Lecture Notes: Oct. 28

Econ. 103, Fall 2002, Prof. Nancy Folbre

I'm hopeful that your TAs will hand back your mid-terms in discussion section this week.

We now begin the second half of the course, which will, I think, be easier, especially if you have improved your ability to think in graphical terms.

I had hoped last week to show you a clip from Danny DeVito's film Other People's Money, but I ran out of time. I encourage you to check it out on video sometime.

A comment on the Giants and Angels: I felt bad for the Giants, not just because Barry Bonds deserved to win, but also because I liked the Giants Dads. But I am mostly using this comment as an excuse to make a point about corporate governance. Letting firms hire auditors who they also pay as consultants is like hiring umpires for a game who are also coaches (and actually make more money from coaching than being an umpire). No truly competitive game would allow such conflicts of interest. Check out the article in the New York Times of 10/28/02 called "The New Arbiters of Accounting,"  by Floyd Norris, for a nice summary of debates over the new Public Company Accounting Oversight Board. (Note: New York Times articles from the last 7 days are free at www.nyt.com. After that you have to pay a small fee per article. They may require you to register, but that's free too.)

This week we focus on Chapter 9, forms of imperfect competition.

The most important thing to remember about imperfect competition is that it represents a more realistic picture of the economy, one in which firms have some discretion about the prices they charge and engage in strategic thinking about how other firms will react to their decision. This is very different from the the world of perfect competition, in which firms are simply price-takers.

We represent this graphically with a downward-sloping demand curve for the firm.

Because the demand curve slopes down, marginal revenue is no longer equal to price.

Hold on to your hats. This sounds confusing, at least initially.

The reason is that when a firm lowers price, it has to lower it for everyone, not just for the most recent consumer....so the effect of lowering the price of one unit is multiplied by the number of units that are sold; marginal revenue will be lower than price. And the difference between marginal revenue and price will increase, the greater the number of units sold.

The Power Point slides that I emphasize in class are the following:

9-2 Forms of Imperfect Competition

9-3 Essential Difference

9-5 Market Power

9-6 Sources of Market Power

9-7 Returns to Scale

9-12 Monopolists Marginal Revenue

9-13 Monopolist's Benefit from Selling an Additional Unit

9-19 (Same as Figure 9.9 in chapter) Monpolist's Profit Maximizing Output Level

Here are some multiple choice questions that will help you review this material:

1. A firm that exercises some control over the price it charges is termed a(n)

A) perfect competitor

B) perfect non-competitor

C) monopsonist

D) polypoloist

E) imperfect competitor

The correct answer is E.

2. The correct sequence of market structure from the most to least competitive is

A) pure monopoly, oligopoly, perfect competition, monopolistic competition

B) oligopoly, pure monopoly, perfect competition, imperfect competition

C) perfect competition, monopolistic competition, oligopoly, pure monopoly

D) perfect competition, imperfect competition, pure monopoly

E) perfect competition, monopolistic competition, pure monopoly, oligopoly

The correct answer is C.

D is also basically correct–the only difference is that it includes the generic term "imperfect competition" of which monopolistic competition, oligopoly and monopoly are subsets.

3. Price setters face

A) perfectly elastic demand

B) a market determined price

C) perfectly inelastic demand

D) less than perfectly elastic demand

E) more than perfectly elastic demand

This is a little tricky. You know that it can't be A, because that kind of demand curve describes perfect competition. You know it can't be B, because that would be contradictory (price setters can't face a market determined price). C doesn't make sense–a perfectly inelastic demand curve is vertical. The correct answer is D: demand is less than perfectly elastic–the demand curve for the individual firm slopes down.

4. Constant returns to scale occur when a doubling of all inputs

A) doubles the price of outputs

B) more than doubles output

C) less than doubles the price of the inputs

D) exactly doubles output

E) less than doubles output

The correct answer is D.

Note, you may have been tempted by A. But A is about the PRICE of outputs. Concepts of scale are about the quantity of inputs and outputs.