ECON 201 - Lesson 15 Study Set

Monopolistic competition

A market structure where a large number of firms compete. Each firms produces a differentiated product. Firms compete on product quality, price, and marketing. Firms are free to enter or exit the industry.

Monopolistically competitive firm faces

A downward sloping demand curve because it produces a differentiated product. As a result, a ___ marginal revenue curve lies below its demand curve.

Output and price in monopolistic competition’s in the short run

The firm maximizes its profit by producing the level of output such that MR = MC. The firm might earn an ecomic profit. If it does, free entry means that competitors eventually enter the industry. Alternatively, the firm might incur an economic loss. If it does, it (or other firms) eventually exit the industry.

Output and price in monopolistic competition’s in the long run

The firm maximizes its profit by producing the amount of output that sets MR = MC. The firm does not earn an economic profit or incur an economic loss, so P = ATC.

Capacity output

The output at which average total cost is at its minimum.

Excess capacity

A monopolistically competitive firm has __ because in the long run, it does not produce at the minimum ATC.

Not efficient

From a social standpoint, monopolistically competitive firms are ___. However monopolistically competitive firms produce a large variety of differentiated products and consumers value variety.

Differentiate; marginal cost; marginal revenue

Monopolistically competitive firms constantly strive to ___ their products and (temporarily) earn an economic profit. The extent of innovation and product development is determined by the __ and ___ of innovation and development.

Marketing; fixed costs; ambiguous

Monopolistically competitive firms spend huge amounts on __. Such selling costs are __, which shift the firm’s ATC curve upward. Because all firms advertise, the effect of advertising on the demand for any particular firm’s product is ___.

The efficiency of monopolistic competition is unclear

On the plus side, consumers value variety and advertising might provide valuable information. On the minus side, advertising is costly and monopolistically competitive firms have higher costs because of their excess capacity.

Oligopoly

A market structure in which a few firms compete. Each firm considers the effects of its actions on the behavior of the others and the actions of the others on its own profit.

Kinked demand cure model

The firm believes that, if it raises its price, no competitors will follow but that, if it lowers its price, all its competitors will follow. The firm faces a kinked demand curve, with the kink at the current price and quantity. The kink causes a break in the MR curve. As long as the MC curve remains within this break, the firm’s price and quantity do not vary.

The dominant firm oligopoly model

One large firm has a substantial cost advantage over any small competitors. The large firm acts like a monopoly and sets its profit-maxmizing price. The small firms take this price as given and act like perfect competitors.

Game theory

A tool for studying strategic behavior. Games have rules, strategies, payoffs, an d an outcome.

Rules

Specify permissible actions by players.

Strategies

Are actions, such as raising or lowering price, output, advertising, or product quality.

Payoffs

The profits and lsoses of the players.

Payoff matrix

A table that shows the payoffs for every possible action by each player.

Outcome

Determined by the players’ choices.

Nash equilibrium

Player A takes the best possible action given the action of Player B, and B takes the best possible action given the action of A.

Prisoners’ dilemma

A two-person game. In a one-time prisoners’ dilemma game, each player has a dominant strategy of cheating, that is, conofessing.

Dominant strategy

Occurs when each player has a unique best strategy independent of the other player’s action.

Cooperative equilibrium

An equilibrium in which the players make and share the monopoly profit.

A “tit-for-tat” strategy

Consists of taking the same action (cheating or not cheating) the other player took last period.

Trigger strategy

Cooperates until the other player cheats and then plays the Nash equilibrium strategy (cheating) forever after.

Game tree

Shows the decisions made at the first stage and second stage of a game. It can be used to analyze a sequential game, such as a contestable market.

Contestable market

A market in which one firm (or a small number operate) but in which entry and exit are free, so the existing firm(s) face competition from potential entrants. The company (or companies) in the market can play an entry-deterrence game.

Entry-deterrence game

The firm in the market sets a competitive price (rather than a monopoly price) and earns a normal profit to order to keep potential competitors from entering the market.

Limit pricing

Refers to the situation in which a firm charges a price lower than the monopoly price (and earns less than the monopoly profit).