UNIT II D: Competition
II.
The nature and functions of product markets (55-65%)
D. Firm Behavior and Market Structure (25-35%)
1. Profit:
a. Accounting versus economic profits
b. Normal profit
c. Profit maximization: MR=MC rule
2. Perfect competition
a. Profit maximization
b. Short-run supply and shutdown decision
c. Firm and market behaviors in short-run and long run equilibrium
d. Efficiency and perfect competition
3. Monopoly
a. Sources of market power
b. Profit maximization
c. Inefficiency of monopoly
d. Price discrimination
4. Oligopoly
a. Interdependence, collusion, and cartels
b. Game theory and strategic behavior
5. Monopolistic competition
a. Product differentiation and role of advertising
b. Profit maximization
c. Short run and long-run equilibrium
d. Excess capacity and inefficiency
Chapter
(Krugman)
Chapter
(McConnell)
Module 57
Concepts
Overview of Comp Types
Module 53
(review
last unit
8
(review last
Unit)
Profit



Module
58, 59, 60
9
Perfect Competition
 Profit Maximization
 Entry/Exit decisions Short-Run and Long-Run Analysis
 Efficiency
Module
61, 62, 63
10
Monopoly
 Source of Market Power
 Profit Maximization
 Inefficiency
 Price Discrimination
Module
67, 68
11
Monopolistic Competition
 Product differentiation and role of advertising
 Profit maximization
 Short run and long-run equilibrium
 Excess capacity and inefficiency
Module
64, 65, 66
11
Oligopoly
 Interdependence, collusion, and cartels
 Game theory and strategic behavior
 Nash Equilibrium
Accounting vs Economic Profit
Normal Profit
Profit Maximization
Topic 1
Profit (Review Last Unit)
Krugman Module 53
Objectives
1. Define the concept of maximization of profits.
2. Apply the concepts of marginal cost and marginal revenue to determine maximization of
profits.
3. Understand and apply the rule of MC=MR.
Key Vocabulary
Economic Profit
Accounting Profit
Marginal Revenue (MR)
Total Revenue (TR)
Profit-Maximizing Rule
Marginal Cost (MC)
MR = MC
Key Conceptual Questions
1. How does the economist's definition of profit differ from the accountant's?
2. Why do firms produce at an output level equal to the point where marginal cost is equal to
marginal revenue?
3. Why would an individual firm continue to produce when there are minimization of losses?
Topic 2
Pure (Perfect) Competition
Krugman Module 57 (to review all competition types)
Krugman Modules 58, 59, 60
Objectives
1. List the four basic market models and characteristics of each.
2. Describe characteristics of a purely competitive firm and industry.
3. Explain how a purely competitive firm views demand for its product and marginal revenue
from each additional unit sale.
4. Compute average, total, and marginal revenue when given a demand schedule for a purely
competitive firm.
5. Use both total-revenue—total-cost and marginal-revenue—marginal-cost approaches to
determine short-run price and output that maximizes profits (or minimizes losses) for a
competitive firm.
6. Find the short-run supply curve when given short-run cost schedules for a competitive firm.
7. Explain how to construct an industry short-run supply curve from information on single
competitive firms in the industry.
8. Understand the concept of minimization of losses.
9. Define the shutdown criterion.
10. Explain the long-run equilibrium position for a competitive firm using entry and exit of
firms to explain adjustments from nonequilibrium positions.
11. Explain the shape of long-run industry supply curves in constant-cost and increasing-cost
industries.
Key Vocabulary
Pure Competition
Marginal Revenue (MR)
Minimizing Loss (Loss)
Shutdown
Increasing cost
Decreasing Cost
Price-Taker
Break-even point
Excessive Profit (positive Profit)
Long-Rune Equilibrium
Constant-Cost
Key Conceptual Questions
1.
2.
3.
4.
5.
What are the characteristics of the perfectly competitive market structure?
Draw a side by side graph of a perfectly competitive firm in long run equilibrium with
that of a industry in long run equilibrium
What is the output and price rule of a perfectly competitive firm?
Why is the perfectly competitive market structure considered to be economically
efficient?
Assume that the fast food industry is a perfectly competitive industry and labor is an
important variable input in the production process. Assume that the labor cost
increases throughout the industry.
a. Explain how this increase in labor cost will affect the fast food industry in the
short run?
b. What will be the short run effect on price, output, and profit of atypical firm in the
fast food industry?
c. Will firms enter or exit the fast food industry in the long run? Why?
d.
Topic 3
Monopoly
Krugman Modules 61, 62, 63
Objectives
1. List the five characteristics of pure monopoly.
2. Explain the difference between a “pure” monopoly and a “near” monopoly.
3. List and give examples of the four barriers to entry.
4. Describe the demand curve facing a pure monopoly and how it differs from that facing a
firm in a purely competitive market.
5. Compute marginal revenue when given a monopoly demand schedule.
6. Explain why the marginal revenue is equal to the price in pure competition but not in
monopoly.
7. Determine the price and output level the monopoly will choose given demand and cost
information in both table and graphic form.
8. Discuss the economic effects of pure monopoly on price, quantity of product produced,
allocation of resources, distribution of income, and technological progress.
9. Give examples of how new technology has lessened monopoly power.
10. List three conditions necessary for price discrimination.
11. Explain why profits and output will be higher for a discriminating monopoly as compared
to non-discriminating monopoly.
12. Identify two pricing strategies of monopoly regulation and explain the dilemma the
regulators face in utilizing these strategies.
Key Vocabulary
Barriers to entry
Patents and Licenses
Single Price
Natural Monopoly
AC Regulation
Legal Barriers
Price Discrimination
Legal Monopoly
Rent-seeking
MC Regulation
Key Conceptual Questions
1.
2.
3.
4.
What are the conditions for a monopoly?
Explain how a monopoly decides on output and pricing?
How do monopolist compare with competitive markets in terms of efficiency?
What is the cost to society?
Suppose a monopolist, making economic profits, experiences an increase in its
fixed cost. How will this increase in fix cost affect price and output decisions in
the short run?
Topic 4
Monopolistic Competition
Krugman Modules 67 - 68
Objectives
1. List the characteristics of monopolistic competition.
2. Explain how product differentiation occurs in similar products.
3. Determine the profit-maximizing price and output level for a monopolistic competitor in
the short run when given cost and demand data.
4. Explain why a monopolistic competitor will realize only normal profit in the long run.
5. Identify the reasons for excess capacity in monopolistic competition.
6. Explain how product differentiation may offset these inefficiencies.
7. Compare and contrast the long- and short-run profits in monopolistic competition to those
in perfect competition.
Key Terms
Monopolistic competition
4-firm Concentration Ratio
Long-run Equilibrium
Product differentiation
Herfindahl Index
Excessive Capacity
Key Conceptual Questions
1. Construct a chart (with graphs) comparing and contrasting the three different market
structures (Competition, Monopoly, Imperfect Competition). Your comparison needs to
include:
a. graphical illustrations of each in long run equilibrium
b. explanation of efficiency
c. explanation of how each arrives at price and quantity
d. explanation of profits
e. explanation of number of firms
f. explanation of the relationship between demand and marginal revenue
g. explanation of entry/exit
2. Graphically depict short-run loss on a monopolistically competitive firm. Show the long-run
change due to entry/exit effects.
1. Graphically depict short-run excessive profit on a monopolistically competitive firm. Show
the long-run change due to entry/exit effects.
Topic 5
Oligopoly
Krugman Modules 64, 65, 66
Objectives
1. Describe the characteristics of an oligopolistic industry.
2. Identify and explain the most important causes of oligopoly.
3. Describe and compare the concentration ratio.
4. Use a profit-payoffs matrix (game theory) to explain the mutual interdependence of two
rival firms and why oligopolists might tempt to cheat on a collusive agreement.
5. List the obstacles to collusion behavior.
6. List the positive and negative effects of advertising.
Key Vocabulary
oligopoly
game theory
kinked demand curve
Nash equilibrium
concentration ratio
prisoner’s dilemma
collusion
duopoly
Key Conceptual Questions
1.
2.
3
What is an oligopoly?
When are oligopolies likely to collude?
What is game theory? What does it predict for the equilibrium price and output?