CIS Microeconomics Exam Three

CIS Microeconomics Exam Three Perfect Competition: Characteristics of Perfect Competition: Many small firms  Homogeneous products  Freedom of entry and exit  Perfect information  The Competitive Firm: Firm is a price taker  No choice but to accept the price that has been deter mined by the market  Price is set in the market  Firm is too small to affect the market  Demand Curve: Horizontal demand curve  Can sell as much as it wants at the market price.  Able to double or triple sales without reducing the price of   its product Short Run Equilibrium: Marginal Revenue (MR) = Price (P)  Profit maximizing level of output: Marginal Cost = Price  MC = MR  D = MR = AR = MC at the equilibrium level  of output Zero economic profit means that firms are  earning the normal, economy wide rate of  profit Freedom of entry and exit guarantees this  result in the long run under per fect competition in the long run under perfect competition Business needs to be above average cost so  the business makes money. If they are below in the long run, the business will fail. If they are too high above AC, competitors will enter the market driving prices down Short-Run Supply Curve: A competitive industry has stable equilibrium at the output level where supply equals demand  The competitive industry faces a downward sloping demand curve  Shut Down and Break Even Analysis: Rule One: The firm will make a profit if total revenue (TR) > total cost (TC)  - Should not plan to shut down in either the short run or long run Rule Two: Even if TR < TC, the firm should continue to operate in the short run as long as TR > TVC  - If TR > TVC, the firm can at least pay some of its fixe d costs - The firm should close in the long run if TR < TC The competitive firm will produce nothing unless price lies above the minimum point on the AVC curve 

Long Run Equilibrium: Firms enter or exit the industry in response to profits or losses  Shifts the supply curve and the price until  profits are zero Competitive equilibrium P = MC  Firms are driven to produce at the  minimum point of their average cost curves Output is produced at the lowest possible  cost to society Long Run Supply Curve: Supply curve is also the industry’s long run average cost curve  Driven to the particular supply curve by the entry or exit of firms and by the adjustment of firms already in the  industry Efficient Resource Allocation: Efficiency exists when it is not possible to make some people better off without making others worse off   Society must somehow choose:  - How much of each good to produce  The allocation of society’s resources among different products depends on consumer preferences (demands) and production costs of the good demanded - What input quantities to use in the production process Inputs are assigned to the firms that can make the most productive (most profitable) use of   them - How to distribute the resulting outputs among consumers The price system carries out the distribution process by rationing goods on the basis o f   preferences and relative incomes Central Planners: Planners cannot carry out the coordination tasks of the economy due to  - Lack of necessary data - Computational complications

Monopolies: Pure Monopoly: An industry in which there is only one supplier of a product for which there are no close substitutes and in which it is very hard or impossible for another firm to coexist Only one firm may exist in the industry  No close substitutes for the monopolist’s products may  exist There must be come reason why entr y and survival of   potential competitors is extremely unlikely *Doesn’t have a supply curve because monopolies are price makers (can set the price at anything t hey want)

Characteristics of a Monopoly: Opposite of competitive firms 

Sole producer (industry = firm) Unique product with no close substitutes Price-makers (but can’t ignore the demand curve) Demand curve is downward sloping To increase sales, monopolies must reduce prices If a firm is truly a monopoly, market entry is blocked

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Government Involvement in a Monopoly: The government gives exclusive rights (patents, copy right laws)  No involvement  price maker  Barriers to Entry: Legal restrictions  Patents  Control of a scarce resource or input  Deliberately erected entry barriers  Large sunk costs  Technical superiority  Economies of scale  Compare a Monopoly with Perfect Competition: Compared to perfect competition, a monopoly:  - May enjoy a long run profit - Restricts its outputs to raise its selling price (long r un and short run) - Leads to inefficient resource allocation (MC < MU) Short Run:  - Monopolist and perfect competition can earn economic profit but will just shut down unless AR covers AVC Long Run:  - Monopolists, unlike perfect competition, can continue to earn economic profit as long as the entry of  new firms is blocked

Price Discrimination Discrimination:: Charge different prices to different groups  of customers (or charge the same price in markets where costs vary) Allows a monopolist to maximize profits  Sets marginal revenue (not price) equal in  each market Assumes equal cost conditions in e ach  market Examples: School lunches, student/senior  discounts, property tax Not always desirable:  - May be necessary for a firm to survive - Where there are significant economies of scale, price discrimination may actually lead to lower prices

Monopolistic Competition:

Monopolistic Competition: A market in which products are heterogeneous but which is otherwise the same as a market that is perfectly competitive. A market is said to operate oper ate under the conditions of monopolistic competition if it satisfies these requirements:  - Numerous participants - Freedom of exit and entry - Perfect information - Heterogeneous products  Each seller’s product differs at least somewhat from eve ry other’s Collusion: When a group of firms try to control price or quantity  Illegal  Cartel: 

A group of sellers of a product who have joined together to control its production, sale, and price in the hope of  obtaining the advantages of a monopoly  OUTPUT!

Oligopolistic Markets A market dominated by a few sellers, at least several of which are large enough relative to the total m arket to be able to influence the market price “Big Businesses”  Oligopolies can sell similar products (steel plate from different steel manufacturers) or different products  (Hondas, BMW, Toyota). Some also contain many smaller firms (Different pop manufacturers) but they are still oligopolies because a few large firms carry out the bulk of the industry’s business and smaller firms must follow the larger firms. Price Wars: Each competing firm is determined to sell at a price that is lower than the prices of its rivals, usually regardless  of whether that price covers the pertinent cost. Typically in such a price war, Firm A cuts its price below Firm B’s; then FB retaliates by undercutting A. Prisoner Dilemma & Game Theory: Economists most widely used approach to analyze oligopoly behavior.  Work under the assumption that their rivals are extremely ingenious strategic decision makers. Each oligopoly  acts as a competing player in a strategic game. Uses two concepts: Strategy and the payoff matrix  The payoff matrix reports the profits that e ach firm can expect to earn, given its own pricing choice and that of   its rival The Maximin Strategy and the Prisoners’ Dilemma:  - Maximin Criterion: Requires you to select the strategy that yields the maximum payoff on the assumption that your opponent does as much damage to you as they can. - To best protect a company, game theory suggests that the firm should base their strategy based on the minimum payoff