2.11 Market Failure - Market Power (theory Of The Firm ) Flashcards
What is perfect competition, the components, and the graph
A situation in a market which buyers and sellers are so numerous and well informed that all elements of monopoly are absent
Components:
- homologous products
- large number of firms
- producers have no infelices on price
- no barriers to entry
Positives of perfect competition
Allocative efficiency
Low prices for consumers
Competition leads to the closing down of inefficient producers
The marker responds to consumer tastes
Negatives of the perfect competition model
Unrealistic assumptions
Cannot take advantage of economies of scale
Lack of product variety
Limited ability to engage in new product development
What is monopoly, the components, and the graph
Situation where there is a single seller in the market
Components:
- higher barriers to entry
- price setting ability
- economies of scale
Criticisms of monopoly
Welfare loss, allocative inefficiency and market failure
Higher price and lower output in monopoly
Loss of consumer surplus to monopolist
Negative impacts on the distribution of income
Lack of competition may give rise to higher costs
Potential benefits of monopoly
Economies of scale
Natural monopoly
Research and development for product development and technological innovation
When is profit maximization
MC = MR
When is revenue maximization
When MR = 0
What is total revenue + calculation
Total earnings of a firm from sale of output
TR = P * Q
What is marginal revenue + calculation
Additional revenue of a firm arising from the sale of additional unit of output
MR = change in TR / change in Q
What is average revenue + calculation
Revenue per unit of output
AR = TR/Q
What are explicit costs
Bills a business must directly pay e.x rent
What are implicit costs
Costs that are not directly paid but implied e.x entrepreneur gives up wages that they could’ve earned working for someone else
What is total costs
Sum of all explicit and implicit costs
What are average total costs
Total cost per unit of output
AC = TC/Q
What is marginal cost + calculation
The change in cost arising from one additional unit of output being produced
MC = change in TC / change in Q
What are long-run average costs
U-shaped curve showing average costs in lung run when all firms inputs are variable
What is profit
TR - TC
What is normal profit
Occurs when total revenue equals total costs and is the minimum amount of revenue required by a firm to keep running
What is abnormal profit
Profit that results when total revenue is greater then total costs. It is the revenue that is over and above normal profit
What are losses
Negative profit; occurs when total revenue is less then total costs
Monopolistic competition definition, components and graph
Type of market structure where many companies are present in an industry and produce similar but differentiated products
Components:
- low barriers to entry
- large number of firms
- product differentiation
- price setting ability
- less inelastic demand curve then monopoly
Comparison of monopolistic competition and perfect competition
Similarities:
- large number of firms
- free entry of firms into an industry
- normal profit in lung run, abnormal profit or loss in the short run
Differences:
- market power and demand curve
- allocative effeciency
- product variety
- economies of scale
Comparison of monopolistic competition and monopoly
Similarities:
- no allocative efficiency therefore a form of market failure
Differences:
- number of producers
- size of firms
- barriers to entry
- normal and abnormal profits
- competition and prices
- market power
- competition and costs
- research and development
- economies of scale
- product variety
Oligopoly definition and components
A state of limited completion, in which a market is shared by a small number of producers and sellers
Components:
- high barriers to entry
- small number of large firms
- firms are interdependent
- price setting ability
- Homogenous products
Do oligopoly make price changes
No rarely, due to high price fragility
What does game theory illisutrate
The interdependence and strategic behavior of oligopolies
What is a price war
When rival firms match price cuts, then all firms end up with lower prices and lower profits
Ways an oligopoly engages in non-price competition to increase their market share
Product development
Advertising
Branding
Customer service, warranties, provision of credit, discounts
2 types of oligopoly
Collusive oligopoly
Non collusive oligopoly
What is collusive oligopoly and the 2 types
Situation where firms agree to from an agreement between themselves to limit competition, increase market power and increase profits e.x cartels, they limit competition between the member firms and attempt to maximize joint profits
Formal collusions —> firms make formal agreement to stick to high prices, can involve the creation of a cartel
Tacit collusions —> firms make informal agreements or collude without speaking to rials
Benefits of collusion
- increased market power and ability to control price of products
- increased profits due to higher prices
- elimination of competition
What are non-collusive oligopoly
Refers to oligopolistic firms that do not collude in any way
What is concentration ration and what does it measure
Provides indication of the percentage of output produced by the largest firms in an industry and it measures market concentration
Criticism of oligopoly
- welfare loss, allocative efficiency and market failure
- higher prices and lower quantities of output then under competitive conditions
- loss of consumer surplus to oligopolies due to higher prices
- negative impacts on redistribution of income
- may be higher production costs due to lack of competition
- possibly less innovative
Benefits of oligopoly
- economies of scale can be achieved , lower production costs
- product development and technological innovations can be perused due to abnormal profits
- technological innovations improve efficiency and lower costs of production, which may be passed to consumers in the form of lower prices
Advantages and risks of large firms with significant market power
Advantages:
- advantages arising from large economies of scale
- ability of such firms to carry out R&D on new product and technology development
Risks:
- allocative inefficiency and welfare loss
- higher prices and lower output
- loss of consumer surplus to the large firms
- negative impact on the distribution of income
- higher average costs due to lack of competition
- possible less innovative
What is abuse of market power and give examples
Situations where firms engage in activities that result in reduced competition
Examples:
- charging high prices
- depriving smaller competitors by selling at very low prices
Government intervention in response to abuse of market power
Legislation and regulation
Fines
Government ownership
Explain the intervention of legislation to protect against the abuse of of market power
Legislation to protect competition —> firms found guilty of anti-competitive behavior are asked to pain fines or may be broken up into smaller firms
Difficulties of legislation to protect competition:
- if firms collude it is difficult to discover evidence of the collusion
- enforcing laws may be time consuming and governments may not want to enforce them strictly
Legislation in the case of mergers —> a merger is an agreement between 2 or more firms to join together and become a single firm - legislation will set limits on the size of combined firms
Explain the intervention of fines to protect against the abuse of of market power
Imposed on firms undertaking anti-competitive behavior
Problems:
- breaking the law may be cheaper then the fine and prove more beneficial
- profits of firms that abuse market power are great enough that they are better off paying the fines
