AP Micro Unit 4 - Imperfect Competition

Monopoly

* A kind of a market where only one firm that dominates the industry and sells a very unique product

Oligopoly

* A kind of market where there are a few, large firms that dominate the industry (usually less than 10)

Monopolistically Competitive Market

* A kind of market where a large number of sellers offer differentiated products

Characteristics of Imperfectly Competitive Firms

* Fewer, larger firms in the industry
* Firms are “price makers” - firms have some or total control over the price they choose to sell their goods at
* Higher barriers to entry, meaning firms cannot enter as easily
* Firms earn long run profits (except for monopolistic competition - it breaks even in the long run)
* Products sold are differentiated
* Non-price competition is used - tools like advertising to promote products
* Firms are inefficient in the long run
* Demand is greater than Marginal Revenue

Example Barriers to Entry

* Geography
* If location is close to resources
* Firms is the only one selling product in the area
* Government (US)
* Issues patents and other protections
* Common Use
* Brand name and reputation
* Economies of Scale
* Availability of firms to mass produce at a low-cost
* High Fixed Costs
* Firms may not have the financial resources to pay the upfront costs of entering the market

Monopoly

* A market structure where an individual firm has sufficient control over a market or industry
* They determine the terms of access to other firms

Natural Monopoly

* Occurs when an individual firm comes to dominate an industry by producing goods and services at the lowest possible production cost that other firms cannot compete with
* They’re beneficial to society as they charge low prices and promote productive efficiency

Characteristics of Monopolies

* One, large firm
* Firms are “price makers”
* High barriers to entry
* Firms earn long-run profits
* Products sold are unique
* Non-price competition is used
* Firms are inefficient if left unregulated - overcharge and underproduce

Monopoly Graph

Profit in a Monopoly (graph)

Loss in a Monopoly (graph)

Monopoly with Consumer Surplus, Producer Surplus, and Dead Weight Loss

Monopoly Graph

Profit Maximizing Price and Output

(Loss-Minimizing)

* MR = MC

Monopoly Graph

Socially Optimal Price and Output

* P = MC
* Allocatively Efficient

Monopoly Graph

Fair-return Price and Output

* P = ATC

Monopoly Graph

Maximized Total Revenue Price and Output

* MR = 0

Key Points on Monopoly Graph

* Profit Maximizing - MR = MC
* Socially Optimal - P = MC
* Fair-Return - P = ATC
* Maximized TR - MR = 0

Elasticity in Monopoly

* Unit Elastic Point - point on the demand curve where a horizontal line intersects MR = 0
* Elastic Region - any point above the MR = 0 intersecting line
* Inelastic Region - any point below the MR = 0 intersecting line
* Can also be determined with a TR curve, where the peak matches MR = 0

Price Discrimination

* Practice where specific products are sold to different buyers at the highest price they are willing and able to pay

Conditions required to practice price descrimination

* Monopoly Power
* Able to segregate the market
* Consumers cannot easily re-sell the product

Characteristics of a Price Discriminating Monopoly

* D = MR
* Allocatively Efficient but Productively Inefficient
* Larger long-run economic profits
* Zero consumer surplus

Characteristics of a Pure Monopoly

* D > MR
* Allocatively and Productively Efficient
* Smaller long-run economic profits
* Some consumer surplus

Perfect Price Discrimination

* AKA 1st degree price discrimination
* Demand exactly equals MR
* Three curves: MC, D = MR, and ATC

Characteristics of Monopolistic Competition

* Many, various sized firms
* Firms are “price makers”
* Low barriers to entry
* Firms break even in the long-run
* Products are differentiated
* Non-price competition is used
* Firms are inefficient if left unregulated
* Firms experience excess capacity - they are productively inefficient

Non-Price Competition

* Ways that firms seek to increase sales and attract consumers through methods other than price
* Examples: Brand names and packaging, product attributes and service, advertising

Monopolistic Competition Graph

* Demand and MR are more elastic
* (Missing ATC)

Monopolistic Competition Earning a Profit

Monopolistic Competition Earning a Loss

Monopolistic Competition in the Long Run

* ATC will be tangent to the demand curve in the downward sloping region (economies of scale region)
* Productively and Allocatively Inefficient

Monopolistic Competition

Short Run to Long Run

* Firms earn short-run profits, so more firms enter the market
* More substitutes are created, so there is less market share for existing firms, so demand and MR curves shift left together until demand is tangent to ATC
* Firms earn short-run losses, so firms exit the market
* There is more market share for existing firms, so demand and MR curves shift right together until demand is tangent to ATC

Excess Capacity

* The difference between a firm’s current inefficient level of production and the productively efficient level of output
* If there is productive efficiency, there is no excess capacity, but Monopolistically Competitive Firms are Productively Inefficient in the long-run

Oligopoly

* An imperfect market structure where the industry is dominated by a few, large firms
* Two kinds:
* Colluding Oligopolies
* AKA cartels
* Firms communicate with each other and act in one unit
* Non-Colluding Oligopolies
* Firms compete and do not work together

Characteristics of Oligopoly

* Few, large firms
* Firms are “price makers”
* High barriers to entry
* Firms earn long-run profits
* Products are differentiated
* Non-price competition is used
* Firms are inefficient if left unregulated

Game Theory

* The study of how people behave in strategic situations

What is a game (in economics)?

* Any set of circumstances that has a result dependent on the actions of two or more decision-makers

Payoff Matrix

* A chart that shows the actions of two firms and the payoffs of each combination of choices

Dominant Strategy

* A strategy a firm should take no matter what the other firm does
* Sometimes a firm doesn’t have a dominant strategy because their actions should differ based on the other firm’s actions

Nash Equilibrium

* A point at which there is a stable state in the game in which no participant can unliterally improve their position
* It’s a point where the game equilibrates because **neither** player can improve their position without the other player moving
* You can find this point by determining the best option for either player, and if there are two circles in one box, that is the equilibrium point

Price Leadership

* Model of oligopoly where the dominant firm will initiate a price change in the industry
* We can model the change with a kinked demand curve
* If the dominant firm raises prices, the other firms can either match those prices or ignore those prices and get more consumers - elastic
* if the dominant firm lowers prices, the other firms will usually match your prices and the market will stay relatively similar - inelastic
* Note: Not necessary for the AP, but can help show how the market is influenced by interdependence