[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

Review and Practice
SUMMARY
1. Both monopolists and firms in conditions of perfect
competition maximize their profits by producing at the
quantity at which marginal revenue is equal to marginal
cost. However, marginal revenue for a perfect competitor
is the same as the market price of an extra unit,
while marginal revenue for a monopolist is less than the
market price.
2. Since in a monopoly price exceeds marginal revenue,
buyers pay more for the product than the marginal
cost to produce it; there is less production in a monopoly
than there would be if price were set equal to
marginal cost.
3. Imperfect competition occurs when a relatively small
number of firms dominate the market or when firms
produce goods that are differentiated in ways that
reflect consumer preferences.
4. An industry in which fixed costs are so large that only
one firm can operate efficiently is called a natural
monopoly. Even when there is only one firm (or a few
firms), the threat of potential competition may be sufficiently
strong that price is driven down to average costs;
there are no monopoly profits. Such markets are said to
be contestable. If, however, there are sunk costs or other
barriers to entry, markets will not be contestable, and
monopoly profits can persist.
5. With monopolistic competition, barriers to entry are
sufficiently weak that entry occurs until profits are
driven to zero; there are few enough firms that each
faces a downward-sloping demand curve, but a sufficiently
large number of firms that each ignores rivals’
reaction to what it does.
6. Oligopolists must choose whether to seek higher profits
by colluding with rival firms or by competing. They must
decide what their rivals will do in response to any action
they take.
7. A group of firms that have an explicit and open agreement
to collude is known as a cartel. While the gains
from collusion can be significant, important limits are
posed by the incentives to cheat and the need to rely on
self-enforcement, and by the difficulty of coordinating
the responses necessitated by changing economic
circumstances. Although cartels are illegal under U.S.
law, firms have tried to find tacit ways of facilitating
collusion—for example, by relying on price leaders and
“meeting-the-competition” pricing policies.
8. Even when they do not collude, firms attempt to restrict
competition with practices such as exclusive territories,
exclusive dealing, tie-ins, and resale price maintenance.
In some cases, a firm’s profits may be increased by raising
its rival’s costs and making the rival a less effective
competitor.
KEY TERMS
pure profit or monopoly rents
price discrimination
natural monopoly
four-firm concentration ratio
imperfect substitutes
product differentiation
collusion
cartel
game theory
prisoner’s dilemma
restrictive practices
entry deterrence
entry-deterring practices
REVIEW QUESTIONS
1. Why is price equal to marginal revenue for a perfectly
competitive firm but not for a monopolist?
2. How should a monopoly choose its quantity of production
to maximize profits? Explain why producing either
less or more than the level of output at which marginal
revenue equals marginal cost will reduce profits. Since a
monopolist need not fear competition, what prevents it
from raising its price as high as it wishes to make higher
profits?
3. What are the primary sources of product differentiation?
4. Under what circumstances will price be equal to average
costs, so that even though there is a single firm in the
market, it earns no monopoly rents?
5. What is a natural monopoly?
REVIEW AND PRACTICE ∂ 285