ECON 100 Test 3- Market Structures

Short-Run Economic Profit

Profits earned when total revenue exceeds total costs, possible in all four market structures.

Long-Run Economic Profit

Profits earned in the long run, possible ONLY in Monopoly and Oligopoly due to barriers to entry.

Barriers to Entry

High obstacles (patents, high startup costs, regulations) that prevent new firms from entering a market and eating away profits.

Price Discrimination

The business practice of charging different prices to different consumers for the exact same good or service based on their willingness to pay (e.g., student discounts, airline tickets).

Purpose of Price Discrimination

To capture consumer surplus and convert it into additional producer profit.

Monopolistic Competition Entry Effect

When existing firms earn economic profit, new firms enter, increasing choices, shifting existing firms' demand curves to the left until economic profit reaches zero.

Product Differentiation

Making a product distinct from competitors' products through quality, features, style, or branding.

Product Differentiation & Advertising

As product differentiation increases, the likelihood and necessity of advertising also increase to highlight those differences.

Consumer Value of Brand Names

Brand names help consumers by providing information about product quality and consistency, reducing purchasing risk.

Oligopoly Characteristics

A market structure dominated by a few large, interdependent firms with high barriers to entry selling identical or differentiated products (e.g., wireless carriers, automobile manufacturers).

Duopoly

An oligopoly consisting of only two dominant firms, which can choose to compete aggressively or cooperate like a single monopoly.

Collusion

An agreement among firms in a market about quantities to produce or prices to charge.

Cartel

A group of colluding firms acting together as a single monopoly to maximize combined profits.

Market Structure Copied by Colluding Oligopolies

Monopoly, because it restricts output to charge the highest price and earn the maximum total market profit.

Effect of Number of Firms in Oligopoly

As the number of firms increases, output rises and prices fall toward competitive levels; as the number decreases, output drops and prices rise.

Nash Equilibrium

A situation in game theory where each economic actor chooses their best strategy given the strategies chosen by all others, leaving no incentive for anyone to unilaterally change their move.

Finding Nash Equilibrium

Compare each player's best response to every possible strategy of the rival; any cell in a payoff matrix where both players are simultaneously playing their best response is a Nash Equilibrium.

Temptation to Cheat

The main reason collusion is hard to maintain, as individual firms can increase their own short-run profits by secretly producing more or undercutting agreed-upon prices.

Prisoners' Dilemma

A game theory scenario illustrating why cooperation is difficult to maintain even when it is mutually beneficial, due to individual incentives to cheat.

Price vs. Quantity Across Market Structures

Perfect Competition produces the highest quantity at the lowest price; Monopoly produces the lowest quantity at the highest price; Monopolistic Competition and Oligopoly fall in between.

Price Takers

Firms with zero market power that must accept the market equilibrium price, found in Perfect Competition.

Price Makers

Firms with market power that can set or influence their prices, found in Monopoly, Oligopoly, and Monopolistic Competition.

Payoff Matrix

A visual grid used in game theory showing all players, their possible strategies, and the resulting outcomes or profits.

Dominant Strategy

A strategy that yields the best outcome for a player regardless of what strategy the rival player chooses.

Market Structure Equilibrium Comparison

Perfect competition yields long-run economic profits of zero and no market power, monopolistic competition yields zero economic profit with product differentiation, oligopoly relies on strategic interdependence, and monopoly holds maximum price control and long-run profit potential.

Monopolistic Barriers to Entry

Natural monopoly

 

Water and electric companies

Control of a physical resource

 

DeBeer Diamonds

Legal monopoly

 

Post Office

Patent, trademark, and copyright

 

New drugs or software

Intimidating potential competitors

 

Predatory pricing; well-known brand names