ECONOMICS UNIT #2 MICROECONOMICS Market Structures https://www.youtube.com/watch?v=9Hxy-TuX9fs

CHARACTERISTICS OF PERFECT (PURE) COMPETITION Large number of sellers Standardized product Easy entry and exit into the market Firms are “price takers” Firms will break even in the long-run (no economic profit) https://www.youtube.com/watch?v=61GCogalzVc

WHAT IS A COMPETITIVE MARKET? In a competitive market… The actions of any single buyer or seller in the market have a negligible impact on the market price. Each buyer and seller takes the market price as given.

PERFECTLY ELASTIC DEMAND Firms cannot obtain a higher price by restricting output and do not need to lower their price to increase sales

A firm is considered a monopoly if . . . it is the sole seller of its product. its product does not have close substitutes. https://www.youtube.com/watch?v=7UWgKZsKZOc

WHY MONOPOLIES ARISE The fundamental cause of monopoly is barriers to entry.

WHY MONOPOLIES ARISE Barriers to entry have three sources: Ownership of a key resource. The government gives a single firm the exclusive right to produce some good. Costs of production make a single producer more efficient than a large number of producers.

Government-Created Monopolies Governments may restrict entry by giving a single firm the exclusive right to sell a particular good in certain markets.

Government-Created Monopolies Patent and copyright laws are two important examples of how government creates a monopoly to serve the public interest.

Natural Monopolies An industry is a natural monopoly when a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms.

Natural Monopolies A natural monopoly arises when there are economies of scale over the relevant range of output.

THE WELFARE COST OF MONOPOLY Monopolies charge higher prices than perfectly competitive firms

PUBLIC POLICY TOWARD MONOPOLIES Government responds to the problem of monopoly in one of four ways. Making monopolized industries more competitive. Regulating the behavior of monopolies. Turning some private monopolies into public enterprises. Doing nothing at all.

PRICE DISCRIMINATION Price discrimination is the business practice of selling the same good at different prices to different customers, even though the costs for producing for the two customers are the same.

PRICE DISCRIMINATION Examples of Price Discrimination Movie tickets Airline prices Discount coupons Financial aid Student discounts Ladies’ night Quantity discounts

CHARACTERISTICS OF MONOPOLISTIC COMPETITION Relatively large number of sellers Differentiated products Easy entry and exit Nonprice competition and advertising Break even in the long run (no economic profits) https://www.youtube.com/watch?v=T3F1Vt3IyNc

LARGE NUMBER OF SELLERS Each firm has a small market share Collusion is unlikely Firms act independently of one another

DIFFERENTIATED PRODUCTS Firms try to distinguish their products Product attributes Service Location Brand names/packaging Product differentiation does allow some control over price

EASY ENTRY AND EXIT Not as easy as perfect competition but significantly easier than oligopoly or monopoly

NONPRICE COMPETITION AND ADVERTISING Product differentiation and advertising are referred to as nonprice competition

COMPETITION WITH DIFFERENTIATED PRODUCTS When firms make profits, more firms enter the industry and reduce the profits of existing firms

OLIGOPOLY CHARACTERISTICS A few large producers Homogeneous or Differentiated Products Control Over Price but Mutual Interdependence Barriers to Entry Can make profits in the long-run https://www.youtube.com/watch?v=ElBF2D7IHAI

CONCENTRATION RATIO 4 Firm Concentration Ratio sales by the four largest firms 40% or more=oligopoly

MARKETS WITH ONLY A FEW SELLERS The key feature of oligopoly is the tension between cooperation and self-interest. Firms are interdependent with other firms

Competition, Monopolies, and Cartels Firms could work together to make the industry work like a monopoly (usually illegal) Collusion An agreement among firms in a market about quantities to produce or prices to charge. Cartel A group of firms acting in unison. https://www.youtube.com/watch?v=N0L00FZnhtg

The Equilibrium for an Oligopoly A Nash equilibrium is a situation in which companies choose their best strategy given the strategies that all the others have chosen.

GAME THEORY AND THE ECONOMICS OF COOPERATION Game theory is the study of behavior in strategic situations. https://www.youtube.com/watch?v=JMq059SAQXM

The Prisoners’ Dilemma The prisoners’ dilemma provides insight into the difficulty in maintaining cooperation. Often people (firms) fail to cooperate with one another even when cooperation would make them better off.

Figure 2 The Prisoners’ Dilemma Bonnie’ s Decision Confess Remain Silent Bonnie gets 8 years Clyde gets 8 years Bonnie gets 20 years Clyde goes free Confess Clyde’s Decision Bonnie goes free Clyde gets 20 years gets 1 year Bonnie Clyde gets 1 year Remain Silent Copyright©2003 Southwestern/Thomson Learning

The Prisoners’ Dilemma The dominant strategy is the best strategy for a player to follow regardless of the strategies chosen by the other players.

The Prisoners’ Dilemma Cooperation is difficult to maintain, because cooperation is not in the best interest of the individual player.

Figure 3 An Oligopoly Game Iraq ’ s Decision High Production Low Production Iraq gets $40 billion Iran gets $40 billion Iraq gets $30 billion Iran gets $60 billion High Production Iran ’ s Decision Iraq gets $60 billion Iran gets $30 billion Iraq gets $50 billion Iran gets $50 billion Low Production Copyright©2003 Southwestern/Thomson Learning

Oligopolies as a Prisoners’ Dilemma Self-interest makes it difficult for the oligopoly to maintain a cooperative outcome with low production, high prices, and monopoly profits.

Figure 4 An Arms-Race Game Decision of the United States (U.S.) Arm Disarm U.S. at risk USSR at risk U.S. at risk and weak USSR safe and powerful Arm Decision of the Soviet Union U.S. safe and powerful USSR at risk and weak U.S. safe USSR safe (USSR) Disarm Copyright©2003 Southwestern/Thomson Learning

Figure 5 An Advertising Game Marlboro’ s Decision Advertise Don ’ t Advertise Marlboro gets $3 billion profit Camel gets $3 Camel gets $5 billion profit Marlboro gets $2 Advertise Camel’s Decision Camel gets $2 billion profit Marlboro gets $5 Camel gets $4 billion profit Marlboro gets $4 Don ’ t Advertise Copyright©2003 Southwestern/Thomson Learning

Figure 6 A Common-Resource Game Exxon ’ s Decision Drill Two Wells Drill One Well Exxon gets $4 million profit Texaco gets $4 Texaco gets $6 million profit Exxon gets $3 Drill Two Wells Texaco’s Decision Texaco gets $3 million profit Exxon gets $6 Texaco gets $5 million profit Exxon gets $5 Drill One Well Copyright©2003 Southwestern/Thomson Learning

Why People Sometimes Cooperate Firms that care about future profits will cooperate in repeated games rather than cheating in a single game to achieve a one-time gain.

Figure 7 Jack and Jill Oligopoly Game Jack’s Decision Sell 40 Gallons Sell 30 Gallons Jack gets $1,600 profit Jill gets Jill gets $2,000 profit Jack gets $1,500 profit Sell 40 Gallons Jill’s Decision Jill gets $1,500 profit Jack gets $2,000 profit Jill gets $1,800 profit Jack gets Sell 30 Gallons Copyright©2003 Southwestern/Thomson Learning

https://www.youtube.com/watch?v=UkXI-zPcDIM