Exam 3
game theory
A model of the strategic moves and countermoves of rivals
price leadership
A pricing strategy in which a dominant firm sets the price for an industry and the other firms follow
Which of the following statements are true about both monopolistic competition and monopoly? Check all that apply. - Firms earn zero economic profit in the long run. - Price is above marginal cost. - Price equals average total cost in the long run. - Firms can earn positive economic profit in the long run. - Firms are not price takers.
- Price is above marginal cost. - Firms are not price takers.
price maker
A firm that faces a downward-sloping demand curve and therefore can choose among price and output combinations along the demand curve
price taker
A seller that has no control over the price of the product it sells
Why does a monopolist produce less and charge a higher price compared to a competitive market?
Because MR = MC at a lower output. Less supplied by a monopolist, because it is the market supplier, results in a higher price charged.
Why don't monopolists charge the highest possible price market demand will bear?
Because by doing so, the monopolist would sell only one unit of output, and that is not likely to be the most profitable output level.
What happens to employment opportunities and wages paid in all non-competitive product markets? Why?
Because they all restrict production then the demand for workers (as well as other resources) is lower. This creates lower wages and fewer employment opportunities than would otherwise be observed.
How can a monopoly maintain its single-seller status?
By maintaining the present barriers to entry, or creating new ones which are successful in preventing potential competitors from moving into the market.
In a non-collusive oligopoly if one firm increased its price what would the other firms likely do? What about a price decrease? How is this related to a kinked demand curve?
Firms will not follow a price increase. They'll follow a price decrease. This explains the nature of a kinked demand curve because if firms do not follow a price increase then the firm which increased its price initially will experience a significant loss in total revenue (sales) to its competitors. That is, an elastic (relatively flat) demand is observed---elastic demand means a price increase will decrease total revenue. Conversely, a price decrease followed by competitors will mean all firms are now selling at lower prices resulting in a decline in each firm's total revenue. Because a decrease in price results in a decrease in total revenue we observe an inelastic (steep) demand. Hence the demand curve is kinked around the prevailing price. This helps explain why prices are usually "sticky" in oligopolies.
How long can a monopoly earn economic profits?
For as long as it is successful in preventing potential competitors from entering its market---assuming continued demand for its output.
A monopoly, unlike a perfectly competitive firm, has some market power. Thus, it can raise its price, within limits, without quantity demanded falling to zero. The main way monopolies retain their market power is through barriers to entry, which prevent other companies from entering monopolized markets and competing for customers. Consider the market for taxi services. In order to own and operate a taxi, drivers are required to obtain a taxi medallion. Which of the following best explains the barriers to entry that exist in this scenario?
Legal barriers
What are some strategies that firms use to collude?
Strategies for collusion include carving out markets, setting prices, and self-imposed production quotas.
Monopoly harms consumers on two fronts:
The monopolist charges a higher price and produces a lower output than would result under a perfectly competitive market structure.
In perfect competition
a firm maximizes profit or minimizes loss by producing the output where marginal revenue equals marginal cost.
Buyers in an oligopoly may or may not be
indifferent as to which seller's product they buy.
A firm can charge higher prices if
it makes its products seem unique.
The demand curve for a monopolistically competitive firm is less elastic (steeper) than for a
perfectly competitive firm and more elastic (flatter) than for a monopolist.
A monopolist always maximizes profit by
producing at a price on the elastic segment of its demand curve.
The firm will shut down when
the price drops below the minimum average variable cost (AVC)
The few-sellers condition is met when
these few firms are so large relative to the total market that they can affect the market price.
The long-run supply curve in a perfectly competitive increasing-cost industry is
upward sloping
perfectly competitive firm's short-run supply curve
A firm's marginal cost curve above the minimum point on its average variable cost curve
Monopoly
A market structure characterized by (1) a single seller, (2) a unique product, and (3) impossible entry into the market
oligopoly
A market structure characterized by (1) few large sellers, (2) either a homogeneous or a differentiated product, and (3) difficult market entry
increasing-cost industry
An industry in which the expansion of industry output by the entry of new firms increases the individual firm's average total cost curve
natural monopoly
An industry in which the long-run average cost of production declines throughout the entire market; as a result, a single firm can supply the entire market demand at a lower cost than two or more smaller firms
True Or False: Positive Long-Run Profit Can Occur As A Result Of Advertising In A Monopolistically Competitive Market.
False
If a firm has TFC = $2,000 per day, and is currently losing $1,500 per day, should the firm shut down?
No, because losses are less than TFC which have to be paid even if it shuts down.
If a company charges different prices to different customers as a result of differences in providing the product to these different customers then is that price discrimination?
No. Price discrimination exists only when different prices are charged to different customers and these price differences are not a reflection of costs differences.
If a profit-maximizing firm is producing an output level in which marginal revenue exceeds marginal cost, should it produce more, less or the same?
Produce more until MR = MC.
marginal revenue (MR)
The change in total revenue from the sale of one additional unit of output
perfectly competitive industry's long-run supply curve
The curve that shows the quantities supplied by the industry at different equilibrium prices after firms complete their entry and exit
If a firm is producing where MR =MC, and at that output level TR = $4,500, TC = $5,000, and TVC = $4,000 per week, is the firm making or losing money? How much? Should the firm shut down?
The firm is losing $500 per week. Because its losses are less than its TFC of $1,000 per week then the firm should remain in operation.
Which market structure do most real world markets approximate?
The monopolistically competitive. For example, most businesses have a relatively large number of competitors, have some control over price, and attempt to differentiate their product out of necessity to survive
price discrimination
The practice of a seller charging different prices for the same product that are not justified by cost differences
product differentiation
The process of creating real or apparent differences between goods and services
nonprice competition
The situation in which a firm competes using advertising, packaging, product development, better quality, and better service, rather than lower prices
In perfect competition
a firm's marginal revenue equals the price that the firm views as a horizontal demand curve.
Because of economies of scale
a single firm in an industry will produce output at a lower per-unit cost than two or more firms.
If a product is homogeneous
buyers are indifferent as to which seller's product they buy.
Perfect competition requires that resources be
completely mobile to freely enter or exit a market
A monopolized market is characterized by: a. a sole seller of a product for which there are few suitable substitutes. b. very strong barriers to entry. c. a single firm facing the market demand curve. d. all of the above.
d. all of the above.
The marginal revenue curve for a straight-line demand curve intersects the
quantity axis halfway between the origin and the quantity axis intercept of the demand curve.
As the number of people connected to a network goods system increases
the greater the benefit each person receives from the network good.
market structure
A classification system for the key traits of a market, including the number of firms, the similarity of the products they sell, and the ease of entry into and exit from the market
network good
A good that increases in value to each user as the total number of users increases; as a result, a firm can achieve economies of scale
cartel
A group of firms that formally agree to reduce competition by coordinating the price and output of a product
perfect competition
A market structure characterized by (1) a large number of small firms, (2) a homogeneous product, and (3) very easy entry into or exit from the market
monopolistic competition
A market structure characterized by (1) many small sellers, (2) a differentiated product, and (3) easy market entry and exit
mutual interdependence
A situation in which a change in price strategy (or in some other strategy) by one firm will affect the sales and profits of another firm (or other firms). Any firm that makes such a change can expect the other rivals to react to the change.
decreasing-cost industry
An industry in which the expansion of industry output by the entry of new firms decreases the individual firm's average total cost curve
constant-cost industry
An industry in which the expansion of industry output by the entry of new firms has no effect on the individual firm's average total cost curve
True or False: Negative long-run profit can occur as a result of advertising in a monopolistically competitive market.
False (In the short run (before entry occurs), it is possible for advertising to create positive profit, but in the long run, economic profit is always zero under monopolistic competition with or without advertising.))
A monopoly, unlike a perfectly competitive firm, has some market power. Thus, it can raise its price, within limits, without quantity demanded falling to zero. The main way monopolies retain their market power is through barriers to entry, which prevent other companies from entering monopolized markets and competing for customers. Consider the market for electronics. Patents are granted to inventors of products or processes for a certain number of years to encourage innovation. Without patents, research and development needed to improve electronics are unlikely to occur, as nothing would then prevent other firms from stealing ideas and copying products. Which of the following best explains the barriers to entry that exist in this scenario?
Legal barriers
If a competitive industry expands and higher wages must be paid to attract more workers then what will the long-run supply curve for this industry look like?
It will be upward sloping because this is an increasing-cost industry.
What effect would a successful advertising campaign differentiating a product from one's competitors have on a monopolistically competitive firm's demand and its elasticity of demand? What does this do to the firm's profits? You may have heard the slogan: "advertising doesn't cost, it pays?" Is that sometimes true?
It would increase the firm's demand and make it more inelastic (because now there would be fewer acceptable substitutes). This would increase its profits. Sometimes, if advertising is successful, it does pay more than it costs.
If a monopoly is losing money then when should it shut down?
Like any firm, a monopoly would shut down if price is less than average variable costs (or when operating losses exceed total fixed costs; or, otherwise stated, when price is total revenue is less than total variable costs).
Consider two gas stations. One is located at a major intersection used by people commuting from populous neighborhoods to jobs located in the downtown area. The other is located on the outskirts of the city. Both gas stations sell high-grade or premium-grade gas for a higher price than low-grade or regular-grade gas. However, the gas station along the more congested route charges higher gas prices for all grades than the station on the outskirts of town. These gas stations offer product differentiation based on which of the following? Check all that apply.
Location & Quality (Each gas station differentiates products on the basis of quality, offering both higher-grade and lower-grade gasoline. The gas is also differentiated on the basis of location. The station along the congested route can charge more for all grades of gas precisely because it is located in a busy area that is convenient for many commuters.)
Consider two sandwich shops owned by the same firm. Both shops offer the exact same menu, so the sandwich quality is identical. One shop is located in an upscale downtown area. The other shop is located in a strip mall in the suburbs. The interior of the downtown shop includes leather booths, oak tables, and plasma televisions. The interior of the suburban shop is more modest, with plastic tables and folding chairs. Sandwich prices are considerably higher at the downtown shop. Product differentiation between the two sandwich shops is based on which of the following? Check all that apply.
Location & Style (Although the sandwiches are identical, the downtown shop's product is differentiated from the suburban shop's product on the basis of style and location. Its location in an upscale area and its nicer interior allow the downtown shop to charge higher prices for the same sandwiches.)
If a competitive industry is currently losing money, what can be expected to happen to the number of sellers, the price of the product, the volume of output and losses in this industry over time?
The number of sellers will decrease, the price will rise, output will fall, and the losses will disappear.
arbitrage
The practice of earning a profit by buying a good at a low price and reselling the good at a higher price
perfectly competitive industry's short-run supply curve
The supply curve derived from horizontal summation of the marginal cost curves of all firms in the industry above the minimum point of each firm's average variable cost curve
If a profit-maximizing firm is producing an output level in which marginal revenue equals marginal cost, then is this firm earning a profit?
We don't know. We would need to know what ATC are at that output level. Note: just because the firm is producing the profit-maximizing or loss-minimizing output level we don't know whether an economic profit, normal profit, or loss is incurred.
What evidence suggests that some government regulation may reduce competition in practice?
Whenever government talks about deregulating some industry, usually the first ones to oppose that move are the regulated firms in that industry.
Can a monopoly lose money?
Yes. Like any other firm if costs are relatively high or demand is relatively weak then a monopoly could lose money. The shut down rule remains the same.
One of the necessary conditions for price discrimination to occur is that: a. buyers in different markets have different elasticities of demand. b. the demand curve is upward sloping. c. buyers must be allowed to resell the good at a higher price elsewhere. d. all of the above are necessary for price discrimination to occur.
a. buyers in different markets have different elasticities of demand.
A monopolistically competitive market is characterized by: a. many small sellers selling a differentiated product. b. a single seller of a product that has few suitable substitutes. c. very strong barriers to entry. d. mutual interdependence in pricing decisions.
a. many small sellers selling a differentiated product.
If a competitive firm is losing money then: a. it should always shut down. b. it should shut down if losses are greater than total fixed costs. c. it should shut down if total fixed costs are greater than losses. d. it should raise its price.
b. it should shut down if losses are greater than total fixed costs.
Which of the following is true of a perfectly competitive firm? a. The firm is a price maker. b. If the firm wishes to maximize profits it will produce an output level in which total revenue equals total cost. c. The firm will not earn an economic profit in the long run. d. The firm's short-run supply curve is its MC curve below its AVC curve.
c. The firm will not earn an economic profit in the long run.
A monopoly will price its product: a. where total revenue is maximized. b. where total costs are minimized. c. at that point on the market demand curve corresponding to an output level in which marginal revenue equals marginal cost. d. at that point on the market demand curve which intersects the marginal cost curve.
c. at that point on the market demand curve corresponding to an output level in which marginal revenue equals marginal cost.
Perfectly competitive markets are characterized by: a. a small number of very large producers. b. very strong barriers to entry and exit. c. firms selling a homogeneous product. d. all of the above.
c. firms selling a homogeneous product.
As long as the benefits exceed the costs
cheating can threaten formal or informal agreements among oligopolists to maximize joint profits.
Which of the following is true about advertising by a firm? a. It is not always successful in increasing demand for a firm's product. b. It can increase demand and make demand more inelastic. c. It may reduce per unit costs of production when economies of scale are experienced. d. All of the above.
d. All of the above.
Which of the following is true of a perfectly competitive market? a. If economic profits are earned then the price will fall over time. b. In long-run equilibrium P = MR = SRMC = SRATC = LRAC. c. A constant-cost industry exists when the entry of new firms has no effect on their cost curves. d. All of the above.
d. All of the above.
A cartel: a. is a group of firms formally agreeing to control the price and the output of a product. b. has as its primary goal to reap monopoly profits by replacing competition with cooperation. c. is illegal in the United States, but not in other nations. d. all of the above.
d. all of the above.
A monopolistically competitive firm will: a. maximize profits by producing where MR = MC. b. not likely earn an economic profit in the long run. c. shut down if price is less than average variable cost. d. all of the above.
d. all of the above.
A monopoly: a. faces the market demand curve which is downward sloping. b. has a marginal revenue curve which slopes downward and lies below its demand curve. c. will maximize profits by producing an output level where MR = MC. d. all of the above.
d. all of the above.
An oligopoly: a. and monopolistically competitive market produce less and charge higher prices than if their markets were perfectly competitive. b. is characterized by mutual interdependence of pricing decisions. c. may be characterized by a kinked demand curve. d. all of the above.
d. all of the above.
The profit maximizing, or loss minimizing quantity of output for any firm to produce exists at that output level in which: a. total revenue is maximized. b. total cost is minimized. c. marginal cost is minimized. d. marginal revenue equals marginal cost.
d. marginal revenue equals marginal cost.
The long-run supply curve in a perfectly competitive decreasing-cost industry is
downward sloping
The demand and the marginal revenue curves of the monopolist are
downward sloping, in contrast to the horizontal demand and corresponding marginal revenue curves facing a perfectly competitive firm.
The many-sellers condition is met when
each firm is so small relative to the total market that each firm's pricing decisions have a negligible effect on the market price.
The large-number-of-sellers condition is met when...
each firm is so small relative to the total market that not a single firm can influence the market price.
The long-run supply curve in a perfectly competitive constant-cost industry is
perfectly elastic and drawn as a horizontal line.
A monopolist is characterized by inefficiency because
resources are underallocated to the production of its product.
The pay-off matrix demonstrates why a competitive oligopoly tends to
result in both rivals using a low-price strategy that does not maximize mutual profits.
kinked demand curve
the demand curve for a noncollusive oligopolist, which is based on the assumption that rivals will match a price decrease and will ignore a price increase
If the positions of a monopolist's demand and cost curves give it a profit and nothing disturbs these curves
the monopolist will earn profit in the long run.
What are some relevant public policy questions when government considers breaking up a monopoly?
How large are the social costs associated with the monopoly? How costly is it for government to intervene? What are the estimated benefits associated with busting up the monopoly? As with all rational decisions, undertake an activity only if the benefits exceed the costs and continue to do so only for as long as the marginal benefits exceed the marginal costs.
What kind of agreements may cartels work out to reduce competition among themselves?
In addition to setting prices and production quotas, they may carve out markets and agree not to compete on each other's turf.
How can cartels sow the seeds of their own destruction?
There is an inherent tendency for members to cheat on the agreement.
How are the professional sports leagues like a cartel?
They are the only legal cartel in the U.S. The agreements made within the leagues are cartel arrangements. Consider the draft.
What are some barriers to entry that may prevent potential competitors from entering a market?
Threat of violence, large financial capital required to get started, technology (have to know how to produce the product), product differentiation, sole ownership over a strategic input, government laws and regulations, etc.
True or False: Positive short-run profit can occur as a result of advertising in a monopolistically competitive market.
True (In the short run (before entry occurs), it is possible for advertising to create positive profit, but in the long run, economic profit is always zero under monopolistic competition with or without advertising.)