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| Recall Economic Profit (Π) = |
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| Total Revenue (TR) – Total Cost (TC) |
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| Perfect Competition (Assumptions for this type of market structure) |
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Definition
1. Price-takers (take price as dictated by the market)
2. Many buyers and sellers in the market
3. Homogeneous (perfectly standardized) product
4. Unrestricted entry and exit of firms
5. Infinite supply of labor at a given wage rate (w) |
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| equilibrium (E*) occurs where |
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| Marginal Revenue Product (MRP) |
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| measures additional revenue earned from employing an additional unit of an input. |
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| the difference between the price a consumer is willing to pay for a good and the price charged for that particular good |
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| this specifies the maximum amount a buyer is willing to pay for a particular good or service |
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| measured as the amount of “surplus” a seller receives from a transaction |
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| this specifies the minimum amount a seller is willing to receive for a particular good or service |
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| the ability of a firm to increase its price without losing a significant amount of sales |
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| as prices increase, quantity demanded will decrease, but the extent to which quantity demanded falls determines the ability of firms to set their prices (to an extent) |
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| there are three market structures in which firms hold a significant amount of market power, allowing them to set prices |
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| In a monopoly, there is only one seller to provide the good. This provides the most market power to a firm since they literally do not face competition |
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| Assumptions of Monopoly Markets |
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Definition
1. One seller supplies 100% of the industry
2. Unique product
3. Entry barriers
4. No interdependence of firms (because there’s only 1 firm) |
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| Monopolistic Competition exists when there are several sellers in a market, but each seller’s product is slightly differentiated. Many industries fall into this market structure category |
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| Assumptions of Monopolistic Competition |
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Definition
1. Many buyers and sellers
2. Differentiated product
3. Relatively few entry barriers
4. Non-Price Competition |
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| The more competitors there are in a market, the more substitutes there are available to buyers and thus the demand curve is more elastic. On the other hand, for firms with market power, elasticity is lower because there are fewer substitutes available. Firms will still find the optimal level of output to be at the point where MR=MC |
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| Cross-Price Elasticity of Demand |
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Definition
| Positive cross-price elasticity between two goods implies that these products are substitutes. Availability of substitutes suggests that a firm has little market power. The larger the positive result is, the weaker the firm’s market power. Conversely, low cross-price elasticity between two goods implies that the goods are not very “substitutable” and that the firm holds a relative amount of market (price-setting) power |
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measures the degree of market power by calculating the ratio by which P>MC.
= (P – MC)/P |
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| when it is very difficult for new firms to enter a market where existing firms are earning economic profits |
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| a proportionate saving in costs gained by an increased level of production |
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| Government-Created Barriers to Entry |
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| Government creates barriers to entry by providing licenses, franchises, patents, and copyrights to firms |
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| Market power can be strongly correlated with the control of resources (inputs). |
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| customers feel a certain degree of allegiance to specific brands. This is commonly observed for firms that have been in existence for a long period of time. |
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| Some products become entrenched in society. People get used to them, and are reluctant to bear the cost (time, money, etc…) of switching to a new product or method. |
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| Network externalities occur when the value of a specific product increases as more and more people buy and use it. Because of network externalities, new products (that may be superior to existing products) face a push-back in the marketplace. |
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| Marginal Revenue Product (MRP) |
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Definition
measures additional revenue due to employing one additional unit of an input (K, L):
MRPL = ΔTR/ΔL, and MRPK = ΔTR/ΔK |
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| Market consisting of a few relatively large firms. Each firm holds a substantial share of the market and operates interdependently with the other firms (rivals). |
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| provides a decision making tool to help firms behave interdependently |
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| used to simulate decision-making situations in which people (firms) compete with each other for the purpose of gaining the highest individual payoff or the lowest individual cost |
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| are often used to show the choices rivals have and the potential payoffs to be made and/or costs to be incurred |
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| these games create a situation in which rivals must make their decisions simultaneously, without knowing the decisions/actions of their rivals |
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| assumed in which all rivals involved are informed of all potential payoffs presented in the table unless otherwise specified |
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| a strategy/action that always provides the best outcome regardless of the rivals’ decisions. A dominant-strategy equilibrium is reached when both players (rivals) have dominant strategies and play them. |
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| this equilibrium consists of a set of actions for which all rivals are choosing their best actions given the actions chosen by their rivals. |
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| each rival is selecting their best possible action, no rival would choose to deviate from their position since they cannot improve their individual payoff. |
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| these games simulate sequential decision in which one firm makes an initial decision (move), and then a rival firm makes its decision (move). |
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| a method of finding the Nash equilibrium to a sequential decision by anticipating the moves of rivals and then reasoning backwards to the best current decision. This is also known as backward induction. |
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Few large sellers
Homogeneous or heterogeneous product
Substantial entry barriers
Interdependent behavior
Non-Price competition |
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| a strategy/action that always yields the lowest payoff and thus would not be chosen |
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| Social Economic Efficiency |
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| exists when the production and consumption process fulfills two efficiency conditions: productive efficiency and allocative efficiency |
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| occurs when industry output is produced at the lowest possible cost to society. This ensures that society receives the most output from its resources and that waste is minimized |
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| optimal levels of all goods are produced and sold to consumers who value them most. The optimal level of output is reached when the marginal benefit of another unit to consumers equals the marginal cost to society of producing an additional unit. This occurs where P=MC and is commonly referred to as marginal-cost-pricing. |
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| is shown to be reached at Q.* At this point, MB=MC and thus total cost is minimized for the profit-maximizing level of output. |
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| Social Economic Efficiency |
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| exists when the two conditions described above are met. When social economic efficiency is reached, social surplus is maximized. Social surplus is defined as the sum of consumer and producer surplus |
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| failure of competitive firms to achieve maximum social surplus |
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| Special interest groups often lobby for rules and regulations designed to promote the welfare of one particular group often at the expense of the rest of society. |
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| Sometimes government’s best efforts to address problems are compromised by incomplete information regarding the industries they regulate. |
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| Government bureaucrats face a poor incentive structure that fails to promote efficiency in operations at several levels |
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| when the actions of buyers or sellers create spillover or external effects that spill over to other (uninvolved) members of society. |
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| When the amount of market power held by one firm grows too much |
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| Monopoly Power exists in three ways |
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Definition
Actual or attempted monopolization
Price-fixing cartels
Mergers among horizontal companies |
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| This is the good monopoly. This type of market exists when one firm can produce the entire industry output at a relatively lower cost than can two or more firms. Examples commonly include public utilities such as electricity, phone, water, natural gas, etc |
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| Private cost + External cost |
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| Social cost – Private cost |
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| Marginal Private Cost: Aggregate marginal private costs for all firms within an industry provide a competitive supply curve for the industry, thus MPC=S. |
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| Marginal External Cost: increases with the level of output so upward sloping |
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| Marginal Social Cost: the sum of marginal private cost and marginal external cost |
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| Marginal Social Benefit: benefits to society from an additional unit of output can also represent a competitive demand curve for the industry, thus MSB = D. |
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| Pollution Control (Abatement) |
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| Costly efforts undertaken by firms to reduce or prevent emission of pollutants from their production facilities. |
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| additional damage incurred by society by discharging an additional pollutant into the environment. This measure is equal to the additional societal benefit (MB) acquired through the prevention (abatement) of additional pollutants, thus MD=MB. |
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| Marginal Cost of Abatement (MAC) |
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| measures the addition to total abatement cost of reducing additional units of pollution |
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| a tax levied per ton of pollutants emitted |
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| No one in the economy can be excluded from consuming a public good. This leads to overuse by free riders |
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| Common Property Resources |
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| resources for which (ownership) property rights are absent or poorly defined, thus no one can be excluded from using them. This commonly leads to overuse and underproduction, reducing social surplus |
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| two main characteristics, they are non-excludable and nonrivalrous |
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| one person’s consumption of a good does not reduce the amount, or quality, of the good available for consumption by others |
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| Gov’t Policies to Address Overexploitation |
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Definition
Regulators could takeover the industry and assume property rights over a particular area.
Regulators could determine the efficient rate of production and then monitor the industry.
Impose unitization, which assigns property rights to a resource regardless of which owner produces and sells the resource |
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| Common Property Resources |
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| resources for which (ownership) property rights are absent or poorly defined, thus no one can be excluded from using them. This commonly leads to overuse and underproduction, reducing social surplus. |
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| Social Economic Efficiency |
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| goods and services that society desired are produced and consumed with no waste |
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| Output is maximized given a fixed number of inputs |
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| goods and services are rationed to individuals who place the highest value on consuming them (occurs where P=MC and/or MBSOCIETY=MCSOCIETY |
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