MicroEcon Final Exam

if a group of sellers could form a cartel, what quantity and price would they try to set?

- a high price

how and why does a firm's average total cost curve differs in the short run and in the long run?

- all inputs are variable in the long run. this means that in the long run, fixed cost (like factory size) may also vary - the firm will choose its fixed cost in the long run based on the level of output it expects to produce - there is a tradeoff between higher fixed cost and lower variable cost for any given output level, and vice versa - the long-run average total cost curve shows the relationship between output and ATC when fixed cost has been chosen to minimize ATC for each level of output

Why do oligopolies exist?

- an oligopoly is a market that is dominated by a small number of firms and "imperfect competition" - interdependence - cooperation

public policy and monopoly options

- break up -- use antitrust laws - promote competition -- small business assistance - allow but regulate -- limit price -public ownership - leave alone - create (for example: patents)

changing fixed cost

- buying or selling equipment allows a firm to change its fixed cost - a firm will choose the level of fixed cost that minimized the ATC for its desired output Q - and that may mean closing altogether

product differentiation among firms in monopolistic competition

- differentiation by style or type -- sedans vs SUVs - differentiation by location -- gas station just off highway vs gas station 2 miles away from highway - differentiation by quality -- ordinary chocolate vs gourmet chocolate 2 important features of industries w differentiated products: - competition among sellers: entry by more producers reduces the quantity each existing producer sells - value in diversity: consumers gain from the increase diversity of products

barriers to entry - monopolies

- essential for monopolies - they generate profit for the monopolist in the short run and long run Barriers: - control of natural resources or inputs -- if De Beers owned nearly all of the diamond Ines in the world, it would have a monopoly in diamond production - increasing returns to scale -- a natural monopoly exists when economies of scale provide large cost advantage to a single firm EX: utilities company - technological superiority -- a firm that maintains a consistent technological advantage over potential competitors can establish itself as a monpolist - network externality -- the value of a good or service to an individual increases as more individuals use the same good or service - government-made barriers, including patents and copyrights -- a patent gives an inventor a temporary monopoly in the use or sale of an invention -- a copyright gives the creator of a literary or artistic work sole rights to profit from that work

does a monopoly produce more or less output than the level of output that maximizes total surplus? what is deadweight loss and why does it result from a monopoly

- less - when a monopoly raises prices and lowers Q, consumer surplus falls and deadweight loss is created to avoid this, government policy may attempt to prevent monopoly behavior: -- antitrust policies: 1. limit mergers 2. prevent price fixing 3. break up monoplies

under what conditions will a firm shut down in the (1) short run and (2) long run?

- losses don't mean immediate shutdown - remember, fixed cost must be paid regardless of whether the firm producer in the short run - firms will choose to produce (even at a loss) if they can cover their variables AND SOME of their fixed costs EX: airlines after 9/11 or during pandemic -shortcut: is the price at or below the shut-down price? -- shut-down price: minimum average variable cost - a firm will produce at every price above minimum ATC where the price intersects the MC curve, but will stop producing in the short-run if the market price falls below the shut-down price, so the MC curve (above the shut-down price) is the firm's supply curve - if P > break even price (min ATC), firms are profitable -- this profit attracts new entrants In the short run, when a firm cannot recover its fixed costs, the firm will choose to shut down temporarily if the price of the good is less than average variable cost. In the long run, when the firm can recover both fixed and variable costs, it will choose to exit if the price is less than average total cost.

putting the 4 cost curves together

- marginal cost is upward-sloping because of diminishing returns - average variable cost is also upward-sloping but is flatter than the marginal cost curve - average fixed cost is downward-sloping because of the spreading effect - the marginal cost curve intersects the average total cost curve from below, crossing it at its lowest point.

describe the three attributes of monopolistic competition. how is monopolistic competition like a monopoly? how is it like perfect competition?

- monopolistic competition is a market structure that's a little like monopoly and a little like perfect competition. -- it like perfect competition because there are many competitors and easy entry and exit -- it is like a monopoly because products are similar, but not identical EX: restaurants are monopolistic competitors

how does a monopolistically competitive firm decide how much to sell and at what price?

- same rule: produce where MR = MC - like monopoly firms, set price according to demand

hiring workers: the demand for labor

- the demand for labor is a "derived demand" results from the demand of the output being produced ex: after major hurricanes like Katrina and sandy, the demand for new housing increased so the demand for construction and repair workers increased - a firm is willing to hire a worker when the worker increases the firm's revenues more than the firm's costs - the increase in revenue created by hiring an additional worker is called the marginal product of labor - the increase in costs from hiring an additional worker (for a competitive firm) is simply the worker's wage firms hire more workers as long as VMPL > wage (VMPL = P * MPL) - profit maximizing level of employment st VMPL = W

Define economies of scale and explain why they might occur. Define diseconomies of scale and explain why they might occur.

- there are economies of scale when long-run average total cost declines as output increases - occurs when firms can more efficiently use resources when they increase the scale of operations -- labor specialization -- more efficient use of capital (machinery, etc) - there are diseconomies of scale when long-run ATC increases as output increases --may occur when forms get so large, they become difficult to coordinate activities and manage -- not usually as important as economies of scale

explain the shape of a production function that exhibits diminishing marginal product, as well as its associated total cost curve

- total cost curve becomes steeper as more output is produced, a result of diminishing returns.

how does the monopolist determine its profit-maximizing level of output and profit-maximizing price?

- unlike competitive firms, monopolists can choose price - profit maximizing rule: Profit is maximized at the Q where MR = MC where MR = change in TR/ change in Q - MR is below the demand curve - an increase in production by a monopolist has 2 opposing effects on revenue: -- a quantity effect: one more unit is sold, increasing total revenue by the price at which the unit is sold -- a price effect: to sell the last unit, the monopolist cut the market price on all units sold; this decrease total revenue -profit maximization: 1. choose Q where MR = MC 2. choose the highest price that you can get away with, which is the highest price consumers will pay for that quantity Rule: once you've picked your quantity, follow the graph to the demand curve, which shows you how much consumers will pay Pitfalls: monopolists will not always choose this price - monopolists don't have supply curves since there is no set relationship between price and quantity supplied

what are the main characteristics of a competitive market?

1. infinite number of buyers and sellers, each seller having a tiny market share -- market share: fraction of the total industry output accounted for by that producer's output -- price takers --> their actions have no effect on price 2. product is standardized across sellers -- standardized product: consumers regard different sellers' products as equiv. 3. free entry and exit

what is the prisoners' dilemma, and what does it have to do with oligopoly?

A dominant strategy: a strategy that is a player's best action regardless of the action taken by the other player. Depending on the payoffs, a player may or may not have a dominant strategy.• Nash equilibrium (also known as noncooperative equilibrium): the result when each player in a game chooses the action that maximizes his or her payoff given the actions of other players, ignoring the effects of his or her action on the payoffs received by those other players.

give two examples of price discrimination. in each case, explain why the monopolist chooses to follow this business strategy.

Aids pills in Europe (more inelastic demand) and Africa (more elastic demand) - in Europe, sell at a higher price than in Africa price discrimination - selling the same product at different prices -- the principles of price discrimination: 1. if demand curves are different, it is more profitable to set different prices in different markets - the price should be higher in the market with more inelastic demand 2. arbitrage makes it difficult to price discriminate

measuring oligopoly

HHI is the sum of squares of each firm's share of market sales - HHI of < 1000 indicates a strongly competitive market - HHI of 1000 to 1800 indicates a somewhat competitive market - HHI above 1800 indicates oligopoly - HHI is above 1000, a merger that results in a significant increase in the HHI will receive special scrutiny and is likely to be disallowed

average total cost curve

Increasing output has two opposing effects on average total cost: *The spreading effect*: the larger the output, the more output over which fixed cost is spread, leading to lower average fixed cost. *The diminishing returns effect*: the larger the output, the more variable input required to produce additional units, which leads to higher average variable cost.

overcoming prisoner's dilemma

Repeated Interaction and Tacit Collusion: If a game is played repeatedly, players may engage in strategic behavior, sacrificing short-run profit to influence future behavior. Under price leadership, one firm sets its price first, and other firms follow. - But incentives to cheat will persist • Avoid price competition; Engage in nonprice competition• Government Regulation - Examples: Ban cigarette advertising Ban steroids use in sports

short-run industry supply curve and long-run industry supply curve

SHORT RUN - shows the relationship between the price of a good and the total output of the industry as a whole. - shows how the quantity supplied by an industry depends on the market price given a fixed number of producers - there is a short-run market equilibrium when the quantity supplied equals the quantity demanded, taking the number of producers as given comparison: - long run supply curve is flatter (more elastic) than the short-run supply curve -- a higher price attracts new entrants in the long run, raising industry output and lowering price -- a fall in price induces existing producers to exit in the long run, reducing industry output and raising price

explain the difference between a firm's revenue and its profit. Which do firms maximize?

TR = P x Q Profit = TR - TC -if TR > TC, the firm is profitable - if TR = TC, the firm breaks even -if TR<TC, the firm incurs a loss firms maximize profit

why would a firm want to enter an industry if the market price is only slightly greater than the break-even price?

We are using economic profit as out measure, so if the market price is above the break-even level (no matter how slightly), the firm can ear more in this industry than it could elsewhere

what does a monopolist do?

a monopolist reduced the quantity supplied to Q and moves up the demand curve from C to M, raising the price to P

why is the monopolist's marginal revenue less than the price of its good?

because you have to decrease the price in order to sell an additional unit of product

give an example of a government created monopoly. is creating this monopoly necessarily bad public policy?

benefits from monopoly: 1. economies of scale 3. high profit incentives 3. patents and copyrights

does a competitive firm's price equal its marginal cost in the short run, long run, or both?

both

monopsony

exists when there is only one buyer of a good or resource in 2014, the two largest cable providers (Time Warner Cable and Comcast) announced their intention to merge, the FCC was worried about the monopoly and monopsony power: -- the combined company would cover most Americans with cable access -- the combined company would be virtually the only purchaser of programming ---RESULT: amid strong opposition, the deal was cancelled monopsony and hiring workers: - if perfect comp, hire until W = P x MPL - if monopsony, hire until MFC = P x MPL -- hiring additional workers drives up the wage rate -- leads to lower wages and ineffic - if monopoly aiency -- argument for minimum wage? nd monopsony, hire until MFC = MR x MPL -- since a monopolist's price falls as output increases

in a perfectly competitive market, demand is perfectly elastic at the market price

facts

economics of advertising

good and bad advertising - "informative" advertising: price, quality, and availability information - good! - misleading advertising - bad! - cancelling out advertising - wasteful! -- firms could be caught in a prisoner's dilemma which drives them to competitively advertise which raises all firms ATCs

what is the goal?

it is not to have the lowest average cost, but to produce the right number of output that maximize profit profit maximizing rule: continue production until marginal revenue of last unit produced is >= marginal cost

does a competitive firm's price equal the minimum of its ATC in the short run, the long run, or both?

long run

what is marginal product, and what does it mean if it is diminishing?

marginal product: change in output resulting from a one-unit (hour, day, week, etc.) increase in the amount of labor input (change in Q / change in L) - it is the slope of the total product curve - initially rises as more workers are hired; then declines because of the principle of diminishing returns diminishing returns - when an increase in the quantity of that input, holding the levels of all other inputs fixed, leads to a decline in the marginal product of that input

define natural monopoly. What does the size of a market have to do with whether an industry is a natural monopoly or not?

natural monopoly --> formed when economies of scale provide a large cost advantage to a single firm EX: utilities company - natural monopolies bring lower costs, but there's no guarantee the firm will voluntarily pass along its cost savings to consumers

does a monopolistic competitive firm produce the most efficient level of output? should government regulate such firms?

no; firms in a monopolistically competitive industry have excess capaity: they produce less than the output at which ATC is minimized. thus, there is deadweight loss - bc some substitutes are available, demand will tend to be elastic and the deadweight loss will tend to be small - also, the extra diversity of products may be worth the slightly higher price and lower quantity vs perfect competition - generally, economists do not believe government should regulate firms competing in this market structure

explain how the competitive firm chooses the level of output that maximizes its profit.

optimal output rule: profit is maximized by producing the quantity of output at which the marginal revenue of the last unit produced = marginal cost explanation: - If producing another unit adds more to revenue than it costs, profit will increase -- if MR > MC, producing more will add to profit -- If MR<MC, producing less will add to profit -- since MR = P for competitive firms, the profit-maximizing rule is: choose the quantity of output where P=MC pitfalls: if there is no output level at which MR = MC, then you would produce the largest quantity for which marginal revenue exceeds marginal cost

market structures summary

perfect competition: - infinite # firms - no entry cost - standardizes product - price taker - no advertising - no long-run profits - good Econ models - uncommon EX: agricultural products, lumber, truckers, stock market monopolistic competition: - many firms - low entry cost - differentiated product - price maker - lots of advertising - no long-run profits - fair Econ models - common EX: restaurants, clothing stores, movies, novels oligopoly: - few firms - significant entry cost - standardized or differentiated products - interdependent price strategy - little or lots of advertising - maybe long-run profits - fair/complex Econ models - common EX: cell phone service, breakfast cereals, cars, tennis balls monopoly: - one firm - prohibitive entry cost - one product - price maker - little advertising - long-run profits - very good Econ models - uncommon EX: utilities, Cable TV, diamonds

why is the pricing decision of an oligopolist more complicated than it is for firms in the other market structures?

prisoner's dilemma collusion or not

public ownership

public (government) ownership: publicly owned companies, however, are often poorly run price regulation: a price ceiling imposed on a monopolist does not create shortages if it is not set too low -- if the monopoly's price is regulated at P, consumer surplus rises (and profits fall)

give an example of an opportunity cost that an accountant might not count as a cost

salary of having a different job

in a monopolistically competitive market, can firms earn economic profit in the short-run and the long run?

short run profit maximization: - same rule: produce where MR = MC - like monopoly firms, set price according to demand in long run... - new entrants mean fewer customers for the original firms: demand and MR shift left - (economic) profits fall to 0. firms break even and new entry stops - if firms are earning economic profits, new firms will want to enter the industry. this will reduce the demand curve facing each individual producer - in the long run, each supplier will earn normal profits, and price will = ATC

normal profit

the minimum profit necessary to keep a firm in operation

minimum average total cost

the quantity of output at which average total cost is lower - the bottom of the U-shaped average total cost curve 3 general principles are always true about a firm's marginal cost and average total cost curves: - at the minimum cost output, average total cost = marginal cost - at output < minimum-cost output, MC < ATC and ATC is falling - at output > minimum-cost output, MC>ATC and ATC is rising

define total cost, average total cost, and marginal cost. How are they related? Where does the marginal cost curve cross the average total cost curve for a typical firm?

total cost: sum of the fixed cost and the variable cost of producing a certain quantity of output. (TC= FC +VC) - total cost curve becomes steeper as more output is produced, a result of diminishing returns. average total cost: total cost per unit of output produced (ATC = TC/Q) -- average fixed cost = (FC=Q) --average variable cost = (VC/Q) Marginal cost: change in total cost generated by one additional unit of output (MC = change in TC/ change in Q)

production short run vs long run

turning inputs into outputs - In the short run, at least one input is fixed

at high levels of output the spreading effect is:

weaker than the diminishing returns effect