Economics Exam 3Monopoly:- an industry with a single firm in which the entry of new firms is blocked (ex: Coca-Cola isn’t a monopoly because people can just drink Pepsi instead)- a market with a single seller that sells a good with no close substitutes Monopolist:- faces the (downward-sloping) market demand curve- P doesn’t equal MR- MR= P (1-1/IEI)- P > MRProfit Maximization:- profit maximizing monopolist will produce a quantity where P > MR (what society is willing to pay for additional unit for good) - MR=MC- P > MR = MC, therefore P > MC- monopolist sets P above MC- monopolist will produce too little output for social efficiency Example of a Monopoly Problem:D: P= 100-2QMR=100-4Q (double slope)Suppose MC= 20Profit Max: MR=MC100-4Q= 2080=4QQm= 20P= 100-2(20) = 100-40= 60Pm= 60If the market were perfectly competitive:Pc= MCPc= 2020= 100-2QQc= 40A monopolist will charge a higher price and produce a lower quantity then if the market were perfectly competitiveConsumer Surplus (CS): monopoly:CS= Pc (Qc) / 2 previous example: 20 (40) / 2 = $400perfect competition: CS= Qc (Pc + Pm) / 2 previous example: 40 (80) / 2 = $1,600Producer Surplus (PS):monopoly:PS= Pc (Qc)previous example: 20 (40) = $800perfect competition:PS= always $0previous example: $0Dead Weight Loss (DWL):DWL: ½ (Qc-Qm) (Pm-Pc)previous example (monopoly): 40(20) / 2 = 400Price Discrimination: - occurs when a firm charges different prices to different consumers for the same product - examples: student movie tickets, coupons, student discountsNecessary Conditions for Price Discrimination:1. Firm must face a downward sloping demand curve2. Firm must be able to identify two or more groups of consumers who have different price elasticities of demand 3. It must be difficult to resell the productOligopoly:- industry in which there is a small number of firms, each large enough so that its presence affects prices- an industry with a few dominant firms - examples: Hardware Stores, Grocery Stores, etc.- firms are strategically interdependent- economists use Game Theory to model the behavior of firms in an oligopoly - Game Theory: a game consists of 3 elements: 1. Set of players 2. Set of strategies for each play (ex: charge high/low price) 3. Payoff function which assigns a payoff to each player for all possible strategy combinations- Dominant Strategy: strategy that always yields a higher payoff than any other strategy, regardless of strategies chosen by the other players- Nash Equilibrium: combination of strategies where no player can improve their payoff by switching to a different strategy, given the strategies chosen by the other player (s)- Maximin Strategy: to find a player’s maximin strategy: find the worst outcome for each strategy that the player has. Choose the strategy that yields the highest payofffrom all of the worst-case outcomes.Monopolistic Competition:- all of the assumptions of perfect competition are met except that firms produce differentiated products instead of identical products - assumptions: - lots of buyers and sellers - firms produce differentiated products - buyers and sellers have complete information - easy entry and exit in market - no transaction costs - no externalities (occurs when action effects someone else) - no government interference (no taxes or subsidies)- example: restaurant industry- short run monopoly: monopolist charges higher price and produces a lower quantity- long run monopoly: monopolist chargers lower price and produces a higher quantityExternalities:- an externality occurs when someone takes an action which imposes a cost or bestowes a benefit on someone who is not involved in that action (is external to thataction)- negative externalities: imposes a cost on someone else (example: people talking in class, distracting students who want to pay attention)- positive externalities: bestowes a benefit on someone else (example: someone asking an important question that everyone else is wondering)- marginal private cost: the cost of producing an extra unit of output that is paid by the firm producing that output- marginal damage cost: the cost of producing an extra unit of output that is paid by people external to the firm that is producing the output- marginal social cost: MSC=MPC+MDC - if a negative externality exists and it is NOT corrected, there will be too much of theactivity for social efficiency - not paying full cost (someone else is)- if a positive externality exists and it is NOT corrected, too little of the activity will exist for social efficiency - not getting all benefit (someone else is too) - example: suppose you are considering a home improvement project. Suppose it costs $15,000. Suppose it increases the value of your house by $10,000. Suppose it would also increase the value of your 4 neighbors’ houses by $3,000 each.- correcting for externalities: taxes (negative externality) or subsidies (positive externality) - in the case of a negative externality, the tax should equal the marginal damage cost - regulate the activitiesCoase Theorem: - if there are few people involved and there is NO costs of negotiations, then the parties involved can solve the problem on their own in a manner which is socially efficient- whoever can solve the problem more cheaply will be the one to solve it Pollution Permits (Cap and Trade):- suppose there are two firms A and B- suppose that each firm is producing 5 units of pollution- government wants to cap at 9 units Firm A Firm BReduction in PollutionTC MC Reduction in PollutionTC MC1 $5 $5 1 $8 $82 $12 $7 2 $22 $143 $21 $9 3 $45 $234 $33 $12 4 $80 $355 $50 $17 5 $120 $50The government issues 2 pollution permits to each firm. One their own, each firm would have to abote (clean up) 3 units of pollution. This would cost firm A: $21 and firm B: $45, total cost = $66. Firm A would abote a 4th unit of pollution. This would cost them an extra $12. They would have 1 pollution permit to sell to firm B. Firm B would be willing to pay up to $23 for the extra permit. Total cost of abatement: firm a: $33 and firm B: $22, total cost: $55Public Goods: - non-rival: a good is non-rival in consumption if one person using (consuming) the good, does not affect another person’s ability to use the good - example: watching fireworks, this class- non-excludable: once the good is produced, no one can be