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OU ECON 1123 - Final Exam Study Guide

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Econ 1123 1st EditionFinal Exam Study Guide Lectures: 18 – 24NOTE: This final is cumulative, so this study guide is to be used with study guides 1 and2 for the full study guide. Tip: The book is a really good place to find the definitions for the define and explain portions.Lecture 18 (March 6)Concepts covered:I. Monopoly InefficiencyWhen a monopoly is inefficient, the demand schedule and marginal revenue schedule will not meet at the same place on the upward sloping marginal cost graph.Sometimes this causes deadweight loss: The loss of consumer and producer surplus because some transactions are not undertakenNote: monopolies are more inefficient because they are protected from competition,so they have weaker incentives to minimize costs.Monopolists could devote all economic profits to rent seeking and still earn normal accounting profits.Price Discrimination- Pre- supposes some degree of “market power” (or monopoly power, i.e., some control over the price charged (unlike pure competition who are price “takers”Generally, charging different consumer groups different prices for the same product or serviceRequirements for price discrimination:-Sellers must have some “market” or “monopoly” power-Sellers must be able to separate consumers based on their elasticities of demand-Sellers (with market power) must be able to prevent arbitrage (prevent low price buyers from reselling to high price buyers)II. Monopoly Characteristics RevisitedSources of monopoly power:Monopoly InefficiencyRent seeking: x-inefficiencyPrice D Regulating a Natural MonopolyAnti- Trust Policy*In monopoly there is one seller with no close substitutes and significant barriers to entrySource of monopoly power: economies of scale: decreasing average costs over a large range out outputExamples of Natural Monopolies- (intel, local newspapers, electrical utilities)Definitions:Rent Seeking- behavior directed toward avoiding competition, resources expended to protect a monopoly position (lobbying, licensing requirements)Lecture 19 (March 8) Concepts covered:Price Discrimination- charging different customers different prices for the same productThree types of price discrimination:1. First degree (perfect) price discrimination- charging each customer the maximum priced each is willing to pay. They will do this until the demand meets the ATC schedule because if they do that past that point on the demand schedule they will incur loss.2. Second degree Price discrimination- Charging different customers based on the quantities purchased. This is called “tiered pricing”3. Third degree price discrimination- charging different groups of customers different prices. (example: airlines will charge business people more than vacationers because business people have more inelastic demand that says that they really need to be somewhere.I. Regulating the Natural MonopolistNatural monopoly = large economies of scale (declining ATC) mean the efficient scale of operations is roughly equal to market demand (electrical company, water company)Marginal Cost pricing rule- Regulations force the natural monopoly (public utility) to charge a price that equals marginal costAverage Cost Pricing- Regulators require the natural monopoly to charge a price = to average total costsAt Price of average total costs the utility earns normal accounting profitsRate of return regulation- Regulators allow the monopoly to earn normal accounting profits by estimating or calculating a reasonable return on invested capitalProblem: which costs and capital investments should be included?Price Caps- regulators only allow the monopoly (utility) to charge certain “Capped” maximum pricesCase study: California energy crisis 2000-2001Wholesale prices for the company went up 800% but the electric company sells in the retail market at capped prices (trying to make electricity available for everyone) The company went bankrupt and there were shortages of power in San Francisco.II. How do you measure monopoly power?a) Concentration ratiob) Herfendal- Hirschman Index (HHI)Concentration ration- equal to the share of industry sales accounted for by the largest firms in the industry usually largest 4 or largest 8.However, sometimes you cannot just rely on the CR, so you use HHI.Herfendal-Hirschman index- A way of measuring industry concentration equalto the sum of the square of market shares of all firms in the industryDefinitions:Price Discrimination- charging different customers different prices for the same productHerfindahl-Hirshman Index (HHI)- A way of measuring industry concentration,equal to the sum of the squares of the market shares for all firms in the industryLecture 20 (March 13)Concepts covered:I. Antitrust PolicyAntitrust Policy- laws designed with intention to maintain competition and prevent monopolies from developing Examples:Sherman Anti-Trust Act (1890)- conspiracies in the restraint of trade and attempt to monopolize are illegalClayton Act (1914)- Makes price discrimination illegal IF it lessens competitionFederal Trade Commission Act (1914)- Unfair or deceptive commercial practices are illegalII. Measuring the Extent of monopoly powerStigler: “All products or enterprises with large long run elasticities of demand should be combined in a single market”Cross elasticity of demand= (% change in Qdemanded of X)/(% change in Price Y)You look at the relationship between these and if they are both increasing then they are substituesHerfendal-Hirschman Index- Way of measuring industrial concentration, equal to the sum of the squares of market shares of all firms in the industry.HHI= (S1)^2 + (S2)^2+….(SN)^2Where S1, S2, SN = percentage market share (% total industry sales of each firm in the industry)This takes away the errors that you can get using only concentration ratioHHI ranges from approximately 0 (a very large number of firms with very small market shares like pure competition) to 10,000 which would be pure monopoly.1992 FTC Guidelines:If HHI<1,000 unconcentrated1000<HHI<1800 moderately concentratedHHI>1800 Highly concentrated Mergers resulting in HHI>1000 (approved)Mergers resulting in HHI 1000<HHI<1800 (closely evaluated)Criteria for evaluation: if HHI rises by 100 points them typically its disapprovedMergers resulting in HHI> 1800 (typically challenged and disapproved if HHI goes up by 50)III. Contestable MarketsMarkets that may appear to be monopolistic, but entry and exit costs that the threat of competition keeps prices


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