ECON 201 1st Edition Exam 4 Study Guide Lectures 20 23 Lecture 20 Market structure refers to the physical characteristics of the market within which firms interact the numbers of firms in the market and the barriers to entry Monopolistic competition there are many firms selling differentiated products There are few barriers to entry Oligopoly there are a few interdependent firms There are often significant barriers to entry and strategic decision making Defining a Market Structure What problems are there in defining a market What is an industry and what is its geographic market local national or international What products are to be included in the definition of an industry What do you use Use cross elasticity Use North American Industry Classification System NAICS is a classification system of industries adopted by Canada Mexico and the U S in 1997 The concentration ratio 4 CR the value of the sales by the top 4 firms of an industry stated as a percentage of the total industry sales Higher 4 CR closer to monopoly 60 The Herfindahl index HI an index of market concentration calculated by adding the squared value of the individual market shares of all firms in the industry HI 1000 merge allowed Problems of using 4 CR and HI conglomerates What are the distinguishing characteristics of monopolistic competition Many sellers no collusion independent Differentiated products monopolistic power can influence price Multiple dimensions of competition differentiation matters What are dimensions Physical service location image Easy entry of new firms in the long run limit long run profit A monopolistically competitive firm prices in the same manner as a monopolist where MC MR SR profit is possible But the monopolistic competitor is not only a monopolist but a competitor as well At equilibrium ATC equals price and economic profits are zero In the long run Lecture 21 How do you compare a perfect and monopolistic competition Both make zero economic profit in the long run P C demand curve is perfectly elastic Zero economic profit means that it produces at the minimum of the ATC curve A M C faces a downward sloping demand curve and produces where MC MR ATC curve is tangent to the demand curve at that level which is not at the minimum point of the ATC curve Why Differentiation excess capacity 22 000 funeral homes could handle 4 million but only 2 4 million die Market share matters for M C How do you compare monopolistic competition with monopoly It is possible for Mono to make economic profit in the long run No long run economic profit is possible in M C Advertising forms in P C Market have no incentive to advertise M C have a strong incentive to do so it will increase the demand make it inelastic But it will increase ATC Oligopolies What are the characteristics of an oligopoly Oligopolies are made up of a small number of mutually interdependent firms Each firm must take into account the expected reaction of other firms There is a strong barrier to entry Example Digital TV and broadcast Sega s dreamcast What are models of oligopoly behavior Cartel i It is a combination of firms that acts as if it were a single firm It is a shared monopoly ii The oligopoly sets a monopoly Price iii Increase profit but need to limit entry iv How assign outputs quotas total product is maximizing joint profit What are some models of a cartel Formal collusion is illegal Use Implicit price collusion mutiple firms make the same pricing decisions even though they have not consulted with one another Example Price Leader in Airline OPEC It can be destroyed with new technology They invest in R D What is the contestable market model According to the contestable market model barriers to entry and barriers to exit determine a firm s price and output decisions Even if the industry contains only one firm it could still be a competitive market if entry is open An oligopoly with no barriers to entry set a competitive price How do you compare the contestable market and cartel models The stronger the ability of oligopolists to collude and present market entry the closer it is to a monopolistic situation The weaker the ability to collude is the more competitive it is Oligopoly markets lie between these two extremes Lecture 22 What is strategic pricing Both the cartel and contestable market models use strategic pricing decisions firms set their price based on the expected reactions of other firms Market entrance game Price matching policy Price wars are the result of strategic pricing decisions gone wild Predatory pricing strategy involves temporarily pushing the price down to drive a competitor out of business What is game theory Most oligopolistic strategic decision making uses game theory Game Theory is the application of economic principles to interdependent situations What is the Prisoner s Dilemma The Prisoner s Dilemma demonstrates the difficulty of cooperative behavior in certain circumstances where mutual trust gets one out of the dilemma Lecture 23 What is a payoff matrix A payoff matrix provides a summary of each player s strategies and how the outcomes of their choices depend on the actions of other players What is the Nash equilibrium An equilibrium of a game that results from a non cooperative game when each player plays his or her best strategy What is a dominant strategy A dominant strategy is preferred regardless of one s opponent s move A mixed strategy is choosing randomly What is behavioral economics It examines deviations between formal game theoretical predictions and actual outcomes of games Endowment and framing effects are examples of finding in behavioral economics that challenge the traditional model s predictions The traditional model remains relevant because it only takes a few people to realize that money has been left on the table for the results of the standard model to hold