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UW-Madison ECON 101 - Final Review Sheet

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Economics 101Fall 2007Final Review Sheet Prof. KellyNote: This is a list of important and key points for topics after the second midterm. This list should be used together with the previous two review lists, as the final will be cumulative. As before, these review sheets should serve as a checklist for you to see whether you have studied everything you need to for the final. Good luck!MONOPOLY1. Definition and fundamental sources of Monopoly.a. Barriers to entry (examples?)i. exclusive ownership of a key resourceii. exclusive right assigned by the governmentiii. economies of scaleiv. threat of force or sabotage2. Natural Monopolya. arises where it’s more efficient for a single firm to serve the society.(Examples? What will happen if we have more than one firm in themarket?)b. regulation3. Profit Maximization Condition (for a single-price monopoly): MR=MC.a. The demand curve facing a monopoly is the same as the industry demandcurveb. MC and ATC are similar to those for perfectly competitive firmsc. At the optimal point, MR is less than the price: MR<P (why?)d. If demand is linear (P=a-bQ, where a and b are positive constants), thenmarginal revenue is: MR = a-2bQ.e. A monopolist can earn a positive economic profit even in the LR (there isno entry!)4. Inefficiency of Monopoly.a. Compared to an identical perfectly competitive industry, output is less andprice is higher with a monopolyb. Less output and higher price will result in a loss in Consumer Surplus(CS) relative to the CS found under perfect competition and an increase inProducer Surplus (PS) relative to the PS found under perfectcompetition---and there will be a dead-weight loss (DWL) with amonopoly c. DWL, which measures the inefficiency of the monopoly, is graphically thearea between the demand and MC curves for units between the monopolyquantity and the efficient quantity.5. Ways for policy makers to correct the inefficiency.a. antitrust lawsb. regulations (AC regulation and MC regulation)c. public ownership6. Price Discrimination--selling different units of a good/service for different prices.a. price discrimination captures some of the CS for the monopolist andincreases the monopoly’s total revenueb. forms of price discriminationi. First-Degree price discriminationii. Second-Degree price discriminationiii. Third-Degree price discriminationOLIGOPOLY1. Definition---a market structure in between monopoly and perfect competition. Anoligopoly is a market structure where only a few sellers offer similar or identicalproducts. (How is it different from the Monopolistic Competition? Examples?)2. Key feature: tension between cooperation and self-interest.a. The group of oligopolists is better off if they cooperate and act like amonopoly --- producing less and charging a higher price (know definitionof collusion, cartels)b. But every oligopolist has an incentive to act on his own as it cares onlyabout its own profit; therefore, the ability to cooperate is limited.3. A duopoly is an oligopoly with only TWO members. This is the simplest form ofoligopoly4. Equilibrium for an oligopoly.a. It’s often difficult for oligopolies to form cartels because of antitrust lawsand the instability of cartels.b. When firms in an oligopoly individually choose production to maximizeprofit, they end up somewhere between perfect competition andmonopoly.i. monopoly quantity < oligopoly quantity < competitive quantityii. monopoly price > oligopoly price > competitive price.c. The size of an oligopoly: an oligopolistic market looks more like acompetitive market if there are more sellers in the oligopoly.5. Some Game Theorya. Definition--- a situation where the players or participants' payoffs dependboth on own actions as well as on rival's actions.b. Four elements to describe a game.i. Playersii. Rules: when each player moves, what actions are possible, what isknown to each player at the moment they move…iii. Outcomesiv. Payoffs as a function of the outcomesc. Dominant strategyd. Important example: Prisoner’s Dilemma (Definition? What real-lifesituations can be represented as a prisoner’s dilemma game?)6. Public policy toward oligopoliesa. Restraint of tradeb. Antitrust lawsc. Controversies over antitrust policy.MONOPOLISTIC COMPETITION1. Definition---a market structure where many firms sell products that are similar butnot identical.2. Characteristicsa. Many sellersb. Product differentiationc. Free entry3. Short-Run---product differentiation gives the seller in a monopolisticallycompetitive market some ability to control the price of its product.4. Long-Run (free entry)a. Price exceeds marginal cost (why?)b. Price equals ATCc. Firms in monopolistic competition earn zero economic profit as in perfectcompetition.5. Monopolistic competition vs. perfect competitiona. Excess capacityb. Markup over MC6. Welfare in monopolistic competitiona. Inefficiencyi. One source is the markup of price over MCii. Another source is the externality effects from entry (the product-variety externality and the business-stealing externality).FACTOR MARKETS1. We considered only the labor market (our work here could be extended to othertypes of factor markets). 2. Important assumptionsa. Labor market is competitiveb. Product market is competitive.3. Solving these problems:a. Firms will hire labor up to that point where the marginal cost of hiring anadditional unit of labor is equal to the additional revenue that the firm getsfrom hiring that additional unit of labor. b. The firm thus needs to choose a quantity of labor to equate the marginalfactor cost (MFC) to the marginal revenue product of labor (MRPL). c. The marginal revenue product of labor is found by multiplying themarginal revenue from selling additional units of the good (in the case of afirm in a perfectly competitive industry the marginal revenue is equal tothe price of the product) times the marginal product of the unit of labor.4. Labor supply and labor demand curve5. Labor supply and labor demand curvea. The labor supply curve shifts with a change in the market wage rate inother labor markets, a change in the cost of acquiring human capital, achange in the number of qualified people, or a change in tastes. b. The labor demand curve shifts with a change in the demand for a firm’sproduct, a change in


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UW-Madison ECON 101 - Final Review Sheet

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