econ ch7

Marginal and average cost in the short run

Market for supply and demand in perf competition

Short run profits in perf comp

Difference in where P and AC is set is where it determines a firms profit (P above AC = abnormal, P=AC Normal, P lower than AC = loss)

Long run equilibrium in perf comp

Allocative efficency in perf comp long run

TR, MR and AR curves in monopoly

AR and P represent demand curve, MR curve lies below demand curve

Profits in monopolies, MR and cost approach

Natural monopoly

higher price and lower output in perf comp (left), and monopoly (right)

Market failure in perf comp (left), and monopoly (right)

Allocative efficiency (left) and inefficency (right) monopoly

(P=MC) AE, (P>MC) AI

Demand curves for perf comp, monopoly, and monopolistic comp

Profits of monopolistic comp

Long-run equilibrium of monopolistic comp

Game theory

(Final result is called Nash equilibrium)

Profit maximizing in a cartel

Concentration ratio

indication of percentage of output produced by the largest firms

Market power

extent to which each individual firm in the industry is able to control the price at which it sells its products

Perfect competition

firms have no market power (don’t result in market failure, and achieve allocative efficiency, highly unrealistic)

Monopoly

a single firm has the ability to control price of its product (holds all market power)

Market structure characteristics

1. Number of firms

2. 2. Product differentiation

3. 3. Difficulty in barriers to entry

Product differentiation

how similar or different goods and services are produced

Barriers to entry

the difficulty for new firms to enter the industry

Perfect competition characteristics

1. Large number of firms

2. 2. Homogeneous products

3. 3. No barriers to entry

Monopoly characteristics

1. Single dominant seller

2. 2. Heterogeneous products

3. 3. High barriers to entry

Monopolistic competition characteristics

1. Fairly large number of small firms

2. 2. No barriers to entry

3. 3. Product differentiation

Oligopoly characteristics

1. Small number of large firms

2. 2. Both differentiated and undifferentiated

3. 3. High barriers to entry

4. 4. Interdependence

Interdependence traits

1. Strategic behaviors: actions that take into account rivals possible course of action

2. 2. Conflicting incentives: incentives to collude or incentive to compete

Total revenue (TR)

Price X Quantity

Average Revenue (AR)

TR/Q (note: always equal to price, AR=P)

Marginal Revenue (MR)

additional revenue arising from sale of additional unit of output (sum of TR/ sum of Q)

Average total cost

total cost per unit of output (TC/Q)

Marginal cost (MC)

change in cost arising from one additional unit of output (Sum of TC/ sum of Q)

Revenues in 2 different types of markets

1. Perfect competition: firm is unable to control the price

2. 2. Firm has control of the price, monopoly, oligopoly, monopolistic competition

Implicit cost

the sacrificed income arising from the use of self-owned resource by a firm

Economies of scale

decreases in average cost of production over the long run as a firm increases all its factors of production (explains downward sloping portion of LRAC curve

Reasons why economies of scale occur

1. Specialization of labor

2. 2. Specialization of management

3. 3. Bulk buying of inputs

4. 4. Financing economies

5. 5. Spreading of certain costs

Specialization of labor

as scale of production increases, more workers must be employed, allowing for greater specialization of labor, thus increasing efficiency and allow output to be produced at lower average cost

Specialization of management

larger scale of production allows for more managers to be employed, increasing specialization and increasing greater efficiency

Bulk buying of inputs

as quantities of input purchases increase, the price per unit drops

Financing economies

larger firms may have lower interest rates, thus contributing to lower costs per unit of output

Spreading of certain costs

activities such as marketing, and advertising, design, research and development, result in lower average costs

Diseconomies of scale

increases in the average cost of production in the long run as a firm increases its outputs by increasing its inputs

Reasons for diseconomies of scale

1. co-ordination and monitoring difficulties

2. 2. Communication difficulties

3. 3. Poor worker motivation

Co-ordination and monitoring difficulties

as a firm grows larger, management may run into difficulties of co-ordination, organization, co-operation and monitoring. Results involves growing inefficiencies causing higher average costs

Communication difficulties

larger firm size may lead to difficulties in communication between various components parts of the firm, resulting in inefficiencies and higher average costs

Poor worker motivation

workers begin to lose their motivation, to feel bored and to care little about their work, become less efficient

Profits (calculations)

revenue – cost of production, total revenue – total costs, total revenue – the sum of explicit costs + implicit costs (Total costs)

Profit maximization

theory of firm that assumes firm behavior is guided by the goal to maximize profits (MC=MR) and (profit/Q = P-AC)

Profit amounts

TR>TC (abnormal profits), TR=TC (normal profits), TR<TC (loss)

Normal profit

minimum number of profit in order to keep the firm running (when TR = TC+Profits = 0)

Allocative efficiency

when firms produce the particular combination of goods and services the consumers prefer ( P=MC or MB=MC)

Natural monopolies

firms that have economies of scale so large they can produce for an entire market

Barriers to entry for monopolies

Economies of scale,

natural monopoly,

branding,

legal barriers,

control of essential resources,

aggressive tactics

Legal barriers to monopolies

1. Patents

2. 2. Licenses

3. 3. Copyrights

4. 4. Tariffs and other trade restrictions

Criticisms of monopoly

1. Welfare loss, allocative inefficiency and market failure

2. 2. Higher price and lower output in monopoly

3. 3. Loss of consumer surplus to monopolists

4. 4. Negative impacts on distribution of income

5. 5. Lack of competition gives rise to higher costs

6. 6. Possibly less innovative

Benefits of monopoly

1. Economies of scale

2. 2. Natural monopoly

3. 3. R&D for product developments

Price competition

when a firm lowers its price to attract customers away from rival firms

Non-price competition

when firms use other methods than price to attract customers

Nash equilibrium

shows the conflict between individual self-interest and collective firm interest on Game Theory

Collusive oligopoly

when firms form an illegal agreement between themselves to limit competition, increase market power and profits

Cartels

A formal agreement that may involve limiting and fixing the quantity to be produced by each firm. (key objective is to limit competition between member firms and attempt to maximize joint profits)

Cartel incentives

1. Increased market power

2. 2. Increased profits

3. 3. Elimination of competition between firms

Cartels difficulties in maintaining

1. Incentive to cheat

2. 2. Cost differences between firms

3. 3. Number of firms

4. 4. Possibility of price war

Other types of collusion

1. Price leadership

2. 2. Non-collusive oligopoly

Criticisms of oligopoloy

1. welfare loss,

2. 2. higher prices and lower quantities,

3. 3. loss of consumer surplus,

4. 4. Negative impacts on distribution of income

5. 5. Higher production costs due to no comp

6. 6. Possibly less innovative

7. 7. A lot easier to get under anti-monopoly policies

Benefits on oligopoly

1. Economies of scale

2. 2. Product and technology developments

3. 3. Increased product variety

Abuse of power

when firms engage in activities that result in reduced competition

Legislation to protect competition

competition policy; firms that are found guilty to anticompetitive behavior results in fines or may be broken up into smaller firms