ECON 251 Final Exam Review 1

what is monopolistic competition?

ECON 251 Final Exam New Material Study Guide:

Chapter 12 Monopolistic Competition: 

Key Points:

1. Describe and identify monopolistic competition

• Monopolistic competition is a market structure in which a large number of firms  compete

• Each firm produces a product that is slightly different from the products of its  competitors

• Firms compete on price, quality, and marketing

• New firms are free to enter the industry

• Monopolistic competition is identified by a low degree of concentration measured by  either the four-firm concentration ratio or the HHI

2. Explain how a firm in a monopolistic competition determines its output and price in the  short run and the long run

• Firms in monopolistic competition face downward-sloping demand curves and  produce the quantity at which marginal revenue equals marginal cost

what type of market in which a small number of interdependent firms compete behind a barrier to entry?

• Entry and exit result in zero economic profit and excess capacity in long run  equilibrium

3. Explain why advertising costs are high and why firms use brand names in monopolistic  competition

• Firms in monopolistic competition innovate and develop new products to maintain  economic profit

• Advertising expenditures increase total cost, but they might lower total average cost  if they increase the quantity sold by enough

• Advertising expenditures might increase total demand, but they might also decrease  total demand facing a firm by increasing competition

• Whether monopolistic competition is inefficient depends on the value people place  on product variety

Key Terms:

• efficient scale = the quantity at which average total cost is a minimum -the quantity at the bottom of the U-shaped average total cost curve

what is market with only two firms?

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• excess capacity = when the quantity that a firm produces is less than the quantity at  which average total cost is a minimum

• four-firm concentration ratio = the percentage of the value of sales accounted for by the  four largest firms in an industry

-almost zero ???? perfect competition

-100% ???? monopoly

• herfindahl-hirschman index = the square of the percentage market share of each firm  summed over the largest 50 firms (or summed over all the firms if there are fewer than  50) in a market

ECON 251 Final Exam Review 2

-HHI < 1,000 ????monopolistic competition

-1,000 < HHI < 1,800 ????oligopoly

-HHI > 1,8000 ????uncompetitive (monopoly)

• markup = the amount by which price exceeds marginal cost

-in perfect competition price always equals marginal cost and there is no markup -buyers pay a higher price in monopolistic competition than in perfect competition and  pay more than the marginal cost

• product differentiation = making a product that is slightly different from the products of competing firms

-has close substitutes but no perfect substitutes

• signal = an action taken by an informed person (or firm) to send a message to  uninformed people

-example) advertising by coke: coke advertisers spend a lot of money on flashy  advertising to show consumers how good their product is

Chapter 13 Oligopoly: 

Key Points:

1. Describe and identify oligopoly and explain how it arises If you want to learn more check out ua star exam

• Oligopoly is a market type in which a small number of interdependent firms compete  behind a barrier to entry

• The barriers to entry that create oligopoly are both natural (economies of scale and  demand) and legal

2. Explore the range of possible price and quantity outcomes and describe the dilemma faced  by firms in oligopoly

• Firms in oligopoly would make the same economic profit as a monopoly if they could act  together to restrict output to the monopoly level

• Each firm can make a larger profit by increasing production, but this action damages the  economic profit of other firms

3. Use game theory to explain how price and quantity are determined in oligopoly • Game theory is a method of analyzing strategic behavior

• In a prisoner’s dilemma, two prisoners action in their own interests hard their joint  interest

• An oligopoly (duopoly) game is like the prisoner’s dilemma

• The firms might cooperate to produce the monopoly output or overproduce • In a one-play game, both firms overproduce and the price and economic profit are less  than they would be in a monopoly

• Advertising and research and development create a prisoner’s dilemma for firms in  oligopoly

• In a repeated game, a punishment strategy can produce a monopoly output, price, and  economic profit    

Key Terms:

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• cartel = a group of firms acting together to limit output, raise price, and increase economic  profit

-illegal but they do exist in some markets

• duopoly = a market with only two firms

• game theory = the tool that economists use to analyze strategic behavior—behavior that  recognizes mutual interdependence and takes account of the expected behavior of others • nash equilibrium = an equilibrium in which each player takes the best possible action given  the action of the other player

• payoff matrix = a table that shows the payoffs for each player for every possible  combination of actions by the players Don't forget about the age old question of 1.673x10^-27

• prisoners’ dilemma = a game between two prisoners that shows why it is hard to cooperate  even when it would be beneficial to both players to do so

-captures essential features of duopolists’ dilemma

• strategies = all the possible actions of each player in a game

Chapter 14 Externalities and Public Goods: 

Key Points shown by graph examples:

1. An external Cost If you want to learn more check out gwu textbooks

• The MC curve shows that the private  

marginal cost borne by the factories that produce a  

chemical

• The MSC curve shows the sum of marginal 

private cost and marginal external cost 

- MSC = MC + marginal external cost

2. Inefficiency with an external cost

• Market supply curve is the marginal private  

cost curve (S = MC)

• The demand curve is the marginal benefit  

curve (D = MB)

ECON 251 Final Exam Review 4

3. Property rights achieve an efficient  outcome

• (1) With property rights, the marginal cost curve  that excludes the cost of pollution shows only part of  the producers’ marginal cost

• The marginal private cost curve (2) includes the  cost of pollution so that the supply curve is S = MC

4. A pollution tax

• (1) a pollution tax is imposed that is equal to the  marginal external cost of production

• the supply curve becomes the marginal private cost  curve, MC, plus the tax—the curve labeled S = MC  +tax

5. An external benefit

• The MB curve shows the private marginal benefit  enjoyed by the people who receive a college  education

• The MB curve shows the sum of marginal private benefit and marginal external benefit

ECON 251 Final Exam Review 5

6. Inefficiency with an external benefit

• the market demand curve is the marginal private  

benefit curve, D = MB  

• the supply curve is the marginal cost curve, S = MC

7. Public provision or  

private subsidy to achieve an  

efficient outcome

• the efficient quantity is  

where marginal social benefit  

equals marginal cost

8. Four-fold classification of goods

• a private good (top left) is one for which

consumption is rival and from which consumers  

can be excluded

• a public good (bottom right) is one for  

which consumption is nonrival and from which it  

is impossible to exclude a consumer

• a common resource (top right) is one that is  

rival but nonexcludable

• and a natural monopoly (bottom left) is nonrival but excludable  

Key Terms:

• externality = a cost or benefit that arises from production that falls on someone other than  the producer; or a cost or benefit that arises from consumption that falls on someone other  than the consumer

-three main methods that governments use to cope with externalities are: -emission charges

-marketable permits

-taxes

ECON 251 Final Exam Review 6

• negative externality = a production or consumption activity that creates an external benefit -logging and clearing of forests ???? negative production externality

-noise and air pollution ????negative production externality

-smoking tobacco????negative consumption externality

• positive externality = a production or consumption activity that creates an external benefit -bees and orchard growers ???? positive production externality

-getting a flu vaccine ???? positive consumption externality

-education ???? positive consumption externality

• marginal private cost = the cost of producing an additional unit of a good or service that is  borne by the producer of that good or service

• marginal external cost = the cost of producing an additional unit of a good or service that  falls on people other than the producer

• marginal social cost = the marginal cost incurred by the entire society—by the producer and  by everyone else on whom the cost falls; it is the sum of marginal private cost and marginal  external cost

• property rights = legally established titles to ownership, use, and disposal of factors of  production and goods and services that are enforceable in the courts

• coase theorem = the proposition that if property rights exist, only a small number of parties  are involved and transactions costs are low, then private transactions are efficient and the  outcome is not affected by who is assigned the property right

• transactions costs = the opportunity costs of conducting a transaction -hiring a lawyer or real-estate agent

• marginal private benefit = the benefit from an additional unit of a good or service that the  consumer of that good or service receives

• marginal external benefit = the benefit from an additional unit of a good or service that  people other than the consumer of the good or service enjoy

• marginal social benefit = the marginal benefit enjoyed by society—by the consumers of a  good or service and by everyone else who benefits from it; it is the sum of marginal private  benefit and marginal external benefit

MSB = MB + marginal external benefit

• public provision = the provision of a good or service by a public authority that receives most  of its revenue from the government

-education services produced by public universities, colleges and schools • subsidy = a payment that the government makes to private producers that depends on the  level of output

• voucher = a token that the government provides to households that can be used to buy  specified goods or services

• intellectual property rights = the property rights of the creators of knowledge and other  discoveries

• patent or copyright = a government-sanctioned exclusive right, granted to the inventor of a  good, service, or productive process to produce, use, and sell the invention for a given  number of years

ECON 251 Final Exam Review 7

• excludable = a good, service, or resource is excludable if it is possible to prevent a person  from enjoying its benefits

• nonexcludable = a good, service, or resource is nonexcludable if it is impossible to prevent a  person from enjoying its benefits

• rival = a good, service, or resource is rival if its consumption by one person does decreases  its consumption by other people

• nonrival = a good, service, or resource is nonrival if its consumption by one person does not  decrease its consumption by other people

• private good = a good or service that can be consumed by only one person at a time and  only by those who have bought it or own it

• public good = a good or service that can be consumed simultaneously by everyone and from  which no one can be excluded

• common resource = a resource that is nonexcludable and rival—can be used only once but  no one can be prevented from using what is available

• free rider = a person who enjoys the benefits of a good or service without paying for it  • principle of minimum differentiation = the tendency for competitors to make themselves  identical to appeal to the maximum number of clients or voters

• rational ignorance = the decision not to acquire information because the marginal cost of  doing so exceeds the expected marginal benefit

• problem of the commons = the absence of incentives to prevent the overuse and depletion  of a commonly owned resource