1.5 Perfect competition, Imperfectly competitive markets and Monopoly Flashcards
What is a concentration ratio (CR)?
- ratio that indicates the size of firm in relation to the industry
- number of firms that domiate the market
What are the four barriers to entry?
- Legal = patents, insurance, licenses
- Technical = start up costs, sunk, EoS, natural monopoly
-
Strategic = Pricing - predatory, limit
heavy advertising - Brand loyalty
What are some barriers to exit?
- Sunk costs
- Redundancy
- Undervaluation of assets
- Penalty for leaving contract early
What is Perfect Competiton?
Theoretical market structure that economists use to asses efficiencies of other market structures
- Many buyers & sellers
- Homogenous goods
- No barriers to entry/exit
- D = Price elastic
- perfect info
- profit max.
- firms can sell all output
- price takers
What is Imperfect Competition?
Type of market structure that has some but not all elements of perfect competition
- less firms in market
- differentiation
- some barriers
- suppliers can influence price
- D = downward sloping
What is Monopolistic Competition?
when there are many firms in market but there is some form of product differentiaion
- barriers = low
What is a Monopoly?
Price leaders - can charge high prices but restricted by gov.
Use promo to inform and persuade customers
Can increase sales revenue through increasing market size
have atleast 25% market share - in UK
barriers = high costs, EoS, legal barriers
What is a Oligopoly?
- Only a few firms in market
- compete on non-price
- If one firm cuts price others are likely to follow
What is some objectives of firms?
- profit satisficing
- sales max.
- revenue max.
- profit max.
- other
What is profit satisficing?
- profit below profit max.
- satisfices needs of owners or managers
- covers TC
What is sales maximisation?
max sales to gain market share
increases size of firm
What is revenue maximisation?
max sales revenue
point where MR = 0
What is profit maximisation?
MR = MC
What are the assumptions of Perfect Competition?
- Large no. of buyers and sellers
- Able to buy/sell all output at market price
- Homogenous goods
- No barriers
- Perfect knowledge
- Profit max. (MR=MC)
In Perfect competition firms are price takers and can sell all output at market price
What does this lead to?
- Will not lower prices
- AND will not decrease as consumers will go to other firms
- D = Perfectly price elastic
What are the Disadvantages of Perfect competition?
- Limited choice for consumer
- lack of investment
- no incentive to innovate
- Lack of EoS
Short run and Long run equilibrium in Perfect competition
(see notes 1.5.3)
What is Monopolistic competition?
- Large no. of firms in market
- Differentiated products
- small degree of monopoly power
- barriers = low –> strong competition
- LR = no barriers
What are the main characteristics of monopoly power?
- firms have independance regarding price and output
- profit max. MC=MR
- goods are partial subs, not perfect
Short run and Long run equilibrium in Monopolistic competition
see notes 1.5.4
How can firms in monopolistic competition compete?
Non-price
- advertising
- differentiation
- innovation
- brand loyalty
What are the efficiencies in monopolistic competition?
Productive inefficiency
- firms do not operate at lowest point on AC curve
Allocative inefficiency
- firms set P>MC
Dynamic inefficiency
- supernormal profits gone in LR, however innovation occurs
X-efficiency (lower costs)
- firms must remain competiive
What are the main characteristics of Oligopoly markets?
- Few firms dominate market
- differentiated good (price maker)
- high barriers
- interdependence
- non-price competition
- profit max is not the sole objective
What is the market conduct (behaviour) in Oligopoly markets?
- face uncertainty
- interdependent in competitive oligopolies
- can be non-collusive, collusive, and form cartels
What is interdependence and what does it create in markets?
actions of one firm will impact other firms
- creates uncertainty as firms are unsure of how competitors will react
What is collusion?
allows firms to operate closer to conditions of monopoly and reduce uncertainty
This could be ILLEGAL
Why would firms collude?
firms often collude to segment the market geographically
- monopoly power in own geographical area
- allows inefficient firms to stay in business
What is a cartel?
formal agreement between firms to collude in the operation of the market
- normally price fixing
- or fixing ouput levels
Why would firms form cartels?
allows them to operate closer to conditions of monopoly
seen as against interest of consumer - ILLEGAL
HOWEVER, some cartels might be allowed if it is seen to be in the interest of the consumer
How can oligopolistic firms act like a monopoly?
by colluding, firms can make supernormal profits where AR > AC
How can cooperation be allowed in Oligopoly
if it is seen to be in the interest of th consumer
- e.g. innovate new production processes
- leads to better efficieny in the industry
- lowers cost of production
- benefits consumer as there is low prices
What is price leadership?
dominant firms set the price, others follow
2 types of price agreements in oligopoly?
EXPLICIT = firms overtly agree to set prices
IMPLICIT = tacit agreement to set prices, difficult for regulators to identifiy
tacit = no communication
overt = communicate
Explain how non-collusive oligopoly works?
If firms A raises price, other firms will not drop price and gain market share as firm A sales will fall
Therefore, demand = price elastic
If firm A drops price, other firms will follow to retain market share
Therefore, demand = price elastic
suggests that in oligopoly firms are unlikely to raise or drop prices
What is the Kinked demand curve?
1.5.5 see notes for kinked demand curve
What is price rigidity in oligopoly?
price tends to be stuck , despite changes in demand and supply in the market
What are the factors influencing price and output in oligopoly?
Collusive pricing - agree to set high price, restricts output
Predatory pricing - force competition out by setting low prices, high output to meet high demand
Limit pricing - operates above profit max (MC=MR)
Cost plus pricing - set price based on AC
What are the investment and expenditure on R+D in oligopoly?
heavy investment
high level of capital investment, expenditure on fixed assets
lead to a stream of income in the future
R+D = barrier reducing threat
What are the advertising and marketing policies in oligopoly?
Advertising = sunk cost, deters new entrants. establish brand loyalty
Marketing = differentiated from competition, new product development can increase demand and maintain brand loyalty
What are the reasons for non-price competition in oligopoly?
reduces likely-hood of price wars
- as it leads to lower profits for firms
Advantages of Oligopoly?
- innovating to create competitive advantages
- this is because they can reinvest supernormal profits, leading to dynamic efficiency (EoS)
- HIghly competitive reducing costs
- leads to low prices, and better quality for consumers
Disadvantages of Oligopoly?
- Reduces choice for consumers (high CR firms)
- will act like monopolists, reducing output, increasing price
leads to misallocation of resources and allocative inefficiency - Barriers to entry
small competitive firms struggle to enter - Advertising = manipulate consumers
leads to irrational decision making - Exhibit productive efficiency as they do not operate on the lowest point on LRAC curve
What are the characteristics of a Monopoly?
- only one firm in market
- firm and market demand curve is same D = AR
- profit maximises - MC=MR
- makes supernormal profits as it produces where AR>AC
- Price maker
- opposite of perfect competition
What are the efficiencies in Monopoly?
Productive inefficiency - occurs above the lowest point on the LRAC
Allocative inefficiency - as price does not reflect the value that consumers put on the product as P>MC
X-inefficiency - no incentives to keep costs low. lack of competition
Dynamic efficiency - firm makes supernormal profits in LR
What are the advantages of Monopoly?
Economies of Scale
- lowers AC of production
- can charge low prices
Use retainted profits to invest in R+D
- creates dynamic efficiency as innovation leads to better processes lowering the LRAC curve
- better quality products can be developed as monopolies can invest without the threat of competiitors
What are the disadvantages of Monopoly?
Removes competition due to barriers
- makes supernormal profits in LR by charging high prices
- leads to consumer being exploited
Can reduce choice for consumer and quality of products as there is no competition
