Econ 201 Test 3

Monopolistically Competitive firms charge a price ____ than marginal cost?

Greater

Two ways to find q* for PC firm

1. Calculate TC, TR, and Profit at each possible q, and pick the q that gives the most profit 2. Compare MR and MC If MR > MC produce that unit If MR < MC don't product that unit Produce q* where MR = MC

Graph implications for Monopolistic Competition

1. Demand curve is downward sloping 2. MR (Marginal Revenue) curve is downward sloping and below the demand curve

Market Graph for Perfect Competition

1. Downward Sloping Demand Curve 2. Upward Sloping Supply 3. Equilibrium at the intersection of supply and demand curve

Framework of Sequential Games with Deterring Entry

1. Entry decision: The potential entrant decides whether to enter the market or not. This decision may depend on various factors such as market conditions, expected profitability, entry costs, and potential barriers to entry. 2. Deterrence decision: The incumbent firm, aware of the potential entry, makes a strategic decision to deter or discourage the entry of the potential entrant. The incumbent firm may take actions such as price cuts, capacity expansions, or other strategic moves to make entry less attractive or more difficult for the potential entrant. 3. Entry response: Based on the incumbent firm's deterrence actions, the potential entrant decides whether to enter the market or not. This decision may be influenced by the expected payoffs from entry, taking into account the incumbent firm's deterrence actions. 4. Market outcome: Once the entry decision is made, the market outcome is determined based on the actions and decisions of the incumbent firm and the potential entrant. This may include market prices, quantities, profits, and other relevant market variables.

Oligopoly Characteristics

1. Few Large Firms 2. High Concentration Ratio 3. Interdependence among firms 4. Product differentiation 5. High barriers to entry 6. Price Makers

Practical rule for shading profit/loss for a monopoly

1. Find Q* where MR = MC 2. At Q* go up to the demand curve and then left to the vertical axis to find P*

What situations create high barriers to entry for a monopoly?

1. Government Patents/copyrights (Patents = Physical inventions) (Copyrights = Intellectual incentives) Public franchise: Makes them legal providers for a good/service Tariffs/Quotas 2. Control of a key resource 3. Network Externalities: The usefulness of a good/product increases with the number of consumers who use it 4. Natural monopoly: A situation in which economies of scale are so large, that one firm can supply the entire market at a lower average cost than two or more firms

Profit Maximizing for a monopoly

1. If MR > MC then produce those units 2. If MR < MC then don't produce those units 3. Produce up until MR = MC

Short-Run Considerations for PC

1. If P > AVC = continue to produce in the short-run 2. If P < AVC = shutdown in the short-run 3. If P = AVC = Breakeven at q*

How to know when a perfectly competitive firm is making a loss

If P < ATC at q* then the firm is making a loss

In the long run, will the price charged by this restaurant increase, decrease, or stay the same? What about the quantity? In the long run, will this restaurant's profit increase, decrease, or stay the same? How much economic profit would this restaurant expect to make in the long run?

1. In the long run, prices may decrease or stay the same in a monopolistically competitive market, depending on competition. 2. Output quantity depends on market conditions, with new firms potentially decreasing market share and output, while exiting firms may allow for increased market share and output. 3. Profit in the long run may decrease or approach zero due to increased competition eroding market power. 4. The exact economic profit depends on various factors such as market conditions, competition, demand, cost structure, and differentiation. 5. In the short run, the restaurant may earn positive economic profit, but in the long run, it tends to approach zero due to competition.

Monopolistic Competition Characteristics

1. Large number of small firms 2. Sell differentiated products 3. Low barriers to entry 4. In a monopolistically competitive market, each firm has some degree of market power, as they can influence the price of their product due to the perceived differences in quality or other attributes. However, this power is limited by the presence of close substitutes and the ease of entry for new firms. 5. Price-Takers

Important Properties of Graphing Short-Run Cost Curves

1. MC U-shaped 2. ATC U-Shaped Intersects MC at the minimum of ATC 3. AVC U-shaped Below ATC —> ATC = AFC + AVC Intersects MC at the minimum of AVC Gets closer to ATC as Q increases 4. AFC Decreases as Q increases

The main focus of antitrust laws in relation to monopolies is to prevent and address abusive practices that can result in monopolistic behavior, such as:

1. Monopolization: This occurs when a company, through anti-competitive means, acquires a dominant market share and uses that dominance to exclude or harm competitors. Antitrust laws prohibit such monopolistic behavior, including predatory pricing (setting prices below cost to drive competitors out of the market), exclusive dealing (requiring buyers to exclusively purchase from the monopolist), and other anti-competitive practices. 2. Mergers and acquisitions: Antitrust laws also regulate mergers and acquisitions that could result in a company gaining a dominant market share, which may lead to reduced competition. In such cases, the government may scrutinize and potentially block mergers or acquisitions that could create a monopoly or substantially lessen competition in a relevant market. 3. Price discrimination: Antitrust laws also prohibit unfair and discriminatory pricing practices by monopolists, such as charging different prices to different customers for the same product or service, with the intent to harm competition or consumers. 4. Market power abuse: Antitrust laws also aim to prevent abuse of market power by monopolists, such as engaging in anti-competitive behavior that restricts entry into the market, limits consumer choice, or harms competition.

Monopoly Characteristics

1. One seller 2. No close substitutes 3. Very high barriers to entry 4. Monopolies are price-makers

Firm Graph for Perfect Competition

1. Perfectly elastic (horizontal) demand curve 2. MR (Marginal Revenue) = the demand curve 3. MR = Market Price (P*) from the market graph 4. MC (Marginal Cost) intersects the demand/marginal revenue curve to provide the equilibrium quantity of output (q*)

Situations where coordination on high prices is more likely

1. Repetition 2. Cartels 3. Price-match guarantee

Actions of firms that are aimed at deterring entry include

1. Setting lower prices to keep profits at a level that makes entry less attractive 2. Introducing new products to fill market niches 3. Advertising to create product loyalty

Graph implications for a Monopoly

1. The demand curve is downward sloping 2. The MR curve is downward sloping and below the demand curve

Perfect Competition Characteristics

1. There are many buyers and sellers, each of whom are tiny relative to the size of the market 2. Firms sell identical products 3. There are no/low barriers to entry 4. Perfect Competitive firms are price-takers

Prisoner's Dilemma

A classic game theory example that illustrates how rational individuals may not cooperate even if cooperation leads to a better overall outcome. The prisoner's dilemma is often used to explain why collusion may be difficult to sustain in oligopoly markets. Two conditions: 1. Both players have dominant strategies 2. There exists a cell in the payoff matrix, where both players are better off than they are in the Nash Equilibrium

Nash Equilibrium

A key concept in game theory that represents a stable outcome where no player has an incentive to unilaterally change their strategy. Nash equilibrium is commonly used to analyze oligopoly behavior. All cells where both payoffs of any cell are circles given standard decision process

Short-Run supply curve for a single perfectly competitive firm

A perfectly competitive firm's short-run supply curve equals/coincides with their MC curve above the minimum of AVC

7. For each of the following statements, list which market structure(s) it applies to. You may abbreviate with PC (perfect competition), M (monopoly), and MC (monopolistic competition) a) The market structure is efficient. b) There are lots of buyers and sellers in the market. c) The sellers in the market are price-makers. e) Firm(s) in the market set Q* where MR = MC. f) The market is efficient. g) Firms in the market always make 0 economic profit in a long-run equilibrium.

A) PC B) PC and MC C) MC and M E) All 3 (PC, MC, and M) F) PC G) PC and MC

Efficiency within a Monopolistically Competitive Market

Allocative Efficiency: In monopolistic competition, firms have some degree of market power and are able to set prices above marginal cost due to product differentiation. This results in a markup over marginal cost and a divergence between price and marginal cost. As a result, monopolistically competitive firms may not achieve allocative efficiency, as they may not produce at the level where marginal cost equals marginal benefit (as indicated by the demand curve), leading to a misallocation of resources. Productive Efficiency: In monopolistic competition, firms may not necessarily achieve productive efficiency, as they may produce at levels below the minimum average total cost (ATC) due to product differentiation and the pursuit of differentiated products. This can result in higher average costs and reduced productive efficiency compared to perfect competition. Economic Efficiency: In monopolistic competition, the level of economic efficiency may be lower compared to perfect competition, as firms may not achieve allocative efficiency or productive efficiency due to the presence of market power, product differentiation, and brand competition.

Efficiency of Monoplies

Allocative Efficiency: Monopolies may not achieve allocative efficiency, as they have market power and can set prices higher than marginal cost, resulting in a reduced output level and a deadweight loss, which is a welfare loss to society. Productive Efficiency: Monopolies may not achieve productive efficiency due to lack of competition, which can lead to higher costs and inefficiencies in production. Economic Efficiency: Monopolies may not achieve economic efficiency as they may not produce at the lowest cost and may restrict output to maximize profits, leading to a suboptimal allocation of resources and reduced overall welfare.

Which of the following is a true statement comparing perfect competition, monopoly, and monopolistic competition a) Perfectly competitive and monopolistically competitive firms choose a profit-maximizing output where MR = MC but monopolies choose a profit-maximizing output where MR < MC. b) In the long-run (in equilibrium), perfectly competitive firms make zero economic profit while it is possible that monopolies and monopolistically competitive firms make a positive economic profit. c) A perfectly competitive market is characterized by high barriers to entry while monopolies and monopolistically compentve markets have no barriers to entry. d) Compared to perfect com petition, monopolies set a lower equilibrium quantity and a higher equilibrium price

Answer B

If firms in a monopolistically competitive market are making losses, firms will ____ the market in the long run, which will cause the firm demand (and MR) curves to ___ a) enter, decrease and become more elastic b) exit, decrease and become more elastic c) exit, increase and become more inelastic d) exit, increase and become more elastic

Answer C

If firms in a perfectly competitive market are currently making a profit, then firms will ____ the market in the long-run, which will cause market price to ____ and firm profit to ___ a) exit, decrease, increase b) exit, increase, increase c) enter, decrease, decrease d) enter, increase, increase

Answer C

Monopolistically competitive markets differ from perfectly competitive markets because: a) there are no/low barriers to entry b)there are many firms in the market c) firms sell differentiated products d) firms make zero economic profit in a long-run equilibrium.

Answer C

Which of the following is a true statement about perfectly competitive firms? a) A perfectly competitive firm that is making a loss will always shutdown in the short-run. b) Perfectly competitive markets are not efficient in the short-run. c) In a perfectly competitive market equilibrium, P = MC (i.e. price is equal to marginal cost). d) The long-run supply curve for a perfectly competitive market in a constant cost industry is a downward-sloping line.

Answer C

Practical rule for shading profit/loss for a perfectly competitive firm

At q* start at the price and move vertically to ATC, then over to the vertical axis

Cartels

Formal agreements among firms to collude and act as a single monopolist in a market. Cartels are illegal in many countries, but they can be difficult to detect and prosecute.

What happens to CS, PS, and Economic Surplus within a monopoly

CS: Monopoly causes a decrease in consumer surplus PS: Monopoly causes an increase in producer surplus Economic Surplus: Monopoly causes a DWL which represents a reduction in Economic surplus

What trade-offs do consumers face when buying a product from a monopolistically competitive firm?

Consumers pay a price greater than marginal cost, but also have choices more suited to their tastes

How does the entry of new firms affect the profits of existing firms in monopolistic competition?

Entry will decrease the profits of existing firms by shifting each of their individual demand curves to the left and making the demand curves more elastic

(True/False) A monopoly is efficient when they are breaking even

False

(True/False) In a monopolistically competitive market, P > MC which leads to an inefficient situation where there is deadweight loss

False

Are there high barriers to entry in a monopolistically competitive market? In the long run, will firms have an incentive to enter the market depicted above, exit, or do neither? If firms act as stated in the previous question, describe in words what will be the effect on this individual restaurant's situation.

For monopolistic competition, barriers to entry are quite low normally. If current firms are making economic profits that will incentivize new firms to enter the market. If current firms are making economic losses, that will incentivize those firms to leave the industry and the allowing the firms who stay in to reduce competition, and increase their market share and profits. On the other hand, if firms exit the market and competition decreases, the individual restaurant may benefit from a reduction in competition, potentially allowing it to increase its market share and profits. However, the extent of these changes would depend on various factors such as the number of firms exiting or entering the market, the elasticity of demand, and the individual restaurant's ability to adapt to changing market conditions.

How to know when a monopolistically competitive firm is making a loss in the SR?

If P < ATC then the firm is making a loss

How to know when a perfectly competitive firm is breaking-even

If P = ATC at q* then the firm is breaking-even

How to know when a monopolistically competitive firm is breaking-even in the SR?

If P = ATC then the firm is breaking even

How to know when a perfectly competitive firm is making a profit.

If P > ATC at q* then the firm is making a profit

How to know when a monopolistically competitive firm is making a profit in the SR?

If P > ATC then the firm is making a profit

What should a monopolistically competitive firm do in the short-run?

If P > AVC then continue producing in the SR If P < AVC then shutdown in the SR If firm is breaking-even then continue producing in the SR

How to know when a monopoly is making a profit in the SR

If the monopoly price (P*) is above the ATC curve at the profit-maximizing output level, the monopolist is making a profit.

How to know when a monopoly is making a loss in the SR

If the monopoly price (P*) is below the ATC curve at the profit-maximizing output level, the monopolist is incurring a loss.

How to know when a monopoly is breaking-even in the SR

If the monopoly price (P*) is equal to the ATC curve at the profit-maximizing output level, the monopolist is breaking even.

Industry Equilibrium for a Monopoly.

In a monopolistic market, there is no industry equilibrium as there is only one firm with market power. The monopolist sets the price and quantity based on its profit-maximizing level of output. However, in cases where monopolistic behavior is regulated or challenged by antitrust laws, the monopolist may face constraints on its pricing and production decisions.

Is a monopolistically competitive market allocatively efficient in the short-run? What about the long run?

In a monopolistically competitive market, the short-run outcome may not be allocatively efficient, as firms have some market power and can set prices above marginal cost. This can result in a suboptimal allocation of resources, with prices being higher and quantities being lower than what would be considered socially optimal. In the long run, monopolistically competitive markets tend to approach allocative efficiency, but may not necessarily achieve it fully. As competition increases in the long run due to entry of new firms or exit of firms, firms may face pressure to lower prices and operate closer to the efficient level of output. However, due to product differentiation and imperfect competition, firms may still have some degree of market power, leading to prices that are higher and quantities that are lower than perfect competition.

Industry Equilibrium for a Monopolistically Competitive Firm?

In monopolistic competition, there is no unique industry equilibrium as firms produce differentiated products and face different demand curves. Each firm sets its own price and quantity based on its profit-maximizing level of output. However, in the long run, firms in monopolistic competition tend to earn zero economic profit, as new firms can enter the market and erode profits of existing firms.

A monopolistically competitive firm in a long-run equilibrium produces where

It's demand curve is tangent to its ATC curve

Antitrust Laws

Laws aimed at eliminating collusion and promoting competition among firms

Price-Makers

Monopolies have significant market power, as they can control the quantity supplied and set the price of the product. They also face a downward sloping demand curve as a result

Which type of efficiency does a monopolistically competitive firm achieve in the long​ run?

Neither allocative nor productive efficiency

In the monopoly, are all units of the product for which the marginal benefit (as indicated on the demand curve) greater than the marginal cost produced and sold? What does this tell us about the allocative efficiency of a monopoly?

No, in a monopoly, not all units of the product are produced and sold where the marginal benefit (as indicated on the demand curve) exceeds the marginal cost. Allocative efficiency is not achieved in a monopoly because the monopolist restricts output in order to maximize profits, resulting in a quantity produced and sold that is lower than the level that would achieve allocative efficiency. However, in a monopoly, the monopolist has market power and can set prices higher than marginal cost (MC), which allows them to restrict output in order to maximize their profits. As a result, the monopolist produces and sells a quantity that is lower than the level that would achieve allocative efficiency, where marginal benefit (as indicated on the demand curve) equals marginal cost. This implies that a monopoly can result in an inefficient allocation of resources, as the monopolist may produce and sell fewer units than what would be socially optimal. The difference between the marginal benefit and marginal cost for the units that are not produced and sold due to the monopolist's market power results in a deadweight loss, which is a welfare loss to society.

Is breaking-even possible for a monopoly?

No, in the long run, a monopolist can only earn a profit or incur a loss. Breaking even is not possible in the long run for a monopolist due to barriers to entry that prevent new firms from entering the market.

Monopolistically Competitive firms do ____ produce at the _____ average total cost

Not; minimum

Efficiency of a perfectly competitive market

Perfect competition is often considered an ideal market structure from an efficiency perspective. In perfect competition, firms produce at the lowest possible average total cost (ATC) and there is no deadweight loss, as resources are allocated efficiently. Additionally, perfect competition encourages innovation and allocative efficiency, as firms are constantly competing to improve their products and reduce costs.

Price-Takers

Perfect competitive firms have no ability to impact/change the market price

Illustrating profit for PC

Profit = (P - ATC) * Q If at Q*, P > ATC —> Profit (Economic profit) If at Q*, P < ATC —> Loss (Economic profit) If at Q*, P = ATC —> Break-even (Economic profit)

Sequential Games

Sequential games are an important concept in game theory that can be applied to analyze the strategic interactions and decision-making of firms in an oligopoly. In an oligopolistic market, firms often make decisions sequentially, taking into account the actions and decisions of their competitors.

Sequential Games with Deterring Entry

Sequential games with deterring entry are a type of game theoretic model that analyzes the strategic interactions between an incumbent firm in an oligopoly and a potential entrant, where the incumbent firm takes actions to deter or discourage the entry of the potential entrant into the market. This type of game is commonly used to study the strategic behavior of firms in markets with barriers to entry, where the incumbent firm may have an advantage in terms of market power, resources, or other factors that can be used strategically to deter potential entrants.

Long-Run Supply Curve for a perfectly competitive firm

Shows the relationship between market price and quantity supplied in the long-run once all entry/exit has taken place. It also connects all the long-run equilibria LR supply curve in a perfectly competitive market (constant cost industry) is a horizontal line at the price that makes the firms break-even (at the minimum of ATC)

Long-run equilibrium for a perfectly competitive firm

Situation where there is no incentive for firms to enter/exit the market. Firms are making 0 economic profit (breaking-even)

Examples of Antitrust Laws

Some of the key antitrust laws in the United States include: 1. The Sherman Antitrust Act of 1890 2. The Clayton Antitrust Act of 1914 3. The Federal Trade Commission Act of 1914. These laws provide the framework for the government to regulate monopolies and prevent anti-competitive behavior.

HHI (Herfindahl-Hirschman Index)

The Herfindahl-Hirschman Index (HHI) is a measure of market concentration that is commonly used in economics and antitrust analysis to assess the level of competition in a market. It is calculated by summing the squared market shares of all firms in the market. The HHI ranges from 0 to 10,000, with higher values indicating higher market concentration or less competition. In a market with perfect competition, where all firms have equal market shares, the HHI would be close to 0. On the other hand, in a monopoly, where one firm has 100% market share, the HHI would be 10,000.

Concentration Ratio Oligopoly

The concentration ratio is another measure commonly used to assess the level of market concentration in an oligopoly. It measures the combined market share of a specified number of the largest firms in a market, expressed as a percentage. The concentration ratio can range from 0% to 100%, with higher values indicating higher market concentration. A concentration ratio of 0% would indicate perfect competition, where no single firm has any significant market share, while a concentration ratio of 100% would indicate a monopoly, where one firm has 100% market share.

What happens if a monopolies price is below AVC?

The firm should shutdown and produce zero output, as continuing to produce would incur losses greater than shutting down.

Marginal Revenue for a PC firm

The firm's marginal revenue (MR) is equal to the market price (P*) because the firm can sell additional units without affecting the price.

Backward Induction

The process of analyzing a problem in reverse, starting with the last choice, then the second-to-last choice, and so on, to determine the optimal strategy

Game Theory

The study of strategic decision-making among interdependent parties. Game theory is often used to analyze oligopolistic markets and understand firms' strategic behavior.

(True/False) A perfectly competitive firm's short run supply curve is the portion of their marginal cost curve above the minimum of the AVC

True

MR (Marginal Revenue) for a monopolist

Two things that happen that affect MR when a monopolist lowers their price to sell an additional unit 1. They receive the new lower price on the additional unit (TR inc by P) 2. They receive a lower price on all previous units (TR dec) 3. For a monopoly, MR < P on all units after the first

Dominant Strategy and Dominant Strategy Equilibrium

When a player has a best response regardless of the other player's strategy. Dominant strategy equilibrium represents a stable outcome in a game where each player plays their dominant strategy.

Collusion

When firms cooperate to restrict output or raise prices in order to increase their joint profits. Collusion can lead to monopolistic outcomes and reduce competition.

What happens in the long-run when a perfectly competitive firm is making a loss

When making a loss in the long-run for a perfectly competitive firm 1. In the LR firms will exit the market 2. Market supply decreases (shift left) 3. Market price will increase 4. Firm MR/D curves will increase 5. Firm losses will decrease 6. Process continues until firms break-even (make 0 economic profit)

What happens in the long-run when a perfectly competitive firm is making a profit

When making a profit in the long-run for a perfectly competitive firm 1. In the LR new firms enter the market 2. Market supply increases (shift right) 3. Market price will fall 4. Firm MR/D curves will fall 5. Firm profits will fall 6. Process continues until firms break-even (make 0 economic profit)

Price leadership

When one firm in an oligopoly sets its price first, and other firms follow suit. Price leadership can be either explicit (formal agreement) or implicit (emerging from market dynamics).

Profit Maximization for Monopolistic Competition

Where P > MC