Unit 2 Flashcards
(24 cards)
perfect competition
A theoretical model exploring what happens if competition among firms is taken to its most extreme
Four characteristics:
1. Large number of small firms and large number of customers
2. Freedom of entry and exit (no “entry barriers”)
3. Homogeneity of product (all products sold by all firms in the industry are identical)
4. Perfect information (every customer knows whatever firm is charging)
perfect information
(Every customer knows whatever firm is charging) Firms can get away with charging more than other firms charge.
homogeneity and heterogeneity of product
Homogeneity (all products sold by all firms in the industry are identical): Customers don’t care whom they buy from as long as they get the lowest price.
Heterogeneity: Products made by different firms, while similar, are not identical. Consumers can prefer one firm’s product over another’s. If a firm raises its price, it loses some customers, but not all, because some will be willing to pay more if they like the product more. So, there is not a single market price, nor are firms price-takers.
“price taker”
In a perfectly-competitive market, each firm is a price-taker, meaning that it must charge the prevailing market price. If it charges even a penny more, it loses all customers. It cannot charge less without losing money.
shutdown point
If a perfectly-competitive firm is losing money (P < ATC), should it shut down and go out of business? Maybe…
- First, we assume that in the short run, a firm has at least some “fixed commitments” or legal obligations that it will still owe if it goes out of business. In the long run, we assume all such obligations have expired.
If a firm is losing money in the short run (P < ATC), the firm should stay open as long as P > AVC (or TR > TVC). If price exceeds average variable cost, the firm can cover the cost of producing units and have some money left over to cover its fixed obligations (paying something is better than paying nothing). But, if P < AVC, the firm increases its losses by continuing to produce and should shutdown. in the long run, if the firm is still losing money (P < ATC), it should shut down.
profit box
For positive profit, box is bounded by…
1. D = MR = AR curve on the top
2. ATC at my quantity on the bottom (not the lowest ATC)
3. Y-axis on left
4. Quantity on right
loss box
For negative profit, box is bounded by…
1. D = MR = AR curve on the bottom
2. ATC at my quantity on the top
3. Y-axis on left
4. Quantity on right
monopoly
Two characteristics:
1. One firm ONLY in the industry. No competition. The firm IS the industry.
2. HIGH ENTRY BARRIERS keep potential competition from entering the industry.
entry barriers
Things that make it difficult (or maybe impossible) for new firms to enter an industry.
“price maker”
A monopoly firm is a PRICE-MAKER. It is able to set its own price for the product and is not forced to accept, like perfectly competitive firms do, some other “market power” (ability to set its own price), whereas a perfectly competitive firm does not.
natural monopoly
If a monopoly exists from economies of scale, we call it a NATURAL MONOPOLY. So, a natural monopoly should see its average total cost decline as output increases in the long run, since that is one of the defining criteria of economies of scale.
monopolistic competition
Sort of a hybrid of the perfectly competition and monopoly
Four characteristics:
1. Lots of small firms and lots of customers
2. Freedom of entry and exit (no entry barriers)
3. Perfect information
(First 3 characteristics are the same as perfect competition)
4. Heterogeneity of product.
oligopoly
Three characteristics:
1. Small number of large firms
2. High entry barriers
3. Interdependence
interdependence
Decisions made by firms can depend on what other firms decide to do.
- Makes graphs largely useless at this level.
payoff matrix
Often used when dealing with oligopoly, and is connected to the concept of “student’s dilemma”
dominant strategy
Any strategy that happens to be the best option, regardless of what the other side does.
- May or may not exist, depending upon the numbers.
Nash equilibrium
A stable situation where each has chosen the strategy that best suits it, given the circumstances.
- Predictability + certainty
- If both sides have a dominant strategy, the Nash Equilibrium is where they both pursue it. If only, one side has a dominant strategy, assumes it pursues that strategy + the other side chooses its best option in response.
price leadership
One of the possible forms of oligopoly interaction:
- If one firm in an industry is older, bigger, more established than others, it might be looked to as an industry “leader.” If so, when it changes the price of its product, the other firms might follow its lead and do likewise.
- Not every oligopoly market has a price leader.
tacit collusion
One of the possible forms of oligopoly interaction:
- Working together in an understood way.
- When firms have certain unspoken, uncodified understandings with each other about what they will or will not do when it comes to prices, where or how they will operate, etc.
- Very common.
cartel action
One of the possible forms of oligopoly interaction:
- When firms make explicit agreements with each other about price, output, where and how they will operate, etc.
- In most cases, prohibited in the U.S. today by the antitrust law.
destructive competition
One of the possible forms of oligopoly interaction:
- Competition so intense that it could put firms, in an industry, out of business entirely.
- Firms keep lowering prices more and more in hopes of pulling customers away from competitors and perhaps even killing competitor firms entirely, knowing that it will mean big losses in the short term.
- Price war.
- Not common!!
price war
A form of destructive competition, which is not common, but is one of the possible forms of oligopoly interaction.
- Firms keep lowering prices more and more in hopes of pulling customers away from competitors and perhaps even killing competitor firms entirely, knowing that it will mean big losses in the short term.
product differentiation
How firms in an oligopoly market most often compete with each other
- Not through prices
- Providing other amenities to attract more customers to purchase from them
price discrimination
Charging different customers different prices for the same good.
