Final Exam Study Guide
Final Exam Study Guide ECON-E 201 Peter Olsen
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Date Created: 05/02/15
Final Exam Study Guide Chapter 14 Firms in Competitive Markets What is a Competitive Market 1 Market Power the ability of a rm to in uence the market price of a good it sells B The Meaning of Competition 1 Competitive Market a market in which there are many buyers and sellers in the market the goods offered by the various sellers are largely the same and rms can freely enter or exit the market a The action of any single buyer or seller in the market have a negligible impact on the market price b Each buyerseller is a price taker C The Revenue of a Competitive Firm 1 A rm in a competitive market tries to maximize pro t a Total revenue is proportional to the amount of output in a competitive market 2 Average Revenue total revenue divided by the amount of output a For all types of rms average revenue equals the price of the good 3 Marginal Revenue change in total revenue from the sale of each additional unit of output a For competitive rms marginal revenue equals the price of the good ll Pro t Maximization and the Competitive Firm s Supply Curve A A simple Example of Pro t Maximization 1 Decrease production if marginal revenue is less than marginal cost which will lead to them producing the pro tmaximizing quantity B The MarginalCost Curve and the Firm s Supply Decision 1 Marginal Cost Curve is upward sloping 2 Average total cost curve is Ushaped 3 The marginal cost curve crosses the average total cost curve at the minimum of average total cost 4 The rm s price equals average revenue and its marginal revenue 5 marginal revenue gt marginal cost rm should increase its output 6 marginal cost gt marginal revenue rm should decrease its output 7 pro tmaximizing level of output marginal revenue and marginal cost are exactly equal 8 The pro tmaximizing quantity is found at the intersection of the price with the marginal costcurve 9 The rm 5 marginalcost curve determines the quantity of the good the rm is Willing to supply at any price the marginal cost curve is also the competitive rm 5 supply curve C The Firm s ShortRun Decision to Shut Down 1 A shutdown refers to a shortrun decision not to produce anything during a speci c period of time because of certain market conditions a Still has to pay xed costs b The rm shuts down if the revenue it would earn from producing is less than the variable costs of production TR lt VC TRQ lt VCQ P lt AVC The competitive rm s shortrun supply curve is the portion of its marginal cost curve that lies above the average variable cost 2 Exit refers to a longrun decision to leave the market D Spilt Milk and Other Sunk Costs 1 Sunk costs a cost that has already been committed and cannot be recovered a The irrelevance of sunk costs is important for making business decisions E The Firm s LongRun Decision to Enter or Exit a Market 1 The rm exits the market if the revenue it would get from producing is less than its total costs a Exit if TR lt TC b Exit if TRQ lt TCQ c Exit if P lt ATC d Enter is P gt ATC 2 The competitive rm s longrun supply curve is the portion of the marginal cost curve that lies above the average total cost F Measuring Pro t in Our Graph for the Competitive Firm 1 Pro t TR TC 2 Pro t TRQ TCQ Q 3 Pro t P ATC Q Hi The Supply Curve in a Competitive Market A The Short Run Market Supply with a Fixed Number of Firms 1 Market supply is the sum of the individual supplies of all rms rhme B The Long Run Market Supply with Entry and Exit 1 If rms in the market are pro table new rms have an incentive to enter the market of rms will expand a Quantity supplied will increase and prices and pro ts will decrease 2 If rms in the market are making losses rms will have an incentive to leave the market of rms decreases a Quantity supplied decreases and pricespro ts increase 3 The process of entry and exit ends only when price and average total cost are driven to equality 4 In the long run equilibrium of a market of a competitive market with entry and exits rms must be operating at their ef cient scale C Why do competitive rms stay in business if they make zero pro t 1 ln zeropro t equilibrium economic pro t is zero but accounting pro t is positive D A Shift in Demand in the Short Run and Long Run 1 A shortrun shift in demand causes companies to behave differently in the longrun so the eventual equilibrium is affected by the entry and exits of rms E Why the LongRun Supply Curve Might Slope Upward 1 Some resources used in production may be available only in limited quantities a As supply of the input runs out the price shoots upward 2 Firms may have different costs a The price in the market re ects the average total cost of the marginal rmthe rm that would exit the market if the price were any lower 3 The longrun supply curve is typically more elastic than the shortrun supply curve because rms can enterexit the market Lecture 16 Notes I Market Structure A Behavior of individual rm 1 Output 2 Price 3 Pro ts B In two different market situations 1 Lots of competition a Farmer b Copper producer c Gas station 2 Little or no competition a Electric company b Water company c Education C In the real world 1 Most rms face some competition 2 Most rms have some control over price D Models in chapters 14 and 15 1 Assume one case or the other 2 Attempt to explain not describe E Why do rms exist 1 Cost reduction F Firms are 1 Complex 2 Topdown hierarchy 3 More than a collection of cost and revenue curves G Perfectly Competitive Firm PC a price taker 1 Has no control over price 2 Takes market price as given 3 quotCompetitive rmquot quotPrice takerquot H Characteristics of a Competitive Market 1 Large number of rms each small a ex 240000 wheat farms b ex 8 copper producers c Note number of rms alone does not indicate competitiveness 2 Homogeneous product a Perfect substitutes 3 Freedom of entry and exit Price Taker Firm s Demand Curve 1 Farmer Brown a Small relative to market b Cannot affect price c Takes market price as given 2 Implication a Buyers of wheat will purchase any quantity offered by the rm at market price b Demand curve for individual rm s output is horizontal J Marginal Revenue MR change in total revenue from selling one more unit 1 Constant for a price taker rm 2 Equivalent to the price for a price taker rm MR P K Goal maximize pro t 1 Maximize TR TC 2 Pro t Maximizing Decision Rule a Produce quantity such that i MR gt MC and MC rising ii P gt AVC L Graph of a Price Taker rm 1 Demand curve is a Quantity demanded at various prices 2 Marginal revenue curve is a Marginal revenue at various quantities i Same as the demand curve ll Pro ts 4 cases 1 Economic Pro t 2 Zero Economic Pro t 3 Losses but operating 4 Losses and shut down A Pro ts or losses 1 Compare the price and average total cost 2 Pro t TR TC 3 Pro tQ TRQ TCQ 4 Pro tQ P ATC 5 Pro t exists when P gt ATC B Case 1 Economic Pro ts Exist 1 Find pro t maximizing quantity at a MR MC and MC rising 2 Show Pro t a P gt ATC C Case 2 Zero Economic Pro t 1 At pro tmaximizing quantity a MR MC and MC rising b P ATC D Case 3 Losses but operating 1 Revenue covers variable costs but not all xed costs 2 P gt AVC but P lt ATC 3 Sustain losses in SR only if losses are believed to be temporary E Case 4 Losses and shut down 1 Firm is not operating 2 Q 0 3 P lt AVC 4 Losses xed costs ll Analytical Process for Pro t Cases A Find quantity at MR MC B Draw ATC to show pro t or loss C Draw AVC to show operating or shut down lll Output Decisions SR A Supply is MC curve above the minimum of AVC curve B LR Adjustments 1 If economic pro ts exist a Resources attracted b Entry c Supply shifts right d Price decreases e Pro ts decrease 2 If losses exist for typical rm in an industry a Resources repelled b Exit c Supply shifts left d Price increases e Losses are reduced C Losses are just as important and necessary as pro ts D Losing industries are the source of resources for expanding industries IV Situations A If pro ts exist LR response is 1 Entry 2 Increased supply 3 Decrease price 4 Decrease pro ts B If losses exist LR response is 1 Exit 2 Decrease supply 3 Increase price 4 Losses reduced C LR equilibrium 1 P ATC for typical rm 2 No tendency for entry or exit 3 Qd Qs industry D Long Run Industry Supply 1 Derive with increase in demand 2 Ex Increase in demand for pet care products 3 3 Steps a LR equilibrium b SR effect of increase in demand c LR response i Increase in price ii P gt ATC l pro ts iii Entry increase in supply l decrease price Chapter 15 Monopoly Why Monopolies Arise 1 Monopoly a rm that is the sole seller of its product and its product does not have any close substitutes a Cause of monopolies is barrier to entry A Monopoly Resources a key resource required for production is owned by a single rm B Government Regulation the government gives a single rm the exclusive right to produce some good or service C The production process a single rm can produce output at a lower cost than can a larger number of rms 1 Natural Monopoly a single rm can supply a good or service to an entire market at a lower cost than two or more rms How Monopolies Make Production and Pricing Decisions A Monopoly versus Competition 1 Monopolies are the sole producers in their market while a competitive rm is small relative to its market 2 A monopoly s demand curve is the market demand curve while a competitive rm s demand curve is perfectly eastic B A Monopoly s Revenue 1 Average revenue total revenuequantity of output 2 A monopolist s marginal revenue is always less than the price of its good 3 The Output Effect more output is sold total revenue increases 4 The Price Effect the price falls total revenue decreases C Pro t Maximization 1 The monopolist s pro tmaximizing quantity of output is determined by the intersection of the marginalrevenue curve and the marginalcost curve a Competitive Firm P MR MC i Price equals marginal cost b Monopoly Firm P gt MR MC i Price exceeds marginal cost D A Monopoly s Pro t 1 Pro t P ATC x Q Hi The Welfare Cost of Monopolies A The Deadweight Loss 1 The socialy ef cient quantity is found Where the demand curve and the marginalcost curve intersect 2 The monopolist produces less than the socially ef cient quantity of output 3 There is a deadweight loss because the rm charges more than the marginal cost so some consumers that would buy the product do not buy it 4 A monopolist is like a private tax collector B The Monopoly s Pro t A Social Cost 1 Monopoly pro t is not a social problem because total surplus is not reduced rather producer surplus is increased by the amount that consumer surplus is decreased 2 The problem stems from the inef ciently low quantity of output IV Price Discrimination 1 Price Discrimination rms sell the same good to different customers for different prices even though the costs of producing for the two customers are the same A A Parable about Pricing 1 Firms charge different prices to different customer bases to maximize pro t most often in different geographical areas B The Moral of the Story 1 Price discrimination is a rational strategy for a pro t maximizing monopolist 2 Price discrimination requires the ability to separate customers according to their willingness to pay a Arbitrage the process of buying a good in one market at a low price and selling it in another at the higher price to pro t from the price difference 3 Price discrimination can raise economic welfare C The Analytics of Price Discrimination 1 Perfect price discrimination describes a situation in which the monopolist knows exactly each customer s willingness to pay and can charge each customer a different price a All mutually bene cial trade takes place no deadweight loss entire surplus goes to monopolist in form of pro t 2 Imperfect price discrimination can raise lower or leave unchanged total surplus in a market D Examples of Price Discrimination 1 Movie Tickets a Lower prices for senior citizens and children 2 Airline Prices a Lower price for round trip ticket that stays over a Saturday night because its less likely to be a business traveler 3 Discount Coupons a Not all customers are willing to cut coupons 4 Financial Aid a Need based nancial aid accounts for lower willingness to pay 5 Quantity Discounts a Customer s willingness to pay declines with each additional item ll Public Policy Toward Monopolies A Increasing Competition with Antitrust Laws 1 Antitrust laws ve the government various ways to promote competition and allow the government to prevent mergers or breakup companies 2 Prevent companies from coordinating their activities to make markets less competitive 3 Synergies reduce costs through more ef cient joint production B Regulation 1 Setting the market price equal to the rm s marginal cost and then subsidizing the rm to account for losses a Government pays for subsidies with taxes that cause deadweight losses b Averagecost pricing is like a tax on the good the monopolist is selling 2 Regulatory systems give monopolists no incentive to reduce costs C Public Ownership 1 Government chooses to run the monopoly by itself 2 If the government runs the company poorly the only losers are the customers and taxpayers whose only recourse is the political system D Doing Nothing 1 Some believe that market failure is much smaller than the political failure that results from antitrust regulations lll Situations A If pro ts exist LR response is 1 Entry 2 Increased supply 3 Decrease price 4 Decrease pro ts B If losses exist LR response is 1 Exit 2 Decrease supply 3 Increase price 4 Losses reduced C LR equilibrium 1 P ATC for typical rm 2 No tendency for entry or exit 3 Qd Qs industry D Long Run Industry Supply 1 Derive with increase in demand 2 Ex Increase in demand for pet care products 3 3 Steps a LR equilibrium b SR effect of increase in demand c LR response i Increase in price ii P gt ATC l pro ts iii Entry increase in supply l decrease price Lecture 17 Notes I Monopoly 1 quotPrice Makerquot or quotPrice Searcherquot 2 Firm that has control over price 3 quotMarket Powerquot A Characteristics 1 One Seller 2 No close substitutes 3 Barriers to entry B Sources of Barriers 1 Ownership of raw materials 2 Licensefranchisepatent C Decreasing Cost 1 quotNatural monopolyquot II PriceSearcher Behavior A Goal To maximize pro t B Choose quantity such that 1 MR gt MC C Choose price by nding where MR MC 1 MR lt P for monopolist D A monopoly earning pro t P gt ATC III Why is monopoly an economic problem A The quantity of items sold for a monopoly is less than the socially optimal quantity so consumer surplus is diminished by the existence of monopolies 1 There is a deadweight loss of well being that occurs from a monopoly B Welfare cost of monopoly 1 Compared to a competitive rm a Outputconsumption too low b Price too high 2 Welfare goal a Promote consumption b P MR MC i quotMarginalcost pricingquot IV Policies against Monopolies A AntiTrust 1 Sherman Act 2 Clayton Act 3 Court Decisions B Regulation C Cases of Markets 1 Perfect Competition 2 Monopolistic competition many sellers that differentiate their product 3 Oligopoly few sellers 4 Monopoly one seller V Price Discrimination A Selling the same good to different buyers at different prices not based on cost differences B Necessary conditions 1 Firm must be able to a Choose price b Segment buyers by willingness to pay c Prevent resale C Ex Airfares university tuition movie tickets cars sporting events golf prices D Effects of Price Discrimination 1 More units soldbought 2 More gains from trade 3 Economic well being rises E Price discrimination is common 1 Prediction will become more common F Perfect Price Discrimination 1 Each buyer pays exactly what they re willing to pay 2 P valuation 3 Efficiency result a No deadweight loss b All CS l PS G quotQuasiPrice Discriminationquot 1 Selling more or less the same good at different prices Vl Monopoly results in an inefficiency loss in well being A Q too low B P too high Vll Price discrimination increases wellbeing in monopoly market structure BIG IDEAS Max pro ts or min losses by produce Q where MR gt MC A rm need not cover all its costs in the short run only their variable costs P gt AVC Pro ts Signal Entry of resources Increase supply Decrease price Decrease pro t Losses Signal Exit of resources Decrease supply Increase price Minimize losses MC DeltaTCDeltaQ TC TVC FC TVC AVC x Q
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