3.2 Perfect competition and monopololistic Flashcards
What is efficiency? What are the two types of efficiency?
May be static - at a moment in time or dynamic - over a period of time
Productive and allocative efficiency are static concepts as they assess efficiency at a given moment in time
Dynamic efficiency is focused on how resources are allocated over a period of time.
It is concerned with how well resources are used to produce an end result.
What is productive efficiency?
- Firm is productively efficient when operating at the lowest point on its average cost curve, i.e. where AC=MC.
- Producers minimize wastage of resources, an economic is on their PPF and can only produce more of a good if producing less of another
There is productive inefficiency if the cost is above this.
Productive efficiency only exists with technical efficiency - if a given quantity of output is produced with the minimum quantity of inputs
What is allocative efficiency?
Value consumers place on demand equals the cost of factor production - market price = marginal cost of supply, so AR = MC.
Cost of production and demand of consumers taken into account. MC represents firm’s willingness to supply, AR is demand.
Scarce resources are used to produce a bundle of goods satisfying consumer preferences and maximise the welfare, so none is wasted.
What is dynamic efficiency?
Businesses supplying a market successfully meet changing needs and wants over time, using rapid innovation both in processes of supply and range of products available. This can cause the AC curve to shift downwards
Involved investment by firms, R&D, innovation, sustainable growth - cleaning up waste, reliability, quality, choice
Product innovation: changes to characteristics and performance of a good or service
Process innovation: production organisation, changes in models and pricing strategies
What is X inefficiency?
-Firms are not operating on its optimal LRAC curve
Businesses satisficing profits, organisational slack, rising average costs of labour as wages rise or over manning occurs.
Patents may lead to X inefficiency as they prevent copying of names or concepts, acting as a barrier to entry so new firms cannot enter the market or forces existing firms to cut prices or costs - no need for existing firms to cut costs.
What are the assumptions of a perfectly competitive market?
- Homogenous products - no differentiation
- All firms have same quality factors of production
- Large numbers of buyers and sellers all act independently
- Free entry into market - no barriers to entry
- Perfect knowledge/information
- Profit maximisation assumed as key objective - consumers maximise utility
What are some examples of perfectly competitive markets?
- Small scale farmers
- Sporting bets
- Fruit markets
- Bars in tourist resorts
- Bakeries in a city
How do you graph perfect competition in the short run?
Need two curves - a supply/demand curve showing price at equilibrium level and then a cost revenue curve where AR=MR and so there is perfectly elastic demand as there are many firms so changing prices will not affect demand in the market
In the short run firms profit maximise where MC = MR. Firms either make supernormal profits or subnormal profits
This is allocatively efficient as AR=MC
How do you graph perfect competition in the long run?
In the long run, they will not make supernormal profits or losses as the market reaches a point where firms make normal profits.
If losses are made, firms will leave the industry and reallocate factors of production.
If profits are made, new entrants will join and reduce profits
The supply curve in the supply/demand curve next to it will shift inwards/outwards to where the firms are making normal profits (outwards if supernormal as new entrants join, inwards if subnormal as firms leave) to fix the market to normal profits.
In the long run, AR = AC as it is just enough profits to keep resources in their current use - AC = AR = MR = MC so productively and allocatively efficient
What is some evaluation for perfect competition?
- Is there perfect knowledge
- Are there barriers to entry
- Are there high closure costs
- Are the products being produced really homogenous?
- Firms have price setting power
- Dominance of brands
- Highly complex products - always information gaps
- Patents, control of property ignored by perfect competition
- rare for entry/exit to be costleess
- No externalities
- Impossible to avoid search costs
Why are competitive markets good?
- Lower prices due to competing firms - XED for one product high as substitutes
- Low barriers to entry
- Lower total profit and profit margins than monopoly
- Greater entrepreneurial activity - genuine desire on entrepreneurs to innovate
- Competition ensures firms move towards productive efficiency and avoid X inefficiency
- Threat of competition leads to faster rates of technology development - dynamic efficiency
- Allocative efficiency as supply meets demand
- Increased consumer surplus, reduced producer surplus
- Increased output
- Decreased x inefficiency
- Increased choice
What are the general pros/cons of perfect competition?
Consumers not exploited by firms
Equality - products same regardless of where they are bought so all consumers buy the same product
No wasted costs
However:
consumers lack choice and cannot necessarily find product perfectly meeting their needs
Firms are unlikely to grow large enough to benefit from EofS
What is monopolistic competition and some examples?
Imperfect competition found in many markets such as pizza delivery, hairdressers, taxi companies, sandwich bars, bars and nightclubs
Similar to perfect competition but products are differentiated so businesses have control over products and price setting power - AR curve slopes downwards
What are the assumptions of monopolistic competition?
- Many buyers and sellers
- Perfect information
- Low barriers to entry and exist
- All products in the same market but slightly differentiated - consumers think there are some non price differences
- Firms aim to maximise profit - consumers maximise utility
- Little price making power of own brand
What is monopolistic competition in the short run?
-Effectively a monopoly diagram, firms make supernormal profits at profit maximisation point
