ECON 201 Exam 3

Monopoly

A firm that is the sole seller of a product without close substitutes

Price maker

The ability to influence the market price of the product it sells

Barriers to entry

Other firms cannot enter the market to compete with it

Monopoly resources

A single firm owns a key resource required for production, relatively rare in practice

Government regulation

Government-created monopolies, the government gives a single firm the exclusive right to produce the good, lead to higher prices and higher profits (than under competition), also encourage some desirable behavior (provides incentives for creative activity)

Natural monopoly

A single firm can produce the entire market Q at lower cost than could several firms, arises when there are economies of scale over the relevant range of output

Competitive firm

Price taker, small, one of many, faces individual demand at P: perfectly elastic demand

Monopoly firm

Price maker, market power, faces the entire market demand: downward sloping demand

MR = MC

Sets the highest price consumers are willing to pay for that quantity

Competitive market equilibrium

At P = MC and maximizes total surplus

Monopoly equilibrium

at P > MR = MC, the value to buyers of an additional unit (P) exceeds the cost of the resources needed to produce that unit (MC)

Monopoly inefficiency

Monopoly produces Q < efficient quantity, results in a deadweight loss

Price discrimination

Sell the same good at different prices to different customers, a firm can raise profit by charging a higher price to buyers with higher willingness to pay, requires to separate customers according to their willingness to pay, can raise economic welfare

Perfect price discrimination

Charge each customer a different price (exactly their willingness to pay), monopoly firm gets the entire surplus (profit), no deadweight loss, not possible in the real world

Antitrust laws

Prevent mergers, breakup companies, prevent companies from coordinating their activities to make markets less competitive

Monopoly regulation

Set the monopolies’ price (common in case of natural monopolies)

Public ownership

A government unit can run a monopoly itself, if it does a bad job, losers are the consumers and taxpayers, public ownership is usually less efficient since there is no profit incentive to minimize costs

Perfect competition

Many firms, identical products, price takers, P = MC, quantity at minimum ATC

Oligopoly

Market structure in which only a few sellers offer similar or identical products

Monopolistic competition

Many firms sell similar but not identical products

Concentration ratio

Measure a market’s domination by a small number of firms, the percentage of total output in the market supplied by the four largest firms, less than 50% for most industries

Monopolistic competition characteristics

• Numerous firms competing over customers

• Product differentiation

Not price takers; D curve slopes downward

• Free entry and exit

Zero economic profit in the long run

Excess capactiy

Quantity is not at minimum ATC (it is on the downward sloping portion of the ATC)

Markup over marginal cost

P > MC, market quantity < socially efficient quantity

Sources of inefficiency in monopolistically competitive markets

• Markup of price over marginal cost

• Too much or too little entry (number of firms in the market)

Product-variety externality

Consumers get extra surplus from the introduction of new products

Business-stealing externality

Losses incurred by existing firms when new firms enter the market

Incentive to advertise

When firms sell differentiated products and charge prices above marginal cost, advertise to attract more buyers

Brand names

Spend more on advertising and charge higher prices than generic substitutes

Nash Equilibrium

Economic actors interacting with one another, each choose their best strategy given the strategies that all other actors have chosen

Increase in sellers in an oligopoly

• The price effect becomes smaller

• The oligopoly looks more and more like a competitive market

• The price approaches marginal cost

• The market quantity approaches the socially efficient quantity

The Prisoners’ Dilemma

Particular “game” between two captured prisoners, Illustrates why cooperation is difficult to maintain even when it is mutually beneficial

Dominant strategy

Strategy that is best for a player in a game, regardless of the strategies chosen by other players

Noncooperative oligopoly equilibrium

• May be bad for oligopolists - Prevents them from achieving monopoly profits

• May be bad for society - Examples: Arms race game, Common resource game

• May be good for society - Quantity and price — closer to optimal level

Critics of brand names

Products are not differentiated, irrationality: consumers are willing to pay more

Defenders of brand names

Consumers get more information about quality, firms have an incentive to maintain high quality to protect their reputation

Concentration ratio

• Measure a market’s domination by a small number of firms

• The percentage of the total output in the market supplied by the four largest firms

• Less than 50% for most industries

• Greater than 90% in: aircraft manufacturing, tobacco, passenger car rentals, and express delivery services

Game theory

The study of how people behave in strategic situations

Oligopolists

Make the most profit when they cooperate and together act like one big monopolist, strong incentives hinder a group of firms from maintaining the cooperative outcome

Duopoly

A market with only two sellers, simplest type of oligopoly

Collusion

Agreement among firms in a market about quantities to produce or prices to charge, one possible duopoly outcome

Cartel

A group of firms acting in unison, once formed, the market is in effect served by a monopoly

Tit-for-tat

Whatever your rival does in one round (whether renege or cooperate), you do in the following round

Antitrust laws

Prevent mergers that would give a firm excessive market power, and prevent oligopolists from acting together in was that would make their market less competitive

Predatory pricing

A firm cuts prices to prevent entry or a drive a competitor out of the market

Resale price maintenance

A manufacturer imposes lower limits on the prices retailers can charge

Bundling

A manufacturer bundles two products together and sells them for one price

Factors of production

• Inputs used to produce goods and services: labor, land, capital

• Prices and quantities are determined by supply and demand in factor markets

Derived demand

A firm’s demand for a factor of production is derived from its decision to supply a good in another market

Production function

the relationship between the quantity of inputs used to make a good and the quantity of output of that good

Value of the MPL (VMPL)

P × MPL, the marginal product of an input (labor) times the price of the output

Marginal product of labor (MPL)

ΔQ/ΔL, The increase in the amount of output from an additional unit of labor

Technological change

affects MPL, Can increase the MPL, increasing the demand for labor

Wage

The opportunity cost of leisure, when it increases, the opportunity cost of enjoying leisure goes up

Purchase price

the price a person pays to own a factor indefinitely

Rental price

The price a person pays to use a factor temporarily

Rental income

Equal to the value of the marginal product (VMP)

Neoclassical theory of income distribution

• Factor prices are determined by supply and demand

• Each factor is paid the value of its marginal product

• Used by most economists as a starting point for understanding the distribution of income

Compensating differential

Difference in wages that arises to offset nonmonetary characteristic of different jobs (unpleasantness, difficulty, safety)

Human capital

Accumulation of investments in people, such as education and on-the-job-training

Affects productivity, labor demand, wages

• Firms are willing to pay more for highly educated workers

• Workers bear the cost of education because they expect a reward for doing so

Superstars in their field

Great public appeal and astronomical incomes

Arise in markets where:

• Every customer in the market wants to enjoy the services supplied by the best producers

• The services are produced with a technology that makes it possible for the best producers to supply every customer at low cost

Monopsony

Market that has only one buyer

Non-compete clauses

• Bar employees from leaving to work for a competitor

• Protect employers’ trade secrets

• Curb competition in the labor market, keeping wages below their equilibrium levels

Minimum wage laws

Raise wages above the level they would earn in an unregulated labor market

Union

Worker association that bargains with employers over wages and working conditions

Efficiency wages

Above-equilibrium wages paid by firms to increase worker productivity

Theory of efficiency wages

Firms may pay higher wages to reduce turnover, increase worker effort, or attract higher-quality job applicants

Surplus of labor

Effect of above-equilibrium wages

Discrimination

Offering of different opportunities to similar individuals who differ only by race, ethnicity, age, gender, religion, sexual orientation, or other personal characteristics; another source of differences in wage

Compensating differentials

Men and women do not always choose the same type of work, different working conditions

Profit motive

Natural antidote to employer discrimination in competitive market economies

Statistical discrimination

Arises because an irrelevant but observable personal characteristic is correlated with a relevant but unobservable attribute

Market economies

Usually achieve greater prosperity, but prosperity is not shared equally

Labor

The most important factor for determining households’ standard of living

Poverty rate

Percentage of the population whose family income falls below an absolute level (poverty line)

Poverty line

Set by the federal government (three times cost of providing an adequate diet)

Economic mobility

the movement of people among income classes

Economic life cycle

Regular pattern of income variation over a person’s life

Permanent income

A person’s normal income (normal, or average, income over several years)

Utility

A measure of happiness or satisfaction

Utilitarianism

Government should choose policies to maximize the total utility of everyone in society

Diminishing marginal utility

As a person’s income rises, the extra well-being derived from an additional dollar of income falls