Micro economics chapter 12 (Imperfect competition)

Why are firms price setters in an imperfect economy?

Firms are price setters in an imperfect economy because they have some control over their prices due to product differentiation, market power, and the lack of perfect competition.

What are the three barriers of entry?

1. Technological barriers

2. Legal barriers

3. Strategic barriers

What are the three technological barriers and explain about them?

1. Economies of scale: average cost falls with the amount of output. Production cost is not as efficient when many firms are in the market. This leads to natural monopolies. Ex. Drinking water, gas, electricity.

2. Network effects: consumers experience positive effects when more consumers choose the same product. Here is also included direct network effect and indirect network effect.

3. Exclusive ownership of scarce input: when one firm is the exclusive owner of a scarce input or non-imitable knowledge they have the power. Ex. One company controls 80% of diamond mines or Coca-Cola formula

What’s the difference between indirect network effect and direct network effect?

Direct network effect occurs when the value of a product directly increases with more users (e.g., social media platforms). Indirect network effect occurs when increased usage of one product increases the value of a different product (e.g., more users on a gaming console increases game development).

What are legal barriers?

Governments can impose a ban on competition or issue licenses for certain activities. Ex. Trains or pharmacies in a specific place

What are patents?

Patents are legal rights granted by the government to inventors, giving them exclusive rights to produce, use, and sell their invention for a certain period of time, usually 20 years.

What are strategic barriers?

A firm might make entry of competitors more difficult to protect their market power. a monopolist can build s good reputation etc.

What’s the differences between a monopoly and perfect competition? (Focus on monopoly and 6)

• monopolist does not have a supply curve

• A monopolist will always produce on the elastic part of the demand curve

• The price set by a monopolist will always exceed marginal cost. The quantity offered by a monopolist is smaller than the equilibrium quantity under perfect competition.

• The difference between the monopoly price and the marginal cost increases as market demand is less elastic

• Total surplus is lower in the case of a monopoly. There is an efficiency loss and deadweight loss in monopoly.

• Compared to the outcome under perfect competition, some of the consumer surplus has gone to the monopolists profits.

What is price discrimination?

Price discrimination is a pricing strategy where a firm charges different prices for the same product or service to different customers, based on their willingness or ability to pay.

What is perfect price discrimination?

Perfect price discrimination is a pricing strategy where a firm charges each consumer the maximum price they are willing to pay for a product, capturing all consumer surplus and leading to increased profits for the firm.

What is price discrimination through market segmentation?

Price discrimination through market segmentation is a strategy where a firm charges different prices based on specific characteristics of groups within the market, such as age, location, or purchasing behavior, allowing firms to capture more consumer surplus.

What is self-selection?

Self-selection is a process where individuals choose to participate in a particular market or situation based on their own preferences, characteristics, or opportunities, often resulting in a specific type of participant group.

What is intertemporal price discrimination?

Intertemporal price discrimination is a pricing strategy where a firm charges different prices for the same product at different times, often based on consumers' varying willingness to pay over time.

What is the mark up?

Ratio of price over marginal cost

What is an oligopoly?

An oligopoly is a market structure characterized by a small number of firms that have significant market power, leading to limited competition and interdependent pricing strategies.

What is a duopoly?

A duopoly is a market structure where two firms dominate the market, each holding significant market power, leading to interdependent pricing and competitive strategies.

What is Bertrand competition?

Bertrand competition is a market situation where firms compete by setting prices rather than quantities, leading to price reduction until they reach marginal cost, and often resulting in lower profits compared to Cournot competition.

What is Bertrand paradox?

The Bertrand paradox refers to a situation in which two firms in an oligopoly set prices simultaneously. According to the model, if firms compete on price, they will continue to undercut each other until prices reach marginal cost, leading to zero economic profit, which contradicts the intuition that oligopolies can maintain higher prices and profits.

Why can firms have market power (the Bertrand paradox does not hold) 4

1. Product differentiation

2. Switching costs (costs that consumer incur when switching suppliers)

3. Search costs (consumers are not always willing to look for other prices)

4. Capacity constraints (firms are not always able to increase their scale of production if demand increases

What is the Cournot model?

The Cournot model is an economic theory that describes an oligopoly market structure where firms choose quantities to produce independently and simultaneously, leading to a Cournot-Nash equilibrium where each firm's output decision affects the market price.

What is vertical product differentiation?

When products differ in quality

What is horizontal product differentiation?

Product differ only in subjective valuation

What are the three ways firms try to differentiate their product?

1. Product features

2. Promotional campaigns

3. Invest in distribution networks or seek exclusivity from retailer

What is monopolistic competition?

Monopolistic competition is a market structure characterized by many firms selling products that are similar but not identical, allowing for some degree of market power and product differentiation.