4. Market Structure and Firm Strategy

Question 1

What is market definition?

Answer 1

a market is any facility (e.g., physical location, virtual system, etc.) that enables sellers (supply) and buyers (demand) to interact for the exchange of specific goods or services.

Question 2

What are 4 major market structures?

Answer 2

Perfect competition.
Perfect monopoly.
Monopolistic competition.
Oligopoly.

Question 3

What are 2 profit concepts?

Answer 3

1. Normal profit: just the amount of profit necessary to cover operating costs and compensate owners for their capital investment and/or managerial skills.
2. Economic profit: any amount greater than that of normal profit.

Question 4

What is economic profit also called?

Answer 4

Accounting profit.

Question 5

What is a central element in determining the nature of market structure?

Answer 5

The extent of competition in the market.

Question 6

Perfect competition: what are 6 characteristics?

Answer 6

1. Large number of independent buyers and sellers, each too small to affect price.
2. Homogeneous products/service.
3. Firms can enter/leave market easily.
4. Resources are completely mobile.
5. Buyers/sellers have perfect info.
6. Government does not set the price.

Question 7

Perfect competition: what does demand curve looks like on a graph?

Answer 7

Constant (horizontal).

Question 8

Perfect competition: what is demand curve equal to?

Answer 8

Marginal revenue (revenue derived from the last item.

Question 9

Perfect competition: when is the profit maximized? How much does it cost to produce the qty?

Answer 9

PMAX=MR=MC (where the point meets).

Where it meets ATC (QxATC=TC).

Question 10

Perfect competition: where is the area of profit?

Answer 10

Between the price of max profit and price of total cost.

Question 11

Perfect competition: what is short-run result depend on? What are 4 cases?

Answer 11

Firm’s ATC/AVC vs market price.

• If market price > ATC = Short-run profit
• Market price = ATC = breakeven in short-run
• market price < ATC, but >AVC = short-run losses, but covering FC.
• market price < ATC and < AVC = firm shuts down

Question 12

Perfect competition: what does long-run graph look like? Why is it?

Answer 12

MR=D - horizontal.
MC is half U shape and MR=MC=LAC (where MR meets MC is the lowest point of LAC (long-run average cost) because in the perfect competition, firms will adjust that no-one can make profit (all firms exactly break-even).

Question 13

Perfect monopoly: What are characteristics?

Answer 13

*Single seller
*Good or service for which there are no close substitute
*Market entry is restricted
Single firm = Market

Question 14

Perfect monopoly: What are 2 basic reasons monopolies exist and example? What are they called?

Answer 14

• Economies of scale: A single producer can produce at a lower cost than multiple producers (ex: public utilities) - Natural monopolies.
• Legal authority or control: A single producer has sole legal authority or sole control of resource (Ex: holding patent).

Question 15

Perfect monopoly: what does short-run graph look like?

Answer 15

Demand=downward straight line to the right.

MR=starting the same as D, but downward straight line toward the right on the left side of D line (below the D curve).

Question 16

Perfect monopoly: when is the profit maximized on short-run? How is the cost determined?

Answer 16

Where MR meets MC.

Where the above line meets demand curve.

Question 17

Perfect monopoly: what does short-run result depend on? What are 3 cases?

Answer 17

Firm’s ATC vs market price.

• ATC < market price = profit
• ATC = market price = breakeven
• ATC > market price = loss

Question 18

Perfect monopoly: does it assume firm will make profit?

Answer 18

No.

Question 19

Perfect monopoly: long-run: where on a graph monopolistic firm produce?

Answer 19

MR=MC

Question 20

Perfect monopoly: long-run: how can a firm make a profit and increase?

Answer 20

By reducing marginal and average cost by changing plant size.
Increase demand by advertising and promotions.

Question 21

Perfect monopoly: long-run: compared to perfect competition, what does monopolistic firm result in?

Answer 21

Higher price and inefficient use of resource (because there is excess profit because of price at optimum output > MC).

Question 22

Monopolistic competition: characteristics?

Answer 22

1. A large number of sellers.
2. Firms sell a differentiated product or service (similar but not identical).
3. Firms can easily enter/exist market
4. Product sold has close substitute.

Question 23

Monopolistic competition: what does a graph look like?

Answer 23

Same as perfect monopoly (MR curve is sharper slope).

Question 24

Monopolistic competition: where does it maximize profit?

Answer 24

MR=MC.

Question 25

Monopolistic competition: what does short-run result depend on? What are 3 cases?

Answer 25

Firm's ATC vs market price. * ATC < market price = profit * ATC = market price = breakeven * ATC > market price = loss

Question 26

Monopolistic competition: what happens when firms are making profits? Losing?

Answer 26

More firms will enter the market and there will be less demand for each firm. Firms will leave the market and there will be more demand.

Question 27

Monopolistic competition: long-run: what happens to equilibrium?

Answer 27

It will reach it and all firms break even and no long-run excess profit.

Question 28

Monopolistic competition: long-run: what is the state of resource allocation compared to perfect competition?

Answer 28

Misallocated because P>MC.

Question 29

Oligopoly: Characteristics?

Answer 29

* Few sellers * Firms sell either homogeneous or differentiated items * Market entry is restricted

Question 30

Oligopoly: what is the relationship between sellers and how do they impact each other?

Answer 30

Interdependent. | Actions of each seller affect others.

Question 31

Oligopoly: what does the graph look like?

Answer 31

MC = half U shape. Demand curve = downward slope with "kink" (market price) in the middle. MR=downward slope below demand curve till it hits the qty line below kink. Then it goes down on the qty line and comes out as downward straight slope to the right.

Question 32

Oligopoly: what is assumed about demand above kink (market price)? Below kink? Why does it happen?

Answer 32

Above: More elastic demand. Below: Less elastic demand. Below market price, no one tries to raise price because they may lose market share, but above kink, firms may reduce price to meet competition.

Question 33

Oligopoly: where is the firm most profitable? What is the price?

Answer 33

Where MC=MR. | Where kink=demand on Y-axis.

Question 34

Oligopoly: Short-run analysis: Does firm make profit?

Answer 34

Depends on ATC vs Market price. * ATC < market price = profit * ATC = market price = breakeven * ATC > market price = loss

Question 35

Oligopoly: Long-run analysis: Doe firm make profit?

Answer 35

If the firm makes profit in a shot-run, it will continue to make profit because market entry is restricted.

Question 36

Oligopoly: what is the relationship between price and MC? What does it result in?

Answer 36

Price > MC resulting in misallocation of resources.

Question 37

Oligopoly: what is the price tendency?

Answer 37

Tend not to change due to having a few sellers, resulting in "price war"

Question 38

Oligopoly: how do firms tend to compete with each other?

Answer 38

On other factors than price. | Advertising, promotion, packaging, service.

Question 39

Oligopoly: what is overt collusion? What is tacit collusion? Is it legal in US?

Answer 39

Overt (cartel): Conspiring to set outputs, prices or profits among firms = Illegal. Tacit: Firms following prices set by market leader = Not illegal.