BUS 207 Final Notes

Lecture 5: Perfect competition

A perfectly competitive market contains many firms of equal size and firms are price takers making minimal profits.
In this competition, the demand curves shifts in response to income, competitor pricing. For supply, the curves shift
in response to input prices, productivity, and entry and exit.

Elements of Market Structure

Perfect Competition Monopolistic Oligopoly Monopoly

Number & size of Large number of Large number of Few firms One firm
distribution equal size firms equal size firms
Product Same Differentiated Either same or
differentiated
Entry & exit Easy Easy Hard Very hard
Type of rivalry Cost (price takers Location, quality Price, capacity, None
location, quality
Industry profits Low Low Low-high, depends Very high

Price taker:

In perfect competition, prices are made so that it removes excess supply and excess demand. If the demand were to
increase, prices would increase thus firms will make a larger profit. In this case, the profit made by these firms
attracts new firms as entry and exit is easy. Thus more firms will enter the market and therefore pushes the supply
curve out until the price reaches back to equilibrium (where no firms are making profit). In PC, price is equal to
marginal revenue

Profits in the short run:

Profit is maximized by: setting output level MR=MC=P

- Costs: TC= VC+ FC

- ATC= TC/Q= AFC +AVC
- MC= ΔTC/ΔQ

Social Welfare is maxed through perfect competition because in the long run, perfect competition makes zero
profits and so they invest in new products and develop new products thus stimulating the economy and changing
market structure through decision making

- Price ceiling, price floors, total social welfare (consumer + supplier surplus)

Shut Down Rule: basically when AVC is higher than price. Because the price should at least cover variable costs.
Long Run Perfect Competition

*Remember in the long run, there are more firms that enter the market thus causes increase in supply, it’s not the
fact that firm number stays constant and firms are producing more! In fact, because there are more firms, they
might produce less than before.

Free Trade

Country 1 and Country 2 engage in trade of a commodity. P1 is the pre-trade price in Country 1, while PW is the
lower world price that emerges after trade. Before trade, all of Country 1’s consumption was produced
domestically; after trade, ce is imported. Consumers in 1 gain P1PWaf; producers lose P1PWab, resulting in a net
social benefit (gain) of abf. Similar reasoning will indicate that in country 2 there is a gain of abc. In country 2 the
gains are mainly made by producers. In each country there are winners and losers, but social welfare has improved.

Tariff & Quota

If a country imposes a tariff that raises domestic prices from Pw to Pt, the result is a social loss. Although producers
gain profits in the amount A, and the government gains revenues of B, consumers lose A+B+C+D, resulting in a
social loss of C+D. This loss is sometimes referred to as a deadweight loss (DWL).

A quota works similarly with one main difference. If under free trade price = Pw, with imports of Q2-Q1, a quota
would have have the effect of reducing imports and therefore supply. Prices would rise to P1 because of the excess
demand at Pw. In this case, the social loss would include the shaded rectangle above (in addition to the DWL)
because the government does not claim that amount in revenue. The shaded amount is earned by foreign
producers as profits from the higher prices. Quotas result in higher welfare losses than do tariffs.
Externalities

Positive:

Negative:

Public goods & Freerider problem

Rivalrous Consumption Non-rivalrous Consumption

Excludable Private good Marketable public good
Non-excludable Common proporty resource Pure public good

Summary

- Firm decision under perfect competition

- Market equilibrium
- Short run and long run
- Welfare analysis
o Consumer surplus and producer surplus
o Free trade and tariffs
- Market failure
o Externalities
o Public goods

Lecture 6: Monopoly

A monopolist faces no rivals; a monopoly firm is the industry and the monopolists demand curve is the industry
demand curve. A. monopoly can influence market price through their own actions. Although there are a few
monopolists, there are many firms that are dominant in their industries and can affect market price. This is called
firms with monopoly/ market power. In a monopoly, the demand curve and supply curve is both the market and
industry. It is free to raise prices and not lose sales but it cannot raise It indefinitely

MR is always less than price because

when MR is equal to price, it means it’s
making zero profits (what we see in PC).
What we DO see is MR=MC because
when this occurs, it means it is
maximizing profits.
In cartels, they split the profits in equal parts however cartels are hard to achieve because of human greed to lower
the price or sell more.

Comparing perfect competition and monopoly in terms of demand, supply, MC, ATC, AND MR. In PC everything at
equilibrium. This is the whole market.

What’s good about monopoly power?

1. Monopolies might be more efficient

2. Monopolists may have greater ability to incentivize and innovate
3. There may be cost-based natural monopoly
4. There may be perfect competition for monopoly power that benefits the consumer and reduces monopoly
profits
5. FOR EXAMPLE: monopolies are efficient because they know how much to produce and their ability to
innovate is encouraged because

Summary

- Characteristics of Monopoly
- How it differs from perfect competition
- Why monopolies might be good:
o Monopolies can be more efficient
o Monopolies can innovate more
o Natural monopoly
o Competing to be a monopolist: network externalities and patent races
- Public policy towards monopoly
- Monopolistic competition: how it differs from monopoly and perfect competition

Lecture 7: Oligopoly

Limits to first mover

- Limits to preemption
o The first mover may not be capable of occupying the entire market, leaving room for a second
mover
o The product may be differentiable, allowing second movers to enter with better or different
products
- Limits to imitation barriers
o Input technologies are often available to all (software)
o Knowledge spillovers can be rapid
- Switching costs are minimal
 o Internet reduces switching costs
- Network effects are exaggerated
o Network effects exist, but early movers move too early and do not benefit from them, or the
product or technology is not proprietary
- Firms overestimate their ability to extend their reach (new customers and new products) on the internet

Summary

- Oligopoly
o Herfindahl index
- Important oligopoly theories
o Cournot: compare with monopoly and PC
o Bertrand: Bertrand with differentiation, compare with Cournot
o Stackelberg: sequential move, first move and second mover advantage

Lecture 8: Game theory

Summary

- Game theory: Concepts

- Simultaneous move games: basic
o Prisoners dilemma
o Dominant strategy
- Simultaneous move games with multiple equilibria
o Coordination games
o Chicken games
- Sequential games
o First or second mover advantage
o Game tree

Lecture 9: Risk, uncertainty, and information

Summary

- Risk and unvertainty

o Concepts: risk and risk attitudes (risk neutral, risk advert, risk lover)
- Decision making
o Expected value and expected utility
o Human inconsistency
- Asymmetric information
o Adverse selection: the market for lemons
 o Moral hazard: how to choose contracts

Lecture 10: Pricing and Auctions

Summary

- Different pricing mechanisms

- Price discrimination
o First third and second degree
o Others: two-part tariffs, versioning, bundling
o Information goods
- Auctions
o English, Dutch, sealed bid (first price and second price
o Optimal bidding strategies
o Contract in competitive procurements

Lecture 4: Cost Concepts

Summary:

- Cost concepts
o Sunk costs, fixed and variable costs
- Cost functions
o Short tun cost curve, long run cost curve
o Relationship between MC, ATC, AND AVC
o Some concepts:
§ Economies of scale, the learning curve, economies of scope
- Transaction costs
o How transaction costs affect the size of the firm
o Application: transaction characteristics and governance structure

Lecture 3: Productivity

Summary

- Production function
o Short run and long run
o AP and MP
o Returns to scale
- Choices of factors to optimize profits
o Short run: choose labour
o Long run: choose labour-capital proportions
Lecture 2: Demand Analysis

Summary

- Demand function and marginal revenue

- Calculating elasticity
o Own price
o Income
o Cross price
- Linking elasticity and revenue
- Applications of price elasticities
o Optimal markup pricing
o Tax burden