Week 3: Monopoly, monopolistic competition, oligopoly and government Intervention

Question 1

Six characteristics of monopoly

Answer 1

1. high barriers to enter market, no close substitutes
2. only one firm
3. sold quantity can only increase if price is lowered
4. price is higher than marginal revenue
5. demand curve is average revenue curve
6. is able to manipulate the price

Question 2

Four consequences of monopoly

Answer 2

1. results in high prices
2. results in low quantities sold
3. results in high monopoly profits
4. results in a total welfare loss (deadweight loss) as profits increase less than consumer surplus falls

Question 3

Definintion price discrimination

Answer 3

Charging different prices for different groups of customers

Question 4

Three conditions of price discrimination

Answer 4

1. It must be possible to distinguish the different groups clearly
2. both groups cannot trade the product with each other
3. elasticity of demand strongly differs for the different groups

Question 5

Seven assumptions/characteristics of monopolistic competition

Answer 5

1. many suppliers, many buyers and a heterogeneous differentiated product
2. Market behaviour of 1 firm does not have any influence on the market
3. the goal of firms is maximizing profit
4. firms have more or less identical cost structures (identical cost curves)
5. firms are able to manipulate their price
6. in the long run there are no barriers to entry or exit of firms
7. firms compete on product quality, price and marketing

Question 6

Differences between monopoly and monopolistic competition

Answer 6

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Question 7

Four characteristics of oligopoly

Answer 7

1. only a limited number of firms are active
2. If there are only two firms: duopoly
3. usually some barriers to entry, or some economies of scale
4. profits not only depend on the decisions (price) of the firm but also on the decisions of its competitors

Question 8

Game theory & its strategy for profit maximalisation

Answer 8

Oligopolistic model. Whatever strategy the competitor chooses, it will be most attractive to spend a lot on advertising

Question 9

Cartel and its profit maximalisation

Answer 9

Oligopolistic model, however cartel works as a monopoly as it uses monopolistic pricing.

Question 10

Monopolistic pricing

Answer 10

Pricing strategy followed by a seller whereby the seller prices a product to maximize his or her profits under the assumption that he or she does not need to worry about competition.
Remember: price above marginal revenue; demand curve is average total revenue curve and a higher quantity can only be sold when price decreases

Question 11

The five problems of cartels

Answer 11

1. with too many firms it is difficult to make arrangements
2. free-rider problem, participants have an incentive to cheat and to produce too much
3. high prices and high profits attracts competitors
4. for an individual firm it is attractive to remain outside cartel (freedom to decide how much to produce and sell it at a self-designed price)
5. cartels and collusion to manipulate prices are prohibited

Question 12

Five main micro-economic government measures

Answer 12

1. price floors/ price guarantees
2. subsidies on production
3. taxation
4. price ceilings/ price support
5. quota

Question 13

Price floors/ price guarantees & consequences

Answer 13

minimum prices. Often combined with the government buying the overproduction at a set price.

• Leads to overproduction, extra costs on the government (that will sell it for a low price on the world market)
• Leads to deadweight loss as it blocks certain transactions

Question 14

Quota and consequences

Answer 14

maximum production to create higher prices and protect producers.
When set lower than q equilibrium, will lead to deadweight loss

Question 15

Price ceiling/ maximum price: aim and consequence

Answer 15

protecting consumers for high prices

welfare loss, less quantity offered

Question 16

Subsidy consequences

Answer 16

• Higher quantity; lower prices and higher MC
• Welfare loss
• Increase in consumer and producer surplus due to the cost of subsidy being higher than the welfare gain

Question 17

Societal welfare and Pareto

Answer 17

Societal welfare is at its maximum if no potential Pareto improvement is possible
Potential Pareto improvement is seen as a rise in welfare

Question 18

Potential Pareto improvement

Answer 18

An improvement to a system when a change in the allocation of goods harms no one and benefits at least one person.

Question 19

Seven reasons for government intervention justifies by economic theory

Answer 19

1. protection of property rights
2. public goods
3. semi-public goods (cost of collection high)
4. merit and demerit goods
5. redistribution of income
6. fighting unemployment
7. monopoly pricing and cartels (as it generates welfare loss)
8. taxation
9. positive and negative external effects

Question 20

Three types of monopolies

Answer 20

1. legal monopoly: patents to stimulate innovation
2. cartel: oligopolistic firms working together
3. natural monopoly (high fixed costs or only one place where a natural resource can be found)

Question 21

Four characteristics of natural monopoly

Answer 21

1. TFC are huge
2. ATC will diminish at high production
3. MC of extra production is low
4. to have one firm is economically the most efficient (having the lowest average costs)

Question 22

Taxation and elasticities

Answer 22

The more inelastic the demand, the higher the share in the tax that consumers have to pay (huge price increase)
The more inelastic the supply, the higher the share in the tax the producers have to pay (limited price increase)
The more inelastic demand or supply, the higher the
tax revenue as the quantity sold hardly diminish

Question 23

negative externalities

Answer 23

A cost that is suffered by a third party as a consequence of an economic transaction.
Without intervention lower price and higher quantity than with governmental intervention.
-> MSC is higher than MC, leading to a welfare loss

Question 24

Four solutions to negative external effects

Answer 24

1. government intervention creates a welfare optimum, which eliminates the deadweight loss. Government regulation and quotas (to mandate clean technology)
2. Coase theorem: allocate property rights to one of the parties involved. problem: high transaction costs of negotiations
3. taxation of polluting production or taxation of pollution directly
4. Marketable/ tradable permits; cap-and-trade. Advantage: you can control the total pollution in an efficient way. Problem: government needs to know firms’ production costs

Question 25

Coase theorem

Answer 25

allocate property rights to one of the parties involved. Problem: high transaction costs of negotiations

Question 26

merit goods

Answer 26

The government thinks that the consumption of certain products have very positive effects, where people themselves are not aware of. Also people do not take the long term beneficial effects enough into account

Question 27

demerit goods

Answer 27

The government thinks that people are not aware of the disadvantages of consuming certain products. Also, people do not take the long term negative effects enough into account.

Question 28

Four characteristics of perfect competition

Answer 28

1. large number of firms 2. produce at lowest cost possible 3. make zero profit in long run 4. firms are efficient

Question 29

Large number of firms implies

Answer 29

1. small market share 2. ignore other firms 3. Collusion is impossible

Question 30

Maximum profit according to cost and revenue functions

Answer 30

maximum profit is where MC equals MR

Question 31

Two differences between monopolistic competition and perfect competition

Answer 31

1. excess capacity in monopolistic competition, whereas it doesn't exist in perfect competition (due to ATC being at its lowest) 2. markup exist in monopolistic competition but not in perfect competition. Markup is the price that exceeds marginal cost in perfect competition, the price equals marginal cost

Question 32

Efficient degree of product variety

Answer 32

Marginal Social Benefit = Marginal Social Cost

Question 33

Consequences of small number of firms in the market

Answer 33

interdependence: each firm's actions influence profits of all other firms temptation to cooperate: cartel would limit output, whereas price and economic profit would increase

Question 34

Two theories on regulation

Answer 34

Social interest theory: political and regulatory process relentlessly seek out inefficiencies and introduce regulation eliminating deadweight loss and allocate resources efficiently Capture theory: regulation serves self-interest of producer who captures the regulator and maximises economic profit

Question 35

Marginal cost pricing rule

Answer 35

regulation for monopoly rule setting price equal to marginal cost (no mark up) Reaction company to cover ATC: two-part tariff: one-time connection fee, plans at fixed prices with afterwards free access

Question 36

average cost pricing

Answer 36

regulation for monopoly | price equals ATC: creates deadweight loss

Question 37

government subsidy in regulation

Answer 37

Monopoly regulation | direct payment to firm equal to its economic loss: taxes create deadweight loss

Question 38

Three regulations for monopoly

Answer 38

1. marginal cost pricing rule 2. average cost pricing rule 3. government subsidy

Question 39

antitrust law

Answer 39

regulates oligopolies preventing them from becoming monopolies or behaving like them. Synonym: competition and monopoly law

Question 40

three main methods of intervention in market for farmers products

Answer 40

1. quota: upper limit to the q of a good that may be produced, decrease in s, rise in p, decrease in MC, inefficient underproduction, incentive to cheat and overproduce 2. production subsidy: increase in t, fall in p and rise in q, increase MC, inefficient overproduction 3. price support: rise in p, increase in MC, inefficient overproduction

Question 41

Fourfold classification of goods

Answer 41

private goods: excludable and rival public goods: non-excludable and non-rival common ressources: non-excludable and rival natural monopoly good: non-rival and excludable

Question 42

Tragedy of commons

Answer 42

problem for common ressources where overconsumption and underinvestment lead to depletion of a common ressource

Question 43

Rational ignorance

Answer 43

it's rational for a voter to be ignorant about an issue unless that issue has a perceptible effect on voter's economic welfare

Question 44

Positive externalities

Answer 44

biggest two mixed goods: education and healthcare | social benefits exceed private benefit

Question 45

Marginal Social Benefit

Answer 45

MSB= MB + marginal external benefit marginal benefit enjoyed by society Demand is MSB

Question 46

marginal external benefit

Answer 46

benefit from an additional unit of a good or a service that people other than its consumer enjoy

Question 47

Tax incidence & factors it is dependent on

Answer 47

division of burden of a tax between buyers and sellers ``` elasticity of supply and demand elastic supply: sellers pay tax elastic demand: buyers pay tax inelastic supply: buyers pay inelastic demand: sellers pay ```

Question 48

When is tax efficient?

Answer 48

when there is no deadweight loss, meaning that in perfectly inelastic demand and supply situations, q bought and sold doesn't change. -> no deadweight loss

Question 49

Two principles of fairness for a tax system

Answer 49

benefits principle: people should pay taxes equal to benefits they receive from services provided by government ability-to-pay principle: people should pay taxes according to how easily they can bear burden of tax

Question 50

Pigovian tax

Answer 50

incentivize producers to cut back on pollution | setting tax rate equal to marginal external cost