ap economics: module 57 terms

4 primary models of market structure

1. perfect competition: many firms, identical product

2. monopoly: one firm, single and undifferentiated product

3. oligopoly: few firms, products can be identical or differentiated

4. monopolistic competition: many firms, differentiated products

the system of market structure is based on what 2 dimensions?

1. number of firms (one, few, many)

2. whether the goods offered are identical or differentiated

differentiated goods

different, but considered somewhat substitutable by consumers

if a firm in a perfectly competitive market changed their output, what would happen to the market price?

it would be unaffected; there’s so many firms that each of them is too small within the scope of the market to make a significant difference

price-taking firm

a firm whose actions have no effect on the market price of the g/s it sells

• takes market price as given

• seen in perfect competition (small and numerous firms)

price-taking consumer

a consumer whose actions have no effect on the market price of the g/s they buy

• market price is unaffected by how much they pay

perfectly competitive market

all market participants are price-takers

• consumption and production decisions don’t affect the price of the good

supply and demand model

model of a perfectly competitive market

• demand is horizontal @ market price (firms can’t charge more, as consumers would buy substitutes; no point in charging less)

perfectly competitive industry

an industry where firms are price-takers

2 necessary conditions for an industry to be perfectly competitive

1. must contain many small firms, none of whom have a large market share

2. consumers regard the products of all firms as equivalent; output is a standardized product

market share

the fraction of the total industry output accounted for by that firm’s output

standardized product/commodity

when customers regard the products of different firms as the same good

• producers can’t change prices b/c people will buy subs in a P.C. market

extra feature that characterizes P.C. industries

in the LR it is easy for firms to enter or exit the industry

• no obstacles preventing entry (govt. regulations, limited access to key resources)

• no costs associated with exit/shutting down business

entry

arrival of new firms into an industry

exit

the departure of firms from an industry

free entry and exit

when new firms can easily enter into the industry and existing firms can easily leave the industry

• not needed for P.C., but ensures that # of firms can adjust to changes in market conditions AND firms cannot prevent others from joining

monopolist

a firm that is the only producer of a good with no close substitutes

monopoly

an industry controlled by a monopolist

antitrust laws

made with the intent to prevent monopolies

why can’t other firms just interfere with a monopoly and get in on profits?

barriers to entry that protect monopolists, allowing them to earn economic profits

barrier to entry

something that prevents other firms from entering the industry

• protects monopolies and allows them to persist and be profitable

4 main types of barriers to entry

1. control of a scarce resource/input

2. economies of scale

3. technological superiority

4. government-created barriers

how can control of a scarce input be a barrier to entry?

prevents other from being able to get the input and enter the industry

how can economies of scale be a barrier to entry?

• large firms are profitable (ATC decreases as output increases), driving out small businesses

• established firms have a cost advantage compared to an entrant (natural monopoly)

natural monopoly

created and sustained by economies of scale; exists when economies of scale provide a large cost advantage to a single firm that produces all of an industry’s output (compared to many firms)

• minimum-efficient scale is so large that the monopoly possesses economies of scale over the industry’s relative range of outputs

source of a natural monopoly

large fixed costs; given quantity of output is produced at a lower ATC by one firm as opposed to many

how can technnological superiority be a barrier to entry?

• allows for better production

  • usually a SR barrier → competitors will upgrade

• however, not a guarantee of success

why might technological superiority not be a guarantee of success?

network externalities; firm w/ largest network has an advantage in attracting new customers (regardless of how advanced their tech is)

network externalities

when the value of a good to a consumer rises as the number of other people who also use the good rises

how can the government create a barrier to entry?

patents and copyrights

patents

gives an inventor a temporary monopoly in the production, use, and sale of an invention

• 16-20 years usually

copyright

gives the holder for a literary/artistic work the sole right to profit from that work for a specific period of time

• creator’s lifetime + 70 years usually

justification for patents and copyrights

incentives

• inventor/creators not protected → little gain, other may copy their work → decreased incentive to event invent/create in the firts place

• law allows these temporary monopolies to encourage invention and creation

compromise made with patents and copyrights

while in effect: high prices compensate inventors/creators

once over: lower prices benefit consumers

oligopoly

an industry with only a small number of firms

oligopolist

a producer in an oligopoly; has market power and can influence prices

imperfect competition

when no one firm has a monopoly, but producers nontheless realize they can affect market prices

• 2 forms: oligopoly and monopolistic competition

IMPORTANT INFO

oligopoly doesn’t mean large firms, just a few firms

collusion

when oligopolists work togther to limit direction competition, allowing them to raise prices and profits

IMPORTANT INFO

oligopolies can result from the same factors that create monopolies, but just in a weaker form

• strong effects → monopoly

• weaker effects → oligopoly

2 measures of market power/structure

1. concentration ratios

2. Herfindahl-Hirschman index (HHI)

concentration ratios

measure the percentage of industry sales accounted for by the “X” largest firms

• X is any number of firms

• 4 and 8 concentration ratios are the most common

• higher concentration ratio → more concentrated market → more likely to be an oligopoly

Herfindahl-Hirschman index (HHI)

the square of each firm’s share of market sales summed over the industry

• gives more weight to larger firms

• produces much larger numbers when a larger share of an industry is dominated by fewer firms

• higher HHI → more concentrated market → more likely to be an oligopoly

what provides the incentive for oligopolists to collude?

interdependence

monopolistic competition

when there are many competing firms in an industry, each firm sells a differentiated product, and there is free entry/exit in the LR

• producers have slight market power + ability to change prices (enabled by differentiated product, limit by competition from close substitutes)