the market conditions they face
game theory
the study of how people behave in strategic situations
a firm's total cost is...
the sum of fixed and variable costs
for many firms, the division of total costs between fixed and variable costs depends on...
the time horizon (many decisions are fixed in the short run but variable in the long run-- i.e. cost of factories)
tying is a form of price discrimination because...
the use of the variable good reveals each customer's willingness to pay (if different theaters value the the film differently, tying may allow studios to increase profit by charging a combined price closer to the buyer's total willingness to pay)
Oligopolists would be better off cooperating and reaching the monopoly outcome; yet, because they pursue their own self interest...
they do not end up reaching the monopoly outcome and maximizing their joint profit. Each oligopolist is tempted to raise production and capture a larger share of the market-- as each of them tries to do this, total production rises and price falls
When firms in an oligopoly individually choose production to maximize profit...
they produce a quantity of output greater than the level produced by monopoly and less than the level produced by perfect competition
to move the allocation of resources closer to the social optimum, policymakers should try to induce firms in an oligopoly...
to compete rather than cooperate
the short run: market supply with a fixed number of firms
to derive the market supply curve, we add the quantity supplied by each firm in the market
average total cost
total cost (fixed + variable) divided by the quantity of output
profit equation
total revenue - total cost
When a competitive firm increases its output by 25%, what happens to its total revenue?
total revenue also increases by 25% (demand curve perfectly inelastic)
average revenue
total revenue divided by the quantity sold; tells us how much revenue a firm receives for the typical unit sold
profit
total revenue minus total cost
