AP Microeconomics Review #4

Market Structure The nature and degree of competition between firms in the same industry  4 Categories: 1.Perfect Competition 2.Monopolistic Competition 3.Oligopoly 4.Monopoly

Monopoly Price-Maker, only provider of product, perfectly inelastic good Still faces elasticity…there is a limit to how high they can raise prices Downward sloping demand and MR curve

Monopoly Lerner Index:  Measures pricing power of firms  How much can the firm charge for product over cost of product?  (P – MC) P Herfindahl Index:  Measures the size of a firm compared to its industry  Bigger the size = more market power

Graph: Price & Cost Output Demand MR MR will cross the x- axis at demand’s midpoint; this helps to show elasticity!! MC AC QXQX PXPX Profit Cost Total Revenue Cons. Surplus P = MC; allocative efficient, if perfect comp where P x = price of resources Dead Weight Loss; waste

Types of Monopolies Natural Monopolies (regulated)  Better for whole to have one efficient supplier of product; large companies show economies of scale as they grow  Ex) utilities  Gov’t will choose fair-return price (P = AC) Unregulated Monopolies  Illegal in the country  Sherman, Clayton, Justice Dept., ICC, FTC, etc.

Monopolistic Competition Characteristics:  Many firms  Very similar products  Product differentiation (advertising) leads to pricing power (P>MC)  No barriers to entry Graph:  Same graph as monopoly; all represent imperfect competition  Why? 1.Has some price power, therefore downward sloping MR!!! 2.Both Lerner and Herfindahl index are much lower than monopoly though!!!

Long Run Equilibrium Why? 1.LR means making profit and can expand 2.Very similar products and no barriers to entry means more firms will enter a profitable market. 3.Demand for individual firms decrease as more suppliers enter driving down profits!! Graph: Output Price & Cost D MR MC QXQX PXPX AC

Oligopoly Price Leader  One major firm and a few small firms Cartel  Firms working together to set price and quantity (collusion) Kinked  Strategy Game; follow for a price drop but not for a price raise

Kinked Graph: Output Price & Cost Demand MR MC QXQX PXPX ATC Profit

Game Theory Strategy theory that choices made by players based on the reaction expected by opponents. Dominant Strategy: a strategy that is best no matter what the opposition does Nash Equilibrium: the result of all players playing their best strategy given what their competitors are doing.

Game Theory Circle Test: use to find dom. strategy: circle your opponents best move based on your move; if player gets two circles in same decision, then it is a dominant strategy LeftRight Top+100, 0+100, +100 Bottom-100, 0+200, +100 Rick Jim If Jim Chooses Top, Rick’s best move: If Jim Chooses Bottom, Rick’s best move: Rule, since both circles are in Rick’s right option it is his dominant strategy!! Does Jim have a dominant strategy? No, his best results are in different choices!! Best Play: Rick will always choose Right, Jim will see Rick’s strategy and will always choose Bottom

Market Failures & Need for Govt When the market (firms & households) cannot determine price or quantity there is a need for gov’t to do so!!

Externalities Unintended side effects of an economic decision-activity Negative: pollution Gov’t taxes firm the value of social cost Positive: education Gov’t subsidizes firm value of benefit

Internalizing Externalities GRAPH: Quantity Price Output Cost S0S0 D MR MC QXQX MSC S1S1 PXPX P new Taxes on the firm will decrease supply and thus raise the price

Public Goods Free Rider: People can receive and never pay for them Rent: Getting more money than what is deserved, P > MC Goods which are non-exclusive;  Private firms won’t offer because can’t deny  Gov’t must provide with tax revenue

Imperfect Information  Caveat emptor, let the buyer beware  Truth in advertising laws  Gov’t agencies to regulate firm’s (FDA) Imperfect Competition  Monopolistic, Oligopoly, & Monopoly  Anti-trust laws & regulatory agencies (FTC, ICC, SEC)

Efficiency Allocative Efficiency  P = MC  Resources are being used efficiently to produce all society would like to have  P X = value of output  MC X = value of inputs to make the output Pareto Efficiency  An improvement for society as long as some people are gaining without others losing  If efficient to begin with, there are no improvements possible without hurting some people.  Must weigh costs & benefits

Income Redistribution Haves: 1.Family $ 2.Talent - Skill 3.Education 4.Power – Connection 5.Luck Have-Nots: -below poverty level Economic Stabilizers: Ways for gov’t to help: -welfare, food stamps, WIC, HEAP, SSI, unemployment, housing, loans. Transfer Payments: $ the gov’t gives w/o anything in return

The Lorenz Curve Measures Income Distribution of entire nation’s population; compare to perfect equality. Population is ranked and then split into fifths (quintiles) and studied. GRAPH: % OF HOUSEHOLDS %OFINCOME%OFINCOME Perfect Equality Lorenz Curve Income Gap