ECON MIDTERM 2 GARY LEMON, Econ Exam Study guide 2

What is a Monopoly?

1 Seller, Many buyers

What are the three basic assumptions of perfect competition?

All firms produce identical, or nearly identical, products. There is free entry and exit from the market All firms and consumers are price takers.

What do 2nd degree price discriminators do?

Block pricing

What is an example of intertemporal price discrimination?

Charging a high price for a hardback edition book and a lower price for the paperback version released a year later.

What is an example of the best form of a first degree price discriminator? Why is this?

College tuition because the price discriminator adjusts the price for each buyer above the equilibrium and consumes all of the consumer surplus

What are heterogenous products?

Firms have the opportunity to raise its price above that of its competitors without losing all of its sales.

What is the output rule?

If a firm is producing any output, it should produce at the level at which marginal revenue equals marginal cost.

Must Gillette be a monopoly producer of its blades as well as its​ razors?

It​ doesn't have to be a monopoly producer of blades if all customers have identical demand curves.

What would a​ profit-maximizing monopoly do in the short run if its fixed costs​ increased?

Keep price and output the same.

Why is there a social cost to monopsony​ power?

Since the price is below marginal​ cost, the amount produced and sold is less than the competitive​ equilibrium, which results in a net loss of welfare.

What is Price Taking?

That there are many independent firms and independent consumers in the market, all of whom believe that their decisions will not affect prices.

What happens to equilibrium price and quantity in a monopolistically competitive market when a firm introduces a new, improved product?

The demand curve for each of the other firms shifts inward, reducing the price and quantity sold of existing products.

What is profit?

The difference between TR and TC

In which of the following labor markets is there likely to be substantial monopsony​ power?

The market for coal miners in a small mountain town.

Compared to a competitive​ market, a monopsonist will pay

a lower price and purchase less

How does a car salesperson practice price​ discrimination? The salesperson practices

imperfect price discrimination by trying to determine each​ customer's reservation price.

Why might a firm have monopsony power even if it is not the only buyer in the market? A buyer will have some monopsony power if

it faces an upward- sloping supply curve.

A​ price-discriminating monopolist will charge a higher price to consumers whose demand is more or less elastic?

less elastic

Electric utilities often practice​ second-degree price discrimination. Why might this improve consumer​ welfare? ​Second-degree price discrimination might improve consumer welfare​ because, compared with​ single-monopoly pricing,

output is higher

In perfect competition, Marginal revenue is the same as _____________

price

A monopolist that practices perfect price discrimination

-charges each consumer the maximum price the consumer is willing to pay. -drives consumer surplus to zero. -produces the perfectly competitive level of output.

What is Nash Equilibrium?

A firm making decisions anticipating what the other firms are going to do.

What are a few examples that create a barrier to entry?

A government license required to practice law. A patent for a new drug. A copyright on a new computer program. Economics of scale in production.

What does the demand curve look like for individual competitive firms that are price takers?

A horizontal line

What is the general rule for profit maximization that applies to any firm?

A perfectly competitive firm should choose its output so that MC = P

Why does a price ceiling usually result in a deadweight loss?

A price ceiling set below the equilibrium price in a perfectly competitive market will result in a deadweight loss because it reduces the quantity supplied by producers.

Why is product homogeneity important?

Because it ensures that there is a single market price, consistent with supply and demand analysis

Why is the assumption of free entry and exit important for competition to be effective ?

Because it means that consumers can easily switch to a rival firm if a current supplier raises its price. For businesses, it means that a firm can freely enter an industry if it sees a profit opportunity and exit it if losing money.

Does peak-load pricing make consumers better or worse off?

Better off because of increased efficiency

How do you find the firm's profit- maximizing output level?

By analyzing its revenue

What is meant by deadweight loss?

Deadweight loss refers to the benefits lost by consumers/ producers when markets do not operate efficiently.

What are some of the different types of barriers to entry that give rise to monopoly power? Give an example of each. the most common types of barriers to entry are

Exclusive rights, such as copyrights, patents, and licenses. Economies of scale, which can result in natural monopolies.

A certain town in the Midwest obtains all of its electricity from one​ company, Northstar Electric. Although the company is a​ monopoly, it is owned by the citizens of the​ town, all of whom split the profits equally at the end of each year. The CEO of the company claims that because all of the profits will be given back to the​ citizens, it makes economic sense to charge a monopoly price for electricity. True or​ false? Explain.

False. Since the monopoly price is higher than marginal cost, less than the competitive quantity is produced, so there is still a deadweight loss even if all the profits are given back to the citizens.

What assumptions are necessary for a market to be perfectly competitive? For a market to be perfectly competitive,

Firms must be price takers, firms must produce a homogenous product, and firms must be able to easily enter and exit the market

What is a two part tariff?

Form of pricing in which consumers are charged both an entry and usage fee

How does a car salesperson practice price​ discrimination? How does the ability to discriminate correctly affect his or her​ earnings?

If the negotiated price is higher than the reservation​ price, a sale is​ lost, and if the negotiated price is lower than the reservation​ price, some profit is lost.

When is a market highly competitive?

In the sense that firms face highly elastic demand curves and relatively easy entry and exit.

A perfectly competitive firm is producing the output that maximizes its profit. If its fixed cost increases, and industry price remains constant, how should it respond in the short run?

It should keep output the same

Will a monopsonist buy more or less than a competitive buyer?

Less

When pricing​ automobiles, American car companies typically charge a much higher percentage markup over cost for​ "luxury option" items​ (such as leather​ trim, etc.) than for the car itself or for more​ "basic" options such as power steering and automatic transmission. Explain why.

Luxury options have a lower price elasticity of demand than basic options.

What all is present within the demand curve acing an individual firm in a competitive market?

MR, AR, and price

What is a Monopsny

Many sellers, 1 buyer

What is profit maximization in perfect competition?

Marginal Revenue = Marginal Cost

What is the condition for profit maximization?

Marginal Revenue equals marginal cost at a point in which marginal cost curve is rising

What is the rule of elasticities for monopolies?

Monopolies will always operate in the elastic region of the demand curve.

Why is there no market supply curve under conditions of monopoly?

Output decisions depend not only on marginal cost but also on the demand curve. Shifts in demand lead to changes in price, output, or both. Meaning, there is no one-to one correspondence between price and the seller's quantity.

Price discrimination requires the ability to sort customers and the ability to prevent arbitrage. Explain how the following can function as price discrimination schemes and discuss both sorting and​ arbitrage: a. Requiring airline travelers to spend at least one Saturday night away from home to qualify for a low fare. Customers are sorted based on ____________ Arbitrage is prevented by _____________

Preferences Requiring and ID

What are the three basic assumptions of The Model of Perfect Competition?

Price Taking, Product Homogeneity, Free Entry and Exit

Suppose a monopolistically competitive firm is making a profit in the short run. What will happen to its demand curve in the long run?

Profit in the short run induces other firms to enter and as new firm's enter, it reduces profit- maximizing quantity. Meaning In the long run, profits will fall to zero.

The kinked demand curve describes price rigidity. Explain how the model works

The Kink in the demand curve leads to a discontinuity in the marginal revenue curve, so only large changes in marginal cost lead to changes in price.

Why is the pricing of a Gillette safety razor a form of​ two-part tariff?

The razor is the entry fee and the blades are the usage fee.

If the gains to buyers from monopsony power could be redistributed to​ sellers, would the social cost of monopsony power be​ eliminated?

The social cost cannot be eliminated because the gain in consumer surplus is not enough to offset the loss of producer surplus.

What do price taking firms know is certain?

Their production decisions will have no effect on the price of the product.

Suppose the supply curve for a good is completely inelastic. If the government imposed a price ceiling below the market-clearing level, would a deadweight loss result? Explain.

There is no deadweight loss because there is no reduction in the amount of the good produced. The imposition of the price ceiling transfers all lost producer surplus to consumers, meaning consumer surplus will increase.

Why is the firm's demand curve flatter than the total market demand curve in monopolistic competition?

This is because of the firm's elasticity of demand being greater than the elasticity of market demand .

What is Free Entry and Exit?

This means that there are no special costs that make it difficult for a new firm to either enter an industry and produce, or to exit an industry if it cannot make a profit.

True or False? Competitive Firms are Price Takers

True

Suppose you were advising Gillette on how to determine the two parts of the tariff. What advice could you​ offer?

When consumers have identical demand​ curves, the blade price should equal marginal cost and the razor price should equal consumer surplus for each consumer.

When do prices become rigid in a Kink demand curve?

When prices are outside of the gap

What is Product Homogeneity?

When the products of all the firms in a market are perfectly suitable with one another.

What is monopolistic competition?

When there are many firms with free access in the market and products are differentiated.

An individual firm's demand curve in perfect competition is

a horizontal line at the market price

Why is a kink demand curve kinked?

because of different assumptions being made at the given price.

If a law requires a​ price-discriminating monopolist to charge every consumer the same​ price,

consumers who used to pay the high price will be better off and those who used to pay the low price will be worse off. In​ addition, the monopolist will be worse off.

A monopolist is producing at a point at which marginal cost exceeds marginal revenue. How should it adjust its output to increase profit? The monopolist should

decrease output until marginal revenue equals marginal cost

How is​ peak-load pricing a form of price​ discrimination? It is a form of price discrimination because

demand can vary with the time of day; thus, the firm can charge a lower price when demand is more elastic and marginal cost is lower.

Price discrimination requires the ability to sort customers and the ability to prevent arbitrage. Explain how the following can function as price discrimination schemes and discuss both sorting and​ arbitrage: e. Charging​ high-income patients more than​ low-income patients for plastic surgery. Customers are sorted based on ____________ Arbitrage is prevented by _____________

demographic information the product being non transferable

What assumptions are necessary for a market to be perfectly competitive? If firms can easily enter and exit a market, then

firms will produce at minimum average cost in the long run

Price discrimination requires the ability to sort customers and the ability to prevent arbitrage. Explain how the following can function as price discrimination schemes and discuss both sorting and​ arbitrage: b. Insisting on delivering cement to buyers and basing prices on​ buyers' locations. Customers are sorted based on ____________ Arbitrage is prevented by _____________

geography resales not being profitable

Why is there a social cost to monopoly power? There is a social cost to monopoly power because

monopoly production occurs where price is greater than marginal cost.

You produce widgets for sale in a perfectly competitive market at a market price of $10 per widget. Your widgets are manufactured in two plants, one in Massachusetts and the other in Connecticut. Due to changes in the labor market in Connecticut, you are allowed to lower wages there, so that marginal costs in that plant decrease. In response to this, should you shift production and produce less in your Massachusetts plant? Due to the lower marginal cost of production at the Connecticut plant, you should

not shift production to the Massachusetts plant, but should increase production in the Connecticut plant until that plant's marginal cost of production equals price.

Suppose a long bridge into a major U.S. city charges a higher toll​ (price) to keep traffic moving at the same rate during rush hour on weekdays than at other times of the day. This is an example of

peak- load pricing.

Suppose a competitive industry faces an increase in demand​ (i.e., the demand curve shifts​ upward). What are the steps by which a competitive market ensures increased​ output? Will your answer change if the government imposes a price​ ceiling? With a binding price ceiling,

price and profit will be lower, reducing the incentive for existing firms to produce more and for new firms to begin producing.

A perfectly competitive firm should shut down in the short run if

price is below minimum average variable cost.

Why would a firm that incurs losses choose to produce rather than shut​ down? In a perfectly competitive​ industry, if a firm is incurring​ losses, then it might choose to produce in the short run because

price is greater than average variable cost, resulting in smaller losses than would result from shutting down.

Suppose a competitive industry faces an increase in demand​ (i.e., the demand curve shifts​ upward). What are the steps by which a competitive market ensures increased​ output? Will your answer change if the government imposes a price​ ceiling? If demand​ increases, then output will increase with competition because

price will increase, increasing profit, prompting new firms to begin producing output.

What assumptions are necessary for a market to be perfectly competitive? If firms produce a homogenous product, then

products will be perfectly substitutable with one another

Price discrimination requires the ability to sort customers and the ability to prevent arbitrage. Explain how the following can function as price discrimination schemes and discuss both sorting and​ arbitrage: c. Selling food processors along with coupons that can be sent to the manufacturer for a​ $10 rebate. Customers are sorted based on ____________ Arbitrage is prevented by _____________

sensitivity to price limiting the number a person can buy

Price discrimination requires the ability to sort customers and the ability to prevent arbitrage. Explain how the following can function as price discrimination schemes and discuss both sorting and​ arbitrage: d. Offering temporary price cuts on bathroom tissue. Customers are sorted based on ____________ Arbitrage is prevented by _____________

sensitivity to price resales not being profitable

What is meant by the term​ "monopsony power"? Monopsony power refers to

the buyer's ability to affect the price of a good because the marginal expenditure curve lies above the average expenditure curve.

Catepillar​ Tractor, one of the largest producers of farm machinery in the​ world, has hired you to advise it on pricing policy. One of the things the company would like to know is how much a​ 5-percent increase in price is likely to reduce sales. What would you need to know to help the company with this​ problem? Explain why these facts are important. To determine how much a​ 5-percent increase in price is likely to reduce​ sales, you would need to know

the elasticity of demand to determine the percentage decrease in sales, and you would also need to know the initial quantity sold to determine the lower level of sales

Why does optimal​ third-degree price discrimination require that marginal revenue for each group of consumers equals marginal​ cost? Assume that marginal cost increases with output and that there are only two groups of consumers. If marginal revenue for one group was greater than marginal​ cost,

the firm could increase profit by lowering the price and increasing output for that group, and then decreasing output and raising the price for the other group.

If a regulator requires a natural monopoly to sell its product at the price where P​ = MC,

the firm will incur economic losses and shut down in the long run.

Suppose a firm can practice​ perfect, first-degree price discrimination. What is the lowest price it will​ charge, and what will its total output​ be? The lowest price and total output will occur at the point where

the marginal cost curve intersects the demand curve.

How should a monopsonist decide how much of a product to​ buy? A monopsonist should buy the quantity where

the marginal value curve intersects the marginal expenditure curve.

If the gains to producers from monopoly power could be redistributed to​ consumers, would the social cost of monopoly power be​ eliminated? Redistributing monopoly gains would not eliminate social costs because

the monopoly's profits are less than lost consumer surplus

A firm sells a product and the refills that must be used to operate the product​ (like printers and ink​ cartridges). The firm wants to design a​ two-part tariff for pricing the product​ (the entry fee​) and its refills​ (the usage fee​). If all its customers have the same demand​ curve, the firm should set

the price of the refills equal to marginal cost and the price of the product equal to each customer's consumer surplus.

What assumptions are necessary for a market to be perfectly competitive? If firms are price takers, then

they will produce where price equals marginal cost