Market types

Question 1

Assumptions of perfect competition

Answer 1

Sellers and buyers are price takers

There is free entry in the long run

Question 2

When are the perfect competition assumptions likely to hold?

Answer 2

• there are many buyers and sellers
• firms produce homogeneous products
• consumers have full information
• transaction costs are negligible
• there are no market barriers

Question 3

Ad valorem tax

Answer 3

When the tax is a % of the value of the good being taxed (e.g VAT)

Question 4

Specific or unit tax

Answer 4

Tax is a specified amount in £ collected per unit of output

Question 5

Statutory incidence

Answer 5

Who is legally responsible for paying the tax?

Question 6

Economic incidence

Answer 6

What is the actual change in the distribution of income brought about by the tax

Question 7

What does the economic incidence depend on?

Answer 7

The price elasticity of supply and demand

Question 8

When is the economic incidence entirely on the consumer?

Answer 8

When supply is perfectly elastic

Question 9

Causes of monopoly

Answer 9

Cost advantages
•superior technology or organisation
•exclusive control over an important production input
•natural monopoly where average cost curve is always downwards sloping

Government intervention
•where government is sole provider of good or service
•patents create temporary monopoly to encourage innovation

Question 10

When will a monopoly shut down?

Answer 10

If revenue < variable cost

Question 11

At what output do monopolies produce at?

Answer 11

Where MC=MR

Question 12

Marginal revenue for monopoly

Answer 12

MR= dR(Q)/dQ= dp(Q)/dQ xQ + p(Q)

Question 13

How can marginal revenue for a monopoly be written as a function of price elasticity of demand and what does this imply

Answer 13

MR= p(Q) x (1+ 1/Ed)

That the firm will never operate on the inelastic part of the demand curve

Question 14

What are methods of preventing or regulating monopolies?

Answer 14

Structural remedies: alter an industry’s structure to make it more competitive. Could block mergers, force companies to restructure and even break up companies

Conduct remedies: restrict a monopolists behaviour without changing the underlying market structure

Question 15

Problems with price regulation

Answer 15

• regulator only has limited information about demand and marginal cost curves, so it is hard to set a price
• the monopolist must be allowed to mags at least zero profits, for a natural monopoly if p=MC the firm will shut down
• regulatory capture: monopolist have better info about curves so must be involved in regulation. This leads to regulator becoming too closely alliance with the firm

Question 16

Price discrimination

Answer 16

When a firm charges consumers different prices for the same good for reasons not associated to cost

Question 17

First degree price discrimination

Answer 17

Perfect price discrimination where each unit is sold for the customers reservation price

Question 18

Second degree price discrimination

Answer 18

Price varies with the quantity purchased, but all customers who buy a given quantity pay the same price

Question 19

Third degree price discrimination

Answer 19

Firms charge different groups of customers different prices

Question 20

What are the necessary conditions to be able to price discriminate?

Answer 20

1. The firm must have market power
2. The firm must be able to identify which customers are willing to pay more
3. The firm must be able to prevent resale between customers

Question 21

Is 1st degree price discrimination efficient?

Answer 21

Yes since the profit maximising output is the same as in perfect competition but this time there is no consumer surplus since it is all taken by the producer

Question 22

What does price discrimination do to welfare, consumer surplus and producer surplus when compared to a normal monopoly?

Answer 22

Welfare increased
Consumer surplus decreased
Producer surplus increased

Question 23

In 3rd degree price discrimination which group is charged the higher price?

Answer 23

The group that is less elastic

Question 24

Assumptions of monopolistic competition

Answer 24

1. Firms are price makers
2. Buyers are price takers
3. There is free entry in the long run

Question 25

Assumptions that sellers have market power is more likely if one or more of the following hold

Answer 25

* there are few firms in the market * firms produce heterogeneous products * imperfect information and transaction costs may be present

Question 26

How do firms in monopolistic competition behave in SR and LR?

Answer 26

In SR, firms behave like monopolists | In LR, entry shifts demand curve inwards until AC=p and so each firm faces zero economic profits

Question 27

Is monopolistic competition efficient?

Answer 27

* firms produce where MC=MR

MC which isn’t efficient * firms produce where AC is not minimised, this is called excess capacity problem * excess capacity problem ignores that consumers value variety and there is greater variety with more firms

Question 28

What does the number of LR firms in monopolistic competition depend on?

Answer 28

Fixed costs. If fixed costs are high there will be fewer firms

Question 29

How does the entry of a third firm effect welfare, consumer surplus and producer surplus?

Answer 29

Increases consumer surplus Decreases producer surplus Welfare depends on the case

Question 30

Game theory

Answer 30

A set of tools to analyse strategic decision making of rational individuals

Question 31

Payoff function

Answer 31

Specifies each players payoff as a function of the actions chosen by all players

Question 32

Dominant strategy

Answer 32

A strategy that produces a higher payoff than any other strategy the player can use for every possible combination of their rivals outcome. A rational player must play a dominant strategy if they have one

Question 33

Nash equilibrium

Answer 33

A set of strategies such that, when all players use these strategies no player can obtain a higher payoff by choosing a different strategy

Question 34

When does a Nash equilibrium occur?

Answer 34

When both firms are using a best response

Question 35

Assumptions of models about oligopolies

Answer 35

* sellers have market power and behave strategically * buyers are price takers * there are significant barriers to entry even in the long run

Question 36

Why do oligopolies have an incentive to form a cartel?

Answer 36

Forming cartels allows the firms to behave like a monopoly and increase profits

Question 37

Detecting and punishing cheating firms is easier if

Answer 37

* you have access to firms cost and revenue functions * it is easier to monitor rivals’ output levels and prices * there are fewer firms * product differentiation means lower profit from cheating, punishment is less effective, more complex agreements are needed

Question 38

Cournot model

Answer 38

Explains how oligopolies behave if they don’t collude

Question 39

Residual demand curve

Answer 39

Market demand not met by other seller at any given price

Question 40

Where is the cournot equilibrium

Answer 40

Where the firms beat response functions intersect. No firm has an incentive to deviate from this quantity

Question 41

Bertrand model

Answer 41

Oligopoly model where firms choose rices rather than quantity

Question 42

Nash Bertrand equilibrium

Answer 42

Where all firms in the market price at p=mc giving the same outcome as perfect competition

Question 43

Why doesn’t the Nash Bertrand equilibrium occur in real life?

Answer 43

* firms actually set quantity not price in homogeneous markets * in most markets products are differentiated so dropping price doesn’t mean every customer will buy your goods

Question 44

Key features of demand functions for differentiated products

Answer 44

* demand decreases with own price, increases with competitors price * firms don’t lose all sales if price is slightly higher than competitor’s * demand changes smoothly with price * products are imperfect substitutes

Question 45

What is the difference in cournot best response functions and betrand best response functions

Answer 45

Cournot’s are downward sloping | Bertrand’s are upward sloping

Question 46

How efficient is the Bertrand model when products are differentiated?

Answer 46

P>MC so not perfect competition outcome

Question 47

Which of the following statements about a profit maximising, perfectly competitive firm is false? A) the firm will expand output until MC=P B) the firm will expand output until MC=MR C) the firm will shut down if p

Answer 47

D) the firm will operate where ac are minimised