AP Microeconomics

Review #4

Market Structure

The nature and degree of competition between firms in the same industry

4 Categories:1. Perfect Competition2. Monopolistic Competition3. Oligopoly4. Monopoly

MonopolyPrice-Maker, only provider of product,

perfectly inelastic goodStill faces elasticity…there is a limit to how

high they can raise pricesDownward sloping demand and MR curve

Monopoly

Lerner Index: Measures pricing

power of firms How much can the

firm charge for product over cost of product?

(P – MC)

P

Herfindahl Index: Measures the size

of a firm compared to its industry

Bigger the size = more market power

Graph:

Price & Cost

Output

Demand

MR

MR will cross the x-axis at demand’s

midpoint; this helps to show

elasticity!!

MC

AC

QX

PX

Profit

Cost

Total Revenue

Cons. Surplus

P = MC; allocative efficient, if perfect comp where Px = price of resources

Dead Weight Loss; waste

Types of Monopolies

Natural Monopolies (regulated) Better for whole to have one efficient supplier of

product; large companies show economies of scale as they grow

Ex) utilities Gov’t will choose fair-return price (P = AC)

Unregulated Monopolies Illegal in the country Sherman, Clayton, Justice Dept., ICC, FTC,

etc.

Monopolistic Competition Characteristics:

Many firms Very similar

products Product

differentiation (advertising) leads to pricing power (P>MC)

No barriers to entry

Graph: Same graph as

monopoly; all represent imperfect competition

Why?1. Has some price

power, therefore downward sloping MR!!!

2. Both Lerner and Herfindahl index are much lower than monopoly though!!!

Long Run Equilibrium

Why?1. LR means making profit

and can expand

2. Very similar products and no barriers to entry means more firms will enter a profitable market.

3. Demand for individual firms decrease as more suppliers enter driving down profits!!

Graph:

Output

Price & Cost

D

MR

MC

QX

PX

LRAC

Oligopoly

Price Leader One major firm and a few small firms

Cartel Firms working together to set price and quantity

(collusion)

Kinked Strategy Game; follow for a price drop but not

for a price raise

Kinked Graph:

Output

Price & Cost

Demand

MR

MC

QX

PX

ATC

Profit

Game Theory

Strategy theory that choices made by players based on the reaction expected by opponents.

Dominant Strategy: a strategy that is best no matter what the opposition does

Nash Equilibrium: the result of all players playing their best strategy given what their competitors are doing.

Game Theory Circle Test: use to find dom. strategy: circle your

opponents best move based on your move; if player gets two circles in same decision, then it is a dominant strategy

Left Right

Top +100, 0+100, +100

Bottom

-100, 0+200, +100

Rick

Jim

If Jim Chooses Top, Rick’s best

move:

If Jim Chooses Bottom, Rick’s

best move:

Rule, since both circles are in Rick’s right option it is his dominant strategy!!

Does Jim have a dominant strategy?

No, his best results are in different choices!!

Best Play: Rick will always choose Right,Jim will see Rick’s strategy and

will always choose Bottom

A.P. Microeconomics

Have out Unit IV Review Sheet!!

Market Failures & Need for Govt

When the market (firms & households) cannot determine price or quantity there is a need for gov’t to do so!!

Externalities

Unintended side effects of an economic decision-activity

Negative: pollution

Gov’t taxes firm the value of social costPositive: education & smoke detectors

Gov’t subsidizes firm value of benefit

Internalizing ExternalitiesGRAPH:

Quantity

Price

Output

CostS0

D

MR

MC

QX

MSCS1

PX

Pnew

Taxes on the firm will decrease supply and thus raise the price

Public Goods

Free Rider:

People can receive and never pay for them

Rent:

Getting more money than what is deserved, P > MC

Goods which are non-exclusive; Private firms won’t offer because can’t deny Gov’t must provide with tax revenue

Imperfect InformationCaveat emptor, let the buyer bewareTruth in advertising lawsGov’t agencies to regulate firm’s

(FDA)Imperfect Competition

Monopolistic, Oligopoly, & MonopolyAnti-trust laws & regulatory agencies

(FTC, ICC, SEC)

Efficiency Allocative Efficiency

P = MC Resources are being

used efficiently to produce all society would like to have

PX = value of output MCX = value of

inputs to make the output

Pareto Efficiency An improvement for

society as long as some people are gaining without others losing

If efficient to begin with, there are no improvements possible without hurting some people.

Must weigh costs & benefits

Income Redistribution Haves:1. Family $

2. Talent - Skill

3. Education

4. Power – Connection

5. Luck

Have-Nots:-below poverty level

Economic Stabilizers:

Ways for gov’t to help:

-welfare, food stamps, WIC, HEAP, SSI, unemployment, housing, loans.

Transfer Payments: $ the gov’t gives w/o anything in return

The Lorenz CurveMeasures Income

Distribution of entire nation’s population; compare to perfect equality. Population is ranked and then split into fifths (quintiles) and studied.

GRAPH:

% OF HOUSEHOLDS

%

OF

INCOME

Perfect Equality

Lorenz Curve

Inco

me

Gap