Chapter 6 1. Market structures affects the behavior of firms and thus market outcomes.

Market

structures range from perfect competition to monopoly.

2.

A perfectly competitive firm has no power to alter the market price of the goods it

sells: it is a price taker. The perfectly competitive firm confronts a horizontal demand curve for its own output even though the relevant market demand curve is negatively sloped.

3.

Profit maximization induces the competitive firm to produce at that rate of output

where marginal cost equals price. This represents the short-term equilibrium of the firm.

4.

A competitive firm's supply curve is identical to its marginal cost curve. In the

short run, the quantity supplied will rise or fall with price.

5.

The determinants of supply include the price of inputs, technology, and

expectations. If any of these determinants change, the firm's supply curve will shift. Market supply will shift if costs or the number of firms in the industry change.

6.

If short-term profits exist in a competitive industry, new firms will enter the

market. The resulting shift of supply will drive market prices down the market demand curve. As prices fall, the profit of the industry and its constituent firms will be squeezed.

7.

The limit to the competitive price and profit squeeze is reached when price is

driven down to the level of minimum average total cost. Additional output and profit will be attained only if technology is improved (lowering costs) or if demand increases.

8.

If the market price falls below ATC, firms will exit an industry. Price will stabilize

only when entry and exit cease (and zero profit prevails).

ATC

9.

The most distinctive thing about competitive markets is the persistent pressure

they exert on prices and profits. The threat of competition is a tremendous incentive for producers to respond quickly to consumer demands and to seek more efficient means of production. In this sense, competitive markets do best what markets are supposed to doefficiently allocate resources.

Chapter 7 1. Market power is the ability to influence the market price of goods and services.

The extreme case of market power is monopoly, where only one firm produces the entire supply of a particular product. A monopolist selects the quantity to be supplied to the market and sets the market price.

2.

The distinguishing feature of any firm with market power is that the demand curve

it faces is downward-sloping. In a monopoly, the demand curve facing the firm and the market demand curve are identical.

3.

The downward-sloping demand curve facing a monopolist creates a divergence

between marginal revenue and price. To sell larger quantities of output, the monopolist must lower product prices. Marginal revenue is the change in total revenue divided by the change in output.

4.

A monopolist will produce at the rate of output at which marginal revenue equals

marginal cost. Because marginal revenue is always less than price for a monopoly, the monopolist will produce less output than will a competitive industry confronting the same market demand and cost opportunities. That reduced rate of output will be sold at higher prices, in accordance with the (downward-sloping) market demand curve.

5.

A monopoly will attain a higher level of profit than a competitive industry because

of its ability to equate industry (i.e., its own) marginal revenues and costs. By contrast, a competitive industry ends up equating marginal costs and price, because its individual firms have no control over the market supply curve.

6.

Because the higher profits attained by a monopoly will attract envious

entrepreneurs, barriers to entry are needed to prohibit other firms from expanding market supplies. Patents are one such barrier to entry. Other barriers are legal harassment, exclusive licensing, product bundling, and government franchises.

7.

The defense of market power rests on (1) the ability of large firms to pursue long-

term research and development, (2) the incentives implicit in the chance to attain market power, (3) the efficiency that larger firms may attain, and (4) the contestability of even monopolized markets. The first two arguments are weakened by the fact that competitive firms are under much greater pressure to innovate and can stay ahead of the profit game only if they do so. The contestability defense at best concedes some amount of monopoly exploitation.

(1) 2 (3) (4) , 12 3 4

8.

A natural monopoly exists when one firm can produce the output of the entire

industry more efficiently than can a number of smaller firms. This advantage is attained from economies of scale. Large firms are not necessarily more efficient, however, because either constant returns to scale or diseconomies of scale may prevail.