econ 102 kong cmp final review session 2014 fall benji huang › ... › 7 › 2014 › 12 ›...

Econ 102 – Kong

CMP final review session

2014 – fall

Benji Huang

agenda

1. monopoly

2. monopolistic competition

3. oligopoly

4. pre-midterm 2 problem set

monopoly – basic 1

def:

• market with only 1 firm

• no close substitute

• barrier to enter

no close substitute:

• cuz it’s the only firm in the market

• Bedaquiline (a.k.a Sirturo) – patented tuberculosis

medication by JNJ

• Paypal – undisputed market leader

• Monsanto – patented roundup ready corn

monopoly – basic 2

barrier to entry:

• natural monopoly

economies of scale, 1 firm is better than 2

e.g. BC Hydro

• ownership (of key resources)

e.g. Panama Canal

• legal

public franchise, patent, copy right

e.g. Coast Mountain Bus Company (public franchise)

monopoly – pricing 1

pricing context:

• monopoly has no competition

• sets the price it wants

• firm’s demand curve = market demand curve

2 strategies:

• single price: every unit same price

• used when monopolist can’t prevent reselling

• price discrimination: different units different price

• used when it is easy to tell apart different customers

• used when reselling is difficult


• marginal revenue: revenue from 1 additional unit

• math for marginal revenue:

• P = a + bQ

R = P*Q = aQ + bQ2

MR = dR/dQ = d(aQ + bQ2)/dQ

MR = a + 2bQ

• graph for marginal revenue:

• curve is 2x as steep

• same as price when Q = 0

• 0 when quantity is at midpoint, elasticity = 1...


• marginal revenue is

• > 0 when demand is elastic

• = 0 when demand is unit elastic

• < 0 when demand is inelastic

• conceptually:

• when P is in the elastic range, dropping P (increasing

Q) increases revenue, thus marginal revenue must be

positive.

monopoly – single pricing 1

• single-price monopolist’s price will always be in the

elastic range

• other-wise, firm can increase P (increase R) and

reduce cost (cuz TC drops when Q drops)

• math for single price max profit :

• Profit = R – C

MP = MR – MC

MP = 0 => Profit is greatest

0 = MR – MC => MR = MC

• conceptually:

• if extra unit earns more than it costs – make!

monopoly – efficiency 1

• monopoly CAN sustain positive econ profit in long run due

to no entrants

• does NOT mean monopoly will always make a profit

• single price monopoly vs perfect competition:

• perfect competition – efficient, optimal Q, optimal R,

highest total surplus

• single price monopoly – inefficient, P too high, Q too

low, DWL exists

• if all individual firms in a market merges into a monopoly

charging a uniform price - inefficient


• conceptually

• single price monopoly charges where MR = MC, but P >

MR, thus P > MC, thus marginal social benefit >

marginal social cost, thus DWL comes from surplus that

is not captured

• graphically

• PS increases by less than CS decreases: DWL

• rent seeking:

• def: economic rent – any surplus (CS or PS)

• tries to earn profit by capturing rent

• buy monopoly / make monopoly


• buy monopoly

• government can capture rent by issuing permit and

charging a fee– government revenue (not a social cost)

• monopoly owners can trade the permit

• buyers expend time to search – a social cost

• all these chip away from PS

• create monopoly

• lobbying, campaign donation (e.g. telecom)

• rent seeking equilibrium:

• with no barriers to buy or make monopoly, rent

seeking chips away all PS – increase DWL

monopoly – price discrimination 1

• conditions

• can distinguish between buyer

• low possibility of reselling

• types of price discrimination:

• discriminating among customers

• age, employment, health, credit history

• captures highest price of a buyer will pay

• discriminating among quantity of a good

• quantity discount, tier pricing

• captures buyer’s marginal benefit

monopoly – price discrimination 2

• price discrimination:

• turns some CS into PS

• lower price for marginal unit no longer means firm has

to lower price for all previous units!

• willing to sell as long as P > MC

• increases TS as Q increases

• perfect price discrimination:

• sell every unit at the highest price

• MR = demand curve

• market is efficient, turns all CS into PS

monopoly – regulation 1

• natural monopoly is often regulated

• ideally we should regulate (set rules for) natural

monopoly that can’t price discriminate

• why? single price monopoly creates DWL

• but deregulation (removing regulation) also works if

regulation is responsible for creating the monopoly in

the first place...

• social interest theory: political system is effective in

seeking out and eliminating inefficiency

• capture theory: producers can get politicians to act in

their interest cuz they have money


• ideal - marginal cost:

• forcing company to charge their MC

• market is efficient, optimal equilibrium

• but monopoly makes a loss

• two-part pricing /tariff can cover loss

1. base rate = MC (e.g. $/month)

2. one time fee (e.g. set up fee)

• other choices:

• average cost pricing: company must charge price =

ATC, but who know the true ATC? DWL still persist as

well.


• other choices (continued):

• government subsidy: paying firms directly to cover

their econ loss, but subsidy creates DWL

• rate of return regulation: ask monopoly to show it is

not making a profit, but firm can lie

• price cap: use a price ceiling designed to increase

output and reduce DWL; works if government can

correctly deduce ATC

practice – monopoly 1

A monopoly ________ make positive economic profit in the long run because ________.

A) can; barriers to entry prevent other firms from entering the market and sharing the profitB) cannot; eventually demand will decrease and prices will fallC) cannot; other firms will enter the market until all firms are making zero economic profitD) can; new technology constantly lowers costs for the monopoly firm and for its competitorsE) can; demand constantly increases and price constantly rises

2013 sample final, reproduced with permission from Wai Ching Kong


When perfect price discrimination occurs, which one of the following statements is false ?

A) Buyers cannot resell the product. B) The firm can distinguish between buyers. C) The firm sets prices. D) The firm captures consumer surplus. E) The outcome is less efficient than with single-price monopoly.



Which area in figure indicates the deadweight loss from a perfect price-discriminating monopoly?

A) EACFB) ACDC) ABDD) BCDE) None of the above.



Refer to table. If a perfect price-discriminating monopoly faces the demand schedule shown in Table 13.4.1 and if marginal cost is constant at $3, output is

A) 2 units. B) 3 units. C) 4 units. D) 5 units. E) 6 units.



Table shows the demand schedule faced by a monopoly. If the monopoly is a perfect price-discriminating monopoly the marginal revenue from the sale of the 3rd unit of output is

A) $2. B) $6. C) $4. D) $3. E) $5.



Figure shows a situation similar to that facing TransCanada, the firm that operates a natural gas distribution system in the United States. The firm is a natural monopoly that cannot price discriminate. What quantity will TransCanada produce and what is the price of natural gas if TransCanada is

a. Regulated to make zero economic profit? (2 points)

b. Regulated to be efficient? (2 points)



Briefly explain whether the following statements are true or false.a. “Because they can control product price, monopolists are always

assured of profitable production by simply charging the highest price consumers will pay.” (1 point)

b. “The monopolist seeks the output that will yield the greatest per-unit profit.” (1 point)

c. “An excess of price over marginal cost is the market’s way of signalling the need for more production of a good.” (1 point)


monopolistic comp. basic

• def:

• large number of firms (like pure competition)

• differentiated products

• compete on quality and price

• no barrier to entry (like pure competition)

• product differentiation:

• similar products, imperfect substitutes

• downward sloping demand curve, somewhat elastic

monopolistic comp. – pricing 1

• almost exactly the same as monopoly

• maximized profit by setting P & Q where MR = MC

• short run

• stay in business if P > AVC

• at least loss can be minimized

• long run

• stay un business if P > ATC

• differences from monopoly:

• entry is possible

• more firms, more substitutes, lower demand


• long run:

• demand shifts down until it is tangent to ATC

• firm produces the Q at the tangent point and make

zero profit

• differences from pure competition

• excess capacity (even in long run):

• because demand slops down

• firms do not produce Q at minimum point on ATC

(aka efficient scale)

• efficient scale - actual Q = excess capacity

• empty theatre seats, unsold food in stores


• differences from pure competition (cont.)

• markup: selling above marginal cost

• P – MC = markup

• conceptually:

because demand curve slopes down, MR = MC

but MR ≠ P so P ≠ MC

monopolistic comp. – efficiency

• inefficient in the sense that DWL exists

• P ≠ MC in the long run; some surplus is lost

• but consumers benefit from variety

• but social benefit of variety can’t be shown graphically

• variety is also costly (e.g. no cost of searching when

you only got one option!)

• true efficiency is where marginal benefit of variety =

marginal cost of variety

oligopoly – basic 1

• a few firms in the market

• interdependence (like monopolistic comp.)

• a firm is affected by decision of rival

• temptation to cooperate, form cartel by collusion and

price fixing (illegal)

• collectively act like a monopoly

• barriers to entry exist:

• natural oligopoly, when a few firms serve market

better than a lot of firms

• legal barriers: government licence


• oligopoly examples:

• Intel vs AMD

• Mac OS vs Windows

• Toyota vs GM vs Volkswagen

• Telus vs Rogers vs Bell

• in case you don’t know, Telus owns Koodo, Rogers

owns Fido, and Bell owns Télébec

• Duracell vs Energizer

• Boeing vs Airbus


• if firms act independently

• they set price to maximize individual profit

• competition between firms lowers price

• cartel:

• collusion to increase individual profit

• agree on slitting the monopoly Q

• however firms have incentives to cheat

because by producing more than the agreed

upon q, they can earn more individually at the

expense of the other firm

oligopoly – game

• in reality the same games operate in monopolistic market,

but due to the number of players, it is impossible to

model and analysis cost-effectively

• game theory (study of strategic behaviour)

• commonalities of most games

• rules (what can or can’t be done)

• strategies (player’s plan of action)

• payoffs (consequences of actions)

• outcome (how the game plays out)

oligopoly – static game 1

• games predict behaviour of firms in oligopoly, especially

with regard to cartel

• Nash equilibrium:

• def: given what the rival firm’s strategy, neither firm

regrets his own chosen strategy

• caveat:

• Nash equilibrium isn’t always the best

• there can be 0, 1, 2 or any number of Nash

equilibriums in a single game

• idea is that outcome is “unstable” unless it is a

Nash equilibrium


• dominant strategy:

• when a firm’s best response is the same regardless of

the rival’s strategy

• dominant-strategy Nash equilibrium:

• a special type of Nash equilibrium in which both firms

play their dominant strategy

• prisoner’s dilemma game:

• a special type of dominant-strategy Nash equilibrium

in which outcome is NOT ideal

• in the classic case, it is better for both prisoners to not

confess


• classic games:

• prisoner’s dilemma

• game of chicken:

• 2 Nash equilibriums (i.e. no unique Nash)

• in both equilibriums, one firm (the winner) makes

big bucks at the expense of the other (the chicken)

• repeated games:

• when the same game is played more than once by the

same players

oligopoly – repeated game 1

• in repeated games, firms can penalize the other for

cheating behaviours in future rounds

• cooperative equilibrium (e.g. collusion in the case of

oligopolies) MIGHT be possible

• ways to punish:

• trigger strategy: cooperate until the rival cheats, then

say “s{&ew it!” and play static game Nash equilibrium

forever after

• tit-for-tat: for every round, copy the rival’s decision to

cheat or comply in the last round

oligopoly – repeated game 2

• whether punishment strategy works depends on:

• how much firms value future income compared to

present income

• how many firms in the market and how easy it is to

detect cheating

• how many games will there be in the future

• oligopoly price wars in perspective:

• tit-for-tat punishment in play

• when firms are exhausted - cooperate again

• triggered by entrants, fluctuating demand

oligopoly – sequential game 1

• contestable market: no barrier to entry, incumbent firms

faces competition from potential entrants; can be

modeled by sequential games

• sequential game is played out in stages

• incumbent firm chooses an action in stage 1

• potential entrant chooses an action in stage 2

DEPENDING on the leader’s pervious action

• this is assuming that incumbent firm CAN’T change its

action in stage 2

oligopoly – sequential game 2

• deterring entry:

• incumbent chooses a price such that if the entrant

enters the entrant is guaranteed to make a loss

• therefore incumbent single price monopolies don’t

always choose to maximize profit

oligopoly – regulations

• anti-combine law: prevent cartel/collusion/price fixing

• why? competition is better; competition leads to greater

efficiency, higher total surplus

• criminal offense to arrange agreements on prices, force

retailers to charge a certain price

• price discrimination consistently favouring some buyers,

harms competition (usually in B2B setting) - illegal

• merger that harms competition is forbidden

• RBC and TD merger proposal broken up by gov.

• predatory pricing not allowed

practice – past material 1

A firm will want to increase its scale of plant if

A) it is persistently producing on the upward-sloping part of its short-run average total cost curve. B) it is persistently producing on the downward-sloping part of its short-run average total cost curve. C) it is producing below minimum efficient scale. D) marginal cost is below average total cost. E) marginal cost is below average variable cost.



The long-run average cost curve is the relationship between the lowest attainable average total cost and output, when plant size is ________ and labour is ________. The long-run average cost curve is made up of the segments of individual average ________ cost curves with the lowest average ________ cost for a given output.

A) varied; varied; variable; variableB) varied; varied; total; totalC) varied; held constant; variable; variableD) held constant; varied; total; totalE) held constant; varied; variable; variable



Refer to Figure which shows the total product curves for four different plant sizes as Tania varies the quantity of capital and workers. The curve that represents the plant using the largest amount of capital is

A) plant A. B) plant B. C) plant C. D) plant D. E) all curves because each

plant uses the same number of machines, just different amounts of labour.



Refer to Figure which illustrates the total product curves for four different plant sizes. One of the fundamental technological facts reflected in the shape of each of the total product curves is the

A) price of the inputs. B) price of the output. C) law of diminishing marginal

returns. D) law of economies of scale. E) fact that capital and

labour cannot be substitutedfor each other.



For perfect competition to arise, it is necessary that market demand be

A) inelastic.B) elastic.C) perfectly elastic.D) large relative to the minimum efficient scale of a single firm.E) small relative to the minimum efficient scale of a single firm.



Suppose a firm is trying to decide whether or not to temporarily shut down to minimize total loss. If price equals average variable cost, then

A) total revenue equals total fixed cost, and the loss equals total variable cost. B) total revenue equals total variable cost, and the loss equals total fixed cost. C) total fixed cost is zero. D) total variable cost equals total fixed cost. E) total cost equals total variable cost.



Refer to Table, which represents Swanky's production possibilities as the firm varies the quantities of knitting machines and workers per day. If Swanky increases the number of knitting machines from 2 to 3 and increases the number of workers employed from 2 to 3, the factory experiences

A) economies of scale. B) constant returns to scale. C) diseconomies of scale. D) constant marginal product. E) minimum efficient scale.



Refer to Table, which represents Swanky's production possibilities as the firm varies the quantities of knitting machines and workers per day. If Swanky increases the number of knitting machines from 1 to 2 and increases the number of workers employed from 1 to 2, the factory experiences

A) economies of scale. B) constant returns to scale. C) diseconomies of scale. D) constant marginal product. E) minimum efficient scale.



If price falls below minimum average variable cost, the best a firm can do is

A) increase production and incur a loss equal to total variable cost. B) increase production and incur a loss equal to total fixed cost. C) stop production and incur a loss equal to total fixed cost. D) stop production and incur a loss equal to total variable cost. E) stay at the same production level and incur a loss equal to the difference between total cost



Refer to Figure, which shows a perfectly competitive firm's total revenue and total cost curves. answer question on next slide



Refer to Figure in previous slide, which shows a perfectly competitive firm's total revenue and total cost curves. Which one of the following statements is false?

A) Economic profit is the vertical distance between the total revenue curve and the total cost curve. B) At an output of Q1 units a day, the firm makes zero economic profit. C) At an output greater than Q3 units a day, the firm incurs an economic loss. D) At an output of Q2 units a day, the firm incurs an economic loss. E) At an output less than Q1 units a day, the firm incurs an economic loss.



If a profit-maximizing firm in a perfectly competitive market is incurring an economic loss, then it must be producing a level of output where

A) price is greater than marginal cost. B) price is greater than marginal revenue. C) marginal cost is greater than marginal revenue. D) average total cost is greater than marginal cost. E) average total cost is less than marginal cost.



Technological change spreads through a perfectly competitive industry. Choose the statement that is incorrect.

A) The market price falls and the equilibrium quantity increases. B) The technological change brings permanent gains for consumers and producers.C) Firms that do not change to the new technology will incur an economic loss and eventually go out of business. D) Firms that are quick to adopt to the new technology will make economic profits initially, but in the long run they will make zero economic profit. E) Average cost will fall for firms who adopt the new technology.



Average variable cost is at a minimum at the same output at which

A) average product is at a maximum. B) average product is at a minimum. C) marginal product is at a maximum. D) marginal product is at a minimum. E) marginal cost is at a minimum.



Refer to Figure, which illustrates short-run average and marginal cost curves. Which one of the following statements is false? A) Average fixed cost decreases

with output. B) The vertical gap between curves

B and C is equal to average variable cost.

C) Line B comes closer to line C as output increases because of a decrease in average fixed cost.

D) Curve D is the marginal cost curve. E) The vertical gap between curves

B and C is equal to average fixed cost.



Which of the following quotes best illustrates the idea of marginal product?

A) "If I have 10 workers on my assembly line, I can produce 13 tables a day."B) "If I add an 11th worker, I can produce 1 extra table a day."C) "Each worker produces 2 tables a day."D) "I find if I add an extra shift at night, table production only rises by 80 percent because I need more maintenance time on the assembly line."E) "If I double workers and double the assembly line, I can make 120 percent more tables."



Which one of the following statements is true?

A) All technologically efficient methods are also economically efficient. B) All economically efficient methods are also technologically efficient. C) Technological efficiency changes with changes in relative input prices. D) Technologically efficient firms will be more likely to survive than economically efficient firms. E) none of the above



A firm that uses the latest technology ________ technologically efficient because ________.

A) is not necessarily; the firm might not use the least amount of inputs to produce a given outputB) is not necessarily; new technology is more expensive than old technologyC) is; efficiency is about costs rather than when the technology was developedD) is; new technology isn't developed unless it is efficientE) is; most consumers want access to the latest technology



A subsidy

A) raises marginal social benefit above marginal social cost.B) makes marginal social cost equal marginal social benefit.C) results in efficient production.D) raises marginal social cost above marginal social benefit.E) makes world prices higher than domestic prices.



Choose the correct statement.

A) When marginal product of labour is greater than average product of labour and marginal product is either increasing or decreasing average product of labour is increasing.B) When total product is increasing average product of labour and marginal product of labour are both increasing.C) When marginal product of labour is greater than or equal to average product of labour, average product of labour is increasing.D) When marginal product of labour is increasing, average product of labour is greater than marginal product of labour.E) When total product is increasing, average product of labour is decreasing and marginal product of labour is increasing.



The price of gasoline rises by 25 percent and remains fixed at the new higher level. Choose the correct statement. A) The demand for gasoline will increase after consumers adjust their consumption behaviour to the new higher price.B) The demand for gasoline will decrease after consumers adjust their consumption behaviour to the new higher price. C) Initially after the price change, the price elasticity of demand will be less elastic than it will be a few years after the price change.D) The price elasticity of demand for gasoline will decrease in the future.E) Initially after the price change, the price elasticity of demand will be more elastic than it will be a few years after the price change.



If the demand for a good is unit elastic, then a 5 percent increase in price results in

A) a 5 percent increase in total revenue. B) a 5 percent decrease in total revenue. C) no change in total revenue.D) an increase in total revenue greater than 5 percent. E) an increase in total revenue less than 5 percent.



A production possibilities table for two products, corn and paper, is found below. Usual assumptions regarding production possibilities are implied. Corn is measured in tons, and paper is measured per unit.



refer to table in previous slide

a. What is the opportunity cost of producing the first unit of paper? (1 point)

b. What is the opportunity cost of producing the fourth unit of paper? (1 point)

c. Explain how increasing opportunity costs are reflected in the production possibilities curve. (1 point)



Harvey quit his job where he earned $45,000 a year. To start the business, he cashed in $100,000 in bonds that earned 10 percent interest annually to buy a software company, Extreme Gaming. In the first year, the firm sold 11,000 units of software at $75 for each unit. Of the $75 per unit, $55 goes for the costs of production, packaging, marketing, employee wages and benefits. His company rented a building for $200,000 per year. Harvey also required a normal profit of $50,000 a year. Explain whether Harvey has made a good decision. (2 points)



Briefly discuss the three factors that influence the elasticity of demand. (3 points)



Business people speak about price elasticity of demand without using the actual term. Which one of the following statements reflects inelastic demand for a good?

A) "A price cut won't help me. It won't increase sales, and I'll just get less money for each unit." B) "I don't think a price cut will make any difference to my bottom line. What I may gain from selling more I would lose on the lower price." C) "My customers are real bargain hunters. Since I set my prices just a few cents below my competitors, customers have flocked to the store, and sales are booming." D) "With the recent economic recovery, people have more income to spend and sales are booming, even at the previous prices." E) both A and B


econ 102 kong cmp final review session 2014 fall benji huang › ... › 7 › 2014 › 12 ›...

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