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MicroEconomics Critical Thinking Assignment

MicroEconomics Critical Thinking Assignment

Abstract

The purpose of the assignment is to critically respond to four economic questions. Question 1 explains why firms in an oligopoly are worried over how other industry firms will react to whatever they do. The second question explains why the idea of introducing price ceilings is bad. Question 3 justifies the reasons why price searchers are three times more than price takers in a real-world market situation. The last question provides critical analysis to the statement, “there is no substitute for an airline pilot” in the context of the factors affecting demand.

Q1. Firms in oligopoly must constantly think in terms of how other firms in the industry will react to whatever they do. Why do they have to do this? Why is it that firms in perfect competition and in monopoly don’t have to worry about how other firms will react? (5 Marks)

An oligopoly is characterized by a few small sellers/firms who control most of the industry sales. According to O’Sullivan, Sheffrin, & Perez (2014), oligopoly players are large relative to the market in which they run their businesses. So, if one oligopoly company changes its price, this has a significant effect on the rival firm(s). As such, the firms in the oligopoly market must do certain things by colluding. Oligopoly firms limit competition among themselves and act as they were a monopoly (Rice University, 2018). This is why they are likely to agree in unison which price to charge and what quantity to produce. As a result, they are forced to consider the effect of their actions on the other firms in the industry. For example, if Coke lowers its price by 10 cents per bottle, Pepsi will be affected since many customers might switch from Pepsi products to Coke products. As a result, Pepsi might be forced to lower the price further by 20 cents to maintain its market share. The continuity of this price war will have adverse effects on both firms in the long run; hence, the need to consider how the actions one firm will affect the reaction of other firms in the same industry. When firms in the oligopoly market unite and make the key decisions together, they keep prices high.

Oligopoly firms can prevent a hurtful reaction from other firms in the industry by employing non-pricing strategies, such as product promotion and advertisement to convince broader target market (Shmanske, 2006). Like in the above example, if Pepsi fails to respond, a significant market share will be lost. Therefore, Pepsi must lower its price to maintain its market position. Thus, this high interdependency in oligopoly firms makes it easy to affect each other’s market position to a great extent. As such, oligopolies must always make their strategic options based on how other industry players will react to cope with the competition.

Unlike oligopoly markets, perfect competition and monopoly markets are characterized by unique features that do influence other firms’ reactions. For example, in the perfect competition, it is assumed that is firs are price takers and cannot determine the market price of the products. It is also assumed that the market share does not influence prices. With these features, perfect competition to present a threat of competition (Thampapillai, 2010). As such, the action of one firm cannot force other firms to react. The monopoly markets, on the other hand, are stand-alone units that remain unaffected by the presence and actions of other firms (Blanckenburg & Neubert, 2015). They are assumed to face no competition since, and this gives them the authority to make decisions without considering the reaction of other firms.

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Q2. Governments are frequently tempted to introduce price ceilings in markets. Use an example to explain why this is not such a good idea, at least when markets are competitive. Give some ideas as to what the government could do instead in order to help consumers in these markets. (5 Marks)

Governments enact price ceilings to keep prices low for consumers. The price ceiling also limits the exploitation of the consumers by the companies and supplies who have an advantage of the monopoly power. The price control is again fundamental for goods such as rent and food, which social benefits to consumers.  However, despite these benefits, price ceiling, especially in competitive markets, is not a good idea. When the market prices are disallowed to rise to the equilibrium level, quantity demanded exceeds quantity supplied, and thus a shortage occurs as illustrated in the diagram below. In general terms, price ceiling by the government distorts how the market works and leads to oversupply and shortages. Rather than solving problems in the markets, price ceilings exacerbate more problems (Karim & Huda, 2012). The apparent result of price ceiling is supply shortage or excess demand. Here, producers in the market become unable to produce to the desired level at the lower price, while demand by consumers tends to increase because the products and services are offered at a cheaper price (O’Connell, 2019). For example, in 1970, the U.S. government introduced a price ceiling on gasoline products due to the rising oil prices. As a result, old domestic firms have a financial disadvantage due to the low oil prices regulated by the government; thus, oil production was interrupted, leading to low oil supply in the Middle East. This price ceiling decision led to the development of shortages whose impact was detrimental to the economy.

The price ceiling can lead to more harm than the anticipated benefits. For example, it has been established that price control encourages the emergence of the black markets as people strive to overcome the shortage (Aylor, 2013). As a result, they end paying more than the market price. As such, the government needs to allow the forces of demand and supply to determine prices in the competitive markets.

Instead of setting price ceiling, governments can opt for price control measures such as minimum price, buffer stocks, direct price setting, maximum price, and limiting price increases (O’Sullivan, Sheffrin, & Perez, 2014). Alternatively, the government should finance production through subsidies to cut down production expenditure and prices for those goods and services. By doing so, the government will create a balance between the producers and the consumers, since it will encourage producers to reduce in large volume. This will prevent adverse effects brought by product shortages.

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Q3. If perfectly competitive firms are price takers, and monopolistic, monopolistic competitive, and oligopolistic firms are price searchers, then it follows that three times as many firms in the real world are price searchers than are price takers. Do you agree or disagree? Explain your answer. (5 Marks)

Q4. Critically analyze the following statement with views of your own:
“There is no substitute for an airline pilot: Someone has to fly the plane. Therefore, an increase in the wage of airline pilots will not change the number of pilots used by the airlines.”(5 Marks)

References

Aylor, B. R. (2013). Government Price Controls. Capella University.

Blanckenburg, K. v., & Neubert, M. (2015). Monopoly Profit Maximization: Success and Economic Principles. Economics Research International, 1-11. https://doi.org/10.1155/2015/875301

Cento, V. (2010). Markets Without Substitutes: Substitution Versus Constraints as the Key to Market Definition in Antitrust. European Competition Law Review, 12-23.

Hammock, M. R., & Mixon, J. W. (2013). Price-Searcher Markets. In: Microeconomic Theory and Computation. New York, NY: Springer.

Karim, R., & Huda, K. (2012). Price control, Government intervention, and regulations Vs. Business environment: An analytical review. International Academic ResearchJournal of Economics and Finance, 1(1), 1-17.

O’Connell, B. (2019). What Are Price Ceilings and How Do They Impact Me? Personal Finance, 2-7.

O’Sullivan, A., Sheffrin, S. M., & Perez, S. J. (2014). Survey of Economics: Principles, Applications, and Tools. Upper Saddle River, NJ: Pearson Education.

Parenti, M., Ushchev, P., & Thisse, J.-F. (2016). Toward a theory of monopolistic competition. Journal of Economic Theory, 1-37. doi:10.1016/j.jet.2016.10.005

Rice University. (2018). Principles of Economics. Creative Commons Attribution. Retrieved from https://opentextbc.ca/principlesofeconomics/chapter/10-2-oligopoly/

Seim, K., & Waldfoge, J. (2010). Public Monopoly And Economic Efficiency: Evidence From The Pennsylvania Liquor Control Board’s Entry Decisions. NBER Working Paper Series, 1-42.

Shmanske, S. (2006). The Monopoly Nonproblem: Taking Price Discrimination Seriously. The Independent Review, 10(3), 337-350.

Simpson, B. P. (2011). Two Theories of Monopoly and Competition: Implications and Applications. Journal of Applied Business and Economics, 11(2), 1-13.

Stamate, A., & Muşetescu, R. (2016). A Short Critique of Perfect Competition Model From the Perspective of the Austrian School of Economics. Romanian Economic and Business Review, 112-122.

Thampapillai, D. J. (2010). Perfect competition and sustainability: A brief note. International Journal of Social Economics, 37(5), 384-390. doi:10.1108/03068291011038963

Veljanovski, C. (2010). Markets Without Substitutes: Substitution Versus Constraints as the Key to Market Definition in Antitrust. European Competition Law Review, 1-6.

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