Econ 2302 Exam 3
THE CONDITIONS OF LONG RUN COMPETITIVE EQUILIBRIUM 3 no firm has an incentive to change its plant size to produce its current output; that is , SRATC =LRATC at the quantity of output at which P=MC - no firms has an incentive to change its plant size
that is at level of output where P = MC, short run ATC must equal long run ATC, indicating that he firm is producing at its optimal scale long run competitive equilibrium exists when P = MC = SRATC =LRATC
which antitrust legislation made price discrimination illegal?
the Clayton Act
Microsoft, the European Union and the internet -while Microsoft was negotiating with regulators in the US, it also face antitrust investigation in the EU
the Eu has fined Microsoft repeatedly for antitrust violations -in 2007 technology had changed and Microsoft now faces competition from free software offered by Google online
define natural monopoly
the condition where economies of scale are so pronounced that only one firm can survive
what determines whether a firm is a price taker or a price searcher?
the demand curve it faces
define consumer surplus
the difference between maximum price a buyer is willing and able to pay and the actual price paid
there are two competing view of competition (judgment by performance) we should judge the competitiveness of markets by the behavior (performance) of the firms in the market
(judgment by structure) we should judge the competitiveness of markets by the structure of the industry
why oligopoly firms might want to form a cartel?
- in a cartel, several firms band together in order to act as a monopoly and capture the benefits that would accrue to a monopolist in that market -as a group, the cartel will reduce output and increase price (compared to what the members would produce as individuals) in an effort to increase total profits -a successful cartel will earn its member monopoly profits that they otherwise would not achieve
application: The Standard Oil and American Tobacco Cases examples of judging market competitive by performance -a firm considered a monopoly only if it commits monopolistic abuses
-in 1911 the supreme court found standard oil and the america tobacco company, both structural monopolies, guilty of unfair business practices and were broken up -in the 1920s U.S. Steel case, the court ruled that while the company was structural monopoly, it was not a monopoly in performance -U.S. Steel was not required to break up into smaller companies
economist and regulation II -besides outlining the benefits and costs of regulation, the economist tries to point out the unintended effects that can occur with regulation
-in the early 1970s, many economist basing their arguments on the capture and public chose theories of regulation, argued that regulation was actually promoting and protecting market power instead of reducing it -they argued for deregulation. since the late 1970s, many industries have been deregulated, including airlines, trucking, long distance telephone service, and others
contestable market theory had led to a shift in policy perspectives
-policy on number of sellers in a market -issue of entry into and exit from an industry
the justice department considers a Herfindahl index less than _____ to be representative of an un-concentrated (competitive) industry
1,000
the literature about contestable market theory lists the following results
1. a market with only a few firms might be extremely competitive 2. profits can be zero in an industry even if the number of sellers is small 3.inefficient producers cannot survive if a market is contestable 4. firms in a contestable market may be resource allocative efficient
the different theories of oligopoly do have three common assumptions:
1. there are many buyers and a few interdependent sellers 2. firms produce and sell either homogenous or differentiated products 3. there are significant barriers to entry
list the 3 basic assumptions that deal with the theory of monopolistic competition
1. there are many sellers and buyers, and each firm has some control over price 2. each firm produces and sells a slightly differentiated product 3. there is easy entry and exit
there is monopolist when 3 assumptions are verified
1. there is one seller 2. the single seller sells a product for which there are no close substitutes 3. there are extremely high barriers to entry
HERMAN ACT 1890 1. every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several states, or with foreign nations, is hereby declared to be illegal
2. every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons to monopolize any part of the trade or commerce.... shall be guilty of misdemeanor criticism: the provisions of the Sherman Act are vague. for example, the act never explains which specific acts constitute "restraint of trade" although it declares such acts illegal
TRUE FALSE a decreasing cost industry is characterized by a upward sloping long run supply curve
FALSE a decreasing cost industry is characterized by a DOWNWARD SOPING long run supply curve
theory of a perfect competition 1. there are many sellers and buyers, none of which is large in relation to total sales or purchases 2. each firm produces and sells a homogeneous product
3. buyers and sellers have all relevant information with respect to prices, product quality, sources of supply, and so on 4. there is easy entry into
CLAYTON ACT 1912 The clayton act makes he following business practices illegal when their effects "may be to substantially lessen competition or tend to create a monopoly" 1. Price discrimination- charging different customers different prices for the same product where the price differences are not related to cost differences 2. exclusive dealing - selling to a retailer on the condition that the retailer not carry any rival products
3. tying contracts- arrangements whereby the sales of one product is dependent on the purchase of some other product(s) 4. the acquisition of competing companies' stock if the acquisition reduces competition 5.interlocking directorates- an arrangement whereby the directors of one company sit on the board of director of another company in the same industry. these were made illegal, irrespective of their effects 6 criticism: a major loophole of the act is that it does not ban the acquisition of competing companies' physical assets and therefore does not prevent anticompetitive mergers as it was designed to do
In the short run to maximize product Perfectly Competitive Firm sets
MR = MC
at what output level is the firm maximizing profits (minimizing costs)
MR = MC
When does long run competitive equilibrium exist for a perfectly competitive firm
P = MC = SRATC = LRATC
a perfectly competitive firm shuts down in the short run if price is less than average variable cost
P<AVC firm shuts down
if market demand increases for a good produced by firms in a constant cost industry, price will initially rise and then fall,
eventually reaching its original level
FEDERAL TRADE COMMISSION ACT 1914
The federal trade commission act declares illegal "unfair method of competition in commerce" this act also created the federal trade commission TFC to define and deal with "unfair methods of competition
What is the supply curve for a perfectly competitive industry
The horizontal summation of each individual firm's supply curve
if market demand increases for a good produced by firms in an increasing cost industry, price initially will rise and then fall
eventually settling at a price above the original equilibrium price
MARGINAL REVENUE (MR) Price = Marginal revenue for a perfectly competitive firm
a demand curve plots price against quantity, whereas a marginal revenue curve plots marginal revenue against quantity -if price equals marginal revenue (P=MR), then the demand curve and marginal revenue curve are the same
define merger
a general term meaning the act of combining two firms
a perfectly competitive firm produces in the short run as long as price is above average variable costs
a perfectly competitive firm shuts down in the short run if price is less than average variable costs
a perfectly competitive firm produces in the short run as long as total revenue is greater than total variable costs
a perfectly competitive firm shuts down in the short run if total revenue is less than total variable costs
define price taker
a seller that cannot control the price of the product it sells, but must rely on the market to set the price at which its output will be sold
THE CONDITIONS OF LONG RUN COMPETITIVE EQUILIBRIUM 2 firms are producing the quantity of output at which price (P) is equal to marginal cost (MC) firms naturally move toward the profit maximizing level of output.
at the level of output, MR = MC, and as shown earlier, since P = MR, P = MC
For a perfectly competitive firm, profit maximization or loss minimization occurs at the output at which a. MR = MC b. MR = AVC c. P = ATC d. MR =ATC
a. MR = MC
define acquisitions
acquisitions which are transactions in which a company buys another company and the purchaser has the right of direct control over the resulting operation (but does not always exercise that right)
define constant cost industry
an industry in which average total costs do not change as (industry) output increases or decreases
define decreasing cost industry
an industry in which average total costs fall as output increase and rise as output decreases
Define increasing cost industry
an industry in which average total costs rise as output increase and average total costs falls as output decrease
antitrust policy has a few unsettled points -one centers on the proper definition of a maker specifically whether it should be defined narrowly or broadly. how this question is answered has an impact on which firms are considered monopolies
antitrust authorities are also beginning to consider the benefit of innovation in ruling on proposed mergers
Any profit seeking firm will continue to produce as long as MR > MC
any profit seeking firm will not continue to produce as long as MR < MC
lowering the price of additional units of the good will lower the price of all units sold marginal revenue will fall more rapidly than price
as a result, after the first unit of output is sold,the monopolist's marginal revenue (MR) curve will always lie below its demand curve
the problem of cheating one the cartel agreement has been made, cartel member have an incentive to cheat on the agreements and sell additional output
as long as the cartel price remains intact, the cheating firm may sell additional output at the cartel price and, thus, reap additional profits
mergers rose significantly in the late 1990s and into the early 2000s the primary reasons for the increase are globalization, deregulation, and technological change
at the same time that these mergers are taking place, firms are also engaging in de-acquisitions when one company's sale of either parts of another company it has bough or parts of itself the US market structure is continually changing landscape
why is the market supply cure upward sloping?
because it is the horizontal summation of firms' upward-sloping supply curves
why does each firm have an upward sloping supply curve?
because its supply curve is the upward sloping portion of its marginal cost curve (above AVC)
within the theory of perfect competition, do higher costs mean higher prices? costs increases will not necessarily be passes on to consumers, a cost increaser that is experience by just one from (or even a handful) will not result in a higher price
because the market price is based upon the cost conditions prevailing in the entire market. on the other hand, if there is a widespread cost increase, then the market supply curve will shift, and consumers will have to pay higher prices
why is the marginal cost curve upward sloping?
because they reflect the law of diminishing marginal returns
A perfectly competitive firm should increase its level of production as long as a. total revenue is less than total cost b. the total revenue curve is rising c. marginal revenue is greater than marginal cost d. the marginal revenue curve is rising
c. marginal revenue is greater than marginal costs
Herfindahl Index is equal to the sum of the squares of the market shares of each firm in the industry
competitive Herfindahl index: less than 1,000 monopolist Herfindal index: 10,000 or greater
high concentration ratios imply that few sellers make up the industry
concentration ratios are not perfect guides to industry concentration, since they do not take into account foreign competition and competition from substitute domestic goods
the Herfindahl index measure the
degree of concentration in an industry
define lock-in effect
descriptive of the situation where a particular product or technology becomes settled upon as the standard and is difficult or impossible to dislodge as the standard
what kind of demand curve does the perfectly competitive industry face
downward sloping
Speed Limit Laws
everyone gets into an agreements to establish a speed limit on the road to avoid accidents. but individuals have an incentive to cheat because those who speed will be better off than those who obey the speed limit. an efficient enforcement mechanism is required to ensure all obey the speed
define economies of scale
exist when inputs are increased by some percentage and outputs increase by a greater percentage causing unit costs to fall
for the perfectly competitive firm P=MR
for the monopolist P>MR
from one perspective, profit serves as an incentive for individuals to produce, prompting or encouraging certain behavior
from another perspective, it serves a signal by identifying where resource are most welcome
if a firm faces a horizontal (or flat) demand curve, then it is a price taker. a horizontal (or flat) demand curve implies that the firm can sell its good at only one price. the price determined by the market
if a firm faces a downward sloping demand curve, then it is a price searcher because of what each demand curve implies about the firm's ability to control
why if the monopolistically competitive firm not resource allocative efficient
it chargers a price greater than marginal cost
why is the monopolistically competitive firm not productive efficient
it does not charge a price equal to its lowest ATC
since the firm produces in the short run if P>AVC, and shuts down if P<AVC
it follows that the firm's short run supply curve is that portion of its marginal cost curve that lies above the AVC curve
for a perfectly competitive firm, price equals marginal revenue, since price will not change as output changes
it follows that the marginal revenue curve for the perfectly competitive firm is the same as the firm's demand curve
the problem of formulation cartel policy
making policy for the whole cartel is liable to be painstakingly complicated and frustrating, since each member is likely to have its own priorities
a firm is resource allocative efficient if it produces the level of output at which price equals
marginal cost (P=MC)
define Herfindahl Index
measures the degree of concentration in an industry
perfect competition: P=MR and P=MC
monopoly: P>MR and P>MC
ASSESSMENT OF U.S. ANTITRUST POLICY -economic scholars' overall assessment of antitrust policy is mixed -in certain cases, such as the IBM case, most agree that antitrust prosecution went too far
most believe that other decisions (as in the standard oil and american tobacco case) set a healthy precedent by encouraging a more competitive US business enviroment
the monopolist produces the quantity of output (Q1) at which MR=MC, and charges the highest price per unit at which this quantity of output can be sold (P1)
notice that at profit maximizing quantity of output, price is greater than marginal cost, P>MC
define point of productive efficiency
perfectly competitive firms produce at the lowest point on their ATC curve in the long run
the Sherman Act of 1890 was passed with the intent of..
preventing monopolization and/or conspiracy in the restraint of trade
what will happen if market demand increases for a good produced by firms in an increasing cost industry
price will initially rise and then fall, eventually settling a ta price above the original equilibrium price
"exclusive dealing" is
selling to a retailer on the condition that the retailer not carry any rival products
if the market demand increases for a good produced by firms in a decreasing cost industry, price will initially rise and then fall,
settling at a price below the original equilibrium price
regulatory issues I -government regulation of a natural monopoly can distort the incentives of those who operate the natural monopoly -some firms are regulated even though they are not natural monopolies
some economist view the regulation of competitive industries as unnecessary. they see it as evidence that the firms being regulated are , in turn, controlling the regulation to reduce their competition
IBM case in 1967 the justice department sued IBM for violation of antitrust laws: -IBM unfairly bundled hardware, software and maintenance service -IBM constantly redesigned its hardware, so that competitors couldn't keep up in its defense, IBM argued: -the market was larger than the government claimed -changing technology and customer demand forced it to constantly upgrade its equipment
the government dropped its suit in 1982 -mainframe computers were replaced by PCs -globalization of the computer industry made IBM's dominance the US far less important =the prosecution likely led to IBM's problems in the 1990 -IBM didn't buy the DOS operating system for Microsoft because of the litigation -PCs replaced mainframes
define antitrust policy
the government's policy toward the competitive process
a firm is productive efficient if it produces its output at
the lowers per unit or average total cost (P=ATC)
Recent Antitrust Enforcement -since the 1980s the government has been more lenient in antitrust cases because of -change in american ideology -globalization of the US economy -the increasing complexity of technology
there have been three recent important computer and telecommunication cases: 1. IBM 2.AT&T 3.Microsoft
when does the perfectly competitive from achieve productive efficiency
when it is in long run equilibrium
The perfectly competitive firm is a price taker no control over the price of the product it sells
the monopoly firm is a price searcher. it has some control over the price of the product it sells
If one farmer's land is more productive than another farmer's land, he will be able to sell or rent his land for a higher price
the new owner will now have a higher total costs and the ATC curve will shift up to reflect this fact -the probability of the land has been incorporated in the price of the land
a price searcher raises its price and still sells its product
the number of units sold will fall as prices rise
TRUE FALSE the monopolistic competitor will most likely earn no economic profit in the long run
TRUE
TRUE FALSE a firm in a perfectly competitive market that discriminates because of a worker's race, religion, or gender will see an INCREASE in its total costs, pushing him into taking economic losses
TRUE the more discrimination costs, the less there will be
TRUE/FALSE a perfectly competitive firm is said to be a price taker
TRUE the perfect competitive firm has not market power, offers a product that is indistinguishable from its competitors, is subject to new competitor, and does business in a market where all buyers and sellers are well informed.
Diagrammatically represent a perfectly competitive firm that is incurring short run losses, but still is better off continuing to produce than shutting down
- at a market price of $10 unites where MR=MC -the total revenue earned by the firm (TR)=P*Q=$10*100=$1,000 -the firm's TC =average total cost*Q=$11*100=$1,100 -since TC>TR, the firm takes a loss of $100 -if the firms shuts down, it loses its total fixed cost, which is equal to $200 -if the firm continues to produce in the short run, it loses $100 but if it shuts down it loses $200 therefore, the firm is better off continuing to produce than shutting down
What are the four basic assumptions of a Perfectly Competitive Firm
-Many sellers and buyers -Information -Easy entry and exit -Homogenous product
the perfectly competitive firm's short run supply curve is that portion of its marginal cost curve that lies above the AVC curve
-a perfectly competitive firm will operate in the short run as long as P>AVC -if P<AVC it will shut down in the short run
-demand and marginal revenue curves and with MC1=ATC1 -because cost is "so high", no firm produces the good
-a single firm figures out who to lower costs to MC2=ATC2 -the firm produces Qm and chargers the monopoly price of Pm per unit
economists and regulation I -economists re neither for nor agains such government regulations -the job of the economist is to make the point that regulation involves both benefits and costs. to the person who sees only costs, the economist asks, what about the benefits?
-and to the person who sees only the benefits, the economist asks, what about the costs -then, the economist goes on to outline the benefits and the costs as best as she can
is Microsoft a predatory monopolist? -the justice department argued that Microsoft had acted unfairly in gaining its large share of the software market and maintaining barrier to entry
-by directing the development of software to favor windows, Microsoft strengthened the barriers to entry created by network externalities -Microsoft penalized PC manufacturers that installed windows if they also installed competing software
-is monopoly preferable to no firm producing the good? -form a consumer's perspective, the answer is yes
-consumers' surplus is zero when no firm produces the good -consumers' surplus is area PmAB when the monopoly firm produces the good
the problem into the industry even if cartel members manage to agree upon policy and achieve monopoly profits, those high profits may attract new firms into the industry
-if profits are high enough, potential barriers to entry are easy to overlook -if cartel members cannot prevent entry, then their production targets will upset by the presence of additional suppliers
-if the market is perfectly competitive, the demand curve is the marginal revenue curve -the profit maximizing output is Qpc and price is Ppc -consumers surplus is the area PpcAB
-if the market is a monopoly market, the profit maximizing output is Qm and price is Pm -consumer surplus is the area PmAC - -consumers surplus is greater in perfect competition than in monopoly; it is greater by the area PpcPmCB
INDUSTRY ADJUSTMENT TO A DECREASE IN DEMAND -if demand falls, equilibrium price will fall, shifting the individuals firm's demand curve down -existing firms will decrease output, since P=MC is now at a lower level of output (since P has decreased) -as a result, existing firms will suffer losses in the short run
-over time, firms will exit the industry until losses "dry up" -this will, in turn, shift the industry supply curve leftward raising equilibrium price -Exit will continue until long run competitive equilibrium (specifically, zero economic profit) is re-established
UNSETTLED POINTS IN THE ANTITRUST POLICY
-proper definition of a market: should a market be defined narrowly or broadly? -the use of concentration ratios, and more recently the Herfindahl index -the benefits of innovation in ruling on proposed mergers
application: The ALCOA Case examples of judging market competitiveness by structure -judgment by performance governed antitrust policy until the ALCOA case of 1945
-the court did not rule the ALCOA had engaged in unfair practices, but that it dominated the market by expanding capacity and keeping prices low -the court changed its viewpoint to judging markets by structure
-the monopolist's profit maximizing short run level of output will be that quantity where MR=MC -the monopolist will charge the highest price per unit at which that quantity can be sold
-the monopolist charges a price greater than marginal cost P>MC -(perfectly competitive price taker firm charges a price P=MC)
regulation: The Natural Monopoly -if economies of scale are so pronounced or large in an industry that only one firm can survive, that firm is a natural monopoly
-the only existing firm produces Q1 at an average total cost of ATC1. (Q1 is the output at which MR = MC; to simplify the diagram, the MR curve is not shown
-to sell an additional unit of its good, a monopolist needs to lower price -this price reduction both gains revenue and loses revenue for the monopolist
-the revenue gained (yellow) and revenue lost (green) are compared -marginal revenue (MR) is equal to the larger yellow area minus the smaller green area
how do economies of scale act s a barrier to entry? -economies of scale exists when a firm doubles inputs and its output more than doubles, lowering its unit costs (average total costs) in the process -if economies of scale exist only when a firm produces a large quantity of output and one firm is already producing this output, then new firms (that initially produce less output) will have higher unit cost than those of the established firm
-this will make the new firm uncompetitive when compared to the established firm -economies of scale act as a barrier to entry, effectively preventing firms from entering the industry and competing with the established firm
-resource allocative efficiency exists at Q2. there are two ways to obtain this output level 1.the only existing firm can increase its production to Q2 or 2. a new firm can enter the market and produce Q3, which is the difference between Q2 and Q1 the first way minimizes total costs, the second way does not
-this, then, is a natural monopoly situation: one firm can supply the entire output demand at a lower cost than tow or more firms can
GAME THEORY: mathematical technique used to analyze the behavior of decision makers who
-try to reach an optimal position for themselves through game playing or the use of strategic behavior -are fully aware of the interactive nature of the process at hand, and anticipate the moves of other decision makers
the problem of forming the cartel, forming a cartel poses two major problems
1, first in many parts of the world cartels are illegal 2 second even if the cartel is legal, they are expensive to set up (especially when the number produces is fairly large), and many potential cartel members may resist the cost when they may benefit from the carpet as "free riders"
the conditions that characterize long run competitive equilibrium include:
1. economic profit is zero 2. firms are producing the quantity of output at which price is equal to marginal cost 3. no firm has an incentive to change its plant size to produce its current output
a contestable market is one in which the following conditions are met:
1. there is extremely easy entry into the market and virtually costless exit from the market 2. new firms entering the market can produce a the same per unit costs as existing firms 3. firms exiting the market can easily dispose of their fixed assets by selling or using them elsewhere
give 5 reasons unrelated firms combine
1. to achieve economies of scope 2. to get a good buy 3. to diversify 4. to ward off a takeover bid 5. to strengthen their political-economic influence
The Perfect Competitive Firm's short run supply curve is that portion of its Marginal Cost curve that lies where
Above the AVC curve
TRUE/FALSE while the market demand curve is horizontal, the demand curve facing a single firm is downward sloping
FALSE ( while the market demand curve is DOWNWARD SLOPING, the demand curve facing a single firm is HORIZONTAL)
TRUE FALSE a monopolistic competitor sets MR=MC in order to maximize profit in the long run
FALSE a monopolistic competitor sets MR=MC in order to maximize profit in the SHORT RUN
TRUE FALSE an increasing cost industry is characterized by a horizontal long run supply curve
FALSE an increasing cost industry is characterized by a UPWARD SLOPING long run supply curve
a perfectly competitive firm shuts down in the short run if total revenue is less than total variable costs
TR<TVC firm shuts down
a perfectly competitive firm produces in the short run as long as total revenue is greater than total variable cost
TR>TVC firm produces
the profit maximization for the perfectly competitive firm says to produce the quantity at which
MR = MC
TRUE FALSE a constant cost industry is characterized by a horizontal long run supply curve
TRUE
a perfectly competitive firm produces in the short run as long as price is above average variable cost
P>AVC firm produces
according to the profit maximization rule, a firm will produce the quantity of output at which MR=MC and the price P=MR -resource allocative efficiency is achieved when a firm produces the quantity of output where P=MC
Perfectly competitive firms exhibit resource allocative efficiency because they produce where MR = MC, and since for the competitive firm P=MR, then necessarily they produce where P(=MR) = MC
TRUE FALSE excess capacity is the trade off for product differentiation
TRUE
economist use concentration ratios to help identify industries dominated by a small number of firms
concentration ratios measure the percentage of sales, assets, output, labor force, or some other factor that is controlled by a particular number of firms in the industry
Antitrust law is legislation passed for the stated purpose of
controlling power and preserving and promoting competition
antitrust law is legislation passed for the stated purpose of controlling monopoly power and preserving and promoting competition. two major criticism have been directed at the antitrust acts.
first, some argue that the language in the laws is vague, for example, even though the words "restraint of trade" are used in the Sherman Act, the act does not clearly explain what actions constitute a restraint of trade second, it has been argues that some antitrust acts appear to hinder, rather promote, competition
what kind of demand curve does the perfectly competitive firm face
horizontal
supplier-set price Vs. market-determined price: collusion or competition?
if all the firms in an industry charge the same price, this is not necessarily evidence of collusion. it could be that all firms are price taker
if price is below short run average total cost is a perfectly competitive industry then entry will occur, driving price down
if price is below short run average total cost in a perfectly competitive industry then exit will occur, driving price up
THE MICROSOFT CASE -microsoft controls about 50% of the market for software and over 90% of the operating systems market
in 1998 the justice department charged microsoft with: 1. possessing monopoly power in the PC operating systems market 2. tying other Microsoft software product to its windows operating system 3. entering into agreements that keep computer manufacturers that install windows from offering competing software
is Microsoft a monopolist? the software industry is characterized by barriers to entry in the form of: -networking externalities -economies of scale
in a static framework -with its 90% market share, Microsoft is a monopoly from a dynamic perspective -there are potential competition from other operating systems and the merging of hardware and software
what does the excess capacity theorem state
in equilibrium, a monopolistically competitive firm will produce an output smaller than the one that would minimize its units costs of production
THE MICROSOFT CASE: RESOLUTION -in 2000 the court ruled that Microsoft violated the Sherman Act by anti competitive means to maintain its monopoly power
in the settlement Microsoft agreed that -it would not prohibit PC maker from using competing products -it would release technical information on windows improvements to software makers -it could continue to bundle email and media players with windows
define vertical merger
is a combination of two companies that are involved in different phases of producing a product -an example is the DuPont/General Motors case
define horizontal merger
is the merging of two companies in the same industry -standard oil, AT&T and cingular are examples
what is the reason behind a horizontal demand curve on a perfectly competitive firm
it is a price taker, it may sell all of the output it is capable of producing at or below the market price, but it will not be able to sell anything at a price higher than the market price
in case 2, TR<TC and the firms takes a loss -it shuts down in the short run because it minimizes its losses by doing so;
it is better to lose $400 in fixed costs than to take a loss of $450
in case 3, TR<TC and the firm takes a loss -it continues to produce in the short run because it minimizes its losses by doing so
it is better to lose $80 by producing that to loose $400 in fixed costs by not producing
why is the quantity of output the perfectly competitive firm will produce at MR = MC? -the firm's demand curve is horizontal at the equilibrium price
its demand curve is its marginal revenue curve. the firm produces that quantity of output at which MR = MC
define oligopoly
often referred to as "monopoly of the few", occurs when a small number of firms control a large enough share of the market that, if they were to band together, they could act like a monopoly
natural monopoly exist when
one firm can supply the entire output demand at lower cost than two or more firms can
an increase in demand for a product can throw an industry out of long run competitive equilibrium first, equilibrium price will rise, shifting the individual firm's demand curve upward second, existing firms will increase output, since MR and P=MC is now at a higher level of output as a result, existing firms will enjoy additional profits in the short run
over time, new firms will enter the industry in search of economic profits this will, in turn, shift the industry curve rightward, lowering equilibrium price. entry will continue until long run competitive equilibrium (Specifically, zero economic profit) is reestablished the new long run equilibrium price may be higher, lower, or the same as the old one, depending of the industry
regulating a natural monopoly -the government can regulate a natural monopoly through : 1.price regulation 2.profit regulation 3.output regulation
price regulation usually means marginal cost pricing, and profit regulation usually means average cost pricing
what will happen if the market demand increases for a good produced by firms nine a decreasing cost industry
price will initially rise and then fall, settling at ta price below the original equilibrium price
what will happen if market demand increases for a good produced by firms in a constant cost industry
price will initially rise, and then fall, eventually reaching its original level
define product differentiation
product differentiation makes each good slightly different form its substitutes
define takeovers
takeovers which are the purchase of one firm by a shell firm that then takes direct control of all the purchased firm's operations
if price is below average total cost but above average variable cost
the firm minimizes its losses by continuing to produce in the short run instead of shutting down
define conglomerate merger
the merging of two companies in relatively unrelated industries -tyco is an example
the perfectly competitive firm charges a price equal to marginal cost
the monopolist chargers a price greater than marginal cost
in a perfectly competitive market, the firm is a price taker
the monopolist is a price searcher. its unique statues in its market gives the monopolist the ability to control the price of the product it sells
the perfectly competitive firm's demand curve is its marginal revenue curve
the monopolist's demand curve lies above its marginal revenue curve
is the monopolistic competitor resource allocative or productive efficient
the monopolistic competitor is neither resource allocative nor productive efficient
the perfectly competitive firm faces a horizontal demand curve
the monopoly firm faces a downward sloping demand curve
most economist think that oligopoly firms that enter into a cartel agreement are in a prisoner's dilemma, and that each will act so as to avoid the worst result for themselves, rather than acting cooperatively as a result, they will earn lower profit than they could have if they had cooperated
the only way out of prisoner's dilemma is to have some entity actually enforce the carte agreement so that no cheating occurs sometimes government acts as the enforcer
define market structure
the particular environment of a firm, the characteristics of which influence the firm's pricing and output decisions
define prisoners dilema
the prisoner's dilemma illustrates a case where individually rational behavior leads to a jointly inefficient outcome. this section describes the mechanic of the prisoners dilemma game
even if price is below average total cost and a loss is being incurred, a firm should not necessarily shut down
the shut down decision depends in the short run, on whether the firm loses more by shutting down than by not shutting down
define resource allocative
the situation when firms produce the quantity of output at which price equals marginal cost P= MC
regulatory issues II -regulation requires information 1. the cost information is not easy to determine, even for the natural monopoly itself 2. the cot information can be rigged (to a degree) by the natural monopoly, and therefore, the regulators will not get a true picture of the firm 3.the regulators have little incentive to obtain accurate information because they are like to keep their jobs and prestige even if they work with less than accurate information
there are regulatory lags- the time period between when a natural monopoly's costs change and when the regulatory agency adjust prices for the natural monopoly
at the long run equilibrium, there is no incentive for firms to enter or exit the industry;
there is no incentive for firms to produce more or less output and there is no incentive for firms to change plant size
MONOPOLY LOSS price below average total cost at Q1
therefore, TR (the area 0P1AQ1) Is less than TX (the area 0CBQ1) and losses equal the area P1CBA
MONOPOLY PROFIT -price is at above average total cost at Q1, the quantity of output at which MR=MC
therefore, TR (the area 0P1BQ1) is greater than TC (the area 0CAQ1), and profits equal the area CP1BA
Will the Perfectly competitive firm advertise? from a perfectly competitive firm's viewpoint, advertising has costs and no benefits
therefore, an individual firm operating in a perfectly competitive market will not advertise. the industry as a whole may advertise in an attempt to shift the industry demand curvet the right
THE CONDITIONS OF LONG RUN COMPETITIVE EQUILIBRIUM 1 price (P) is equal to short run average total cost (SRATC) for long run competitive equilibrium to exist, there must be no incentive for firms to enter or exit the market.
this condition is brought about by zero economic profit (normal profit), which is a consequence of market price being equal to short run average total cost (SRATC)
in recent years, economist have shifted the emphasis from the number of sellers in a market to the issue of entry into and exit from an industry
this focus is a result of the work of economists who have put forth the idea of contestable markets
a monopoly: produces a smaller output than is produced by a perfectly competitive firm with the same revenue and cost considerations, charges a higher price and causes a deadweight loss
this is the monopoly power problem, and solving it is usually put forth as a reason for antitrust laws and/or government regulatory actions
The Arms Race
two countries are in a prisoner's dilemma regarding the production of armaments. they get into an agreement to cut competition in the production of armament. but he countries will have an incentive to cheat because a country will be better off it produces more weapons than the other
What does the slope of the long-run supply curve depend on
whether the industry in question is a constant-cost, increasing cost, or decreasing cost
judging by structure is practical though seemingly unfair -if a firm is competing so successfully that all the other firms leave the industry the successful firm will be a monopolist
with judgment by performance, each action of a firm must be analyzed on a case by case basis, which is difficult to do -judging by structure may have problems, but it is necessary
what does monopolistic competition deal with
with markets that are basically competitive but have the extra twist of product differentiation
suppose an industry consists of five equal-sized firms. two of the firms plan to merge. the merger _____ raise anti trust concerns at the justice department given that the Herfindal index before the merger was _____ and the merger would cause the Herfindahl to rise by _____
would greater than 1,8000 more than 100
