Managerial Economics Flashcards

Terms Definitions
Product Characteristics for a Monopoly
Unique Product (Price Makers because lack of substitutes)
Exit/Entry conditions for a monopoly
Blockaded entry and/or exit
Dissemination of information
Imperfect
Long run profits
(Guidelines for efficient monopolies)
Monopolies allow opportunity for long run economic profits
(P>MC and P=AR>AC and profit>0)
Ways a monopoly can occur
1. "Natural Monopoly" - declining long run AC over the relevant market demand2. Gov't Protection of market from entrants, e.g. USPS3. A number of firms acting collusively (Cartels)
Profit maximization for monopoly
MR = MC
Limits to monopoly power
Substitutes & income ---> downward sloping curve
LR Comparison to Perfect Competition
Monopolies: P=AR>MR, P>MC and Profit>0
Perfect Competition: P=AR=MR=MC=AC and Profit=0
Social Costs on Monopoly
Underproduction
DWL
Effect on Consumers
Underproduction occurs when: Equilibrium Q for Monopoly<Equilibrium Q for Perfect competition
DWL: The above results in Dead weight loss
Effect on consumers: =DWL + Wealth Transfer
Wealth Transfer Equation
Monopoly Equilibrium Price * (Monopoly Equilibrium Price - Perfect Competition Equilibrium Price)
Social Benefits of a Monopoly
Natural Monopoly (Economies to scale)
 
Supply at a point where LRAC curve is still declining, the single firm produces the whole market demand.  The market clearing price, where P=MC, occurs at a point where LRAC is still declining.
Social Benefits of Monopolies
Monopoly Regulation
Most common method of regulation is with price control (set a ceiling)
 
*Problem: regulatory lag
Monopsony
Market in which there is a single buyer of a desired product or input.
 
Can obtain a price that is lower than the Perfect Competition equilibrium price
Bilateral Market
Market in which a monopsony buyer faces a monopoly buyer
T/F
A decrease in price elasticity would follow an increase in monopoly power.
True.
An increase in monopoly power would mean there are less substitutes for this type of product or service in the market.  Consumers become less price sensitive because they have fewer choices to choose from.  Thus, you'll observe a decrease in price elasticity.
T/F
A natural monopoly results when the profit maximizing ouput level occurs at a point where LRAC are declining.
False, a natural monopoly results when P=MC where LRAC is declining, not MR=MC (aka profit maximizing point)
T/F

Downward-sloping industry demand curves characterize both perfectly competitive markets and monopoly markets
True
Monopoly market demand curve also slopes downward similar to the perfect competition demand curve.
T/F
In long run equillibrium, monopoly prices are set at a level where price exceeds average revenue.
False
In long run equllibrium, monopoly prices are set at a level where price is equal to average revenue.
T/F
At the profit maximizing level of Q for a monopolist, P>MC and MR=MC
True
Monopolistic competition characteristics
Number of participants
Many buyers
Monopolistic competition characteristics
Product differentiation
Different forms of product
Monopolistic competition characteristics
Entry/exit conditions
Free entry and exit
Monopolistic competition characteristics
Information
Perfect info. on costs, prices and quality
Monopolistic competition characteristics
LR Profits
Only normal profit
Monopolistic competition output decisions
MR = MC (short run monopolist), but P=AR=AC in the LR (normal economic profits)
 
Note: Why in the LR, Monopolistic competition could only enjoy a normal rate of return?
 
In the short run, behaves like a monopolist -> profit>0 -> attract new entrances -> decrease the firm demand (shift to the left) -  profit diminish
Long-run high-price/low-output equillibrium
1. With differentiate products
2. Equilibrium occurs when theslope of AC = the slope of the demand curve
 
*Note: Use the inversed demand curve to solve for quantity. And be aware that the demand curve has shifted to the left.
Also notice the high-price/low-output equillibrium occus at a point above min AC, this doesn't mean the firm is inefficient.
Long-run low-price/high-output equilibirum
1. With homogenous products, no product differentiation
2.  MR=MC, P=AC at minimum LRAC
Oligopoly market characteristics
Number of participants
Handful of sellers, interdependence of P-Q decisions.
Oligopoly Market Characteristics
Number of Participants
Handful of sellers, interdependence of P-Q decisions
Oligopoly Market Characteristics
Product Characteristics
Homogenous or unique products
Oligopoly Market Characteristics
Entry/Exit Conditions
Blockaded entry and exit
Oligopoly Market Characteristics
Information
Imperfect dissemination of info
Oligopoly market characteristics
LR profits
Opportunity for above-normal profit.
P>MC and P=AR>AC
Output-Setting Model Oligopolies
Cournout Oligopoly
Stackelberg Oligopoly
Barometric price leadership
Price-setting Oligopoly Models
Bertrand Oligopoly
Sweezy Oligopoly
Cartels and Collusions Characteristics
Cartels are Overt agreements to create cartels that operate like a monopoly.  Collusion exists when firms reach secret agreements
-Both are illegal
-Hard to enforce because typically shortlived from cheating and can be very profitable the more firms involved in the agreement.
 
 
Concentration ratios
Measure the combined market share percentage of the n leading firms.  When concentration ratios are low, industries tend to include many firms and competition is strong.
 
e.g. CR4 < 20 highly competitive
CR4 > 80 highly concentrated
The Herfindahl-Hirschmann Index
The sum of squared market share percentage for all competitors.  Solves the problem of the degree of size inequality within each group of leading firms.
T/F
Equlibrium in monopolistically competitive markets requires that firms be operating at the minimum point on the long-run AC curve.
False.  It's not rewuired.  With its long-run high-price/low-output equilibrium, the firm is operating at a point above the minimum point on the long-run AC curve.  While with no product differentiation (long-run low-price/high-output equilibrium), the firm is operating at the minimum point on the long-run AC curve.
Competitive Advantage
Unique or rare ability to create, distribute, or service products valued by customers
->Long-lastng above-normal profits require a competitive advantage that cannot be easily duplicated.
Small firm size as a competitive advantage (1 and 2)
1) Decentralized decision making
2) Less complex structure
Limit Pricing
Sets less than maximum monopoly prices to deter entry by competitors
 
* Some short-term profits are forgone by such pricing moderation, but Longer-term profits are boosted if price moderation forestalls competition.
Predatory Pricing
Set price below marginal cost
 
*Trade-off between lower current prices/profits in return for higher subsequent price/profits.
*Goal is to knock out rivals and subsequently raise prices to obtain monopoly profits (illegal in US)
Non-price Methods of Competition
Non-price competition can be difficult to imitate
 
Advertising is the most common method
Pricing Rules of Thumb
Perfect Competition
Has no control over prices. They are price takers.
Profit-max: P=MR=MC
Pricing Rules of Thumb
Imperfect Competition
The uniqueness of product gives rise to a downward sloping demand curve.
Profit-max: P=MC/(1+1/E p)
Note: E  p is the point price elasticity.
Optimal Markup on Price =
= (P-MC)/P; Optimal Markup on Price = -1/(E  p)
Lerner Index
=-1/E  p
 
High markups suggest some pricing power
Price Discrimination
Monopoly profits are the maximum profits a firm can make if it charges the same price to all consumers.  Profits can be increased if the firm could charge higher prices to consumers that are willing to pay more (price discriminate)
Profit Making Criteria
1) Different customers are charged different mark-ups for the same product (not related to differences in costs)
2) Objective is to increase seller revenue effectively capturing consumer surplus by better matching the price charged with the benefits derived from consumption.
3) Need to be able to segmentmarkets based on unique demand or cost characteristics.  Price elasticity of demand must differ in submarkets.
4) Must have the ability to prevent reselling.
First degrees of price discrimination
Extracts the maximum amount each customer is willing to pay for the firm's products.  Potential for sellers to capture all consumer surplus.
 
*It's hard to practice, and extremely unpopular with consumers.
Second degrees to price discrimination
Involves setting prices on the basis of quantity purchased. Such as Quantity discounts.
Third Degrees of Price Discrimination
Assigns different prices by customer age, sex, income (observable characteristics)
Note: This is the most common type.
Consumers are sometimes charged a lump-sum amount plus a usage fee to extract the maximum amount they are willing to pay.
 
*Usage charge = MC, membership fee = Consumer Surplus generated at that per unit fee.
 
Two-part pricing
T/F
With price discrimination, higher prices are charged when the price elasticity of demand is low.
True.
When the price elasticity of demand is low, the demand curve is very steep.  In that case, firms would be able to capture more CS.
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