econ 101 exam 3
profits
(P - ATC) x Q if P > ATC, firm is positive if P = ATC, firm breaks even if P < ATC, firm incurs a loss
shape of total revenue curve
-at low levels of output, the quantity effect outweighs the price effect because as monopolist sells more, they must lower price on only very few units -as output rises, total revenue falls because at high levels of output, the price effect is stronger than the quantity effect because as the monopolist sells more, it has to lower the price on many units of output
regulating monopolies
-break up monopoly with anti-trust legislation -price ceiling --if set at proper amount, can get rid of DWL -increase competition by granting more licenses, reducing trade barriers for foreign firms, alter patent laws, offer subsidies (tax breaks) to competing firms
monopolist's deadweight loss to society
-charge a higher price than marginal cost and produces at a level lower than the efficient (perfectly competitive) output level -example of market failure
perfect price discrimination
-firm charges each customer the highest price they are willing to pay -price = marginal value -MR curve becomes demand curve (MR = Price ≠ AR) -stop producing when P = MC = MR = MV -diminishing MV exists because downward sloping demand curve
profit maximizing condition
-keep producing as long as MR > MC -profits are maximized where MR = MC
perfect price discrimination results in an efficient outcome
-net benefits to society maximized, no DWL -same output level as perfect competition -all benefits go to producer (CS = 0) -efficient but not equitable
oligopoly: collusion vs competition
-oligopolies face limited imperfect competition because barriers to entry still exist -may either compete (non-cooperative) or collude (cooperative)
unit-elastic demand and MR and TR
-price and quantity effects will offset -MR will be zero -MR curve crosses horizontal axis at this point
inelastic demand and MR and TR
-price effect dominates quantity effect -a decrease in price decreases TR -if TR decreases, MR must be negative
elastic demand and MR and TR
-quantity effect will dominate price effect -a decrease in price increases TR -if TR is increasing, MR must be positive -as the price continues to be lowered, the good becomes less elastic and MR becomes smaller
conditions for cooperation
1 - repeated interactions over time 2 - easy to monitor other firms 3 - entry by non-colluding firms difficult 4 - merge
Barriers to entry in a monopoly
1. control of scarce resource or input 2. cost advantage 3. government created monopoly
necessary conditions for price discrimination
1. firm must have market power (anything other than perfect competition has market power) 2. firm must be able to identify differences in willingness to pay between consumers 3. firm must be able to limit resale of a product
necessary conditions for perfect competition
1. industry must contain many producers, all with small market shares 2. consumers must consider all products from this industry as equivalent
how to identify which group an individual belongs to (multi-market price discrimination)
1. observable characteristics e.g. age, location/country (student/senior discounts) 2. get consumers to place themselves into different groups (data analysis) -our behavior places us into different groups (coupons, airline tickets)
under perfect competition
AR = MR = P
shutdown price (short-run)
P = minimum AVC
price or quantity setting
a form of cooperative imperfect competition -setting one (price or quantity) affects the other
perfectly competitive market
a market in which all market participants are price-takers -MR = P, can sell all they want at market price -each additional unit sold provides additional revenue equal to market price -cannot influence market price individually -face perfectly elastic (horizontal) demand curve
why monopolies exist
a monopolist has market power, are able to generate profits in the long-run -in order for profits to persist in the long-run, some form of barrier to entry must be in place. otherwise, firms enter => lowered profits until they no longer exist
monopoly vs. perfect competition
a monopolist: 1. produces smaller quantity (Qm < Qc) 2. charges a higher price (Pm > Pc) 3. earns profit in both short-run and long-run
two-part tariff
a situation in which consumers pay one lump-sum price for the right to buy as much of a related good as they want at a second per-unit price -costco
perfectly competitive industry
an industry where all producers are price-takers
oligopoly
an industry with a small number of producers -barriers to entry exist (not as strong as a monopoly's) therefore profits exist -firms have market power -each firm must consider actions of other firms in the industry
duopoly
an oligopoly consisting of only two firms
the monopolist's profit
as with a competitive firm, the monopolist's profit equals (P - ATC) x Q -charge highest price consumer is willing to pay -monopolist has highest profits possible
profits exist in oligopolies
because barriers to entry exist....
enforcable contract
both sides sign contract to take the mutually beneficial action
marginal revenue (MR)
change in total revenue generated by selling an additional unit of output MR = change in TR / change in quantity benefits firm
price elasticity and the demand curve
changes from left to right, elastic at left, unit-elastic in middle, inelastic at right -applies to total revenue curve as well
price discrimination
charging different prices to different consumers for the same good -increases profits
imperfect competition
competition among firms who have some market power -price searchers -decisions made by each firm has an impact on the market -each firm must consider the actions of the other firms in the industry, this strategic behavior is unique to oligopolies
homogeneous product
consumers regard the product of different producers as the same good
cooperative imperfect competition
decisions made jointly -price/quantity setting (illegal) -collusion -unique to oligopolies
Monopolist's profit-maximizing quantity of output
determined by the intersection of the marginal revenue curve and the marginal cost curve
cost advantage (barrier to entry for a monopoly)
different cost structures with large set-up costs -a given quantity is produced at a lower ATC by one large firm than by 2+ smaller firms => lowered cost of production -natural monopolies: local utilities (water, gas, electric, etc.)
non-cooperative imperfect competition
each firm makes decisions about output and price without consulting each other -just competition -choices impact each other
cartel
firms acting together as if they were a monopoly
profit maximization assumption
firms attempt to maximize benefits
quantity discrimination
firms charge a different price for large quantities than for small quantities of a good -all customers who buy a given quantity pay the same price -takes advantage of downward sloping demand curve where consumers are willing to pay a lower price for successive units
multi-market price discrimination
firms charge different groups different prices according to willingness to pay for the group -most common type of price discrimination -won't know individual willingness to pay but have general idea of group willingness to pay
price searcher
firms that have at least some influence on market price -face downward sloping demand curve -to sell more output, must lower price -by reducing output, price rises
marginal revenue curve and demand curve in a monopoly
for any given quantity, MR < price due to price effect -therefore MR curve lies below the demand curve at any given quantity
nash equilibrium
given what the other players are currently doing, no player can gain a higher payoff by altering their own strategy -can exist without a dominant strategy present
government created monopoly
government in the public's best interest grants a single firm or individual the exclusive right to provide a good or service -government license to serve a certain area -patents: 20 years from date of filing -copyright: 70 years post death
price-taking producer
has no effect on the market price of the good it sells
price-taking consumer
has no effect on the market price on the good they buy
game theory
how monopolists model strategic behavior
repeated game
if prisoners' dilemma is played repeatedly, cooperation may occur if long-term gains from cooperation are greater than short term gains from no cooperation
marginal revenue curve for monopolists
if the demand curve is linear, so is the marginal revenue curve -MR curve will intersect horizontal (Q) axis exactly halfway between the origin and where the demand curve intersects the horizontal axis because of elasticity
price effect
in order to sell the last unit, the monopolist must reduce the market price on all units sold, decreasing total revenue
no, can't possibly know what every single consumer would be willing to pay
is perfect price discrimination achievable?
if monopolist changes quantity produced
market price will change, so MR ≠ price because they face downward sloping demand curve
monopoly
market with one supplier of a good -monopolists know their actions influence market price & take this into account when deciding how much to produce -choose price and quantity to maximize profits but are constrained by the demand curve (downward sloping)
why firms would act like a monopoly (cartel)
monopolist's profits are the best possible, so act as a monopoly to maximize profits -collectively restrict output to increase price -split monopoly outputs & profits
free entry and exit
new producers can easily enter into or leave an industry. ensures: -number of producers in an industry can respond to changing markets -producers in an industry cannot block entry of other firms
quantity effect
one more unit is sold, increasing revenue by the price at which it's sold -if only the quantity effect existed, then MR = Price and MR curve = demand curve
shutdown decision in short-run
only matters if profit is negative -shutdown if P < AVC -fixed inputs can't be changed in short-run
zero economic profit in the long-run
perfectly competitive firms earn 0 economic profit in the long-run due to free entry/exit -if profits > 0, firms enter market, leads to higher supply, prices fall to ATC/breakeven point -if profits < 0, firms exit market, leads to decreased supply, prices rise to breakeven point -therefore, in long-run, P = AC = MC
tit-for tat-strategy
playing cooperatively at first, then doing whatever the other player did in the previous period for all subsequent periods
distance between demand curve and marginal revenue curve for a monopoly
price effect
monopolist's profit-maximizing point
price/quantity at MR = MC
production decision in long-run
produce the quantity where Price (MR) = MC
monopolist's production decision
produce until MR = MC
production decision in short run
produce where MR = MC
maximizes profit of price-taking firms
producing the quantity of output at which the marginal cost of the last unit produced is equal to the market price => ________ -the profit-maximizing point is where MC crosses the MR curve
elasticity is the key element of price discrimination
profit-maximizing to charge a higher price to consumers who are relatively more price inelastic -charging a high price to price sensitive (elastic) consumers may drive them out of the market
profit maximizing quantity of output (short-run)
quantity of output at MR = P = MC
average revenue (AR)
revenue per unit of output TR / Q = (P x Q) / Q = P AR = Price
the short-run individual supply curve
shows how an individual producer's profit-maximizing output quantity depends on the market price, taking fixed cost as given
marginal revenue curve
shows how marginal revenue varies as output varies
shutdown decision in long-run
shut down and leave industry if P < ATC
TR < TC
shut down and leave industry in the long-run if
monopolist's shutdown decision
shut down if: short-run P < AVC long-run P < ATC
TR < VC
shut down in short-run if
dominant strategy
strategy that gives the player a higher payoff no matter what strategy the opponent is playing -if dominant strategy exists, so does nash equilibrium
price takers
take market price as given; no individual impact on market price
if total revenue = total cost
the firm breaks even
if total revenue < total cost
the firm incurs a loss
if total revenue > total cost
the firm is profitable
market share
the fraction of the total industry output accounted for by that producer's output
in order for the monopolist to attract more customers,
they must lower the price because they face a downward sloping demand curve
collusion
two or more firms acting together to set prices or quantity rather than competing
price discrimination is profitable
when consumers differ in their sensitivity to the price
price ceiling in a monopoly
when the monopolist must charge a price equal to ATC, the price output expands and CS expands => monopolist makes 0 profit
differences in size of price effect
why does a colluding duopolist have an incentive to change production levels when a monopolist does not?
because the colluding duopolist only produces a portion of monopoly output -difference in size of market (2 firms vs. 1)
why is the price effect smaller for colluding duopolists than it is for monopolists?
no, MR < MC in this case
will competition among firms in an oligopoly result in a perfectly competitive (socially efficient) outcome?
