EXAM 3 STUDY

Market Structures and Firm Behavior

Perfect Competition

Perfect competition is a market structure characterized by many firms selling identical products, with no single firm able to influence the market price. Firms are price takers and must accept the equilibrium price determined by market supply and demand.

• Key Properties:

  • Large number of buyers and sellers

  • Homogeneous products

  • Free entry and exit

  • Perfect information

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

• Short-Run Decisions:

  • If price > average variable cost (AVC), continue producing.

  • If price < AVC, shut down in the short run.

Example: If the market price is $150 and a firm produces 200 units, total revenue is $30,000 ($150 × 200).

Short-Run Supply Curve

The firm's short-run supply curve shows the relationship between the price of a good and the quantity the firm is willing to offer for sale, given its costs.

• Supply Curve: The portion of the MC curve above AVC.

• Shutdown Point: The minimum point of the AVC curve.

Long-Run Equilibrium

In the long run, firms enter or exit the market in response to profits or losses, leading to zero economic profit.

• Entry and Exit:

  • Firms enter if price > average total cost (ATC).

  • Firms exit if price < ATC.

Monopoly and Pricing Strategies

Monopoly Behavior

A monopoly is a market with a single seller that controls the price and output of a product. The monopolist maximizes profit by producing where MR = MC.

• Demand Schedule: Shows the quantity demanded at each price.

• Revenue Changes: Increasing output can increase or decrease total revenue, depending on the elasticity of demand.

• Profit Maximization: Set output where MR = MC, then use the demand curve to find the price.

Example: If a monopolist increases output from 1000 to 1200 units and the price drops from $7 to $6, total revenue changes from $7000 to $7200.

Price Discrimination

Price discrimination occurs when a firm charges different prices to different groups of consumers for the same product, based on willingness to pay.

• Types:

  • Single price policy: All consumers pay the same price.

  • Student discount: Students pay a lower price than non-students.

• Profit Calculation: Profit = (Price - Average Cost) × Quantity Sold

	Single Price Policy	Student Discount (Price Discrimination)
Price	$6	$5 (Students), $8 (Non-Students)
Average Cost	$1	$1
Tickets Sold	30 (Students), 60 (Non-Students)	50 (Students), 50 (Non-Students)

Example: Under single price, profit = ($6 - $1) × (30 + 60) = $450. Under price discrimination, profit = ($5 - $1) × 50 + ($8 - $1) × 50 = $650.

Game Theory and Strategic Behavior

Duopoly and the Duopolists' Dilemma

Duopoly is a market with two dominant firms. Game theory analyzes strategic interactions between firms, such as pricing decisions.

• Duopolists' Dilemma: Both firms have an incentive to lower prices, but doing so leads to lower profits for both.

• Dominant Strategy: A strategy that yields the best payoff regardless of the other player's actions.

Firm 1	Firm 2	Profit (Firm 1, Firm 2)
High Price	High Price	900, 900
High Price	Low Price	600, 1200
Low Price	High Price	1200, 600
Low Price	Low Price	700, 700

Example: If both firms choose low price, each earns $700. If both choose high price, each earns $900.

Entry Games and Strategic Entry

Entry games model the strategic decisions of firms considering entering a market. Payoffs depend on the choices of both incumbent and potential entrants.

• Game Tree: Shows possible moves and payoffs for each firm.

• Equilibrium: Determined by backward induction, finding the optimal strategies for both firms.

Firm 1 Choice	Firm 2 Choice	Profit (Firm 1, Firm 2)
Small Quantity	Enter	13,000, 13,000
Large Quantity	Enter	9,000, 9,000
Small Quantity	Stay Out	13,000, 0
Large Quantity	Stay Out	10,000, 0

Example: If Firm 1 chooses small quantity and Firm 2 enters, both earn $13,000.

Key Formulas and Concepts

• Total Revenue: $TR = P \times Q$

• Profit: $\text{Profit} = TR - TC$

• Marginal Revenue: $MR = \frac{\Delta TR}{\Delta Q}$

• Marginal Cost: $MC = \frac{\Delta TC}{\Delta Q}$

• Average Total Cost: $ATC = \frac{TC}{Q}$

• Average Variable Cost: $AVC = \frac{TVC}{Q}$

Additional info: Game theory examples and tables have been expanded for clarity. All formulas are provided in LaTeX format for reference.