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Econ Final Review SheetChapter 12 Perfect CompetitionNeoclassical Economics – the “assume” away the problemMP and MC curves shows where the MP starts to fall, and the MC starts to inclinePerfect Competition – what makes the model of the free market work, does not work without thisCharacteristic Assumption of Perfect Competition***1. Infinite Number of Firms2. Homogenous Product – all the same product3. Small market share – No market power – no influence on what goes on in themarket4. No concern with competitors marketing and production decisions5. Perfect information – everybody has access to exactly the same information6. Free Entry and Exit – anyone can enter the industry, anyone can leave the industry, not going to have an impact, it is costless to enter the industryThese firms are price takers, they take the price the market gives them, all the individualfirms, take the price the market gives them. (Looks like a horizontal line)Perfect CompetitionFoundation of free market systemMR > MC => produce moreMR = MC => max profitsMR < MC => produce lessTotal Profit = Total Revenue – Total CostPrice = MRFor perfectly competitive firms, the profit maximizing rule is P(MR) = MCOn a graph, maximized profit occurs where the MC crosses the P lineTR = area of ABCD squareTC = area of ECDF rectangle drawn to the ATC lineTT = Profit Maximizing RuleP = MCRational Firm – wants to maximize profitTotal Profit = TR – TCTR = P x QTC = ATC x Q (area of lower rectangle)When profits are greater than zero, these profits are called excessive profits; economic profits; abnormal profits; and monopoly profits. As price falls, slowly get rid of economic profit.When profits equal zero, these profits are called Normal Profits.Key Characteristics of Perfect Competition in the Long Run1. Profits = Zero, Normal Profit2. P = MC = Min ATCTotal Cost > Total Revenue = - ProfitThe shut down point for a firm is when the price falls at or below minimum average variable cost (AVC)In Roger and Me post, just post your response, no need to pos ton anyone else’s post.Perfect Competition (These define a perfectly competitive market/firm)1. Infinite number of firms2. Homogenous Product3. Small market share/no market power4. No concern with their competitors 5. Perfect information (shared with everyone equally)6. Free entry and exitLong Run Results of P.C.Individual Firm:Profit Max Rule:P=MC1. Normal Profits2. P=MC=MINatc (efficient)3. S=D (sets price)4. Price curve and marginal revenue curve are the same curveMonopolyHow to maintain a monopoly?1. Rigid Barriers to Entry (access to oil to be a company)a. Government Franchise, and Licensesb. Patents and Copyrightsc. Ownership of an entire supply of a resourceDemand curve is downward slopingMC crosses ATC at minimal price (MR=MC)To get quantity, you go where MR = MC, to find price, you go up to the demand curve and go left to find the pricePrice DiscriminationHow are they able to charge one person one price, and someone else another price? (ex. Airline tickets)1. Have to have control over price2. Product can’t be resell able 3. Determine how willingness and ability to pay varies among different buyersImperfect CompetitionWhen more than one seller competes with other sellers that are all producing similar products each firm has some control over their price (How do they do this? Through product differentiation ex. Crest, Colgate) 1. Monopolistic Competition (characteristics below) – when other firms enter the industry it takes away from firms that are already in the industrya. Relatively large number of firms, each with some market powerb. Products are not perfect substitutes, they are differentiatedc. Do not consider rivals reactions when making pricing and production decisionsd. Relative freedom of entry and exite. No opportunity to collude in ways that reduce competitionOligopoly1. Large # of firms, but a few firms dominate the market (set price and control price and everyone else follows)2. Entry is difficult to impossible (there’s strong barriers to entry)3. products can be differentiated or they can be standardized4. Market is highly concentrated (a few firms control the market, comes from number one)5. Firms are aware of, and consider their rivals actions and reactionsMaintaining Oligopoly1. Barriers to entry2. costs and technological advantagePrice Rigidities(sticky/rigid/unresponsive to changes in demand or marginal cost)The Kink demand curve****HerFindahl – Hirschman Index (H-H Index)Square all the market shares of firms in the industry, then sum all the firms in the industry, to decide if the industry is concentrated or not.0 is unlikely = no concentration10,000 (100x1)2 = complete concentration or a single monopoly1. Post Merger HHI < 1000 – consider market to be unconcentrated, unlikely to haveadverse competitive impact2. If Post Merger HHI 1000 ≤ 18000; 1000 ≤ 1800 – moderately concentrated; if HHI changes < 100 then it’s not considered to have adverse competitive consequences; if change in HHI is > 100 then it is going to have adverse competitive consequences 3. Industry is highly concentrated if HHI is > 1800; if post merger change in HHI is < 50 it’s not likely to have adverse competitive consequences; if post merger change in HHI > 50, then it is likely to have adverse competitive consequences; 3+5+10+2+1, find HHI of that (3)2+(5)2+(10)2+(2)2+(1)2 = ??, supposed companies 4 and 5 merge, what’s the new HHI, how does this change the HHI, (3)2+(5)2+(10)2+(3)2= ??********Questions on Perfect Competition, and how to find the profit maximizing level of output, find the long run; how to graph it; long run comparisons between all the firms (monopolies, perfect competition, oligopoly, perfect monopolistic competition)****Cartels – become more like a monopoly; by coming together and speaking with one voice; has to be barriers to entry to organize a cartel- The tendency is to cheat; and if everyone cheats, they’re back to zero and wont make excessive profitsGame theory (A Beautiful Mind) – thinking several moves ahead; and so is your competitor; helps make strategic decisions; pay-off matrixExpect your opponent to make moves in your favor so you can carry out your offensive strategyDominant Strategy: strategy that is best for player no matter the other player’s strategyWhat to deal with game theory, industry leader sets the price, everyone else follows them, it’s illegal, but hard to proveOligopolies – example:


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