Econ 303 - Exam 3

A firm has greater market power with

a less elastic demand

All else being equal, the more elastic the demand for a firm’s product

the lower that firm’s market power

All else being equal, the less market power a firm has

the lower the price the firm can charge for its product and the smaller its producer surplus will be

Suppose that firms begin entering an industry in which a single firm had been enjoying a monopoly. What will the former monopolist experience?

The firm’s demand will become more elastic, and its market power will decrease

If a firm operates in a perfectly competitive industry it

faces a perfectly elastic demand curve, it cannot mark up its price above MC, and it has no market power

Because MR accounts for the gains from selling a greater quantity and the losses from cutting the price, for a firm with market power

MR < P

Company A1 has market power and faces a downward-sloping D curve. The firm’s MC curve is MC = 30 + 3Q. What is A1’s MR?

MR = 300 - 6Q

How does the shape of the demand curve affect the firm’s ability to charge a high price?

The flatter the demand curve is, the lower the price the firm can charge

Market power occurs when a firm

can influence the price of a product

What statement (s) are TRUE? 

I. A natural monopoly owes its existence to economies of scale

II. In contrast to a monopoly industry, industries served by natural monopolies have no barriers to entry

III. Natural monopolies have cost structures characterized by small FCs and steeply rising MCs

I

Bubba Golf, a manufacturer of golf clubs, can sell 3 drivers at $600 each. To sell 4 drivers, they must lower the price to $580 each. The MR of the fourth club is

$520

A firm that can affect the price of its product

faces a downward-sloping demand curve

As Southwest Airlines began operating at various airports around the country

prices at those airports decreased, and the number of passengers using them increased dramatically 

Government encouragement of monopoly

through patents causes higher consumer prices but encourages firms to innovate and bring new products to the market

Rent-seeking refers to

the costly actions that firms undertake in their attempt to receive monopoly privilege from the government

What does it mean when most firms have some market power?

the firm’s production decisions affect the market price of the good it sells

How do firms maintain market power?

Through barriers to entry into the market

What barriers to entry allow firms to maintain market power?

natural monopolies, switching costs, product differentiation, and absolute cost advantages of key inputs

What is a monopoly?

the sole supplier of a good in a market and represents the extreme case of a firm with complete market power

What do monopolies and other firms with market power base their production decisions?

on their MR - the revenue from selling an additional unit of a good

How does MR change as output rises for firms with market power?

MR falls as output rises

Why does MR fall when a firm increases its production of a good?

because it must sell all units of the good (not just the additional unit) at a lower price

Where is the profit-maximizing output level for a monopolist found?

where MR = MC

How does a monopoly’s price compare to its MC?

it will charge a price above its MC

How does the market price for a monopoly compare to that for a perfectly competitive market?

the market price for a monopoly is higher than for a perfectly competitive firm 

What does the Lerner index compute?

how much a firm should mark up its price

How is the Lerner index affected by demand elasticity?

the more inelastic the demand for a product, the higher the firm’s Lerner index and markup

How do cost and demand shocks affect firms with market power compared to perfectly competitive markets? 

the changes in quantity supplied and price created by cost and demand shocks have the same direction, but different magnitutes) for firms with market power as for perfectly competitive markets 

How do firms with market power respond differently to changes in consumers’ price sensitivities? 

they respond differently to rotations in the demand curve than do perfectly competitive firms

What happens when a firm exercises its market power?

it increases its producer surplus, decreases consumer surplus, and creates a DWL

When is producer surplus greater for firms with market power?

when consumers are relatively price-insensitive and the demand curve is steep

Why do governments intervene in markets with firms that have market power?

to reduce the DWL created by firms with market power

What are two govt methods used to reduce firms’ market power?

direct price regulation and antitrust laws

How do govts grant market power to firms, and why?

through patents, copyrights, and other laws as a way of promoting innovation

What is necessary to practice price discrimination?

the firm must have market power and be able to prevent arbitrage of its product

To practice indirect or second-degree price discrimination, a firm must have

market power and the ability to prevent resale, and customers with different demand curves without the firm knowing which customers have which type of demand before purchase of the product

For price discrimination via coupons to be successful, it must be TRUE that

shoppers who use coupons have more elastic demand than shoppers who do not

What can a firm with market power do by using pricing strategies?

extract more producer surplus from a market than by following the monopoly pricing rule where MR = MC

What is required for a firm to extract more producer surplus using pricing strategies?

the situation must satisfy certain criteria, including the firm’s ability to prevent resale among customers

Why must a firm be able to prevent resale among customers?

because if customers can resell, price discrimination breaks down and the firm cannot maintain different prices for different buyers

What determines the type of pricing strategy a firm can follow?

the amount of information the firm has about its customers’ demands

What happens when customers differ and the firm has enough information to charge each person a different price?

perfect or first-degree price discrimination is possible

What is first-degree (perfect) price discrimination?

a strategy of direct price discrimination that allows the firm to capture the entire surplus in the market for itself 

How common is perfect price discrimination?

it is very rare because firms seldom have complete information about each customer’s demand

What can a firm do if it can identify at least two groups of customers with different price elasticities of demand? 

it can charge different prices to the two groups and earn more producer surplus

What is the profit-maximizing rule for direct price discrimination across groups?

follow the single-price monopoly pricing rule separately for each group 

What is third-degree (direct) price discrimination also known as?

segmenting customers based on characteristics, geography, purchase timing, or behavior

How can firms directly separate customers for third-degree price discrimination?

by customer characteristics, geography, past purchase behavior, or timing of the purchase

What must a firm do if it knows customers differ but cannot directly identify which group they belong to before purchase

it must rely on indirect (second-degree) price discrimination

What is indirect (second-degree) price discrimination>

designing choices that induce customers to sort themselves into groups

What are examples of indirect price discrimination strategies?

quantity discounts and versioning a product

When can quantity discounts be used effectively?

when customers who demand higher quantities also have a more elastic demand

What is the key additional requirement for indirect price discrimination?

the pricing structure must be incentive-compatible so that each consumer group chooses the offer designed for it

What can a company do if it sells multiple products with negatively correlated demands?

it can bundle the products to increase producer surplus beyond what it could earn selling separately 

What is mixed bundling?

giving customers the choice of buying individual products at high prices or a bundle of products at a discount 

When is mixed bundling preferable?

when the MC of producing one product exceeds the value a customer places on that product 

What are examples of advanced pricing strategies even when customers are similar?

block pricing and two-part tariffs

What is block pricing?

offering a discount for buying extra quantity

What is a two-part tariff?

charging a fixed fee paid up front in addition to a per-unit price

Why are advanced pricing strategies difficult to implement?

because they become complicated when there are many customers with different demand curves