Session 7 - Monopoly (complete)

Question 1

Which of the following is not true about imperfectly competitive markets?

a. Firms in these markets are price takers.

b. There can be barriers to entry that prevent new firms from entering the market easily.

c. Firms might have some degree of market power, allowing them to influence prices.

d. Product differentiation can exist, leading to brand loyalty.

Answer 1

Correct: A

The correct answer is A. In imperfectly competitive markets, firms are not price takers; this is a characteristic of perfectly competitive markets. In imperfect competition, due to product differentiation or other reasons, firms have some influence over the price of their product. Options B, C, and D are all true for imperfectly competitive markets.

Question 2

Which of the following is not an example of monopolistic competition?

a. Independent coffee shops in a city.

b. A variety of fast food chains in a small town.

c. Local bakeries selling different varieties of bread and pastries.

d. Two firms dominating the local concrete production market.

Answer 2

The correct answer is D. Monopolistic competition is characterized by many firms producing differentiated products and having some degree of market power due to this differentiation. In option D, we see a situation that resembles a duopoly where two firms dominate the market, especially when they produce a homogeneous good like concrete. This differs from the characteristics of monopolistic competition. Options A, B, and C showcase scenarios where various firms offer differentiated products to consumers, which is typical of monopolistic competition.

Question 3

Marginal revenue curves:

a. Are usually upward sloping.

b. Are at least as steep as the demand curve faced by the firm.

c. Are always parallel to the supply curve.

d. Represent the firm’s profit per unit.

Answer 3

The correct answer is B. Marginal revenue curves, especially in the context of monopolistic or monopoly markets, fall faster than the demand curve. This implies that to sell an additional unit, the firm might have to lower the price for all units, thus making the marginal revenue curve steeper than the demand curve. Option A is almost never true, as the demand a firm is facing is most often downward sloping. Option C is simply not true, as by definition marginal revenue and supply curves cannot be parallel. Option D confuses marginal revenue, which is the additional revenue from selling one more unit, with profit, which factors in both revenue and cost.

Question 4

Which of the following is not true about imperfectly competitive markets?

a. Firms have some degree of price-setting power.

b. Products tend to be differentiated.

c. Firms may earn zero economic profits in the long run.

d. Equilibrium prices are always strictly higher than under perfect competition.

Answer 4

The correct answer is D. Bertrand competition, an imperfect competition model, can lead to prices equivalent to marginal cost, mimicking outcomes in perfect competition. Option A is incorrect because imperfectly competitive markets often grant firms some price-setting power. Option B is a feature of monopolistic competition, where differentiation is common. Lastly, even when firms in such markets earn positive short-run profits, market structure can change and profit margins can shrink, making Option C plausible.

Question 5

Which of the following firms is likely to have the least monopsony power?

a. Amazon, when hiring software engineers in Silicon Valley.

b. A small town’s only hospital, when hiring registered nurses.

c. A Berlin bakery, when hiring bakers.

d. Walmart, when sourcing orange juice.

Answer 5

The correct answer is C. Monopsony power refers to the market power a single buyer has in determining the price of a product or service it purchases. In the context of hiring, it’s about the power a firm has in setting wages. A local bakery in a large city will face significant competition from other employers, so its influence on the wage rate is minimal. In contrast, Amazon in the tech hub of Silicon Valley and a sole hospital in a small town both have considerable influence. Walmart faces competition when sourcing products like orange juice, but its size gives it significant market power.

Question 6

1. what are markets characterized by? What is meant by market power?
2. From Perfect to Imperfect Competition - what are the different characteristics?

Answer 6

1. Markets are characterized by
   - number of competitors (as well as their size)
   - degree of differentiation of products

…. both of these are sources of market power, which is characterized as the ability to price above the competitive level

2. Perfect competition:
   many competitors selling the same stuff (homogenous good)

Imperfect competition:
- monopolistic competition: a few competitors selling differentiated goods
- oligopoly: a handful of competitors selling the same stuff (Duopoly: 2 competitors)

No competition: Monopoly, 1 seller

Question 7

Which of the following oligopolistic markets are best captured by Bertrand but not Cournot competition?

a. Two firms selling identical software licenses.

b. Two firms producing and selling cement in a region.

c. Two pharmaceutical companies selling patented, unique drugs for different diseases.

d. Two firms producing luxury cars with distinct brand identities.

Answer 7

The correct answer is A. Bertrand competition focuses on firms setting prices, where consumers buy from the firm offering the lowest price, given identical products. Hence, for identical software licenses, Bertrand competition is an appropriate description. On the other hand, Cournot competition is more suited for markets where production processes are resource-intensive and storage costs are substantial, such as in cement production or luxury car manufacturing. While it was discussed in class that pharmaceuticals might be an industry where firms can compete on prices due to less resource-intensive production, option C involves unique drugs for different diseases. This differentiation pushes it more towards Cournot competition since the differentiation in products makes the competition based more on quantities rather than just prices. Thus, B, C, and D are more in line with Cournot competition.

Question 8

Monopsony

How is Monopsony defined (1), what is a common example for it (2) and how can monopsony power be limited (3)?

Answer 8

1. Market power on the buyer’s side - (and in this case the firm is the buyer of labor for example)

When firms (sellers) have market power, they can affect market prices such that prices are higher than their marginal cost

When buyers have market power, they can also affect the market price so that they can pay less.

2. Example: Labor market
   - employers are the buyers of labor
   - Usually they are the only company/Buyer available in one region, thus having the power to determine prices
3. Unions and minimum wage laws can limit the monopsony power (similar to the role of competition policy that limits the power of the firms)

Question 9

Define Seller’s market power

Answer 9

The extent to which a seller can charge a higher price without losing many sales to competing businesses

In perfectly competitive markets seller’s don’t have any market power

Question 10

The firm’s demand curve

Answer 10

• helps us to understand the firm’s market power

Careful firm’s demand curve is not equal to an individual firm’s demand curve, which summarizes the quantity that buyers demand from an individual firm as it changes its price

Firm’s demand curve reflect the demand faced by the firm, based on its market power

• the more market power, the more it will resemble the market demand (the steeper the curve)
• the less market power, the more it will be horizontal
• the horizontal firm demand under no market power captures that:
  1. market will buy any reasonable quantity this small firm might be able to produce
     
     2. the firm cannot affect the market price by changing its supply

Question 11

Marginal revenue - definition

Answer 11

Marginal revenue: the addition to total revenue you get from selling one more unit

Increasing production by 1 unit has both positive and negative consequences
on revenue
* Revenue goes up, because the extra unit sold brings money to the firm
* Revenue goes down, because increasing sales requires decreasing the price on
the entire production

Firms will be happy to produce until marginal revenue equals marginal cost -
at which point increasing production further does not increase their profits

Question 12

Deriving the marginal revenue curve -> Look at Problem set and finish this card!!

Answer 12

1. calculate total revenue = price x quantity
2. ….

Question 13

Cons of market power - examples of (non)intervention

Answer 13

In order to protect consumer welfare, authorities sometimes need to intervene:

Example: Ticketmaster (ongoing); AT&T and T-Mobile USA (blocked)

Examples, that in retrospect should have been blocked:

Killer acquisitions, where incumbent (= etablierte) firms may acquire innovating startups to terminate their potentially competing innovations

Social media platform mergers (Facebook, Instagram in 2012)

Question 14

What are the traditional criteria triggering authority intervention? Why are they not so good as an indicator?

Answer 14

Market share: Will the merger lead to a significant rise in the largest company’s market share?
Prices: How might the merger impact prices and, consequently, consumer welfare?

-> often overemphasized

May not always be relevant:
- market share assessments can be misleading for killer acquisitions, as large pharmaceutical firms often acquire innovative startups in their infancy

• price considerations become irrelevant for platforms like social media, where the product is priced 0

Question 15

Pros of market power

Answer 15

At larger firms, innovation in production processes and products becomes more
feasible due to economies of scale, increased R&D resources, and the capacity
to undertake significant infrastructure projects.

Firms are also more inclined to innovate if they can reap the benefits of their
innovations, e.g. through patents

Question 16

In a Duopoly - how can 2 firms compete with each other and what are these types of competition called?

Answer 16

Bertrand (price) competition:
- firms set price, and the one with the lowest price wins the whole market
- in equilibrium P=MC
Game theoretical approach: suppose that both firms set the equal price that is larger than MC and split the market in half, one firm can get the whole market by slightly lowering price
- they keep undercutting each other until they reach P=MC -> Nash equilibrium

-> more likely when production and storage are more flexible

Cournot (quantity) competition:
- firms set quantity, and the price is determined by the total quantity in the market
- Market demand: P= -b(q1+q2)+a

-> More common when production processes are resource-intensive and storage is expansive (e.g. commercial aircrafts)

Question 17

Bertrand (price) competition - how does the firm’s demand function look like under Bertrand (price) competition in a duopoly?

Answer 17

In the Bertrand model, a firm’s demand curve is a function of both firm’s prices

Two firms share the market if they charge the same price
1/2 D(p1) if p1 = p2 (or any other quantity)

• However, if one firm sets even a slightly lower price, it captures the entire market (one gets all, one nothing)
• The demand curve is discontinuous: slight changes in prices drastically shift the demand

Bertrand paradox: under Bertrand competition, just two sellers can produce an outcome same as perfect competition
* To see this, notice that any price set above the marginal cost is not a Nash equilibrium: one firm can charge slightly less and capture the entire market.

i.e., it can benefit from another strategy

• The only equilibrium is where both firms charge marginal costs - just as in a perfectly competitive market!

Question 18

Cournot (quantity) competition - what does the demand function look like under duopoly? What is the marginal profit function?

Answer 18

In the Cournot model, the firm’s demand is a function of quantities, as this is what firms compete on
* Again, a firm’s (inverse) demand is a function of both firms’ quantities q1, q2:

p(q1, q2) = a − b(q1 + q2)

Profit = PQ-CQ

-> Insert the new price function for this and you will get a marginal profit of:

(a - c- bq2) * q1 - bq1^2 -> and similarly for the 2nd firm

Unlike under Bertrand competition, the profit functions are continuous

So we can employ standard optimization techniques to find the equilibrium quantities that maximize firms’ (concave) profits

Question 19

How do you find the optimal quantity under Cournot duopoly competition?

Answer 19

2 possibilities
General approach: Solve system of equations to derive q1* and q2*
* Available shortcut: As both firms face same marginal cost c and price p(q1, q2) in this case, they should produce same amounts in the equilibrium

• So, optimal quantity q∗ = q1 = q2
• Substitute in q∗ into one of the best response functions and solve for q∗:
  ∂Π1
  ∂q1 = a − c − bq2 − 2bq1
  q∗ = a − c /2b - q*/2

OR

• take partial derivatives
• to find the maximum, we equate these to 0 and solve for each firm’s quantities
• > These functions are the optimal quantity for each firm, given the quantity of the rival firm; i.e. these are each firm’s best response to the other firm’s strategy (quantity)

Question 20

Cournot competition vs. perfect competition - how does the quantity produced change?

Answer 20

Quantity produced under Cournot duopoly is less than it would be under perfect competition

Question 21

Firm demand - definition

Answer 21

the demand face by the firm, summarizing the quantity that buyers demand from an individual firm as it changes its price

Question 22

Firm revenue - define TR and MR

Answer 22

Total Revenue (TR): price times quantity => (P*Q)
* Marginal Revenue (MR): the revenue generated from selling one additional
unit

Question 23

Firm cost - define TC and MC

Answer 23

Total Cost (TC): cost of producing certain quantity => (C*Q)
* Marginal Cost (MC): the cost from prod

Question 24

Firm Profit

Answer 24

total revenue minus total cost

-> PQ - CQ