Econ 114 chapter 9

Name some regulations the government imposes on firms with market power

1. Direct price regulations that set the price that a firm may charge in a market 2. antitrust laws that restrict firms from behaviors that limit competition in a market.

Name and describe three barriers to entry to a market

1. Natural Monopolies 2. Switching cost 3. Product differentiation 4. Absolute cost advantages of key inputs

Why does a firm have market power?

A firm that can influence the price at which it sells its product holds market power

Compare the consumer and producer surplus of perfectly competitive firms with that of firms with market power

A perfectly competitive firm faces a market price equal to its MC, and thus does not earn a producer surplus. A firm with market power is able to price above its marginal cost; as a result, it earns producer surplus, at the expense of some of the consumer surplus that would benefit buyers under perfect competition.

What is the profit-maximizing output level for a firm with market power?

A profit maximizing firm produces where MR=MC

Absolute cost advantages of key inputs

Ex: suppose one firm owns the only oil well in existence and can prevent anyone else from drilling one. That would be a major cost advantage.

barriers to entry

Factors that prevent entry into markets with large producer surpluses

Why do firms with market power have only demand -- and not supply -- curves?

Firms with market power face a set of profit-maximizing prices and quantity combinations, but these combinations do not, strictly speaking, form a supply curve. These price-quantity combinations depend on the firm's demand curve, while a supply curve by its formal definition exists independent of its associated demand curve.

Firms with market power respond differently to changes in consumers' price sensitivity than do perfectly competitive firms. Explain why this is true.

In perfect competition, suppliers' production decisions are independent of the price sensitivity of demand, this is not true for decisions made by firms with market power. A change in the price sensitivity of demand rotates the demand curve, thereby rotating the firm's MR curve. The firm's profit-maximizing price-quantity combination is now at the intersection of the new MR curve and the MC curve

Describe the connection between the slope of the demand curve for a good and a firm's marginal revenue

Its vertical intercept is identical, and its slope is twice the slope of the demand curve.

Why does the profit-maximizing strategy of a firm with market power create a deadweight loss?

The DWL represents the inefficiency of market power: There are consumers who demand the product at a price above its MC but below the higher price set by the firm with market power. The resulting loss in surplus for these consumers who do not purchase the product under monopoly is the DWL.

Marginal revenue

The revenue from selling an additional unit of a good

Market power

a firm's ability to influence the market price of its product

natural monopolies

a market in which it is efficient for a single firm to produce the entire industry output

Monopoly

a market served by only one firm

Lerner index

a measure of a firm's markup, or its level of market power

Product differentiation

creates an imperfect substitutability across otherwise similar products. As a result, new entrants to the market cannot gain customers simply by selling their product at a lower price

product differentiation

imperfect substitutability across varieties of a product

antitrust laws

laws designed to promote competitive markets by restricting firms from behavior that limit competition

Switching cost

makes it less likely a consumer will switch from one business or product to another, since the consumer will have to give up something in order to make the switch

Oligopoly

market structure in which a few competitors operate

Natural Monopolies

markets in which it is efficient for a single firm to produce the entire industry output

What are the characteristics of a natural monopoly? Why is it efficient for society for a natural monopoly to produce all the output of an entire industry?

Natural monopolies face economies of scale at all output levels. This means that the larger the firm is, the lower its average total costs. Splitting industry output among different firms would increase average total costs, making it most efficient for one firm to produce the entire industry output.