ECO105Y1 Study Guide - Midterm Guide: Marginal Revenue Productivity Theory Of Wages, Tax Rate, Marginal Revenue

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9 Feb 2013
Term Test Three Study Package
(Micro 9-11, Macro 1-3)
Chapter 9: Monopoly Rules (Government Regulation, Competition, and
the Law)
Natural Monopolies create a challenge for policymakersgain the low-cost
efficiencies of economies of scale, but avoid the inefficiencies of monopolies restricted
output and higher price.
Economies of scaleaverage total cost falls as quantity of output increases
Natural Monopolytechnology allows only single seller to achieve lowest average
total cost
-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 corporationspublicly owned businesses in Canada, Achieve economies of
scale, but lac of competition weakens incentives to reduce costs or innovate
(Canada Post)
Rate of return regulationsset price allowing regulated monopoly to just cover
average total costs and normal profits
Strategic interaction among competitors complicated business decisions, creating two
smart choicesone based on trust and the other based on non-trust.
Game theorymathematical 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 dilemmagame with two players who must each make a strategic
choice, where results depend on other players choice.
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Nash equilibriumoutcome 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.
Collusionconspiracy to cheat or deceive others
Cartelassociation 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 behavioralways an active attempt to increase profits and
gain market power of monopolyis 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,
false/misleading advertising
-Civil offences (punished by fines, legal prohibitions):
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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 productsnuclear 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 viewgovernment regulation eliminates waste, achieves
efficiency, promotes public interest
Capture viewgovernment regulation benefits regulated businesses, not public
Evidence mixed on government regulationsome suggests public-interest view,
some supports capture view
Government failureregulation 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.
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