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Monopolistic Competition

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- Relatively large number of sellers. - Differentiated Products. - Easy Entry and Exit.

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Relatively Large # of Sellers

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- Small market shares: each firm has a comparatively small % of the total market. - No Collusion: Presence of a large # of sellers makes collusion unlikely. - Independent Action: There is usually no feeling of interdependence between firms (no attention paid to each other).

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Differentiated Products

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- Product Differentiation is when a product is distinguished. - Product Attributes: Real differences in functional features, materials, design and workmanship are vital aspects of differentiation. - Service: Service is important in someone deciding to buy something. Reputation, Speed, etc. all help in differentiation. - Location: Often location is important, which is why things like small supermarkets that are more expensive can stay open, because they are closer to the consumer. - Brand Name and Packaging: Celebrity connection may help people decide to buy a brand name, even if it is the same as the off brand. - Some control over price: Can change prices, but it has a limited effect. Buyers go with the prices they are comfortable with (if they have more money they will spend more, less money they will spend less).

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Easy Entry and Exit

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- Monopolistically competitive are typically small firms, making entry and exit easy. Sometimes it is difficult to imitate a brand because of patents or trade secrets.

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Advertising

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- Goal is to get consumers to buy their product over other products.

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Monopolistically Competitive Firms

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- Four firm concentration ratio = Output of 4 largest firms/total output in the industry. - If largest four firms account for more than 40% of the industry, it is an oligopoly, if it is otherwise it is a monopolistically competitive industry.

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Price and Output in Monopolistic Competition

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The firms demand curve - The same as the demand curve of a pure monopoly.

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The Short Run: Profit or Loss

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- Produce at MR=MC, go up to the demand curve to find price, same as a pure monopoly (the only way to distinguish between the two is to see them in the long run).

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The Long Run: Only a normal profit

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- Profits: Firms enter - In Short run, if profits are earned, then more firms will enter the industry. - Losses: Firms Exit: - If firms incur loss, many will leave the industry.

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Complications

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Some firms may achieve sufficient product differentiation, so other firms cannot duplicate them.

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Monopolistic Competition and Efficiency: Neither Productive, nor Allocatively efficient.

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- Only pure competition can be efficient in any way, because they do not produce at p= Min. ATC, or P= MC.

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Monopolistic Competition and Efficiency: Excess Capacity

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- Plant and equipment are underused because firms are producing less than min. Output ATC.

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Product Variety: Benefits of Product Variety

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- Range of choice for consumer is increased. - Products are improved upon, better for society. - Greater the excess-capacity, the wider the range of choice.

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To the extent that brand names developed in monopolistic competition provide a benefit to the consumer, it is

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through their assurance that the firm will provide a quality product in order to preserve repeated transactions.

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Which of the following is true of monopolistic competition but is NOT true of perfect competition?

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Each firm distinguishes its product from that of its competitors

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Why do monopolistic competitors not collude to form a monopoly?

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There are too many firms to allow for successful collusion

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A monopolistically competitive firm faces

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a highly elastic demand curve

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Which of the following is true of monopoly but is NOT true of monopolistic competition?

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The firm will earn positive economic profits in the long run.

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What is the effect in the market as more firms enter a monopolistically competitive industry?

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The demand curve faced by each firm shifts in and to the left

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Which of the following would be an example of a monopolistically competitive industry with differentiation by style or type?

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running shoes

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For any given firm in a monopolistically competitive market, the long run economic profit tends to be __________ and firms operate to the ____________ of the minimum point on the average total cost curve.

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zero, left

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Which of the following is true of the long run in perfect competition but NOT true of the long run in monopolistic competition?

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The firm produces where ATC is minimized.

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In the oil change market, monopolistic competition prevails. This means that collusion among oil change suppliers is ______________ and firms engage in ___________ behavior.

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rare, uncooperative

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If monopolistically competitive firms are earning positive economic profits in the short run, then in the long run

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they will make zero economic profits

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Monopolistic competitors engage in product differentiation in order to

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enhance their market power

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The product diversity resulting from monopolistic competition comes at the expense of having

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a higher average total cost of production than would prevail under perfect competition

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The goal of a monopolistically competitive firm is to

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maximize profit.

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Suppose that a monopolistically competitive firm is currently producing at the point where marginal revenue equals marginal cost and is incurring a loss. In this situation, economic theory would predict that the firm will

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exit the industry.

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Since a monopolistic competitor produces a product with many close substitutes, it

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has no market power.

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Monopolistically competitive firms spend money on celebrity endorsements in order to

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send a signal that they are successful companies.

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Which of the following is true of perfect competition but is NOT true of monopolistic competition?

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The firm will produce at a point where price equals marginal cost.

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What accounts for the fact that profit is zero in the long-run equilibrium in monopolistic competition?

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There are no barriers to the entry of new firms.

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In long run equilibrium, a monopolistically competitive firm is producing at a point on its average total cost curve where

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price equals average total cost.

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Monopolistic Competition

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A market structure characterized by a relatively large number of sellers producing a differentiated product, for which they have some control over the price they charge, in a market with relatively east market entry and exit

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Product Differentiation

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The strategy of distinguishing one firm's product from the competing products of other firms

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Economic Profit

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The level of profit that occurs when total revenue is greater than total cost

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Normal Profit

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The level of profit that occurs when total revenue is equal to total cost.

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Loss

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The level of profit that occurs when total revenue is less than total cost

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Productive Efficiency

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Producing output at the lowest possible average total cost of production; using the fewest resources possible to produce a good or service

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Allocative Efficiency

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Producing the goods and services that are most wanted by consumers in such a way that their marginal benefit equals their marginal cost

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Deadweight Loss

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The value of the economic surplus that is forgone when a market is not allowed to adjust to its competitive equilibrium

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Excess Capacity

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The under-utilization of resources that occurs when the quantity of output a firm chooses to produce is less than the quantity that minimizes average total cost

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Oligopoly

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A market structure characterized by a few large producers, of either standardized or differentiated products, operating in industries with extensive entry barriers. These producers are price makers and behave strategically when making decisions related to the features, prices and advertising of their products

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Product Differentiation

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The strategy of distinguishing one firm's product from the competing products of other firms

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Mutual Interdependence

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A situation in which the strategy followed by one producer will likely affect the profits and behavior of another producer

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Game Theory

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The study of the strategic behavior of decision makers

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Payoff Matrix

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A table showing the potential outcomes arising from the choices made by decision makers

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Dominant Strategy

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A situation in which a particular strategy yields the highest payoff regardless of the other player's strategy

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Nash Equilibrium

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An outcome in which, unless the players can collude, neither player has an incentive to change his or her strategy

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Collusion

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A situation in which individuals, firms, or any group of actors coordinate their actions to achieve a desired outcome. Collusion is generally used to achieve an outcome that would not be possible in the absence of coordinated actions, and it is typically associated with illegal or anti-competitive behatiors

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Patents

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It gives firms 20 years exclusive rights to a product

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Non Price Competition

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Competition based on distinguishing one product by means of product differentiation and then advertising the distinguished products to consumers

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Monopolistic Competition

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A market structure in which many firms sell a different product, entry is relatively easy and each firm has some control over its product price, and there is considerable non price competition

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Creative destruction

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It refers to the idea that the creation of new products and new production methods destroys the market positions of firms committed to existing products and old ways of doing business.

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Product attributes Service Location Brand names Packaging

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In monopolistic competition, firms can differentiate their products by:

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Relatively large number of sellers Differentiated products Easy entry and exit Advertising

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Characteristics of a Monopolistic competition

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Small Market Share

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Small percentage of the market thus limited control over the price

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Independent action

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There is no feeling of interdependence and each firm can determine is pricing policy without considering the possible reaction of rival firms.

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No Collusion

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Relatively large number of firms ensures that collusion by a group of firms to restrict output and set prices is unlikely

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Product Differentiation

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A strategy in which firm's product is distinguished from competing products by means of its design, related services, quality, location or other attributes

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The Herfindahl Index

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It is another measure of industry concentration and it is the sum of the squared percentage of market shares of all firms in the industry.

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Four-firm concentration ratios

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These are a measure of industry concentration.

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Advertising

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Make price less a factor in consumer purchases and make the product differences a greater factor and If successful, the firm's demand curve will shift to the right and will become less elastic

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A few large producers Homogeneous or differentiated products Limited control over price Entry barriers Mergers

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Characteristics of Oligopoly

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40%

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To be an oligopoly, the 4-firm concentration ratio must be at least?

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Localized markets

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It may have just one producer which is a monopoly, while a low 4-firm concentration ratio indicates a lot of competition in the national industry.

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Dominant Firms

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The industry exhibit dominance that may be disguised and not reflected in the 4-firm concentration ratio.

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World Trade

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It is not taken into account when calculating concentration ratios.

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Inter-industry competition

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It occurs when industries like glass and plastic compete with each other. This competition is not reflected in their high 4-firm concentration ratios.

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o Localized markets o Inter-industry competition o World price o Dominant firms

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Shortcomings of Oligopoly

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Incentive to Cheat

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Cheating can result in more revenues for the cheater.

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Collusion

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Cooperation with rivals can benefit the firm.

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Mutual Interdependence

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It is when each firm's profit depends on its own pricing strategy and that of its rivals.

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Strategic pricing behavior

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It refers to how a firm's decisions are based on the actions and reactions of rivals.

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Kinked Demand Curve Collusive Pricing Price Leadership

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3 Oligopoly Models

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Kinked Demand Curve

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It is used for noncollusive oligopolies to explain their behaviors and pricing strategies.

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Explains inflexibility, not price Prices are not that rigid Price wars

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Criticisms: Kinked Demand Curve

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Diversity of oligopolies Complications of interdependence

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Reasons for 3 Oligopoly models

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Cartel

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It is defined as a group of firms or nations joining together and formally agreeing as to the price they will charge and the output levels of each member.

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Legal obstacles

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laws prohibit cartels and price collusion

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New entrants

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new producers will be drawn to the industry because of the greater prices and profits which will increase market supply and decrease prices.

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Recession

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overall demand declines during recessions making cheating more attractive.

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Cheating

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there is always a tendency for members to cheat and this erodes the cartel's power over time. See the Prisoner's dilemma.

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Number of firms

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the more firms who are part of the agreement, the harder it is to maintain.

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Demand and cost differences

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Because cost and demand differences exist between the members, it will be difficult for all members to charge the same price.

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Demand and cost differences Number of firms Cheating Recession New entrants Legal obstacles

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Obstacles to Collusion

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Price Leadership

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It is an economic model where a dominant firm initiates price changes and the others in the industry follow the leader.

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Advertising

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It is prevalent in oligopolies since there are differentiated goods and advertising is the best way to communicate product differences

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Advertising

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It is a low-cost way of providing information to consumers about different options and it reduces the consumer's search time for products.

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Advertising

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It also enhances competition between firms and thus aids in economic efficiency.

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Advertising

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It speeds up technological progress by introducing new products. It can help firms obtain economies of scale by reducing long run average costs.

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Can be manipulative Contains misleading claims that confuse consumers Consumers pay high prices for a good while forgoing a better, lower priced, unadvertised version of the product.

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Negative Effects of Advertising

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Monopolistic competition

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A market in which many firms are producing differentiated products with little control of the market, there exist few barriers to entry and exit, firms are independent, and economic profit is only (really) possible in the short-run. Neither allocatively or productively efficient.

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Product differentiation

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The means in which a firm distinguishes itself in the market through changes to a product; occurs when consumers perceive a product as being different in some way from other substitute products. This is done through: 1) Appearance 2) Service 3) Design 4) Quality 5) Expertise and skill 6) Location 7) Brand reputation and image (essentially advertising) Many firms differentiate as a means of non-price competition; product differentiation effectively "creates" demand (even at the expense of consumers, resulting in a DWL). Examples: Restaurants, gas stations, clothing, plumbers, etc. The distinguishing factor of a monopolistic competitive firms from that of a perfectly competitive one.

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Innovation

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When something new or different is introduced; can be considered a form of product differentiation.

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Brand loyalty

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Consistent preference for one brand over all others; where without deep reflection you shop for things. This is created through product differentiation.

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Brand

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The marketing practice of creating a name, symbol or design that identifies and differentiates a product from other products. Can give "an edge" in such competitive markets.

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Non-price competition

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Competition on advertising and differentiation to increase demand and thus market power and price-setting ability.

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Productive efficiency

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The point at which which you receive the highest output per unit of input; MC = AC.

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Allocative efficiency

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The point at which it is most efficient to produce for society, as it best meets society's needs and wants; AR = MC.

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Role and cost of advertising (Mono comp.)

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Creates demand for a product; along with product differentiation, a form of non-price competition. Both a sunk and fixed cost; a barrier to exit.

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Explanation of Mono comp. graph

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EXPLAIN...

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Oligopoly

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A market in which a few firms dominate the industry, even though there may be more in the entire market, having much market power and therefore price control, with significant barriers to entry and exit, having asymmetrical information, with different costs, selling both differentiated and homogenous products, potentially making economic profit in the SR with the possibility of making it in the LR. Firms are also interdependent. Examples: Fixe broadband services in the UK, such as Virgin, BT, Sky, and TalkTalk.

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Dominant firm/tacit-collusive oligopoly (informal collusion)

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Where a single, dominant firm establishes price leadership in a market, and there is an informal recognition by smaller firms on the price-setting ability, as the large firm would win any price war. Firms can still compete in other ways, though.

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Dominant firm

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The firm that dominates the market in terms of market power and price setting ability.

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Non-collusive oligopoly

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[Oligopoly] When firms do not cooperate and exist in a strategic environment. They are, however, interdependent (see game theory).

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Collusive oligopoly

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[Oligopoly] Where firms agree to work together to mutually improve their situation. Illegal.

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Interdependent

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Reliance on others; people watch each other (see game theory).

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Concentration ratio

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A ratio that attempts to quantify the density of market power held by a certain number of firms, and therefore the type of market they operate in. Taken by...

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Kinked demand curve

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The curve that arises from a non-collusive oligopoly, and explains why firms in this market want to keep there prices stable (and may not have to change prices due to changes in cost).

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Explanation of the Kinked demand curve

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The kinked demand curve...

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Collusion

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An agreement, either formal or informal, between competitive parties to limit competition and raise prices.

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Cartel

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When oligopolists agree to take specific market action to enhance profits; a group of competitors, and a form of formal collusion. Can restrict output and drive up prices, not advertise, restrict innovation, fi prices, etc. Essentially a monopoly in this sense. Incentive to cheat, however. OPEC is an example of one.

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Parallel pricing

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Products/services priced the same as those of competitors. Doing the same thing without collusion. Not enough to prove illegal price fixing.

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Quality variations

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Variations in the quality of a product as a result of product differentiation.

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Special promotions

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Discounts, prizes or gifts with particular purchases, free samples used to introduce new products.

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Game theory

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A branch of mathematics and social sciences that attempts to capture the behaviour in strategic situation, and explain the compete or collude dilemma faced by oligopolies. (Assume duopoly)(?)

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Pay-off matrix

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The diagram that depicts the game theory.

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Contestable markets

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A market served by a small number of firms, however is characterized by competitive pricing due to the existence of low barriers to entry and exit (in perfect circumstances, none would exist). Would therefore break even in long run. In this way, a single-firm market may even show highly competitive behaviour. A type of fifth market structure.

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All points on curve

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Allocative efficiency: Productive efficiency: Break-even point: Short-run close-down point: Revenue maximization: Profit maximization:

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Notes

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Be sure to know ALL graphs, including effects on consumer/producer surplus, deadweight welfare losses, and efficiencies!

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Why do some oligopolistic firms engage in non-price rather than price competition?

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Define: Price competition, non-price competition, oligopoly, non-collusive oligopoly. Graph: Kinked demand curve Argument: Oligopolistic firms, particularly those that are non-collusive, often choose to engage in non-price rather than price competition due to the structure of the market, as evident by the kinked demand curve. Should they raise their price a little, they loose many customers, should they lower, they enter price war and don't gain many, therefore it is often better to focus on product differentiation and advertising rather than price wars. Also with collusive oligopolies, as want to keep price very high.

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