AP Microeconomics
Review #4
Market Structure
 The nature and degree of
competition between firms in the
same industry
 4 Categories:
1. Perfect Competition
2. Monopolistic Competition
3. Oligopoly
4. Monopoly
Monopoly
Price-Maker, only provider of product,
perfectly inelastic good
Still faces elasticity…there is a limit to how
high they can raise prices
Downward sloping demand and MR curve
Monopoly
Lerner Index:
Measures pricing
power of firms
How much can the
firm charge for
product over cost
of product?
 (P – MC)
P
Herfindahl Index:
Measures the size
of a firm compared
to its industry
Bigger the size =
more market power
Graph:
MR will cross the xaxis at demand’s
Cons. Surplus
MC
midpoint; this
helps to show
Dead Weight Loss;elasticity!!
PX
waste P = MC; allocative efficient, if
Profit
perfect comp where Px = price
of resourcesAC
Price & Cost
Total
Revenue
Cost
Demand
QX
MR
Output
Types of Monopolies
Natural Monopolies (regulated)
Better for whole to have one efficient supplier of
product; large companies show economies of
scale as they grow
Ex) utilities
Gov’t will choose fair-return price (P = AC)
Unregulated Monopolies
Illegal in the country
Sherman, Clayton, Justice Dept., ICC, FTC,
etc.
Monopolistic Competition
 Characteristics:
Many firms
Very similar
products
Product
differentiation
(advertising) leads
to pricing power
(P>MC)
No barriers to
entry

Graph:
 Same graph as
monopoly; all
represent imperfect
competition
 Why?
1. Has some price
power, therefore
downward sloping
MR!!!
2. Both Lerner and
Herfindahl index are
much lower than
monopoly though!!!
Long Run Equilibrium
 Why?
1. LR means making profit
and can expand
2. Very similar products
and no barriers to entry
means more firms will
enter a profitable
market.
3. Demand for individual
firms decrease as more
suppliers enter driving
down profits!!
Graph:
Price
&
Cost
MC
LRAC
PX
D
QX
MR
Output
Oligopoly
Price Leader
One major firm and a few small firms
Cartel
Firms working together to set price and quantity
(collusion)
Kinked
Strategy Game; follow for a price drop but not
for a price raise
Kinked Graph:
Price
&
Cost
MC
PX
ATC
Profit
Demand
QX
MR
Output
Game Theory
Strategy theory that choices made by
players based on the reaction expected by
opponents.
Dominant Strategy: a strategy that is best
no matter what the opposition does
Nash Equilibrium: the result of all players
playing their best strategy given what their
competitors are doing.
Game Theory
 Circle Test: use to find dom. strategy: circle your
opponents best move based on your move; if player
gets two circles in same decision, then it is a dominant
strategy
Rick
Jim
Left
Right
Top
+100, 0
+100, +100
Bottom
-100, 0
+200, +100
Does Jim have a
Best
Play:
Rick
will
always
choose
Right,
since both circles are in dominant
If Jim ChoosesIf Jim Rule,
Chooses
strategy?
Rick’s
right
option
it
is
his
Jim
will see
Top, Rick’s best
Bottom,
Rick’sRick’s strategy and
No, his best results are in
dominant
strategy!!
move:
best
move:
will always choose Bottom
different choices!!
A.P. Microeconomics
Have out Unit IV Review Sheet!!
Market Failures & Need for Govt
When the market (firms &
households) cannot determine
price or quantity there is a need
for gov’t to do so!!
Externalities
Unintended side effects of an
economic decision-activity
Negative: pollution
Gov’t taxes firm the value of social cost
Positive: education & smoke detectors
Gov’t subsidizes firm value of benefit
Internalizing Externalities
GRAPH:
Price
Pnew
MSC
MC
S1
S0
Cost
MR
PX
D
QX Output
Quantity
Taxes on the firm will decrease supply and
thus raise the price
Public Goods
 Goods which are non-exclusive;
Private firms won’t offer because can’t deny
Gov’t must provide with tax revenue
 Free Rider:
People can receive
and never pay for
them
 Rent:
Getting more money
than what is
deserved, P > MC
Imperfect Information
Caveat emptor, let the buyer beware
Truth in advertising laws
Gov’t agencies to regulate firm’s
(FDA)
Imperfect Competition
Monopolistic, Oligopoly, & Monopoly
Anti-trust laws & regulatory agencies
(FTC, ICC, SEC)
Efficiency
 Allocative Efficiency
P = MC
Resources are being
used efficiently to
produce all society
would like to have
PX = value of output
MCX = value of
inputs to make the
output
 Pareto Efficiency
An improvement for
society as long as
some people are
gaining without others
losing
If efficient to begin
with, there are no
improvements
possible without
hurting some people.
Must weigh costs &
benefits
Income Redistribution
 Haves:
Have-Nots:
1.
2.
3.
4.
5.
-below poverty level
Economic Stabilizers:
Ways for gov’t to help:
-welfare, food stamps,
WIC, HEAP, SSI,
unemployment,
housing, loans.
Transfer Payments: $
the gov’t gives w/o
anything in return
Family $
Talent - Skill
Education
Power – Connection
Luck
The Lorenz Curve
Measures Income
Distribution of
entire nation’s
population;
compare to perfect
equality.
Population is
ranked and then
split into fifths
(quintiles) and
studied.
GRAPH:
%
Perfect Equality
O
F
I
N
C
O
M
E
Lorenz Curve
% OF HOUSEHOLDS