Price Searcher Markets with High Entry Barriers 07 25 2011 Sources of Entry Barriers Characteristics of a Monopoly Market o Barriers to entry Anything that protects a seller from new competition Exclusive ownership of an essential resource A seller can create its own barrier to entry if Economies of scale its owns a significant portion of a key resource required for the production of the good service In practice monopolies rarely arise for this reason i e ALCOA U S vs ALCOA 1945 A monopoly that arises because of economies of scale is called a NATURAL MONOPOLY Natural monopoly provides an economic argument for regulated public utilities Markets characterized by economies of scale often become competitive over time because of technological advances or because of natural growth in the size of the market Government regulations i e USPS Patents o Monopoly A market with a single supplier of a good or service that has no close substitutes and in which there are economic or legal barriers to the entry of new competition Two key features 1 No close substitutes 2 Barriers to entry Examples USPS MLB ALCOA demand curve The demand curve for a monopolist is the market A monopolist maximizes profits by producing where MR MC Monopoly Equilibrium o Short run and long run equilibrium When a monopolist earns short run profits Because new competitors are barred from entering the market a monopolist s short run profits are not competed away They persist into the long run When a monopolist incurs short run losses However if a monopolist incurs economic losses in the short run it exists the market in the long run Monopoly and Competition o Economic Consequences of Monopoly The absence of competition results in Inefficiency and dead weight loss Redistribution of wealth to sellers since they make long term profits Oligopoly Definition o A small number of suppliers in a market with substantial barriers to entry by potential competitors Key Characteristics o 1 Small number of firms o 2 Interdependence among sellers o 3 High barriers to entry substantial economics of scale o 4 Identical or differentiated products Game Theory Collusion o The agreement among firms to avoid competitive practices o Firms will agree to limit output and keep prices high Incentives to Collude cartel o Cartel A group of suppliers acting together to limit output raise prices and increase economic profit Suppliers in a cartel attempt to act as if they were a monopolist so as to maximize their joint profits Examples The short unhappy life of a cartel Obstacles to Collusion Every cartel faces three problems o 1 Reaching agreement more difficult with more firms o 2 Detecting and preventing cheating o 3 Enforcing the agreement and antitrust action o 4 Low Barriers to entry o 5 Unstable Demand Incentive to Cheat o Make more money because everyone goes to your business when you drop the price Game Theory o Defn o Single Play Games Game theory is the study of strategic behavior behavior that recognizes mutual interdependence and takes account of the expected behavior of others In a game the outcome for each individual depends not only on that individual s decision but also on the decisions of other individuals Oligopoly behavior can be modeled as a game Suppliers in a cartel recognize their interdependence Each supplier is aware of its price quantity decisions affect other suppliers profits Each supplier is aware that its profits are affected by the price quantity decisions of other suppliers Oligopoly markets are characterized by strategic behavior which is best analyzed using game theory PRISONERS DILEMMA Provides an arena for the application of game theory o Repeated Games Defn A game played more than once by the same players with the same strategy choices May be plated indefinitely or a fixed number of times This makes a significant difference cooperation is more likely Tit for tat cooperate for the first 2 rounds and then do whatever the one player did in the last round o Dominant Strategy A strategy that is best for a player in the game regardless of the strategies chosen by other players o Nash Equilibrium An equilibrium in which each player takes the best possible action given the action of the other player Oligopoly Prices and Profits Competitive Price Oligopoly Price Monopoly Price o 1 Firms collude price will be closer to monopoly price o 2 Firms cheat price will be closer to competitive price Problems with High Entry Barriers 1 Discipline of market forces is weakened 2 Reduced competition results in inefficiency 3 Resources will be wasted by firms attempting to maintain grants of protection Solutions to High Entry Barriers 1 Anti Trust legislation o 1 Sherman Act 1890 o 2 Federal Trade Commission Act 1914 o 3 Clayton Act Government and Rival firms may bring charges more done by other firms 2 Reduce artificial barriers that limit competition 3 Regulate the price and output of firms in the market o Most likely not to work because Lack of information Cost shifting Regulators may become biased Special interest 4 Government produces the goods and services instead of the o However this and their resource allocation is often done by private sector voting o i e Tallahassee Bus System o i e Allocating funds towards Public Education o Public Choice Earning Differences 07 25 2011 Asymmetric Information o Asymmetric information is a source of inefficiency Exists when one party to a transaction has more or better relevant information that the other party Two kinds Principal agent problem Adverse Selection Arises when one party to a transaction knows more about the attributes of the good being exchanged than the other party i e used cars These problems can be solved by o Signaling Everything you portray about yourself that you send to other people School you attend Classes you take Clothes you wear Sources of Earning Differences 1 Worker productivity and specialized skills more productive and more highly skilled workers earn more money higher output per worker higher wages This is true o A Across countries Tournament Pay o B Across time The reason employees in the U S make more than workers in most foreign countries Reason people make more money today than then did 50 years ago o A type of compensation in which the top performer receives higher rewards than other competitors even if the others perform at only a slightly lower level i e actors athletes sales bonuses 2 Worker Preference Greater desire to make money earn more How many of you
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