Economic Assignment: Monopoly, Competition & Used Car Market

This economics essay discusses key concepts including barriers to entry in monopolistic competition, the role of patents in creating monopolies for societal welfare and innovation, and the impact of asymmetric information in markets, particularly the market for used goods. It explains how low barriers to entry can be restricted by economies of scale, network effects, and high sunk costs. The essay highlights how patents incentivize technological innovation by allowing firms to recover fixed costs, using pharmaceutical drugs as an example. Furthermore, it analyzes how asymmetric information, where buyers and sellers have unequal access to information, leads to market imbalances, illustrated by the used car market example where the presence of both high and low-quality cars, combined with imperfect information, can drive out the high-quality cars, leaving only poor-quality cars in the market. Desklib provides similar solved assignments and study resources for students.

Running Head: ECONOMIC ASSIGNMENT
Economic Assignment
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ECONOMIC ASSIGNMENT
Table of Contents
Answer 1...............................................................................................................................................2
Entry barriers to monopolistic competition........................................................................................2
Patent and Monopoly.........................................................................................................................2
Answer 2...............................................................................................................................................3
Asymmetry information and market for used goods..........................................................................3
References.............................................................................................................................................5

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ECONOMIC ASSIGNMENT
Answer 1
Entry barriers to monopolistic competition
In the monopolistically competitive market there are usually low barriers to entry.
New firms can enter if the market seems profitable to them. However, there are situation that
may restrict entry of new firms. If the incumbent firms exploit considerable economies of
scale, then new entrants are unable of compete with the existing firms and this deters entry.
Presence of network effect is another thing that prevents entry. When there are high set up
cost most of which are sunk costs then firms do not enter (Nikaido 2015). Sunk costs are cost
that cannot be recovered and exists in the form of advertising cost, cost for marketing and
other types of fixed costs.
Patent and Monopoly
Patent is sole ownership right granted by the government for a specific period. The
government by granting patent creates monopoly for welfare of the society. Paten enhances
technological innovation by giving additional edge to the innovators over its competitors.
Technological innovation requires large scale investment. If the new good invented is sold at
the competitive price, then it would take a long time to recover the fixed cost. The patented
goods are considered as lawful monopoly created with State’s interest to encourage creation
of such goods (Longley 2013). Patents are mostly granted for goods that involve huge fixed
cost. For example, pharmaceutical drugs. The pharmaceutical firms would not make
invention of new drugs if they fail to receive sufficient return to recover costs. Patent is the
mechanism that enables producers to recover their fixed production cost.

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ECONOMIC ASSIGNMENT
Answer 2
Asymmetry information and market for used goods
Complete information to all the agents is a pre-condition for competitive market.
When there are discrepancies in the distribution of information of a commodity among
buyers and sellers then then the information set is considered asymmetric (Donnelly, Englund
and Nielsen 2014.).
There are imbalances in market because of information asymmetry. Consider for example the
market for used cars. In such market, there are some cars are of good quality while others are
of low quality. If there are transparency in information about the cars’ quality, then there
should be two separate markets foe each of the two qualities.
Figure 1: Market for used cars
(Source: Pindyck and Rubinfeld 2015)
Figure 1 describes the market for used cars. DH and SH denote the demand and supply curve of
high quality cars. Corresponding price for high quality cars is PH and quantity sold is NH. The
demand and supply condition for low quality cars are indicated as DL and SL respectively.

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ECONOMIC ASSIGNMENT
Equilibrium price for low quality cars is PL and number of low quality cars sold is NL. From
the figure it is seen that NH=NL and PH>PL.
However, the buyers cannot distinguish between the two qualities because of
asymmetry information and therefore willing to pay some price in the midway of PH and PL.
This is reflected by the new demand curve D1. As the new demand curve reduces price of
high quality cars to PH1 while raises that of low quality cars to PL1, the market now left with
more low-quality cars. This further reduces people’s willingness to pay in the market and
demand curve continued to shift leftward. Ultimately prices are reduced so much that only
poor-quality cars are offered in the market.

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References
Donnelly, C., Englund, M. and Nielsen, J.P., 2014. The importance of the choice of test for
finding evidence of asymmetric information. ASTIN Bulletin: The Journal of the IAA, 44(2),
pp.173-195.
Longley, N., 2013. Introduction. In An Absence of Competition(pp. 1-7). Springer, New
York, NY.
Nikaido, H., 2015. Monopolistic Competition and Effective Demand.(PSME-6). Princeton
University Press.
Pindyck, R.S. and Rubinfeld, D.L., 2015. Microeconomics; Eight Edition, Global Edition.