Economics: Market Structures, Efficiency, and the Invisible Hand

Vocabulary review flashcards covering market power, monopoly, monopolistic competition, oligopoly, accounting and economic profit, efficiency, price controls, and the invisible hand.

Imperfect Competition

A market structure in which firms are price setters with some ability to set their own prices, long-run economic profits are possible, and economic surplus is reduced.

Monopoly

An imperfectly competitive market structure with only one firm producing a unique product with no close substitutes, where entry and exit are difficult or impossible, economic profits are possible in the long run, and the firm decides both price ($P$) and quantity ($Q$).

Monopolistic Competition

An imperfectly competitive industry with many firms producing differentiated products that are reasonably close substitutes, characterized by free entry and exit, limited price flexibility, and zero economic profits in the long run.

Oligopoly

An imperfectly competitive market structure with a small number of large firms producing standardized or differentiated products that are close or perfect substitutes, featuring difficult entry and exit, some price flexibility, and possible economic profits.

Market Power

The ability of a firm to raise its price without losing all of its sales, typically arising from factors that limit competition.

Five Sources of Market Power

The factors that give firms price-setting ability: exclusive control over inputs, patents and copyrights, government licenses or franchises, economies of scale, and network economies.

Returns to Scale

The percentage change in output resulting from a given percentage change in all inputs combined.

Constant Returns to Scale

A production characteristic where doubling all inputs leads to an exact doubling of output.

Increasing Returns to Scale

A production condition where output increases by a greater percentage than the increase in inputs, causing average costs to decrease as output expands.

Natural Monopoly

A monopoly market structure that results directly from economies of scale.

Network Economies

A source of market power that occurs when the value of a product increases as the number of users increases.

Variable Cost

The sum of payments made to variable factors of production, such as labor.

Fixed Cost

The sum of payments made to fixed factors of production, such as capital; start-up costs can be considered fixed costs.

Average Total Cost (ATC)

Total cost divided by output, expressed in constant marginal cost models as $\text{ATC} = \frac{F}{Q} + M$, where $F$ is fixed cost, $Q$ is output, and $M$ is constant marginal cost.

Marginal Revenue (MR)

The change in total revenue resulting from a one-unit change in output, which equals price for a perfectly competitive firm but is less than price for a monopolist.

Monopolist's Marginal Revenue Curve

For a straight-line demand curve, a line that has the same vertical intercept as demand, lies below demand, and possesses twice the slope of the demand curve.

Deadweight Loss

The loss of consumer and producer surplus caused by the disparity between price and marginal cost ($P > \text{MC}$).

Price Discrimination

The practice of charging different buyers different prices for essentially the same good or service.

Hurdle Method of Price Discrimination

The practice of offering a price discount to all buyers who overcome some form of obstacle.

Perfect Hurdle

A threshold that completely segregates buyers whose reservation prices lie above it from buyers whose reservation prices lie below it, while imposing no cost on those who jump the hurdle.

Cost-Plus Regulation

A government regulation allowing a firm to charge prices covering explicit production costs plus a markup to cover the opportunity cost of resources supplied by owners.

Sherman Act of 1890

A landmark federal antitrust law that declared conspiracy to create a monopoly illegal.

Clayton Act of 1914

A federal antitrust statute that outlawed transactions, such as mergers and acquisitions, that would substantially lessen competition.

Explicit Costs

Payments firms make to purchase external resources (such as labor and land) and products from other firms.

Implicit Costs

The opportunity costs of the resources supplied directly by the firm's owners.

Accounting Profit

The total revenue of a firm minus its explicit costs ($\text{Accounting Profit} = \text{Total Revenue} - \text{Explicit Costs}$).

Economic Profit

Total revenue minus both explicit and implicit costs ($\text{Economic Profit} = \text{Total Revenue} - \text{Explicit Costs} - \text{Implicit Costs}$), also known as excess profits.

Normal Profit

The difference between accounting profit and economic profit ($\text{Normal Profit} = \text{Accounting Profit} - \text{Economic Profit}$), which equals implicit costs and keeps resources in their current use.

Rationing Function of Price

The process by which market price distributes scarce goods to the consumers who value them most highly.

Allocative Function of Price

The process by which price directs productive resources away from overcrowded markets and toward underserved markets.

Invisible Hand Theory

Adam Smith's theory stating that the actions of independent, self-interested buyers and sellers often result in the most efficient allocation of resources for society.

Barrier to Entry

Any force—such as legal constraints or practical factors—that prevents new firms from entering an industry.

Economic Rent

The portion of a payment made to a factor of production that exceeds the owner's reservation price.

No-Cash-on-the-Table Principle

The economic principle asserting that opportunities for individuals to achieve a more desirable outcome are rapidly eliminated as market participants act upon them.

Economic Efficiency

A condition (also known as Pareto efficiency) where no change can be made to benefit one party without harming another; attained at competitive market equilibrium.

Price Ceiling

A maximum legal price specified by law that prevents market prices from adjusting upward to equilibrium.

Price Subsidy

Government funding applied to essential goods and services to assist consumers by keeping prices below the true cost of supply.