Unit IV Study Guide

AP Micro
Market Structures:

4.1 Imperfect Competition

Types of Markets Characteristics

Monopoly ●​ One business dominates the market

●​ Has high barriers to entry
○​ Product is unique with no
competition
○​ Impossible for any other firms to
enter this market
●​ 100% price control
●​ Positive long run profit is possible
●​ Least competitive of markets

Oligopoly ●​ Just a few large firms dominates the

market
●​ Barriers to entry is extremely high
○​ Gives them pricing power

Monopolistic Competition ●​ Lots of other firms to compete with

●​ Low barriers to entry
●​ Product has to be differentiated and
competes with other firms
○​ Differentiated but highly
substitutable
○​ Differentiation gives them pricing
power
●​ Many sellers
●​ Zero economic profit in the long term
●​ Price seekers and has some influences in
the price

Perfect Competition ●​ Many competitors

○​ Price takers
●​ Identical products (standarized)
●​ Zero long term profit
●​ No barriers to entry → easy to exit or
enter

Demand Curves

Perfectly Competitive Market Imperfectly Competitive Market

 -​ Price takers -​ Price seekers
-​ If perfectly competitive firm increases the -​ Horizontally downwards curve
price above the equilibrium price from the -​ If increase the price → will sell fewer
market → sell zero units units of output
-​ If perfectly competitive firm decreases the -​ If decrease the price → will sell more
price below the market equilibrium → units of output
still sell as much as they can produce + -​ Firms in an imperfectly competitive
lose profit as a result market must lower prices to sell more
-​ Horizontal demand curve units of output
-​ Perfectly elastic

Marginal Revenue is lower than the demand

Perfectly competitive market is allocatively

efficient as it produces where MR = MC.
 Unlike perfectly competitive firms, imperfectly
competitive firms are not allocatively efficient, as
they prce above marginal cost and
under-produce.

As a result, there is a deadweight loss.

4.2 Monopoly

●​ Monopolies have one seller

●​ High barriers to entry
○​ Prevents new sellers from entering
●​ Product is unique
○​ No close substitutes
●​ Have a lot of influence on the price
Monopoly Graph:
Pf + Qf → Profit Maximization point

Profit Zero Profit Loss

ATC = P → Zero Economic

ATC < P → Economic Profit Profit ATC > P → Economic Loss

●​ Monopolies are not productively efficient, as they produce at a quantity above the minimum of
the ATC curve.
●​ Monopolies are not allocatively efficient, as they charge a price above marginal cost, leading to
deadweight loss
 ●​ Monopolies produce a lower quantity and charge a higher price than perfectly competitive
markets.
●​ A natural monopoly has a downward-sloping ATC curve that never touches the MC curve
●​ Natural monopolies always capture economies of scale, and may require regulation to reduce
deadweight loss

4.3 Price Discrimination

●​ When a firm sells different units of outputs at different prices

○​ Have to divide customers by willingness to pay
■​ Customers that have a more elastic demand will pay less
■​ Customers that have a more inelastic demand will pay more
○​ Prevent resales of product
■​ Different prices do not reflect different costs → reflects customer’s willingness to
pay

3rd degree price discrimination 2nd degree price discrimination 1st degree (Perfect) price
discrimination

●​ When a firm charges ●​ When a firm charges ●​ When a firm is able to

different groups of different prices for charge each customer
people different prices, different quantities of a the maximum price they
such as student product, such as bulk are willing to pay for
discounts or senior discounts each unit
citizen discounts

Price Discrimination Graph

On a monopoly graph, price discrimination allows the firm to capture additional economic profit by
charging higher prices to consumers with a higher willingness to pay
Perfect Price Discrimination

●​ On a monopoly graph, price discrimination allows the firm to capture additional economic profit
by charging higher prices to consumers with a higher willingness to pay
●​ With perfect price discrimination, the monopoly firm's marginal revenue curve merges with the
demand curve, making it allocatively efficient and eliminating deadweight loss
●​ Perfect price discrimination allows the monopoly to turn all consumer surplus into economic
profit for the firm

4.4 Monopolistic Competition

●​ Monopolistic competitions have many sellers

○​ Highly competitive
●​ Low barriers to entry
●​ Zero long run profit
●​ Differentiated goods but substitutable
●​ Has some impact on the price

Short run Long run

 ●​ ATC < demand curve
●​ In the long run, monopolistically
competitive firms will break even, with
the average total cost curve tangent to the
demand curve at the profit-maximizing
quantity
●​ The process of firms entering or exiting
the market will drive the industry towards
long-run equilibrium

●​ Although there is an economic loss, it still

operates as p > AVC curve

Characteristics:

●​ In the short run, monopolistically

competitive firms can earn economic
profits or losses
●​ The profit-maximizing quantity is where
marginal revenue equals marginal cost,
and the firm prices at the demand curve
●​ Economic profits are represented by the
area between the average total cost and
the demand curve
 ●​ Economic losses occur when the average
total cost curve is above the demand curve
at the profit-maximizing quantity

Short Run → Long Run

Short Run Profit → Long run Short Run Loss → Long run

●​ Monopolistically competitive firms are not productively efficient, as they operate with excess
capacity
●​ These firms are also not allocatively efficient, as they price above marginal cost, resulting in
deadweight loss
●​ However, the product differentiation in monopolistic competition provides value to consumers,
which may offset the inefficiencies
●​ Changes in fixed costs, such as taxes or subsidies, affect the firm's economic profits or losses in
the short run, but not the profit-maximizing quantity or price
●​ Changes in variable costs, such as input prices, shift both the marginal cost and average total cost
curves, affecting the firm's output and price decisions
4.5 Oligopoly and Game Theory

●​ Oligopolies have few sellers

●​ High barriers to entry
●​ Firms are mutually interdependent as there are only few firms
○​ Actions of one firm will impact the outcome of another
●​ Some impact on the price

Graph

Not important in the AP Exam

●​ Not allocatively efficient

○​ P > MC
○​ Higher price, lower quantity
●​ Not productively efficient
○​ Operate on downward sloping portion of ATC

Game Theory

●​ Method for understanding interdependent strategic behavior

○​ Prisoners’ dilemma
■​ Shows why two prisoners would both confess
Payoff Matrix

●​ The numbers in the payoff matrix represent the economic profits the firms can earn based on their
chosen strategies
●​ The collusion outcome, where the firms maximize their combined profit, is identified as the
quadrant with the highest combined profit
●​ To find the most likely outcome, the video analyzes the firms' best responses to each other's
strategies, leading to the identification of the Nash equilibrium
○​ The Nash equilibrium is the most likely outcome, where neither firm has an incentive to
deviate from the chosen strategy
○​ In the example, the Nash equilibrium is the quadrant where Simar Sandwiches raises their
price and Ryan's Rubin lowers their price

Dominant Strategy

●​ Action taken by a player without regard to the actions of another player