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The Firm and Market Structures

10 important questions on The Firm and Market Structures

What about income-elasticity of demand?

It measures the responsiveness of demand to changes in income, calculation is similar to price-elasticity. With the percentage change in demand over the percentage change in income. For normal goods it will be positive, i.e. negative slope of demand. More luxury goods > 1. Inferior goods have negative value.

Note: a change will result in a total shift of the demand curve!

What about cross-price elasticity?

The change in price of a related product. Therefore the responsiveness as percentage change in demand over percentage change in price of related good.
- - > Positive for substitutes, as a higher price for the other good results in a higher demand for this goods
- - > Negative for complements, as a higher price for the other good makes this good less attractive as well.
This can help us to assess the pricing power of firms in (un)competitive markets.

Price-elasticity in relation to Total Revenue?

- - > if elastic > 1, then if Price increases, demand decreases more therefore TR goes down, vice versa
- - > if unitary elastic a price change doesn't affect TR as price and quantity offset each other.
- - > if inelastic, then if price increases, demand decreases less and therefore TR goes up, vice versa.

Total revenue is maximized if marginal revenue is zero. MR = P(1-1/E(p)), by which it relates to elasticity. Note however that we need the cost of resources to see whether this results in extra profit!
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How does this relate to consumer surplus? I.e. value minus expenditure

The difference between the value that a consumer places on the units purchased and the amount of money that was required to pay for them. The value to the buyer, as price is what you pay and value is what you get. In this way the demand curve tells us the willingness of consumers to pay for an additional product. Therefore the demand curve can be considered as a marginal value curve.

What do we consider in supply analysis in perfect competitive markets?

Economic costs include all the renumeration needed to keeo the productive resources in its current employment or to acquire the resources for productive use.
By that economist refer to the opportunity costs (relative to next best alternative use). So the difference between TR and TC is the economic profit! Accounting profit considers only payments to outsiders and depreciation on capital, but no payments to owners.

When the price increases, sellers take on more physical capital and alternative plans might become profitable at this price (scale oil in US).

What about monopolistic competition?

- There are a large number of potential buyers and sellers
- The products offered by each seller are close substitutes for the products offered by other firms, and each firm tries to make its product look different.
- Entry into and exit from the market are possible with fairly low costs.
- Firms have some pricing power
- Suppliers differentiate their products through advertising and other non-price strategies.
Most distinctive factor is product differentiation (ADVERTISING), which gives some pricing power. However, in the long-run, entry and competition will drive prices and revenues down to an equilibrium similar to perfect competition.

What is pricing interdependence?

- Pricing interdependence, like price wars (e.g. airlines). Gaining market share should be present in the demand curve. Price decrease is inelastic as everyone will follow, a price increase is elastic as no-one would follow. Therefore two demand curves (less steep for price increase, steep for price decrease). They cross were increase and decrease are 0. Combine both and we get a kink at prevailing price.

HOWEVER: incomplete price analysis, although it can explain stable prices in an oligopoly it can't explain the original prevailing price.

What about first-mover advantage (stackelberg model)?

Difference with Cournot is that in a duopoly, the decision is not made simultaneously but sequentially. That is why it is called the first-mover or leader advantage (or top dog), as the other one will follow.

How about the long-run equilibrium in an oligopoly?

Long-run economic profits exist, but history has shown that leader's market share decreases over time due to entry and similar technology by competitors. Price wars are bad, because market share is just temporarily increased. But innovation might help to maintain market leadership.

Long-run equilibrium for monopoly?

Most important is to maintain a monopoly by protection that imposes ongoing barriers to entry. Subsidizing might be important in regulated monopolies. Nationalizing might be a solution, but customers don;t like price increase from the government not even when cost increases! LAstly, franchising might be an option through a bidding war.

The question on the page originate from the summary of the following study material:

Microeconomics

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