Econ 210 - Exam 3

Front 1

Characteristics of monopolistic markets

Back 1

•A single seller.
•No acceptable substitutes for the product.
•Barriers to entry into the market.

Front 2

Different forms of barriers to entry into monopolistic markets

Back 2

•Legal barriers: Patents, licenses, certification requirements
•Control of essential resources: Control of the supply of key inputs (e.g., De Beers Consolidated Mines of South Africa controls world’s diamond mines)
•Economies of scale: Only one firm operating on a large scale is able to produce the product at the lowest possible cost. Monopolies arising due to economies of scale are called natural monopolies.

Front 3

Examples of products sold in monopolistic markets

Back 3

Electricity, water, gas, and regular postal service

Front 4

Relationship between price and marginal revenue for a monopolistic firm

Back 4

•The demand curve a monopolist faces is the market demand curve, which is negatively sloped.
•For a monopolist, there is no supply curve because there is no uniquely positive relationship between price and quantity supplied. In fact, the monopolist decreases the price in order to sell more or sells less in order to charge a higher price. This behavior is opposite to the behavior represented by the supply curve.
•MR < P for all units sold except the first unit because the monopolist must decrease price on all units sold in order to sell an additional unit.

Front 5

Determination of optimal output for a monopolistic firm

Back 5

•Optimal output is determined by finding the intersection of MR and MC curves, where MR = MC, and moving vertically down to the output axis.
•The price corresponding to the optimal output is found by moving vertically up from the optimal output to the demand curve and moving leftward from that point on the demand curve to the price axis.
•A monopolist determines not only how much output to produce (i.e., optimal output) but also what price to charge corresponding to that output.
•In contrast, a perfectly competitive firm determines only the optimal output, given the market price.

Front 6

Decision rule for a monopolistic firm to increase or decrease output from the current level

Back 6

At the current level of output,
•If MR > MC, increase output because that would increase profit or decrease loss.
•If MR < MC, decrease output because that would increase profit or decrease loss.
•If MR = MC, do not change output because profit must be maximum or loss must be minimum.

Front 7

Decision rule for a monopolistic firm to shut down or continue to operate

Back 7

•This decision rule applies to firms that are incurring economic losses in the short run. For these firms, TR < TC or P < AC at any level of output.
•Given P < AC:
•If P > AVC, the firm should continue to operate at least for a while because doing so would result in a smaller loss than shutting down.
P > AVC => TR > TVC => After paying for all the variable costs, the firm will have some revenue left that can be used to pay for part of the fixed costs.
•If P < AVC, the firms should shut down as soon as possible because doing so would result in a smaller loss than continuing to operate.
•P < AVC => TR < TVC => The firm is not earning enough revenue to even pay for all the variable costs.

Front 8

Short-run vs. long-run equilibrium for a monopolistic firm

Back 8

•In the short run, a monopolist may earn economic profits, incur economic losses, or earn only normal profits (i.e., zero economic profits), similar to a perfectly competitive firm.
•In the long run, a monopolist can continue to earn economic profits, unlike a perfectly competitive firm that can earn only normal profits.

Front 9

Price discrimination and conditions for it

Back 9

• Price discrimination is the practice of selling the same good at different prices to different customers, even though the costs of producing for the different customers are the same.
• Conditions for price discrimination include the following:
• Possession of market power, which means the ability to raise the price without losing all sales (i.e., downward-sloping demand curve).
•Ability to identify at little cost different classes of buyers with different price elasticities of demand.
•Prevention of resale from one buyer to another.
•A monopolist that engages in perfect price discrimination charges a different price for every unit sold.

Front 10

Characteristics of monopolistically competitive markets

Back 10

•Large number of sellers.
•Differentiated product.
•Relatively easy entry into the market.

Front 11

Product differentiation in monopolistically competitive markets

Back 11

•When firms in an industry produce differentiated products, the demand curves facing the firms will always be downward-sloping.
•Products may be differentiated on the basis of quality, physical characteristics, customer service, brand name, and location of store.

Front 12

Examples of products sold in monopolistically competitive markets

Back 12

Computer software, clothings, restaurant foods, footware, and jewelry.

Front 13

Relationship between price and marginal revenue for a monopolistically competitive firm

Back 13

A monopolistically competitive firm faces a negatively sloped demand curve. Thus, MR < P for all units sold except the first because the firm must decrease price on all units sold in order to sell an additional unit.

Front 14

Determination of optimal output for a monopolistically competitive firm

Back 14

Same as for a monopolistic firm because the demand curve facing a monopolistically competitive firm is also negatively sloped.

Front 15

Short-run vs. long-run firm equilibrium in monopolistically competitive markets

Back 15

•When a firm in monopolistic competition raises its price, it loses some, but not all, of its customers.
•In the short run, a monopolistically competitive firm may earn economic profits, incur economic losses, or earn only normal profits (i.e., zero economic profits).
•In the long run, a monopolistically competitive firm typically earns zero economic profits, similar to a perfectly competitive firm.

Front 16

Characteristics of oligopolistic markets

Back 16

•Only a few sellers.
•Interdependence in decision making.
•Strong barriers to entry into the market, including the need to achieve economies of scale.

Front 17

Examples of products sold in oligopolistic markets

Back 17

•Aircrafts, airlines, automobiles, computer hardware, and oil & gas.
•The firms producing these goods typically must produce large amounts of output before they can achieve low average costs (i.e., economies of scale).

Front 18

Collusion among firms in oligopolistic markets

Back 18

•Oligopolistic firms make their decisions such as output, prices, advertising, quality improvement, and customer service by taking into account the likely decisions of their rivals.
•Oligopolistic firms can increase profits if they are able to coordinate their decisions by forming collusions. One form of collusions is cartels, such as the Organization of Petroleum Exporting Countries (OPEC).
•Collusions are illegal in the U.S. Oligopolistic U.S. firms attempt to circumvent this by forming tacit collusions. An example of tacit collusions is price leadership used frequently by airline companies. Under price leadership, one firm acts as the leader in making a decision such as a price increase and others act as followers.

Front 19

Cost-plus pricing in oligopolistic markets

Back 19

•Cost-plus pricing is used when a firm lacks access to an estimated form of demand or cost function for its product.
•Cost-plus pricing requires the firm to project the amount that will be sold and then "mark-up" the price based on average variable cost:
P = AVC + Markup
•The markup can be a fixed dollar amount or a percentage of AVC. If a percentage of AVC, the markup will vary as AVC varies.

Front 20

Short-run vs. long-run firm equilibrium in oligopolistic markets

Back 20

•In the short run, oligopolistic firms may earn economic profits, incur economic losses, or earn only normal profits (i.e., zero economic profits).
•The ability of oligopolistic firms to earn economic profits in the long run may depend on whether they succeed in forming collusions and creating strong barriers to entry of new firms.

Front 21

Benefits from international trade

Back 21

•Allow a country to specialize in producing those goods and services that it can produce most efficiently.
•Allow a country to move to a higher consumption possibilities frontier.
•Allow a country's consumption possibilities frontier to lie outside its production possibilities frontier.

Front 22

Opportunity cost and specialization in international trade

Back 22

•To maximize worldwide gains from trade, the country that should produce a good is the one that has the lowest opportunity cost of producing it.
•International trade is most likely to occur if (a) the opportunity costs of production differ between trading partners, (b) one country is more productive than the other, (c) one country is more efficient than the other, (d) each country has a comparative advantage in producing some good, and (e) each of the trading nations gains from trade.

Front 23

Production and consumption possibilities with and without international trade

Back 23

With international trade, a country's consumption possibilities frontier can move outside its production possibilities frontier.

Front 24

Domestic vs. world markets and the occurrence of imports and exports

Back 24

•When the world price is less than the domestic price, quantity demanded at the world price > quantity supplied at the world price. Imports = the amount by which the quantity demanded exceeds the quantity supplied at the world price
•When the world price is greater than the domestic price, quantity supplied at the world price > quantity demanded at the world price. Exports = the amount by which the quantity supplied exceeds the quantity demanded at the world price

Front 25

Gainers and losers from international trade

Back 25

•The losers when a country institutes trade restrictions include that country’s consumers of imported goods, that country’s producers who use imported intermediate goods, and, if other countries retaliate, that country’s exporters.
•As a result of international trade, the loss to producers in the importing country is less than the gain to consumers in the importing country caused by a decrease in price.

Front 26

Tariffs and their impacts on international trade

Back 26

As a result of a tariff on an imported good, domestic producers are better off because they sell more goods at a higher price.

Front 27

Quotas and their impacts on international trade

Back 27

An effective import quota is one that limits imports to less than what would be imported under free trade.

Front 28

The primary difference between a tariff and a quota

Back 28

Tariff revenues go to government, but quotas benefit those with the right to sell foreign goods domestically.

Front 29

GATT and WTO

Back 29

•The establishment of the General Agreement on Tariffs and Trade (GATT) resulted in lower tariff rates.
•The World Trade Organization (WTO) became, in 1995, the institutionalized and more comprehensive successor to the GATT.

Front 30

Arguments used in justifying international trade restrictions

Back 30

•Unemployment, infant industry, domestic industry adjustment, dumping, and national defense.
•The unemployment or loss of domestic jobs argument is used when U.S. workers experience structural unemployment because of the popularity of foreign goods.
•The infant industry argument is used to grant protection to new firms that eventually would develop significant economies of scale in their production processes.
•The domestic industry adjustment argument is used to allow the orderly adjustment of an established domestic industry if it is in jeopardy of being displaced by lower-priced imports.
•The dumping argument is used when a foreign manufacturer sells goods abroad for less than they sell for at home.
•The national defense argument is used if national security is jeopardized when certain goods or services are sold to or purchased from other countries.