Unit 4: Imperfect Competition

a. Define (using graphs where appropriate) the characteristics of imperfectly competitive markets and inefficiency.

• Imperfectly competitive markets include monopoly, oligopoly, and monopolistic competition in product markets and monopsony in factor markets.
• In imperfectly competitive output markets and assuming all else is constant, a firm must lower price to sell additional units.
• In imperfectly competitive markets, consumers and producers respond to prices that are above the marginal costs of production and/or marginal benefits of consumption (i.e., price is greater than marginal cost in an inefficient market).
• Incentives to enter an industry may be mitigated by barriers to entry. Barriers to entry—such as high fixed/start-up costs, legal barriers to entry, and exclusive ownership of key resources—can sustain imperfectly competitive market structures.
• Enduring understanding PRD-3: Even with a common goal of profit-maximization, market structure constrains and influences prices, output, and efficiency.

b. Explain (using graphs where appropriate) equilibrium, firm decision making, consumer surplus, producer surplus, profit (loss), and deadweight loss in imperfectly competitive markets and why prices in imperfectly competitive markets cannot be relied on to coordinate the actions of all possible market participants and can lead to inefficient outputs. c. Calculate (using data from a graph or table as appropriate) areas of consumer surplus, producer surplus, profit (loss), and deadweight loss in imperfectly competitive markets.

• A monopoly exists because of barriers to entry.
• In a monopoly, equilibrium (profit-maximizing) quantity is determined by equating marginal revenue (MR) to marginal cost (MC). The price charged is greater than the marginal cost.
• In a natural monopoly, long-run economies of scale for a single firm exist throughout the entire effective demand of its product.
• Enduring understanding PRD-3: Even with a common goal of profit-maximization, market structure constrains and influences prices, output, and efficiency.

b. Explain (using graphs where appropriate) equilibrium, firm decision making, consumer surplus, producer surplus, profit (loss), and deadweight loss in imperfectly competitive markets and why prices in imperfectly competitive markets cannot be relied on to coordinate the actions of all possible market participants and can lead to inefficient outputs. c. Calculate (using data from a graph or table as appropriate) areas of consumer surplus, producer surplus, profit (loss), and deadweight loss in imperfectly competitive markets.

• A firm with market power can engage in price discrimination to increase its profits or capture additional consumer surplus under certain conditions.
• With perfect price discrimination, a monopolist produces the quantity where price equals marginal cost (just as a competitive market would) but extracts all economic surplus associated with its product and eliminates all deadweight loss.
• Enduring understanding PRD-3: Even with a common goal of profit-maximization, market structure constrains and influences prices, output, and efficiency.

b. Explain (using graphs where appropriate) equilibrium, firm decision making, consumer surplus, producer surplus, profit (loss), and deadweight loss in imperfectly competitive markets and why prices in imperfectly competitive markets cannot be relied on to coordinate the actions of all possible market participants and can lead to inefficient outputs. c. Calculate (using data from a graph or table as appropriate) areas of consumer surplus, producer surplus, profit (loss), and deadweight loss in imperfectly competitive markets.

• In a market with monopolistic competition, firms producing differentiated products may earn positive, negative, or zero economic profit in the short run. Firms typically use advertising as a means of differentiating their product. Free entry and exit drive profits to zero in the long run. The output level, however, is smaller than the output level needed to minimize average total costs, creating excess capacity. The price is greater than marginal cost, creating allocative inefficiency.
• Enduring understanding PRD-3: Even with a common goal of profit-maximization, market structure constrains and influences prices, output, and efficiency.

a. Define (using tables as appropriate) key terms, strategies, and concepts relating to oligopolies and simple games. b. Explain (using tables as appropriate) strategies and equilibria in simple games and the connections to theoretical behaviors in various oligopoly market and non-market settings. c. Calculate (using tables as appropriate) the incentive sufficient to alter a player’s dominant strategy.

• An oligopoly is an inefficient market structure with high barriers to entry, where there are few firms acting interdependently.
• Firms in an oligopoly have an incentive to collude and form cartels.
• A game is a situation in which a number of individuals take actions, and the payoff for each individual depends directly on both the individual’s own choice and the choices of others.
• A strategy is a complete plan of actions for playing a game; the normal form model of a game shows the payoffs that result from each collection of strategies (one for each player).
• A player has a dominant strategy when the payoff to a particular action is always higher independent of the action taken by the other player.
• A Nash equilibrium is a condition describing the set of actions in which no player can increase his or her payoff by unilaterally taking another action, given the other players’ actions. Exclusion: Dominant strategies and Nash equilibrium with more than two players or more than two actions per player, mixed-strategy equilibria, extensive form games, and normal form games with more than two players or more than two actions per player are beyond the scope of the course and the AP Exam.
• Oligopolists have difficulty achieving the monopoly outcome for reasons similar to those that prevent players from achieving a cooperative outcome in the Prisoner’s Dilemma; nevertheless, prices are generally higher and quantities lower with oligopoly (or duopoly) than with perfect competition.
• Enduring understanding PRD-3: Even with a common goal of profit-maximization, market structure constrains and influences prices, output, and efficiency.