Notes
Monopoly
- One seller, no close substitutes, and high barriers to entry (patents, control of a resource, economies of scale).
- The monopolist faces the downward-sloping market demand, so MR is below demand (to sell more it must lower the price on all units).
- It produces where MR = MC and charges the price on the demand curve above that quantity. Compared with perfect competition: higher price, lower quantity, and deadweight loss.
- It's not allocatively efficient ($P > MC$) or productively efficient. It can earn long-run economic profit.
- A natural monopoly has economies of scale so large that one firm serves the market most cheaply (utilities). Regulation: the socially optimal price is $P = MC$; the fair-return price is $P = ATC$.
- Price discrimination: charging different customers different prices based on willingness to pay. Perfect price discrimination captures all consumer surplus and produces the efficient quantity.
Monopolistic competition
- Many firms with differentiated products (restaurants, clothing brands); easy entry. Firms use advertising and branding.
- Downward-sloping demand, so $P > MC$. In the long run, entry drives economic profit to zero ($P = ATC$), but firms have excess capacity (they produce less than the minimum ATC quantity).
Oligopoly
- A few large firms, high barriers to entry, and interdependence: each firm's best choice depends on rivals.
- Game theory: a payoff matrix shows outcomes. A dominant strategy is best no matter what the rival does. A Nash equilibrium is where no player wants to change strategy given the other's choice.
- Collusion (forming a cartel like OPEC) raises prices but is illegal in many countries and tends to break down because each member is tempted to cheat.
Practice
Selling one more unit requires lowering the price on all units.
This creates deadweight loss.
Large economies of scale.
Prices differ by willingness to pay.
Entry drives profit to zero, but $P > MC$ remains.
A few large, interdependent firms.
Each player is making a best response.
Cheating raises a single firm's profit.
Free response
Write your answer first, then open the scoring guide.
Free-response question
Firms A and B choose to advertise or not. If both advertise, each earns 50. If neither advertises, each earns 70. If only A advertises, A earns 90 and B earns 30. If only B advertises, B earns 90 and A earns 30.
(a) Does Firm A have a dominant strategy? Explain.
Show the answer and scoring guide
Yes, advertise. If B advertises, A gets 50 (advertise) vs 30 (not). If B doesn't, A gets 90 (advertise) vs 70 (not). Advertising is better either way.
Check off the points you earned:
(b) Identify the Nash equilibrium.
Show the answer and scoring guide
Both advertise, each earning 50. B's payoffs are symmetric, so B's dominant strategy is also to advertise.
Check off the points you earned:
(c) Explain why the firms might want to collude, and why collusion might fail.
Show the answer and scoring guide
Both would earn 70 instead of 50 by agreeing not to advertise. But each is tempted to cheat and advertise to earn 90, so the agreement tends to break down.
Check off the points you earned: