Market Structures and Game Theory

This set of flashcards covers key concepts and vocabulary related to market structures, including perfect competition, monopolistic competition, oligopolies, and game theory principles.

Perfect Competition

A market structure characterized by a very large number of firms, each producing an undifferentiated (homogeneous) product. Key features include no barriers to entry or exit, perfect information for all market participants, and firms being price takers due to their inability to influence the market price. In the long run, firms in perfect competition earn zero economic profit.

Imperfect Competition

A market structure that deviates from the conditions of perfect competition. In these markets, firms typically have some degree of market power, allowing them to influence prices. This category includes monopolies, oligopolies, and monopolistic competition, where firms may differentiate their products, face barriers to entry, or have a limited number of competitors.

Price Maker

A firm that possesses market power, enabling it to set its own prices rather than accepting the prevailing market price. This ability arises from facing a downward-sloping demand curve, allowing the firm to choose a price-quantity combination that maximizes its profits. Monopolies and firms in monopolistic competition are examples of price makers.

Price Taker

A firm operating in a perfectly competitive market that has no control over the market price and must accept it as given. This occurs because the firm is one of many producers, sells a homogeneous product, and its individual output is too small to affect total market supply. For a price taker, the demand curve is perfectly elastic at the market price.

Allocative Efficiency

A state of the economy in which resources are allocated in such a way that the production of goods and services matches consumer preferences, maximizing total societal benefit. This occurs specifically when the price consumers are willing to pay for a good (representing marginal benefit) equals the marginal cost of producing that good (P=MC). At this point, no rearrangement of production can make anyone better off without making someone else worse off.

Productive Efficiency

The condition where goods and services are produced using the fewest possible resources, meaning they are produced at the lowest possible cost. This is achieved when a firm produces at the minimum point of its average total cost (ATC) curve, where price equals minimum average total cost (P=ATCmin). This implies that production inputs are being utilized optimally, avoiding waste.

Monopoly

A market structure where a single producer or seller controls the entire market for a unique product or service that has no close substitutes. Monopolies are characterized by significant barriers to entry, which prevent other firms from competing. As a price maker, a monopolist can set prices higher than marginal cost and often earns positive economic profits in the long run.

Price Discrimination

A pricing strategy where a seller charges different prices to different consumers for the same product or service, even though the cost of producing for each consumer is the same. For successful price discrimination, the firm must have market power, be able to differentiate between consumer groups based on their willingness to pay, and prevent resale of the product between consumers who pay different prices.

Consumer Surplus

The economic benefit enjoyed by consumers, defined as the difference between the maximum price consumers are willing to pay for a good or service and the actual market price they pay. Graphically, it is represented by the area below the demand curve and above the market price.

Producer Surplus

The economic benefit enjoyed by producers, defined as the difference between the actual market price producers receive for a good or service and the minimum price they would have been willing to accept. Graphically, it is represented by the area above the supply curve and below the market price.

Excess Capacity

A situation, typically observed in monopolistic competition, where a firm produces an output level that is less than the output level associated with productive efficiency (i.e., less than the minimum of its average total cost curve). This occurs because firms in monopolistic competition face a downward-sloping demand curve, and thus, their profit-maximizing output occurs where P > ATC_{min}, leading to some underutilization of plant and equipment.

Oligopoly

A market structure characterized by a small number of large firms that dominate the market for a particular product or service. A key feature of oligopolies is mutual interdependence, meaning that the pricing and output decisions of one firm significantly affect the profits and strategies of its competitors. Oligopolies often face high barriers to entry and may engage in strategic behavior, including price wars or tacit collusion.

Game Theory

A mathematical framework used to analyze strategic interactions among rational decision-makers (players) whose outcomes depend on each other's actions. It provides a structured approach to understanding how agents make choices in situations where their decisions are interdependent, particularly relevant in competitive environments like oligopolies, by considering strategies, payoffs, and equilibria.

Nash Equilibrium

A concept in game theory where, given the strategies of all other players, no player can improve their own payoff by unilaterally changing their strategy. In a Nash Equilibrium, each player's chosen strategy is the best response to the strategies chosen by all other players, resulting in a stable state where no individual has an incentive to deviate.

Dominant Strategy

In game theory, a strategy that yields the highest payoff for a player regardless of what strategy the other players choose. If a player has a dominant strategy, it is always in their best interest to pursue that strategy, as it guarantees the best possible outcome compared to other options, regardless of the opponents' actions.

Tacit Collusion

A form of informal cooperation among firms in an oligopoly to restrict competition and increase profits, without explicit communication, formal agreement, or written contracts. This often involves firms implicitly observing and reacting to each other's pricing or output decisions, leading to outcomes similar to those of explicit collusion, such as price leadership or parallel pricing.