ECON 1001 Textbook Notes PDF

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Chapter 17 ● Oligopoly: only a few sellers, cooperation and self-interest ● Game theory: the study of how people behave in strategic situations ● Duopoly: oligopoly with 2 members ● Jack and Jill

○ ○ Perfectly Competitive: decisions drive P = MC, because the marginal cost of pumping additional water is 0, the equilibrium price of water under perfect competition would be 0, the equilibrium quantity would then be 120 gallons ○ Monopoly: total profit is maximized at a quantity of 60 and $60, a monopolist would make this much product and charge this price, P > MC, this is inefficient bc the quantity of water produced and consumed would fall short of the socially efficient level of 120 gallons ○ Duopoly: Jack and Jill come together and decide on how much water to produce and for how much ■ Collusion: ^This agreement amongst firms ■ Cartel: Jack and Jill’s unionism ■ If they agree on 60 gallons, they each produce 30 gallons and make $1800 ● Nash Equilibrium: a situation in which economic actors interacting with one another each choose their best strategy given the strategies that the others have chosen ○ If Jack produce 40 gallons, so will Jill ● Oligopolists would be better off cooperating and reaching the monopoly outcome. Yet because they each pursue their own self-interest, they do not end up reaching the monopoly outcome and, thus, fail to maximize their joint profit. Each oligopolist is tempted to raise production and capture a larger share of the market. As each of them tries to do this, total production rises, and the price falls

● When firms in an oligopoly individually choose production to maximize profit, they produce a quantity of output greater than the level produced by monopoly and less than the level produced under perfect competition. The oligopoly price is less than the monopoly price but greater than the competitive price (which equals marginal cost) ● When deciding on how much to raise production firms think about ○ The output effect: Because price is above marginal cost, selling one more gallon of water at the going price will raise profit. ○ The price effect: Raising production will increase the total amount sold, which will lower the price of water and lower the profit from all the other gallons sold. ○ If the output effect outweighs the price effect, the well owner will increase production. If the price effect outweighs the output effect, the owner will not raise production. ● As the number of sellers in an oligopoly grows, an oligopolistic market increasingly resembles a competitive market. The price approaches marginal cost, and the quantity produced approaches the socially efficient level. ● Cars are internationally traded because allowing free trade increases the number of producers from which each consumer can choose, and this increased competition keeps prices closer to marginal cost ● The key feature of an oligopolistic market is that ○ a small number of firms are acting strategically. ● If an oligopolistic industry organizes itself as a cooperative cartel, it will produce a quantity of output ________ the competitive level and ________ the monopoly level. ○ less than, equal to ● If an oligopoly does not cooperate and each firm chooses its own quantity, the industry will produce a quantity of output ________ the competitive level and ________ the monopoly level. ○ less than, more than ● As the number of firms in an oligopoly grows, the industry approaches a level of output ________ the competitive level and ________ the monopoly level. ○ equal to, more than ● Prisoners dilemma: a type of game theory, provides a general lesson that applies to any group trying to maintain cooperation among its members

○ ○ Dominant Strategy: the best strategy for a player to follow regardless of the strategies pursued by other players ■ Bonnie’s best strategy is to confess bc she will get less time regardless of what Clyde does ■ Clyde confessing is also a dominant strategy for him ● Nash Equilibrium: they both get 8 years in prison but they would have been better of if they both remained silent, they both pursue their own interest so they both get a worse outcome, self-interest takeover ● Jack and Jill Nash Equilibrium

○ ■ They both end up producing 40 gallons thinking it will increase profit when it does not because they cheat, best option would be to both make 30 gallons ● Arms Race

○ ● Common Resources

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○ Noncooperative equilibrium is bad for society as well as the players ○ US and Soviet Union are at risk ○ Drilling oil wells is a waste Oligopolists trying to maintain monopoly profits, lack of cooperation is desirable from the standpoint of society as a whole ○ When oligopolists fail to cooperate, the quantity they produce is closer to this optimal level The prisoners' dilemma is a two-person game illustrating that ○ even if cooperation is better than the Nash equilibrium, each person might have an incentive not to cooperate. Two people facing the prisoners' dilemma may cooperate if ○ they will play the game repeatedly and expect noncooperation to be met with future retaliation. Sherman Anti-Trust Act: the first Federal act that outlawed monopolistic business practices ○ The Clayton Act of 1914: further strengthened the antitrust laws. According to this law, if a person could prove that she was damaged by an illegal arrangement to restrain trade, that person could sue and recover three times the damages she sustained. The purpose of this unusual rule of triple damages is to encourage private lawsuits against conspiring oligopolists Controversial Business Practices: ○ Resale Price Maintenance: Superduper supplies sells to stores for $50 and demands retailers to sell for $75 ■ Superduper is better off without its retailers being a cartel

■ Business practices that appear to reduce competition may in fact have legitimate purposes ○ Predatory Pricing: Imagine that a large airline, call it Coyote Air, has a monopoly on some route. Then Roadrunner Express enters and takes 20% of the market, leaving Coyote with 80%. In response to this competition, Coyote starts slashing its fares. Some antitrust analysts argue that Coyote’s move could be anticompetitive: The price cuts may be intended to drive Roadrunner out of the market so Coyote can recapture its monopoly and raise prices again. Such behavior is called predatory pricing. ■ Cayote sells cheap tickets and sends out more planes, Roadrunner cuts back on flights → Roadrunner is in a good position ○ Tying: Suppose that Makemoney Movies produces two new films—Superheroes and Hamlet. If Makemoney offers theaters the two films together at a single price, rather than separately, the studio is said to be tying its two products. ■ People argue that ppl will be forced to watch a bad film with a good one ■ Combined movies increases buyers willingness to pay ● The antitrust laws aim to ○ prevent firms from acting in ways that reduce competition. ● Antitrust enforcement is controversial mainly because ○ some business practices that seem anticompetitive may in fact have legitimate purposes. Chapter 16 ● The market for novels fits neither the competitive nor the monopoly model, it is monopolistic competition ● Imperfect competition: when industries fall in between perfect competition and monopoly ● 1. Oligopoly: a type of imperfect competitive market, there are few sellers and each offers a product similar or identical to the products offered by other sellers in the market ○ Less competition bc fewer sellers ● Concentration ratio: Economists use this to measure a market’s domination by a small number of firms, it is the percentage of total output in the market supplied by the four largest firms ○ In the U.S. economy, most industries have a four-firm concentration ratio under 50 percent, but in some industries, the biggest firms play a more dominant role ○ Highly concentrated industries include the market for light bulbs, batteries, tobacco, beer, and home refrigerators and freezers ○ Ex. Apple, Samsung, Nokia, Google → top 4 take up 95% of market ● 2. Monopolistic competition: a market structure in which there are many firms selling similar but not identical products. Each firm has a monopoly over the product it makes, but many other firms make similar products that compete for the same customers ○ Many sellers: There are many firms competing for the same group of customers.

○ Product differentiation: Each firm produces a product that is at least slightly different from those of other firms. Thus, rather than being a price taker, each firm faces a downward-sloping demand curve. ○ Free entry and exit: Firms can enter or exit the market without restriction. Thus, the number of firms in the market adjusts until economic profits are driven to zero. ○ Many sellers, slightly different products ○ Ex. books, computer games, restaurants, piano lessons, cookies, clothing ● Four Types of Market Structure

○ ○ Monopolistic competition: restaurants, kind of the same but slightly different choices ● Which of the following conditions does NOT describe a firm in a monopolistically competitive market? ○ It takes its price as given by market conditions. ● Which of the following markets best fits the definition of monopolistic competition? ○ Haircuts ● The Monopolistically Competitive Firm in the Short Run ○ The firm chooses to produce the quantity at which marginal revenue = marginal cost and then uses its demand curve to find the price at which it can sell that quantity.

○ ● The Long-Run Equilibrium ○ Firm making profit encourages people to enter market → Profit encourages entry, and entry shifts the demand curves faced by the incumbent firms to the left. As

the demand for incumbent firms’ products falls, these firms experience declining profit ○ Firm making losses encourages people to exit market → Losses encourage exit, and exit shifts the demand curves of the remaining firms to the right. As the demand for the remaining firms’ products rises, these firms experience rising profits (that is, declining losses).

○ ■ ATC and Demand curve are tangent = each firm earns 0 profit ● At this same point, MR quantity must = MC quantity ○ As in a monopoly market, price exceeds marginal cost (P> MC). This conclusion arises because profit maximization requires marginal revenue to equal marginal cost (MR = MC) and because the downward-sloping demand curve makes marginal revenue less than the price (MR < P). ○ ○ As in a competitive market, price equals average total cost (P = ATC). This conclusion arises because free entry and exit drive economic profit to zero in the long run. ● Monopolistic versus Perfect Competition

○ ■ Excess Capacity:

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● a) under monopolistic competition, firms produce on the downward-sloping portion of their average-total-cost curves ● b) free entry in competitive markets drives firms to produce at the minimum of average total cost. ● Efficient Scale: quantity that minimizes average total cost ● In the long run, perfectly competitive firms produce AT the efficient scale, whereas monopolistically competitive firms produce BELOW this level ● Excess capacity: a monopolistically competitive firm, unlike a perfectly competitive firm, could increase the quantity it produces and lower the average total cost of production ■ Markup over Marginal Cost: ● Perfectly competitive firm: P = MC ● Monopolistic competitive firm: P > MC bc firm has some market power ● Perfectly competitive market will gain zero profit from another customer whereas monopolistic market will gain profit bc P > MC, Monopolistic markets will send out christmas cards to promote brand Monopolistic Competition and the Welfare of Society ○ a monopolistically competitive market has the normal deadweight loss of monopoly pricing bc the price set may be less than what people are willing to buy ○ Policymakers often decide it is better to live with the inefficiency of monopolistic pricing (pricing being too high for people to buy and running monopolies out of business) ○ Firms entering a market must take into account ■ The product-variety externality: Because consumers get some consumer surplus from the introduction of a new product, the entry of a new firm confers a positive externality on consumers. ■ The business-stealing externality: Because other firms lose customers and profits when faced with a new competitor, the entry of a new firm imposes a negative externality on existing firms. A monopolistically competitive firm will increase its production if ○ marginal revenue is greater than marginal cost New firms will enter a monopolistically competitive market if ○ price is greater than average total cost What is true of a monopolistically competitive market in long-run equilibrium? ○ Price is greater than marginal cost. Advertising

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○ 10-20% of revenue on advertising: over-the-counter drugs, perfumes, soft drinks, razor blades, breakfast cereals, and dog food, typically ○ Very little of advertising: industrial products, such as drill presses and communications satellites, typically spend very little on advertising ○ No advertising: homogeneous products, such as wheat, salt, sugar, and crude oil ○ For the economy as a whole, about 2% of total firm revenue is spent on advertising ○ Critiques of Advertising: ■ Builds the perspective that buying a product will make you have friends and live happily ■ Makes it seem a product is more different than it truly is making it less elastic which increase its profits by charging a larger markup over marginal cost ○ Defense of Advertising ■ Advertising provides information → ability of markets to allocate resources efficiently ■ Customers can take advantage of price differences ○ People buy a product based on brand such as Coca Cola ■ Defending brand names: ● brand names provide consumers with information about quality when quality cannot be easily judged in advance of purchase ● brand names give firms an incentive to maintain high quality because firms have a financial stake in maintaining the reputation of their brand names If advertising makes consumers more loyal to particular brands, it could ________ the elasticity of demand and ________ the markup of price over marginal cost. ○ decrease, increase If advertising makes consumers more aware of alternative products, it could ________ the elasticity of demand and ________ the markup of price over marginal cost. ○ increase, decrease Advertising can be a signal of quality ○ if the benefit of attracting customers is greater for firms with better products. Comparison of Markets

○ Chapter 15 ● If someone wants to buy a copy of Windows, she has little choice but to give Microsoft the approximately that the firm charges for its product. Microsoft is said to have a monopoly in the market for Windows. ● A monopoly such as Microsoft has no close competitors and, therefore, has the power to influence the market price of its product. Whereas a competitive firm is a price taker, a monopoly firm is a price maker. ● Monopoly: firm if it is the sole seller of its product and if its product does not have any close substitutes ● The fundamental cause of monopoly is barriers to entry: A monopoly remains the only seller in its market because other firms cannot enter the market and compete with it. ○ Barriers to entry, in turn, have three main sources: ■ Monopoly resources: A key resource required for production is owned by a single firm. ● Due to international trade, very little firms own resources that have no close substitutes ■ Government regulation: The government gives a single firm the exclusive right to produce some good or service. ● Patent: One can apply for a patent. If the government deems something to be truly original, it approves the patent, which grants the company the exclusive right to manufacture and sell the drug for years ○ Encourages research ● Copyright: when a novelist finishes a book, she can copyright it. The copyright is a government guarantee that no one can print and sell the work without the author’s permission. The copyright makes the novelist a monopolist ○ Encourages to write more and publish better books

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■ The production process: A single firm can produce output at a lower cost than can a larger number of firms. Natural Monopoly: when a single firm can supply a good or service to the entire market at a lower cost than could two or more firms ○ Ex. bridge ○ arises when there are economies of scale over the relevant range of output ○ When a firm’s average-total-cost curve continually declines ○ As a market expands, a natural monopoly can evolve into a more competitive market. Some government grants of monopoly power are desirable if they ○ provide incentives for invention and artistic creation. A firm is a natural monopoly if it exhibits ________ as its output increases: ○ decreasing average total cost Suppose pretzel stands in New York City are a perfectly competitive market in long-run equilibrium. One day, the city starts imposing a $100 per month tax on each stand. How does this policy affect the number of pretzels consumed in the short run and the long run? ○ no change in the short run, down in the long run The key difference between a competitive firm and a monopoly is the monopoly’s ability to influence the price of its output

● ○ (a). Because a monopoly firm is the sole producer in its market, it faces the downward-sloping market demand curve, as in panel (b). As a result, the monopoly has to accept a lower price if it wants to sell more output.

● ○ A monopolist’s marginal revenue is less than the price of its good bc its demand graph is downward sloping ● When a monopoly increases the amount it sells, there are two effects on total revenue (P x Q): ○ The output effect: More output is sold, so Q is higher, which increases total revenue. ○ The price effect: The price falls, so P is lower, which decreases total revenue. ● Demand and Marginal Revenue Curves for a Monopoly

○ ● Profit Maximization for a Monopoly

○ ○ Monopolist’s profit-maximizing quantity of output is determined by the intersection of the marginal-revenue curve and the marginal-cost curve (point A) ○ profit-maximizing price is found at point B ● For a competitive firm: P = MR = MC ● For a monopoly firm: P > MP =MC ○ In competitive markets, price equals marginal cost. In monopolized markets, price exceeds marginal cost. ● A Monopoly’s Profit ○ Profit = TR - TC ○ Profit = (TR/Q - TC/Q) X Q ○ Profit = (P - ATC) X Q

○ ● Profit-Maximizing Rules for a Monopoly Firm ○ Derive thE MR curve from the demand curve. ○ Find Q at which MR = MC. ● On the demand curve, find P at which consumers will buy . ● If P > ATC, the monopoly earns a profit.

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○ When a patent gives a firm a monopoly over the sale of a drug, the firm charges the monopoly price, which is well above the marginal cost of making the drug. When the patent on a drug expires, new firms enter the market, making it more competitive. As a result, the price falls from the monopoly price to marginal cost. For a profit-maximizing monopoly that charges a single price, what is the relationship between price P, marginal revenue MR, and marginal cost MC? ○ P > MR and MR = MC. If a monopoly's fixed costs increase, its price will _____ and its profit will _____. ○ c. stay the same, decrease Thus, the socially efficient quantity is found where the demand curve and the marginal-cost curve intersect Decreasing output would raise total surplus

○ ● Monopoly DWL

○ ● Compared to the social optimum, a monopoly firm chooses ○ a quantity that is too low and a price that is too high. ● The deadweight loss from monopoly arises because ○ some potential consumers who forgo buying the good value it more than its marginal cost. ● Price Discrimination: firms sell the same good to different customers for different prices, even though the costs of producing for the two customers are the same ○ Cant occur in a competitive m...