Module 9 - The Firm & Market Structures

Product innovation

a necessary activity as firms in monopolistic competition pursue economic profits.

Natural Monopoly

a situation where the average cost of production is falling over the relevant range of consumer demand.

What is the Kinked Curve Model?

an increase in a firm's product price will not be followed by its competitors, but a decrease in price will. each firm believes that it faces a demand curve that is more elastic (flatter) above a given price (the kink in the demand curve) than it is below the given price

concentration measures

an indicator of market power

At the higher output level, a firm will...

earn an economic profit in the short run.

What is the Nash Equilibrium Model?

reached when the choices of all firms are such that there is no other choice that makes any firm better off (increases profits or decreases losses).

Monopoly Short-Run Costs and Revenues

shows the revenue-cost structure facing the monopolist.

If the firm is only just covering its variable costs (P = AVC)...

the firm is operating at its shutdown point.

short-run market supply curve

the horizontal sum (add up the quantities from all firms at each price) of the MC curves for all firms in a given industry.

Marginal Revenue

the increase in total revenue from selling one more unit of a good or service.

Price-Taker Demand

the individual firm's demand schedule is perfectly elastic (horizontal).

Price discrimination

the practice of charging different consumers different prices for the same product or service.

How are profits maximized in an oligopoly with regards to Game Theory?

the price will be between the monopoly price (if firms successfully collude) and the perfect competition price which equals marginal cost (if potential competition rules out prices above that level).

N-firm concentration ratio,

the sum or the percentage market shares of the largest N firms in a market. One limitation is that it may be relatively insensitive to mergers of two firms with large market shares.

What are the four models for price and quantity

- Kinked demand curve model - Cournot Duopoly Model - Nash Equilibrium Model - Stackelberg Dominant Firm Model

Where is the short-run supply curve for a firm

it is whent he Mc line is above the AVC

For price discrimination to work, the seller must:

- Face a downward-sloping demand curve. - Have at least two identifiable groups of customers with different price elasticities of demand for the product. - Be able to prevent the customers paying the lower price from reselling the product to the customers paying the higher price.

What does a large number of independent sellers mean to monopolistic competition?

- Each firm has a relatively small market share - Firms need only pay attention to average market price, not the price of individual competitors. - There are too many firms in the industry for collusion (price fixing) to be possible.

How does forcing monopolists to reduce price affect the firm's ATC intersecting the market demand curve?

- Increase output and decrease price. - Increase social welfare (allocative efficiency). - Ensure the monopolist a normal profit because price = ATC.

How do you analyze where an industry falls with respect to the 4 market structures?

- Number of firms and their relative sizes. - Degree to which firms differentiate their products. - Bargaining power of firms with respect to pricing. - Barriers to entry into or exit from the industry. - Degree to which firms compete on factors other than price.

In monopolistic competition, firms compete on price, quality, and marking but what does this mean?

- Quality is a significant product-differentiating characteristic. - Price and output can be set by firms because they face downward-sloping demand curves - Marketing is a must to inform the market about a product's differentiating characteristics.

Marginal cost pricing

- forces the monopolist to reduce price to the point where the firm's MC curve intersects the market demand curve. - This increases output and reduces price, but causes the monopolist to incur a loss because price is below ATC

Average cost pricing

- the most common form of regulation. - forces monopolists to reduce price to where the firm's ATC intersects the market demand curve

What are the key characteristics for Monopolistic competition?

A large number of independent sellers Differentiated products Firms compete on price, quality, and marketing as a result of product differentiation Low barriers to entry so that firms are free to enter and exit the market

How does having differentiated products benefit monopolistic competition?

Each producer has a product that is slightly different from its competitors but competing products are close substitutes for one another

Profit Maximizing Output For A Price Taker

Identical to its demand curve. A profit maximizing firm will produce the quantity, Q*, when MC = MR.

How are profits maximized in an oligopoly with regards to Collusion>

If all producers agree to share the market to maximize total industry profits, they will produce a total quantity for which marginal cost equals marginal revenue and charge the price from the industry demand curve at which that quantity can be sold.

What is the long-run equilibrium output level for a perfectly competitive firm?

MR = MC = ATC, which is where ATC is at a minimum.

Equilibrium in a Perfectly Competitive Market.

Results in the greatest amount of economic surplus, or total benefit to society, from the production of a good or service.

What is the Stackelberg Dorminant Firm Model?

One firm is the "leader" and chooses its price first, and the other firm chooses a price based on the leader's price. In equilibrium, under these rules, the leader charges a higher price and receives a greater proportion of the firms' total profits.

How are profits maximized in Monopolies

Profits are also maximized by producing the quantity for which marginal revenue equals marginal cost. price is greater than marginal revenue and greater than marginal cost.

How are profits maximized in perfect competition?

Profits are maximized by producing the quantity for which marginal cost equals marginal revenue. Note that marginal revenue and price are equal so price also equals marginal cost at the profit-maximizing quantity.

How are profits maximized in a Monopolistic competition?

Profits are maximized when a firm produces the quantity for which marginal revenue equals marginal cost. price is greater than marginal revenue and greater than marginal cost.

Monopoly

Single seller of a product with no close substitutes - downward sloping demand curve and has the power to choose the price at which to sell it to - supported by the government

Describe a firm's supply function under each market structure.

The short-run supply function for a firm under perfect competition is its marginal cost curve above its average variable cost curve the quantity supplied is determined by the intersection of marginal cost and marginal revenue, and the price charged is then determined by the demand curve the firm faces.

How can collusive agreements to increase price in an oligopoly market be more successful?

There are fewer firms. Products are more similar (less differentiated). Cost structures are more similar. Purchases are relatively small and frequent. Retaliation by other firms for cheating is more certain and more severe. There is less actual or potential competition from firms outside the cartel

How are profits maximized in an oligopoly with regards to a Kinked Demand Curve?

This assumes competitors will match a price decrease but not a price increase Firms produce the quantity for which marginal revenue equals marginal cost

Are costs for Advertising expenses high in monopolistic completion ?

Yes because it allows consumers to increase a perception of differences between products that are actually quite similar.

Are the demand curves for Monopolistic competition elastic? If so, why are they elastic?

Yes. because competing products are perceived by consumers as close substitutes.

What type of curve does a Monopoly have?

a downward-sloping demand curve for its product, so profit maximization involves a trade-off between price and quantity sold if the firm sells at the same price to all buyers. they must determine what price to charge, hoping to find the price and output combination that will bring the maximum profit to the firm.

How do firms in monopolistic competition maximize economic profits?

by producing where marginal revenue (MR) equals marginal cost (MC), and by charging the price for that quantity from the demand curve, D.

Oligopoly

few firms that compete in a variety of ways - business strategy and competition - similar products but different through features, branding, and marketing - demand can be more or less elastic Automobile Industry like Ford and Toyota

If the firm does not believe price will ever exceed ATC in the future

going out of business is the only way to eliminate fixed costs.

Short-Run Loss

illustrates that firms will experience economic losses when price is below average total cost (P < ATC). firm must decide whether to continue operating

Short Run Profit Maximization

illustrates that in the short run, economic profit is maximized at the quantity for which marginal revenue = marginal cost. profit maximization also occurs when total revenue exceeds total cost by the maximum amount. <see graphs on notes>

If the firm is not covering its variable costs (P < AVC) by continuing to operate

its losses will be greater than its fixed costs. In this case, firm will shut down (zero output) and lay off its workers. This will limit its losses to its fixed costs

Perfect Competition

many firms produce identical products, and competition forces them all to sell at the market price - compete for sales only on the basis of price - perfectly elastic (horizontal) demand curves at the price determined in the market Example: Wheat in a region

monopolistic competition

many sellers and differentiated products - products are not identical like perfect competition - each firm differentiates from products by combining differences such as marketing - demand curve faced by each firm is downward sloping - Example: toothpaste. Odds are you won't switch if prices increase by 10%

Why do monopolies create a deadweight loss relative to perfect competition?

monopolies produce a quantity that does not maximize the sum of consumer surplus and producer surplus.

How do monopolies maximize price?

monopolists will expand output until marginal revenue (MR) equals marginal cost (MC)

When does economic loss occur?

occurs on any units for which marginal revenue is less than marginal cost.

What is the Cournot Doupoly Model

two firms with identical marginal cost curves each choose their preferred selling price based on the price the other firm chose in the previous period. The equilibrium for an oligopoly with two firms (duopoly), in the Cournot model, is for both firms to sell the same amounts and same quantities, splitting the market equally at the equilibrium price.

How are profits maximized in an oligopoly with regards to a Dominant Firm Model?

we assume one firm has the lowest cost structure and a large market share as a result. The dominant firm will maximize profits by producing the quantity for which its marginal cost equals its marginal revenue and charge the price on its firm demand curve for that quantity

In the short run, what will an increase in market demand do?

will increase both equilibrium price and quantity, while a decrease in market demand will reduce both equilibrium price and quantity.