Econ Midterm 2 - Monopoly, Monopolistic Competition, Oligarchy
Oligopoly - what does the demand curve look like?
Downward-sloping
Monopoly - where is the profit maximizing point?
The monopolist's profit-maximizing quantity of output is determined by the intersection of the marginal revenue curve and the marginal cost curve
What is the best thing for an oligopoly to do? (profit maximizing) Why do oligopolies no always do this?
The oligopolists are best off when they cooperate and act like a monopolist - producing a small quantity of output and charging a price above the marginal cost. Yet because each oligopolist cares only about its own profit, there are powerful incentives at work that hinder a group of firms from maintaining the cooperative outcome
Monopolistic competition - what is excess capacity and why do these firms have it?
The process of entry and exit drives each firm in a monopolistic competitive market to produce at the point of tangency between its demand and ATC curves. However, this point is not the lowest point on the ATC curve Because the firm is not producing at the efficient scale (the lowest point on the ATC curve), the firm could increase the quantity it is producing and lower the average total cost of production. The firm forgoes this opportunity in order to keep the prices higher → when firms could produce more and it would lower ATC, they are said to have excess capacity
Natural monopoly
a distinct type of monopoly that may arise when a single firm can supply a good or service to an entire market at a lower cost than could two or more firms. A natural monopoly only occurs when there are economies of scale over the relevant range of output
Cartel
a group of firms that are colluding
How do you get the profit maximizing price?
While we find the profit maximizing Q at the intersection between the MR and MC curve, we have to go up to the demand curve for the profit maximizing price
How monopolies differ from competitive firms in terms of pricing?
a competitive market is a price taker and a monopoly is a price maker → because for competitive firms price equals marginal cost, their profit will be 0. Hence, they do not care if they get another customer. In monopolies, P > MC, hence making a profit, and so the monopolist does want more customers
Monopoly
a firm that is the sole seller of its product and its product does not have any close substitutes
Monopolistic competition
a market structure in which there are many firms selling products that are similar but not identical (many sellers / free entry and exit / product differentiations)
Oligopoly
a market type in which there are only a few sellers (as a result of only having a few sellers, the actions of any one seller on the market have a large impact on the profits of all the other sellers)
Concentration ratio
a measurement economists use when determining the market's domination by a small number of firms (percentage of total output in the market supplied by the four largest firms)
Nash equilibrium
a situation in which economic actions interacting with one another each choose their best strategy given the strategies the others have chosen (in oligopolies, usually this is matching the output of the other oligopolist)
Monopolistic competition - What is the relationship between the ATC and Demand curve?
ATC tangent to the Demand curve (because profit needs to equal 0 and ATC represents cost and demand represents price) ATC will be tangent to the Demand curve where MC and MR intersect (this is because they both represent where profit will be 0)
What is the impact of free trade on oligopolies?
Allowing free trade increases the number of producers from which each consumer can choose (in the case of oligopolies, makes oligopolies bigger), which increases competition and keeps price closer to marginal cost
Oligopoly - if firms are unable to collude, what level do the firms produce at?
Although the incentive to cheat increases the oligopolies output above the monopoly level, it does not push the oligopolists all the way to the competitive allocation. Instead, it usually pushes the firms to the Nash equilibrium
What are the ways that the government can try and make monopolized industries more competitive? What are the problems with this?
Antitrust laws Problem: Government must be able to tell which mergers are socially desirable and which are not (to make sure it doesn't block synergies)
Oligopoly - if the output effect is larger than the price effect...
produce one more unit
What are the two opposing incentives oligopolies face?
Incentive to collude Incentive to cheat
Monopolistic competition - what is markup and why do these firms have it?
- Price exceeds marginal cost because the firm always has some market power → the zero-profit condition ensures only that price (represented by D) equals average total cost. It does not sure that price equals marginal cost → Since the MC line is x2 steeper than the D line, price will always be above marginal cost
What are the four ways policy makers can respond to monopoly?
1. By trying to make monopolized industries more competitive 2. By regulating the behavior of the monopolies 3. By turning some private monopolies into public enterprises 4. By doing nothing at all
Barriers to entry have three main sources
1. Monopoly resources → a key resource required for production is owned by a single firm 2. Governmental regulation → the government gives a single firm the exclusive right to produce some good or service (ex: patent) 3. The production process → a single firm can produce output at a lower cost than can a large number of firms
What are the two effects oligopolies have when raising production by one unit?
1. The output effect - because price is above marginal cost, selling one more unit at the going price will raise profit 2. The price effect - raising production will increase the total amount sold, which will lower the price of the good and lower the profit on all other units sold
What two things happen when a monopoly increases the amount it sells?
1. The output effect: more output is sold, so Q is higher, which tends to increase total revenue 2. The price effect: the price falls, so P is lower, which tends to decrease total revenue
Monopolistic competition - Where is the profit maximizing quantity and price found?
Because the monopoly has a downward sloping demand curve, it follows a monopolist's rule for profit maximization → it chooses to produce the quantity at which marginal revenue equals marginal cost and then uses its demand curve to find the price at which it can sell that quantity
Monopoly - what does the Demand curve shows?
Demand curve shows price Because the firm's price is its marginal revenue, the demand curve is also the average revenue curve
Monopoly - What does the demand curve look like?
Downward sloping (because they are the one firm providing goods, if they produce more of the good the price will fall)
Monopolistic competition - which way does the demand curve slope?
Downward sloping demand curve
Monopoly - what is the relationship between the average revenue and the price of the good?
Equal
True or False: a monopolist can charge anything they want for their good
False - The market demand curve provides a constraint on a monopolist's ability to profit from its market power → a monopolist can choose any point on the demand curve, but it cannot choose a point off the demand curve
Why would monopolistic competition make it so the number of firms in the market may not be ideal?
Firms in a monopolistic competitive market have two externalities → 1. The product variety externality - because consumers get some consumer surplus from the introduction of a new product, entry of a new firm conveys a positive externality on consumers (Arises because new firms offer different products than existing ones) 2. The business stealing externality - because other firms lose customers and profits from the entry of a new competitor, entry of a new firm imposes a negative externality on existing firms (arises because each firm makes a marginal profit, and hence always wants additional customers) Depending on which externality is larger, a monopolistically competitive market could have too many or too few firms
Monopoly - what is the relationship between price and marginal revenue?
For a monopoly, marginal revenue is lower than the price of a good Because a monopoly faces a downward-sloping demand curve. To increase the amount sold, a monopoly firm must lower the price it charges to all customers (which lowers the marginal revenue - the amount each new good will bring in)
What are the ways that the government can try turning some private monopolies into public enterprises? What are the problems with this?
In this way of responding to monopolies, government runs the monopoly Problem: Private ownership is usually better than public ownership. Why? Because private owners have an incentive to minimize costs and if they are doing a bad job they are fired. By contrast, if the government does a bad job running the monopoly, the customers are the losers
When is it impossible to collude? Does having more members or less members in an oligopoly make colluding easier?
It can be impossible because there will be fighting between cartel members over how to divide the profit. It can be impossible because of antitrust laws that prohibit collusion/forming a cartel (antitrust laws). As the firm gets bigger, it becomes harder to reach and enforce an agreement (collude)
How to measure deadweight loss in a monopoly?
Look at the triangle that is formed between the points of intersections MC-MR, D-MC, and the point on the demand curve at which the monopoly sells it's goods
Monopoly - what is the relationship between the marginal revenue curve and the average revenue curve (demand curve)?
MR curve and AR curve start at the same place. MR curve is x2 steeper than the AR curve The MR can even become negative → this occurs when the price effect is greater than the output effect (so when the firm makes one more good, even though it is selling more goods, profit is actually declining)
Types of market structures
Monopoly - one firm Oligopoly - few firms Monopolistic competition - many firms / different goods Perfect competition - many firms / identical goods
What happens to an oligopoly when there are less firms in it? How about more firms?
More firms in an oligopoly → functions more like a competitive firm (price and quantity produced looks more like a competitive firm) Less firms in an oligopoly → functions more like a monopoly (price and quantity produced looks more like a monopoly)
Monopolistic competition - what is economic profit?
No economic profit (0)
Is monopoly socially efficient?
No, monopoly is not efficient because monopoly pricing (greater than MC) prevents some mutually beneficial trade from taking place (however, not socially inefficient because of the higher price)
Are monopolistic competitive firms socially efficient? Why?
No. Because → 1. The markup price over marginal cost. This makes it so customers who value the good at marginal cost but not at the going price will not buy the good. This created a deadweight loss 2. The number of firms in the market may not be ideal
Oligopoly - what happens to the market once a cartel is formed?
Once a cartel is formed, the market is in effect served by a monopoly
How is a monopolies profit maximizing point similar and different from the profit maximizing point in a competitive market?
Similar → profit-maximizing quantity is at the intersection between marginal revenue and marginal cost Different → in a competitive firm → P = MR = MC and for a monopoly → P > MR = MC
What are the ways that the government can try regulating the behavior of the monopolies? What are the problems with this?
Subsidize the monopoly - the government makes monopolies set the price at the marginal cost and then picks up the losses inherent in marginal-cost pricing Problem: the government needs taxes for this
Collusion
an agreement between oligopolists that agrees on the amount of a good to produce (both in total and by each member) and the price that will be charged for it
Duopoly
an oligopoly with two members
Fundamental cause of monopoly
barriers to entry
Oligopoly - if the price effect is larger than the output effect...
do not produce one more unit (in this case it even may be profitable to reduce production)
Incentive to cheat
each oligopolist is tempted to raise production and capture a larger share of the market (if one firm produces one more unit they will be making more money for themselves), hence they have an incentive to cheat. As each of them tries to do this, total production rises, and the price falls
Economies of scale
economies have an ATC that is continually declining. This happens when there is an extremely high fixed costs and an extremely low variable cost (ex: firms that require large-scale infrastructure)
Incentive to collude
oligopolists realize that they would be better off cooperating and reaching the monopoly output, hence they collude
Price maker
the firm sets the price of the good (complete market power)
Game theory
the study of how behave in strategic situations (your actions, how others will react, and how that will affect you)
Synergies
when companies merge not to reduce competition but to lower cost through more efficient joint production (these merges are socially beneficial)
