ap microeconomics review #4. market structure the nature and degree of competition between firms in...
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AP Microeconomics
Review #4
Market Structure
The nature and degree of competition between firms in the same industry
4 Categories:1. Perfect Competition2. Monopolistic Competition3. Oligopoly4. Monopoly
MonopolyPrice-Maker, only provider of product,
perfectly inelastic goodStill faces elasticity…there is a limit to how
high they can raise pricesDownward 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
QX
PX
Profit
Cost
Total Revenue
Cons. Surplus
P = MC; allocative efficient, if perfect comp where Px = 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
QX
PX
LRAC
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
QX
PX
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
Left Right
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
A.P. Microeconomics
Have out Unit IV Review Sheet!!
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 costPositive: education & smoke detectors
Gov’t subsidizes firm value of benefit
Internalizing ExternalitiesGRAPH:
Quantity
Price
Output
CostS0
D
MR
MC
QX
MSCS1
PX
Pnew
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 InformationCaveat emptor, let the buyer bewareTruth in advertising lawsGov’t agencies to regulate firm’s
(FDA)Imperfect Competition
Monopolistic, Oligopoly, & MonopolyAnti-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
PX = value of output MCX = 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 CurveMeasures 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
%
OF
INCOME
Perfect Equality
Lorenz Curve
Inco
me
Gap