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Answer & Explanation:Microeconomic 30 multiple choice questionsStudy guideChapter 14. Monopoly and monopolistic competition
Chapter 15. Oligopoly and antitrust policy
Chapter 17. Work and the labor market
Chapter 20. Game theory, strategic decision making, and
behavioral economics
Chapter 18. Who gets what? The distribution of incomeEcon Study Guide.doc 
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Chapter 14
1. Summarize how and why the decisions facing a monopolist differ from the collective decisions of
competing firms.
2. Determine a monopolist’s price, output, and profit graphically and numerically.
3. Show graphically the welfare loss from monopoly.
4. Explain why there would be no monopoly without barriers to entry.
5. Explain how monopolistic competition differs from monopoly and perfect competition.
1. Monopoly: a market structure in which one firm makes up the entire market. It is the complete opposite to
competition.
• Monopolies exist because of barriers to entry (legal, sociological, natural, or technical).
• Monopolists produce where MR = MC, not P = MR = MC as competition. If MR > MC : increase
production. If MR < MC: decrease production. Goal is to maximize total profits not profit per item. • MR is lower than P for monopolists. The big difference between this and a competitor’s table is that marginal revenue changes and is not equal to the price. A monopolist sees that if it produces more, the price will be fall. • If the monopolist increases output from 4 to 5, the price it can charge falls from $24 to $21, and revenue increases from $96 to $105, so marginal revenue is $9. MR = change in TR – change in quantity • Determine price, output, and profit graphically P MC D at Qprofit max P ATC Profits MC = MR D MR Q Qprofit max P ATC at Qprofit max MC ATC Losses MC = MR D MR Qprofit max Natural monopoly MC curve is below ATC curve so ATC is always falling. To maximize profit, still produce where MR = MC Q Average Cost PM Profits CM CC PC Losses MR QM QC ATC MC D Q - A natural monopolist produces Qm and charges Pm, therefore earning a profit - If there is government regulation and the monopolist is forced to charge the competitive price, the monopolist produces Qc and charges Pc, therefore earning a loss - Price discrimination: charge consumers with a less elastic demand curve a higher price. • Monopolistic Competition: “A market structure in which there are many firms selling differentiated products and few barriers to entry.” Produce where MR = MC. MR is lower than P. Graphically, monopolistic competition looks very similar to monopoly. The graphs in “Determining price, output, and profit” for monopoly can be used here for monopolistic competition but let me use a different graph. • The firm’s profit-maximizing output and price: 4 units at a price of $4 each. Profit: the monopolist earns $1 of profit on each unit, for a total profit of $4. Do you see how the profit maximizing level of output is determined? Remember MR = MC rule? Now, can you draw the MR curve so you can set MR = MC? • Like perfect competition, make zero economic profit in the long run. Difference is perfect competition: P = ATC = MR = MC. Monopolistic competition: P=ATC > (MR = MC). ATC is not at its minimum
•
•
If making positive economic profit in the short run, new firms will enter the market and profit returns to
zero
The graph below shows the difference between perfect competition and monopolistic competition in the
long run. The subscript PC stands for perfect competition and MC is for monopolistic competition.
An important difference between a monopolist and a monopolistic competitor is the position of the average total
cost curve in long-run equilibrium. For a monopolist, the average total cost can be below price. That means in
the long run, monopolists can make positive economic profit but monopolist competitors can’t.
• Monopolistically competitive firms have a strong incentive to advertise, because advertising
plays an important role in the differentiation of products. The goals of advertising are to shift
the firm’s demand curve to the right and make it more inelastic
Advertising shifts ATC curve up. It only makes sense to advertise if marginal benefit > marginal cost.
P
MC
P
D
MR
Q
Q
Chapter 15: Obligopoly and Anti-trust Laws
–
Few large firms control most of the market
Significant barrier to entry
Firms are interdependent, taking explicit account of a rival’s expected response to a decision they are
making. This can be collusive or non-collusive.
Implicit Price Collusion: is not against the law. Allow a price leader to set the price and the other firms follow
suit.
Why are prices sticky?
P
If P increases, others won’t go
along, so D is elastic
MC1
P
MC2
Gap
MR
D
Q
Q
If current price is P and the firm increases its price, others won’t follow, so % change in Qd > % change in P, D
is elastic (red portion)
If the firm decreases price, others will follow, so D is inelastic (blue portion)
Price does not change when MC fluctuates within the gap.
Antitrust policy
Concentration ratio:
Herfindahl index: how to calculate it. Look at questions 9 and 10 of Chapter 15.
Sharman Antitrust Act & study cases (Microsoft, AT&T, etc).
Chapter 20
Prisoner dilemma: two a well-known two-person game that demonstrates the difficulty of cooperative behavior
in certain circumstances
Nash equilibrium: a set of strategies for each player in the game in which no player can improve his or her
payoff by changing strategy unilaterally
Dominant strategy: a strategy that is preferred by a player regardless of the opponent’s move
B
CONFESS
5 years for A
A
CONFESS
X
X
10 years for A
DOESN’T
CONFESS
DOESN’T
CONFESS
A goes free
5 years for B
A
B
X
B goes free
X
10 years for B
6 months for
A
6 months for B
Both A and B have a dominant strategy and that is to confess. Nash equilibrium is box 1 (when both players end
up in one box, we have a Nash equilibrium)
Chapter 17: Labor Market.
–
When the wage is higher, leisure has a higher opportunity cost. As the cost of leisure goes up, you buy
less of it (you work more).
–
The elasticity of the market supply curve is determined by the elasticity of individuals’ supply curves
and by individuals entering and leaving the labor force
–
If a larger number of people are willing to enter the labor market when wages rise, then the market labor
supply will be highly elastic even if individuals’ supply curves are inelastic.
–
The elasticity of supply also depends on the type of market being discussed; the supply of labor for one
firm of many will be more elastic than the supply facing all firms.
–
Existing workers prefer inelastic labor supplies because an increase in demand for labor will increase
their wage by more. Employers prefer elastic supplies because an increase in demand for labor doesn’t
require large wage increases
–
The demand for labor follows the basic law of demand: the higher the wage, the lower the quantity of
labor demanded
–
Derived Demand: “The demand for factors of production by firms, which depends on consumers’
demands.”
–
The elasticity of the derived demand for labor depends on a number of factors: the elasticity of demand
for the firm’s good (the more elastic the final demand, the more elastic the derived demand); the relative
importance of the factors in the production process (the more important the factor, the less elastic is the
derived demand); the possibility of, and cost of, substitution in production (the easier substitution is, the
more elastic is the derived demand); and the degree to which marginal productivity falls with an increase
in labor (the faster productivity falls, the less elastic is the derived demand).
–
A perfectly competitive firm has more elastic derived demand for labor than does a monopolist. Why?
–
Monopsony: “A market in which a single firm is the only buyer.” Example: a “company town” where a
single firm is the only employer. Just as a monopolist takes into account the fact that if it sells more it
will lower the market price, the monopsonist takes into account the fact that it will raise the market price
if it buys more.
Bilateral Monopoly: “A market with only a single seller and a single buyer.”
Marginal
Factor Cost
W
S
In a competitive labor market,
equilibrium is WC and QC
Monopsony equilibrium is at
point A where fewer workers are
hired, QM, and the wage, WM
WU
A
A union pushes for a higher
wage, WU, and a lower quantity of
workers, QU
WC
WM
D
MR
Q
QU QM QC
Chapter 18:
–
Lorenz Curve: “A geometric representation of the share distribution of income among families in a
given country at a given time.”
A perfectly equal distribution of income would be represented by a diagonal. An unequal distribution of
income is represented by a Lorenz curve that’s below the diagonal line.
Cumulative
% of income
100
Line of
absolute
equality
80
Japan
60
Sweden
U.S.
40
20
Brazil Cumulative
% of Families
0
20
40
60
80
100
The further the Lorenze curve from the line, the less income is equally distributed. From the graph
above, Brazil has least income equality.
For the US, the poorest 20% has less than 5% of income. The richest 20% has about 50% of total
national income.
•
Poverty Threshold: “A family is in poverty if its income is equal to or less than three times an
average family’s minimum food expenditures as calculated by the U.S. Department of
Agriculture.”
•
“The Gini Coefficient” — Economists also use Gini coefficients to talk about the degree of
inequality. The Gini coefficient is calculated using the Lorenz curve. The area between the Lorenz
curve and the diagonal is divided by the entire area underneath the diagonal. A Gini coefficient of
0 represents perfect equality; a Gini coefficient of 1 represents perfect inequality.
Chapter 14
1. Summarize how and why the decisions facing a monopolist differ from the collective decisions of
competing firms.
2. Determine a monopolist’s price, output, and profit graphically and numerically.
3. Show graphically the welfare loss from monopoly.
4. Explain why there would be no monopoly without barriers to entry.
5. Explain how monopolistic competition differs from monopoly and perfect competition.
1. Monopoly: a market structure in which one firm makes up the entire market. It is the complete opposite to
competition.
• Monopolies exist because of barriers to entry (legal, sociological, natural, or technical).
• Monopolists produce where MR = MC, not P = MR = MC as competition. If MR > MC : increase
production. If MR < MC: decrease production. Goal is to maximize total profits not profit per item. • MR is lower than P for monopolists. The big difference between this and a competitor’s table is that marginal revenue changes and is not equal to the price. A monopolist sees that if it produces more, the price will be fall. • If the monopolist increases output from 4 to 5, the price it can charge falls from $24 to $21, and revenue increases from $96 to $105, so marginal revenue is $9. MR = change in TR – change in quantity • Determine price, output, and profit graphically P MC D at Qprofit max P ATC Profits MC = MR D MR Q Qprofit max P ATC at Qprofit max MC ATC Losses MC = MR D MR Qprofit max Natural monopoly MC curve is below ATC curve so ATC is always falling. To maximize profit, still produce where MR = MC Q Average Cost PM Profits CM CC PC Losses MR QM QC ATC MC D Q - A natural monopolist produces Qm and charges Pm, therefore earning a profit - If there is government regulation and the monopolist is forced to charge the competitive price, the monopolist produces Qc and charges Pc, therefore earning a loss - Price discrimination: charge consumers with a less elastic demand curve a higher price. • Monopolistic Competition: “A market structure in which there are many firms selling differentiated products and few barriers to entry.” Produce where MR = MC. MR is lower than P. Graphically, monopolistic competition looks very similar to monopoly. The graphs in “Determining price, output, and profit” for monopoly can be used here for monopolistic competition but let me use a different graph. • The firm’s profit-maximizing output and price: 4 units at a price of $4 each. Profit: the monopolist earns $1 of profit on each unit, for a total profit of $4. Do you see how the profit maximizing level of output is determined? Remember MR = MC rule? Now, can you draw the MR curve so you can set MR = MC? • Like perfect competition, make zero economic profit in the long run. Difference is perfect competition: P = ATC = MR = MC. Monopolistic competition: P=ATC > (MR = MC). ATC is not at its minimum
•
•
If making positive economic profit in the short run, new firms will enter the market and profit returns to
zero
The graph below shows the difference between perfect competition and monopolistic competition in the
long run. The subscript PC stands for perfect competition and MC is for monopolistic competition.
An important difference between a monopolist and a monopolistic competitor is the position of the average total
cost curve in long-run equilibrium. For a monopolist, the average total cost can be below price. That means in
the long run, monopolists can make positive economic profit but monopolist competitors can’t.
• Monopolistically competitive firms have a strong incentive to advertise, because advertising
plays an important role in the differentiation of products. The goals of advertising are to shift
the firm’s demand curve to the right and make it more inelastic
Advertising shifts ATC curve up. It only makes sense to advertise if marginal benefit > marginal cost.
P
MC
P
D
MR
Q
Q
Chapter 15: Obligopoly and Anti-trust Laws
–
Few large firms control most of the market
Significant barrier to entry
Firms are interdependent, taking explicit account of a rival’s expected response to a decision they are
making. This can be collusive or non-collusive.
Implicit Price Collusion: is not against the law. Allow a price leader to set the price and the other firms follow
suit.
Why are prices sticky?
P
If P increases, others won’t go
along, so D is elastic
MC1
P
MC2
Gap
MR
D
Q
Q
If current price is P and the firm increases its price, others won’t follow, so % change in Qd > % change in P, D
is elastic (red portion)
If the firm decreases price, others will follow, so D is inelastic (blue portion)
Price does not change when MC fluctuates within the gap.
Antitrust policy
Concentration ratio:
Herfindahl index: how to calculate it. Look at questions 9 and 10 of Chapter 15.
Sharman Antitrust Act & study cases (Microsoft, AT&T, etc).
Chapter 20
Prisoner dilemma: two a well-known two-person game that demonstrates the difficulty of cooperative behavior
in certain circumstances
Nash equilibrium: a set of strategies for each player in the game in which no player can improve his or her
payoff by changing strategy unilaterally
Dominant strategy: a strategy that is preferred by a player regardless of the opponent’s move
B
CONFESS
5 years for A
A
CONFESS
X
X
10 years for A
DOESN’T
CONFESS
DOESN’T
CONFESS
A goes free
5 years for B
A
B
X
B goes free
X
10 years for B
6 months for
A
6 months for B
Both A and B have a dominant strategy and that is to confess. Nash equilibrium is box 1 (when both players end
up in one box, we have a Nash equilibrium)
Chapter 17: Labor Market.
–
When the wage is higher, leisure has a higher opportunity cost. As the cost of leisure goes up, you buy
less of it (you work more).
–
The elasticity of the market supply curve is determined by the elasticity of individuals’ supply curves
and by individuals entering and leaving the labor force
–
If a larger number of people are willing to enter the labor market when wages rise, then the market labor
supply will be highly elastic even if individuals’ supply curves are inelastic.
–
The elasticity of supply also depends on the type of market being discussed; the supply of labor for one
firm of many will be more elastic than the supply facing all firms.
–
Existing workers prefer inelastic labor supplies because an increase in demand for labor will increase
their wage by more. Employers prefer elastic supplies because an increase in demand for labor doesn’t
require large wage increases
–
The demand for labor follows the basic law of demand: the higher the wage, the lower the quantity of
labor demanded
–
Derived Demand: “The demand for factors of production by firms, which depends on consumers’
demands.”
–
The elasticity of the derived demand for labor depends on a number of factors: the elasticity of demand
for the firm’s good (the more elastic the final demand, the more elastic the derived demand); the relative
importance of the factors in the production process (the more important the factor, the less elastic is the
derived demand); the possibility of, and cost of, substitution in production (the easier substitution is, the
more elastic is the derived demand); and the degree to which marginal productivity falls with an increase
in labor (the faster productivity falls, the less elastic is the derived demand).
–
A perfectly competitive firm has more elastic derived demand for labor than does a monopolist. Why?
–
Monopsony: “A market in which a single firm is the only buyer.” Example: a “company town” where a
single firm is the only employer. Just as a monopolist takes into account the fact that if it sells more it
will lower the market price, the monopsonist takes into account the fact that it will raise the market price
if it buys more.
Bilateral Monopoly: “A market with only a single seller and a single buyer.”
Marginal
Factor Cost
W
S
In a competitive labor market,
equilibrium is WC and QC
Monopsony equilibrium is at
point A where fewer workers are
hired, QM, and the wage, WM
WU
A
A union pushes for a higher
wage, WU, and a lower quantity of
workers, QU
WC
WM
D
MR
Q
QU QM QC
Chapter 18:
–
Lorenz Curve: “A geometric representation of the share distribution of income among families in a
given country at a given time.”
A perfectly equal distribution of income would be represented by a diagonal. An unequal distribution of
income is represented by a Lorenz curve that’s below the diagonal line.
Cumulative
% of income
100
Line of
absolute
equality
80
Japan
60
Sweden
U.S.
40
20
Brazil Cumulative
% of Families
0
20
40
60
80
100
The further the Lorenze curve from the line, the less income is equally distributed. From the graph
above, Brazil has least income equality.
For the US, the poorest 20% has less than 5% of income. The richest 20% has about 50% of total
national income.
•
Poverty Threshold: “A family is in poverty if its income is equal to or less than three times an
average family’s minimum food expenditures as calculated by the U.S. Department of
Agriculture.”
•
“The Gini Coefficient” — Economists also use Gini coefficients to talk about the degree of
inequality. The Gini coefficient is calculated using the Lorenz curve. The area between the Lorenz
curve and the diagonal is divided by the entire area underneath the diagonal. A Gini coefficient of
0 represents perfect equality; a Gini coefficient of 1 represents perfect inequality.
…
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