Study Guide
Chapter 9: Perfect Competition

Characteristics
o Three requirements for perfectly competitive markets:
1. no barriers to entry
2. standardized product
3. many buyers and sellers
o A perfectly competitive firm is a price-taker_
 This means: firm takes prices of market
 Where do they get this price? Draw a graph to help explain.
Where supply meets demand in industry (equilibrium price),
see graphs below
o Draw a graph for this a perfectly competitive firm, label curves.



Elasticity of demand = perfectly elastic
Increase in price above Marginal Revenue curve will lose what
percentage of customers? Lose 100% (all) customers
Short Run Profit Maximization
o How is quantity determined for optimal quantity? MC=MR
o How is price determined for optimal quantity? Given by the market
price
 When
economists make the
graph for the industry,
how do they find the
quantity of the
industry? (where arrow
is) price is taken from
the market price (where
supply meets demand
in industry)

Short Run Profit Maximization Continued
o What are the three steps for finding max profit?
 Step 1: find quantity (MC=MR)
 Step 2: find price (MR)
 Step 3: regraph – find profit box using max profit equation
o What is the profit equation? Profit = Total Revenue-Total Cost
o What is the maximum profit equation? Profit=(Price-ATC)*Quantity



Minimizing Short Run Losses
o Negative profits can be found when P<AC__
o When should firms shut down?
P<AVC
o What is predatory pricing?
When firms charge price far below market price
o Why may a firm predatory price?
In an attempt to drive competitors out of the market
Supply Curve of Perfectly Competitive Market
o Where is the supply curve in the perfectly competitive market?
The segment of MC that is above AVC
o Draw this in a way that helps you remember.
Long-Run Perfect Competition
o Which requirement to be perfectly competitive does not hold in the
long run? Having no barriers to entry
o Why is this? What would this lead to in the long run (what profit)?
In long run, so many suppliers will enter to take advantage of short
run profits, that aggregate supply will drive down, which will drive
the price down. No barriers to entry in the long run lead to zero
economic profits
o Where are economic profits at zero? When price is driven down to
the__________ minimum point of ATC curve
o If short run profits are negative (P<ATC), firms would __exit_ the
market
o If short run profits are positive (P>ATV), firms would _enter___ the
market

Conclusion
o If consumers value another unit of a good by more than it costs
society to produce, then it will be produced.
o What is the cost of society of producing another unit of output? MC
o Is government interference required? No
 Government Interference examples: (add your own examples)
 Externalities in consumption or production pollution,
disease
 Public goods national defense, infrastructure
 Imperfect Information among buyers truth policies
 Insuring against macroeconomic risks hurricanes,
earthquakes
 Normative concerns about an equitable distribution of
goods and services
Chapter 10: Monopolies


Definition of Monopoly
o Pure monopoly – only one seller of goods/service with no close
substitute
Barriers to entry that allow monopolies to develop
1. Natural Monopoly
 What causes natural monopolies? – rises from economies of
scales
 What is economies of scale? – an established firm grows large
enough to produce higher outputs at lower costs
 What causes the lower costs?
When large, may have bundle deals from
suppliers, size, fixed costs spread over outputs
 What is the ATC curve of a natural monopoly?
Downward sloping
2. Firm might control some scarce input
3. Government may create barriers to entry
4. Superior Entrepreneur

Draw a Graph for a Monopoly and Label

Demand Curve of Monopoly
o If a supplier of a perfectly competitive firm increases output, the price
will ___stay the same_____
o If a supplier of a monopoly increases output, the price will __decrease_
o Is it possible that the monopoly may gain a higher revenue by
decreasing price? Yes, very likely

Maximum Profit
o What are the three steps for finding max profit?
 Step 1: find quantity (MC=MR)
 Step 2: find price (MR)
 Step 3: regraph – find profit box using max profit equation
o What is the general profit equation? Profit= Total Revenue-Total Cost
o What is the maximum profit equation? Profit= (Price-ATC)*Quantity

Losses
o A monopoly will suffer losses if: Average total cost is above price (so
the demand curve)
o This tells us, that monopolies’ profits primarily depend on its __costs__

Objections to Monopolies
o Two main inefficiencies:
1. Less incentive to innovate and cut costs
 Do perfectly competitive firms work this way? No, perfectly
competitive firms must work to cut costs. Because they can’t
change the price, cutting costs is the only way they can
increase profits
2. The monopolist fails to produce output that society would have
valued by more than it would have cost to produce
 P>MC
 There is place on the monopolist’s curve that exemplifies this,
please draw this and explain in your own words.



Price Discrimination
What is this called? Deadweight Loss
Please label the loss to consumer surplus and the loss to
producer surplus.
o What is consumer surplus? The difference
between the most you’d be willing to pay and the
actual price
o What is it? Charging different customers different prices for reasons
unrelated to costs.
o If we charge each consumer the highest price the each individual is
willing to pay, this would be: Perfect price discrimination
o Three problems with price discrimination that make it difficult
1. doesn’t work under perfect competition (need downward
sloping demand curve)
2. must be able to prevent low price customers from reselling
to high price customers
3. hard to identify how much people are willing to pay
o Perfect price discrimination gets rid of the __marginal revenue curve__
and sets price where marginal cost hits the demand curve.
o Now the Marginal Revenue = Demand
Chapter 11: Imperfect Competition
Monopolistic Competition

Characteristics
o Three characteristics
1. many buyers and sellers
2. no significant barriers to entry/exit
3. a differentiated product
o Reasons for differentiated product
1. consumers might prefer certain product differences
2. consumers’ ability of obtaining the product might differ across
producers (reasons other than price)
3. incomplete agreeance among consumers about differences in
product quality
o Can the firm change the price without losing all of its customers?
Yes, the firm can change the price
o Why is this?
With differentiated products, consumers may want the product more
than another firms even if the product the consumer wants is more
expensive

o What does the demand curve look like? Downward sloping, but flatter
and more effective to price than monopoly
o Is the firm producing where the average total cost is at its minimum
value? No, it is not at its minimum value
Draw a long run monopolistic competition graph and label.

Cartels come from Monopolistic Competition
o Cartels begin as __perfectly competitive__ markets and acts as
__monopolies__

Cartels want the __highest__ profits and _split__ them amongst
themselves.
o How does the cartel find the quantity that they would like to set? They
find the quantity of a monopoly. Set quantity where MR=MC instead of
where MC=D (like a monopolistic competition)
o What does a cartel gain by setting the quantity at this price? They are
able to raise the price and increase profits. Now Price is greater than
Marginal Cost.
o What is another word for what cartels do (all of above)? colluding
o Draw the graph of a cartel and label.

Problems with Cartels
1. violates anti-trust laws (but not universal laws)
2. economic reason, cartels inherently fail due to “cheaters” and “free
riders”
o What is a “cheater” in the cartel? Someone that produces more than
they’ve agreed to increase their market share and take advantage of
the high prices
o What is a free rider? A firm that isn’t part of the cartel, but benefits
from the high market prices set by the cartel
Oligopoly
 Market dominated by _a few_
 Because there is such close competition, there is rarely a demand curve that
works for each firm.
 The “_game__ theory” is used in oligopolies

“Nash Equilibrium”
o What is the Nash Equilibrium? Combination of actions such that no
player regrets his/her action once it is revealed what everyone has
chosen to do
o Is every competitor necessarily happy at Nash Equilibrium? No
o What is the dominant strategy? Low price
 (Regardless of other person, firm would be better off doing
this.)
o How could the firm collude? Both charge high
 How is this colluding? Banding together to charge a price
above market price
o What is the problem though? What is each firm actually likely to do
even if they do collude? It’s hard to trust what the other person does,
so each will most likely charge the low price, just in case.
o What is Nash Equilibrium in this case? If both charge low
 Why? Because neither would regret charging this price
knowing now what the other has chosen