Microeconomics Final

Modules 8 (Comp. Markets), 9 (Monopoly), and 10 (Oligopoly)

Characteristics of competitive markets

Number of firms, product differentiation, price-setting ability, and barriers to entry.

Perfect competition

Many firms, identical products, free entry/exit, and all firms are price takers.

Marginal revenue in perfect competition

MR = P because firms are price takers.

Output rule for competitive firms

Produce the quantity where P = MC.

When MC > MR

Firm should reduce output until MC = MR.

When MC < MR

Firm should increase output until MC = MR.

Long-run profits in perfect competition

Economic profit = 0 due to free entry and exit.

Shutdown rule (short run)

Shut down if P < AVC.

Exit rule (long run)

Exit if P < ATC.

Positive economic profits (long run)

Causes entry → supply increases → price falls → profits return to zero.

Negative economic profits (long run)

Causes exit → supply decreases → price rises → profits return to zero.

Effect of a decrease in price of substitute

Demand falls → price falls → firms exit in long run.

Allocative efficiency (perfect competition)

P = MC, meaning society values the last unit as much as it costs to produce.

Technical efficiency

Firms produce at minimum ATC in the long run.

Why monopolies exist

Barriers to entry, such as legal restrictions, resource ownership, or economies of scale.

Economic barriers to entry

High fixed costs, economies of scale, technology, advertising.

MR in competition vs monopoly

Competition: MR = P. Monopoly: MR < P.

Why MR < P in monopoly

Must lower price on all units to sell more, creating a price effect.

Output effect

Selling one extra unit increases revenue.

Price effect

Lowering price reduces revenue on previous units sold.

Allocative inefficiency (monopoly)

Monopoly produces where P > MC → underproduction → deadweight loss.

Deadweight loss (monopoly)

Lost surplus from producing less than socially optimal quantity.

Monopoly vs perfect competition

Monopoly sets higher price, lower quantity, and earns higher profits.

Price discrimination

Charging different prices to different consumers for the same good.

Examples of price discrimination

Student discounts, senior discounts, airline pricing, telecom pricing.

Why price discrimination increases profits

Captures more consumer surplus and increases quantity sold.

Natural monopoly

A firm with declining ATC due to high fixed costs; most efficient as a single producer.

Oligopoly characteristics

Few firms, barriers to entry, similar products, and strategic interdependence.

Examples of oligopolies

Airlines, telecom companies, OPEC.

Cartel

Firms explicitly agree to coordinate price or output.

Mutual interdependence

Each firm’s profit depends on actions of other firms.

Why we use game theory

Outcomes depend on strategic interactions among firms.

Nash equilibrium

No player has incentive to change strategy given the other player’s choice.

Dominant strategy

Strategy that is best no matter what the opponent does.

Why firms may not cooperate

Incentive to cheat/undercut to increase own profit (Prisoner’s dilemma).

Why firms may cooperate

Higher joint profits by acting like a monopolist.

Prisoner’s dilemma

Rational self-interest leads both players to a worse outcome.

Tit-for-tat strategy

Cooperate first, then copy the opponent’s previous move.

Credible threat

A threat that benefits the one making it, so it is believable.

Credible promise

A promise the player has incentive to keep.