Chapter 16 Summary

Chapter 16 covered markets that are oligopolies--that is, markets that fall between perfect competition and monopoly. In general, these types of markets are known as imperfectly competitive. Another example of imperfect competition is monopolistic competition, which is when many firms sell similar but different products, such as books, movies, or computer games. In an oligopoly, since there are only a few sellers, each seller greatly impacts the others' prices and profits. In these markets, firms must constantly decide between cooperation and competition. An oligopoly with 2 members is known as a duopoly, and is the simplest type of oligopoly. Firms in an oligopoly can decide to work together to set production and pricing, which is called collusion. Firms that collude in an oligopolistic market are known as a cartel and would lead to a monopoly outcome. However, cartel agreements are prohibited by anti-trust laws. If the oligopolists work independently, they will tend to produce a higher quantity and sell at a lower price, earning a lower total profit than a monopoly would. This equilibrium reached by oligopolists consider the others' actions is named a Nash equilibrium. Because oligopolists must consider the actions of all other sellers, as the number of sellers increases, the market approaches perfect competition. Game theory, especially the prisoner's dilemma, can help explain and predict the behavior of firms in an oligopoly market and the tradeoff between competition and cooperation these firms face.

Chapter 15 Summary

Chapter 15 talks about the behavior of firms that are monopolies, which refers to a situation in which 1 firm represents the entire market supply, and there are no close substitutes for that firm's product. Monopolies arise because of barriers to entry--that is, because there is something preventing other firms from entering the market. These can take the form of one firm controlling a key resource (as occurred with the DeBeers diamond monopoly), a monopoly created by the government (as occurs when the government issues patents), or a natural monopoly (when it is cheaper for 1 firm to supply the market than 2 or more) such as water distribution. While monopoly firms want to maximize profit, they face different production decisions because as they produce more they must lower the market price to sell the additional goods. Therefore, the monopolist's marginal revenue is always less than the price of the good. This leads to 2 effects on total revenue as quantity increases: the output effect (more quantity tends to mean more revenue) and the price effect (more quantity means less price). The monopoly will still set its production at the point where marginal revenue is equal to marginal cost, but here, marginal revenue is less than price, meaning that monopolists make a positive economic profit. Because of their profit-maximizing decisions, monopolies tend to increase the price of the good and reduce the quantity supplied.

Chapter 14 Summary

Chapter 14 expanded on the concepts relating to firms' costs introduced in Chapter 13 by applying them to the decisions firms face in perfectly competitive markets. An important feature of competitive markets is that firms in them are price takers (that is, their production decisions have no impact on the market price). Additionally, perfect competition implies free entry into and exit from the market. Because these firms are price takers, their marginal revenue (or the revenue they get from producing an additional unit of output) is equal to the market price. These firms maximize their profit when the marginal revenue is equal to the marginal cost. In essence, this works because the marginal cost curve is the firm's supply curve. If the firm's revenue in the short run is less than its variable costs, the firm will shut down (i.e. temporarily stop producing), treating its fixed costs as sunk costs (as they cannot be changed in the short run). In the long run, a firm will exit the market if its average total costs are greater than its revenue. When marginal cost is above average total cost when marginal cost is equal to marginal revenue, the firm makes an economic profit. However, this will incentivize other firms to enter the market, thereby increasing supply and reducing the price. Eventually, a competitive market equilibrium will arise with each firm operating at its efficient scale.