Microeconomics Exam 3 Comprehensive Study Guide

Ch. 12: Pure Competition and Monopolistic Competition

Pure Competition

Pure competition is a market structure characterized by a large number of small firms, identical products, and easy entry and exit. It differs from other market structures such as monopoly, oligopoly, and monopolistic competition in terms of the number of firms, product differentiation, and barriers to entry.

• Key Characteristics: Many sellers, homogeneous products, no barriers to entry, price takers.

• Comparison: Monopolistic competition features many firms but with differentiated products.

Price Taker

• Definition: A firm that cannot influence the market price and must accept the prevailing market price.

• Example: Wheat farmers in a competitive market.

Firm’s Demand Curve in Pure Competition

• Shape: Perfectly elastic at the market price.

• Difference from Market Demand: The market demand curve is downward sloping, while the individual firm’s demand is horizontal.

Profit Maximization in Pure Competition

• Rule: Firms maximize profit where marginal cost (MC) equals marginal revenue (MR).

• Graphical Analysis: Identify profit, loss, and shutdown points on cost and revenue curves.

Efficiency in Pure Competition

• Productive Efficiency: Producing at the lowest possible cost.

• Allocative Efficiency: Resources are allocated to their most valued use.

Economies and Diseconomies of Scale

• Economies of Scale: Cost advantages as output increases.

• Diseconomies of Scale: Rising average costs as output increases beyond a certain point.

Ch. 13: Monopolies and Market Power

Characteristics of Monopolies

• Single Seller: Only one firm supplies the product.

• Barriers to Entry: High barriers such as patents, resource ownership, or government regulation.

• Market Power: Ability to set prices above marginal cost.

Sources of Monopoly Power

• Ownership of resources, patents, government franchises, network externalities.

Monopoly Demand and Marginal Revenue

• Relationship: The marginal revenue curve lies below the demand curve for a monopolist.

• Price vs. Marginal Revenue: For a single-price monopolist, MR < Price.

Monopoly Pricing and Output Decisions

• Profit maximization occurs where MR = MC.

• Identify the profit-maximizing price and output on a graph.

Monopolistic Competition

• Similar to pure competition but with product differentiation.

• Firms face downward-sloping demand curves and have some price-setting power.

Market Inefficiency

• Monopolies may result in allocative inefficiency (deadweight loss).

• Difficulty in collusion and maintaining joint profits in oligopoly settings.

Ch. 14: Oligopoly and Game Theory

Oligopoly

• Few large firms dominate the market.

• Firms are interdependent and may collude or compete.

Game Theory

• Used to analyze strategic interactions among firms.

• Payoff matrices and Nash equilibrium are key concepts.

Market Concentration

• Measured by the Four Firm Concentration Ratio.

• High concentration can lead to less competitive behavior.

Antitrust Legislation

• Sherman Act, Clayton Act, and other laws regulate anti-competitive practices.

Ch. 16: Factor Markets and Marginal Productivity

Derived Demand

• Demand for a factor of production depends on the demand for the final good.

Value of Marginal Product (VMP)

• VMP = Marginal Product of Labor × Price of Output

• Firms hire labor up to the point where VMP = Wage

Shifts in Labor Demand and Supply

• Factors: Changes in product demand, productivity, prices of other inputs.

Ch. 1 & 2: Economic Foundations and Trade

Scarcity and Opportunity Cost

• Scarcity: Limited resources vs. unlimited wants.

• Opportunity Cost: Value of the next best alternative forgone.

Production Possibilities Frontier (PPF)

• Shows maximum combinations of goods that can be produced.

• Opportunity cost is represented by the slope of the PPF.

Comparative Advantage

• Ability to produce a good at a lower opportunity cost than others.

• Basis for trade and specialization.

Ch. 3: Supply and Demand

Law of Demand

• As price falls, quantity demanded rises (ceteris paribus).

Law of Supply

• As price rises, quantity supplied rises (ceteris paribus).

Market Equilibrium

• Occurs where quantity demanded equals quantity supplied.

• Shifts in demand or supply change equilibrium price and quantity.

Ch. 6: Elasticity

Price Elasticity of Demand

• Measures responsiveness of quantity demanded to price changes.

• Formula: $E_d = \frac{\%\Delta Q}{\%\Delta P}$

• Elastic if $|E_d| > 1$, inelastic if $|E_d| < 1$.

Elasticity of Supply

• Measures responsiveness of quantity supplied to price changes.

Income and Cross-Price Elasticity

• Income elasticity: Positive for normal goods, negative for inferior goods.

• Cross-price elasticity: Positive for substitutes, negative for complements.

Ch. 4: Economic Efficiency, Price Controls, and Taxes

Market Efficiency

• Efficient markets maximize total surplus (consumer + producer surplus).

Price Ceilings and Floors

• Price ceiling: Maximum legal price (can cause shortages).

• Price floor: Minimum legal price (can cause surpluses).

Taxes and Surpluses

• Taxes create deadweight loss and reduce market efficiency.

Ch. 5: Market Failures and Externalities

Externalities

• Positive externality: Benefits spill over to others (e.g., education).

• Negative externality: Costs spill over to others (e.g., pollution).

• Solutions: Taxes, subsidies, regulation.

Public Goods

• Non-rival and non-excludable goods (e.g., national defense).

• Free-rider problem: People benefit without paying.

Ch. 10: Consumer Behavior

Utility and Marginal Utility

• Utility: Satisfaction from consuming goods/services.

• Marginal Utility: Additional satisfaction from one more unit.

• Law of Diminishing Marginal Utility: Each additional unit adds less satisfaction.

Budget Line and Utility Maximization

• Budget line shows combinations of goods a consumer can afford.

• Utility maximization: Allocate spending so that the marginal utility per dollar is equal across goods.

Ch. 11: Costs of Production

Types of Costs

• Explicit costs: Direct monetary payments.

• Implicit costs: Opportunity costs of using resources.

• Economic profit = Total revenue - (Explicit + Implicit costs)

Cost Formulas

• Total Cost (TC) = Total Variable Cost (TVC) + Total Fixed Cost (TFC)

• Average Total Cost (ATC) = Average Variable Cost (AVC) + Average Fixed Cost (AFC)

Marginal and Average Costs

• Marginal cost: Change in total cost from producing one more unit.

• Understand the relationship between marginal cost and average cost curves.

Long-Run Costs

• Long-run ATC curve shows lowest possible cost at each output level.

• Economies and diseconomies of scale affect the shape of the long-run ATC.