ECO105Y1 Study Guide - Midterm Guide: Marginal Revenue Productivity Theory Of Wages, Tax Rate, Marginal Revenue
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Term Test Three Study Package
(Micro 9-11, Macro 1-3)
Chapter 9: Monopoly Rules (Government Regulation, Competition, and
Natural Monopolies create a challenge for policymakers—gain the low-cost
efficiencies of economies of scale, but avoid the inefficiencies of monopolies restricted
output and higher price.
Economies of scale—average total cost falls as quantity of output increases
Natural Monopoly—technology allows only single seller to achieve lowest average
-Natural monopolies are based on current technology, when technology changes,
natural monopoly may change to more competitive market structure
Two major policies governments use to deal with challenge of natural monopoly are
public ownership and regulation
Crown corporations—publicly owned businesses in Canada, Achieve economies of
scale, but lac of competition weakens incentives to reduce costs or innovate
Rate of return regulations—set price allowing regulated monopoly to just cover
average total costs and normal profits
Strategic interaction among competitors complicated business decisions, creating two
smart choices—one based on trust and the other based on non-trust.
Game theory—mathematical tool for understanding how players make decisions,
taking into account what they expect rivals to do (Nash, beautiful mind)
-Gasoline pricing is a strategic decision that can be understood using game theory
Prisoners dilemma—game with two players who must each make a strategic
choice, where results depend on other players choice.
Nash equilibrium—outcome of game where each player makes own best choice
given the choice if the other player
Two smart choices exists in a prisoners dilemma game; one based on non-trust and
one based on trust
-If other player cannot be trusted, smart choices is cheat/confess; all players driven
to Nash equilibrium outcome where everyone cheats/confesses
-If other player can be trusted smart choice is to cooperate/deny; all players driven
to equilibrium outcome where everyone cooperates/denies
-The prisoners “dilemma” is that each player (prisoner) is motivated to cheat
(confess) yet both would be better off if they could trust each other to cooperate
Cartels collude to raise prices and restrict output to increase economic profits.
Cartels are unstable because members can increase their individual profits by
cheating on the others.
Collusion—conspiracy to cheat or deceive others
Cartel—association of suppliers formed to maintain high prices and restrict
OPEC (organization of petroleum exporting countries) is international cartel
that acts like a monopoly
-Desirable competitive behavior—always an active attempt to increase profits and
gain market power of monopoly—is hard to distinguish from undesirable collusive
-The Competition Act, introduced by government to prevent anti-competitive
business behavior, raises expected costs to business of price fixing (through prison
time, fines, legal prohibition) relative to the expected benefits (profits)
-Criminal offences (punished by prison time, fines): price fixing, big rigging,
-Civil offences (punished by fines, legal prohibitions):
Mergers, abusing dominate market position, lessening competition, competition
tribunal weighs costs of lessening competition against benefits of any increased
The discipline of market competition eventuality eliminates dangerous products, but in
the process people may be harmed. Three major forms of government regulation in
Canada address this problem.
Caveat emptor (“Let the buyer beware”)—buyer alone responsible for checking
quality of products before purchasing
Certain products—nuclear power, medicines, poisonous insecticides-regulated by
government because average consumer is not capable of knowing products quality
Major forms of government regulation in Canada: government departments,
government appointed agencies/boards, professional self-governing bodies.
There are two views of government regulation. The public interest view suggests
government action improve market failure outcomes. The capture view suggests
government actions produce government failure.
Public-interest view—government regulation eliminates waste, achieves
efficiency, promotes public interest
Capture view—government regulation benefits regulated businesses, not public
Evidence mixed on government regulation—some suggests public-interest view,
some supports capture view
Government failure—regulation fails to serve public interest, instead benefits
industry being regulated.
-Sometimes market outcome, even with monopoly power, will be better than
government regulation outcome if there is significant government failure.
-Sometimes government outcome, especially with public interest regulations, will be
better than market outcome if there is significant failure.