Understanding Monopolies, Competition & Oligopolies: Markets with Power, Lecture notes of Economics

Download Understanding Monopolies, Competition & Oligopolies: Markets with Power and more Lecture notes Economics in PDF only on Docsity! CHAPTER 18 MARKETS WITH MARKET POWER Principles of Economics in Context (Goodwin et al.) Chapter Summary Now that you understand the model of a perfectly competitive market, this chapter complicates the picture by adding the element of market power. You will be introduced to the traditional models of monopoly, monopolistic competition, and oligopoly. You will learn about how firms maximize profits in these more complicated theoretical situations, and also about some of the ways in which firms may negotiate with one another–either explicitly or implicitly–to attain their preferred outcomes. At the end of the chapter we will discuss two industries—agricultural products and health care—that, for different reasons, are characterized by highly imperfect competition. Objectives After reading and reviewing this chapter, you should be able to: 1. Define a monopoly and describe how a monopolist maximizes profits. 2. Understand why a monopoly may or may not be efficient. 3. Define monopolistic competition and describe how profits are maximized in these markets. 4. Define oligopoly and discuss firm behavior under conditions of oligopoly. 5. Understand the effect of government farm policy on food markets. 6. Explain the reasons why the health care industry is limited in its degree of competitiveness and understand both the pros and cons. Key Terms pure monopoly monopolistic competition oligopoly barriers to entry natural monopoly exclusionary practices predatory pricing dumping local monopoly regulated monopoly price maker price discrimination nonprice competition industrial concentration ratio duopoly payoff matrix price war collusion tacit collusion price fixing price leadership adverse selection 18-1 Active Review Questions Fill in the Blank 1. A monopoly that emerges because of economies of scale is called a ________________monopoly. 2. Joe’s Superstore prevents competitors from entering the market by temporarily pricing its goods below cost, thus driving new entrants out of business. This practice is known as ________________ pricing. 3. Selling goods to another country at a price below the cost of production is known as ________________. 4. The marginal revenue curve for a monopolist is (flat/downward-sloping/upward- sloping) ________________. 5. Market power in the form of a monopoly creates benefits for the (buyer/seller) ________________ at the expense of the (buyer/seller) ________________. 6. When the government pays a subsidy to the farmer, it results in a(n) ________________ of food. Questions #7, #8, and #9 refer to the graph below. In this graph, QE refers to the quantity of a good that would be provided under conditions of perfect competition, and QM refers to the quantity of the same good that is provided under conditions of monopoly. 7. Area A shows the magnitude of ________________. 8. Area D shows the magnitude of ________________. 9. Area B represents a transfer from ________________ to ________________. 10. A firm that charges different prices to different buyers depending on their ability and willingness to pay is referred to as a ________________ seller. 18-2 2. The following graph shows the demand curve and the marginal cost curve for a monopolistic firm producing electric cars. Demand Quantity C os t a nd P ric e MC a. Sketch a possible marginal revenue curve for this firm. b. On the horizontal axis, label the profit-maximizing level of production as Q1. On the vertical axis, label the price P1 that the firm will charge at the profit maximizing level of production. c. Label the area of deadweight loss in the graph you draw for part (b). d. How do the monopolistic price and quantity compare to those of competitive market equilibrium? _______________________________________________________________ _______________________________________________________________ _______________________________________________________________ 3. Harry’s Auto Shop is a perfectly price discriminating seller. Harry has an uncanny ability to assess how much people are willing to pay for a car, and he sets prices accordingly. a. Sketch the demand curve and the marginal cost curve for Harry’s Auto Shop. b. Show the area that represents consumer surplus on the graph you drew for part (a). c. Show the area of the producer surplus on the same graph. 18-5 4. Ten breakfast cereal producers operate in a market characterized by monopolistic competition. The demand, marginal revenue, and marginal cost curves faced by an individual breakfast cereal producer are shown below. Quantity of Cereal P ric e of C er ea l MC D1 MR1 Suppose that five new breakfast cereal producers enter the market. Show the new demand curve and the new marginal revenue curve that result on the graph above. 5. Suppose the market for cookbooks is a duopoly. The chart below shows a payoff matrix for the two cookbook producers. $20 $80 $1 $20 $100 $1 $80 $100High Price Low Price Pr od uc er 1 ’s o pt io ns Producer 2’s options Low Price High Price a. Based on the information shown in the payoff matrix above, how much profit would each firm make if the firms were non-cooperative? b. If producer 2 charged a high price and producer 1 charges a low price, how much profit would producer 1 make? 18-6 c. If the firms colluded and set prices together, how much profit would each producer make? Self Test 1. Which of the following is a condition of monopoly? a. Two or more sellers. b. Only one buyer. c. A good with several close substitutes. d. Barriers to entry. e. None of the above. 2. A “natural monopoly” is a. An oligopoly. b. A monopoly characterized by diseconomies of scale. c. A monopoly that emerges because of economies of scale. d. A monopoly on a scarce natural resource. e. A monopoly that solves the problem of diseconomies of scale. 3. In international trade, “dumping” refers to a. Exclusionary practices. b. Charging unfairly high prices. c. Providing unwanted goods free of charge. d. Selling goods at a price below the cost of production. e. Selling goods above market price. 4. Which of the following statements is false? a. Monopolistic firms maximize profits at the point where MC=MR. b. Monopolistic firms are price takers. c. Monopolistic firms face a downward sloping demand curve. d. Monopolistic firms face a downward sloping marginal revenue curve. e. All of the above are true. 5. The demand curve for the output of a monopolistic firm is equal to a. The marginal revenue for the product in question. b. The market supply curve for the product in question. c. The market demand curve for the product in question. d. The demand curve for a firm in a perfectly competitive market. 18-7 13. Which of the following statements is false? a. In some cases, monopoly can be a preferable option for society as a whole compared with a situation of perfect competition. b. For some services, such as passenger rail transportation, government subsidies to a monopolist may produce the most socially beneficial outcome. c. Government regulation of an industry characterized by natural monopoly can help to reduce the inefficiencies associated with market power. d. Optimally efficient pricing always leads to self-sustaining revenues. e. All of the above are true. 14. Which of the following is an example of a price discriminating seller? a. Frank sells condominiums only to buyers of a certain ethnic background. b. Ellen charges different prices to different buyers, depending on their ethnic or religious background. c. Amelia charges different prices to different buyers depending on their ability or willingness to pay. d. An airline charges the same price to all travelers. e. Both a and b are correct. 15. When you go shopping you discover that you can choose among twenty different brands of breakfast cereal, all with about the same nutritional content. The proliferation of cereal options is an example of a. product differentiation b. oligopoly c. perfect competition d. a price war e. monopoly 16. Which of the following statements is true of a monopolistically competitive firm? a. It faces a downward sloping demand curve. b. It earns positive economic profits in the long run. c. It produces more than a perfectly competitive firm. d. It charges lower prices than a perfectly competitive firm. e. Its profits are protected by significant barriers to entry. 18-10 17. Under conditions of oligopoly, firms may collude in order to a. Avoid the outcome associated with the prisoner’s dilemma. b. Increase competition. c. Solve the concentration ratio problem. d. Create a prisoner’s dilemma for buyers. e. Initiate a price war with one another. 18. Which of the following is a form of implicit collusion? a. Duopoly b. Price wars c. Non-price competition d. Prisoner’s dilemma e. Price leadership 19. Which of the following statements about oligopoly is false? a. Under conditions of oligopoly, entry into the market is difficult. b. The amount of long-run economic profit made by oligopolistic firms is variable. c. Each firm in an oligopoly makes decisions without regard for the actions of other firms. d. Game theory is used to analyze the behavior of firms in an oligopoly. e. Firms in an oligopolistic market often have an incentive to collude. 20. One type of market distortion employed by the U.S. government in the markets for agricultural produce is a. a price ceiling. b. a price floor. c. a deadweight loss. d. price fixing. e. price discrimination. 21. Which of the following is false about U.S. farm policy? a. It causes land to be degraded more rapidly than otherwise. b. It intensifies inequality by providing disproportionate subsidies to large landholders. c. It sometimes helps relieve famines in other countries, at least in the short term. d. It often distorts international food markets. e. All of the above are true. 18-11 22. Which of the following has the United States not done with its food surpluses in the past? a. Sell it to the Soviet Union. b. Give it to poor countries to help with famine relief. c. Confiscate it and make it available at regional food banks at a low price. d. Destroy it. e. The United States has, at one time or another, done all of the above. 23. Among reasons for why markets in the health care industry are not highly competitive are a. the complete absence of deadweight losses. b. heterogeneous products. c. barriers to entry. d. information asymmetry. e. price ambiguity. 24. The health insurance and pharmaceutical industries are best described as a. monopolies. b. monopolistic competitors. c. oligopolies. d. perfectly competitive markets. e. quasi-governments. 25. A phenomenon that favors the weaker members of a given population to the detriment of the system as a whole is known as a. suboptimal rationality. b. counterproductive targeting. c. rent seeking. d. adverse selection. e. inefficient but fair. 18-12 2. c. Demand Quantity C os t a nd P ric e MC MR Q1 P1 2. d. The quantity sold by the monopolist is lower, and the price charged is higher, than in perfect competition. 3. a. Demand Demand P ric e MC 3.b. There is no area of consumer surplus on this graph. 3. c. Demand Demand Pr ic e MC Producer Surplus 18-15 4. Quantity of Cereal P ric e of C er ea l MC D1 MR1 D2MR2 5. a. They will each make $20. 5. b. Producer 1 will make $80. 5. c. Both firms will make $100. Answers to Self Test Questions 13. d 1. d 14. c 2. c 15. a 3. d 16. a 4. b 17. a 5. c 18. e 6. d 19. c 7. e 20. b 8. b 21. e 9. d 22. c 10. b 23. a 11. a 24. c 12. b 25. d 18-16