3.4 Flashcards
Allocative efficiency
When resources are used to produce goods and services that consumers want, maximising utility
Occurs at p=mc ( D=S)
Productive efficiency
only exists when MC crosses AC at lowest point
Meaning the fewest resources are used to produce each product
This requires technical efficiency
Dynamic efficiency
Occurs in markets where innovation is the key to success
Achieved when resources are allocated efficiently over time
costumer’s needs and wants are met as time goes on
X- inefficiency
Firm fails to minimise its average costs at level of output
Type of productive inefficiency
Characteristics of perfect competition
Homogenous product All firms have same access to factors of production Large number of buyers and sellers Free entry into and out of market Perfect knowledge Perfectly elastic demand Profit maximising is objective
Is there supernormal profits in monopolistic competition, monopoly markets or oligopoly markets
Yes for monopoly and oligopoly
Only in short run for monopolistic
Forms of non price competition
Innovation (quality of good) , costumer service, advertising , after sales service, loyalty bonuses, branding , packaging, promotions
Efficiency in monopolistic competition
Never allocatively efficient because p>mc
Not productively efficient
Dynamically efficient due to consumer choice and innovation
Explain Perfect competition graph
Uses 2 diagrams. Supply and demand + mc/ac
AR = MR is perfectly elastic , determined by the supply and demand Eq point
Draw MR across to 2nd diagram to where MR = MC, this is where production occurs
If supernormal profits are available firms enter the market increasing the supply
This lowers the Eq point on the supply and demand diagram causing MR to = MC at a lower level of output
Efficiency in perfect competition
Productively efficient as they produce where mc=ac
Allocative efficient as they produce where P=mc
Not dynamically efficient as firms will not have enough money for r+d
Competition should keep prices low however firms will not be able to benefit from economies of scale
Characteristics of monopolistic competition
Form of imperfect competition
Large number of buyers and sellers - all relatively small
No barriers to entry
Differentiated goods , giving firms price setting power
Describe the diagram in monopolistic competition
Mc/ac diagram
Downwards sloping MR and AR
Produce where MR=MC
If supernormal profits are being made more firms enter the market forcing MR and AR to shift inwards lowering the output level
Efficiency in monopolistic competition
As firms are only making normal profits in the long run, and firms are profit maximising
AR=AC and MR=MC, therefore as AR does not equal MR
MC cannot equal AC so they are not productively efficient or allocatively
They are likely to be dynamically efficient as sales rely on product differentiation
Economies of scale will be achieved
Characteristics of oligopoly
Few firms that dominate the market and have majority of market share
- products are differentiated
- supply in the industry must be concentrated
- firms are interdependent ( actions of one effects another)
- barriers to entry are present
Collusive behaviour
When firms make collective agreements that reduce competition
When firms compete they lower prices to gain new costumers, this causes other firms to lower prices, However by colluding they can maximise profits
This reduces uncertainty firms face and reduces the fear of engaging in price wars
Key assumptions about contestability
Freedom of entry/ exist Firms do not collude Number of firms can vary Only normal profits in long run Firms can produce similar or differentiated products Perfect knowledge of market
What are sunk costs
Cannot be recovered when market is entered
Act as a barrier to entry as their is significant risk of making losses
E.g advertising
Why would a firm not want to collude
When it has a strong business model and something that sets it apart from competition as they believe they will be able to increase market share
When does collusion work best
Few firms that are very well known to each other
Firms are not secretive about costs and production methods and when products are similar
Dominant firm that others are willing to follow
Overt collusion
Formal agreement called a cartel, which is a group of firms that agree to mutually set prices
May compete freely with non pricing competition
Constant temptation to break cartel
Tacit collusion , examples
No formal agreement ( as collusion is illegal)
Price leadership- one firm becomes dominant firm, other firms follow this firms pricing as they are fearful of taking them on in a price war
Barometric firm price leadership- is when a firm develops a reputation for being good at predicting the next move in the industry and other firms decide to follow
Unwritten rules to not engage in non price competition
Game theory
Explores the reactions of one player to changes in strategy by another player
Dominant strategy - where firm benefits more from making a certain decision irrespective of what the other firm does
Nash equilibrium- where neither firm is able to improve their situation and optimises outcome due to opponents expected decision
Types of price competition
Price wars
Predatory pricing
Limit pricing
When do Price wars occur and what effect do they have
- occur when non price competition is weak
- when costumers are price conscious
- occur when it is difficult to collude
- lowers industry profits
- price wars drive prices down
- e.g supermarkets
Predatory pricing
This occurs when an established firm is threatened by a new entrant or if one firm feels that another is gaining too much market share
Established firm will set such a low price that other firms are unable to make a profit and are driven out of the market. Then raise the price
Illegal and only works when one firm is large enough to be able to sustain loses
Limit pricing
Prevents new entrants
Price is set as low as possible while firm is still making normal profits, to discourage another firm entering the market
The greater the barriers to entry the higher the limit price
Drawback - firms cannot make profits as high as they would be able to
Pure monopoly
Exists when one firm is the sole seller of a product in the market
E.g google
Factors for price discrimination to occur
- must be able to clearly separate the market into groups of buyers
- costumers must have different elasticities of demand
- must be able to control supply and prevent resale
Diagram showing price discriminations
1 diagram
2 AR and 2 MR downwards sloping
Rotated to show different elasticities
Costs and benefits of price discrimination
Firms are able to increase their profits and use the money for research and development
Those in elastic market gain as they are able to pay lower price than they otherwise would
May increase equality may not
Some consumer surplus is lost
Third degree price discrimination
When monopolists charge different prices to different people for the same good
E.g Uber, on/off peak train tickets, pensioners discount
First degree price discrimination
When firms can charge different prices for every unit of the good and eliminate all consumer surplus
Kingston market stall
Second degree price discrimination
Charging different prices for different quantities such as bulk purchases
Natural monopoly
Industry where economies of scale are so large that even a single producers is not able to fully exploit all of them e.g national rail
Pointless to encourage competition as it would just raise average cost
Any new entrants would be price out
Occur due to extremely high fixed costs
not productively efficient because there is no minimum of AC
not allocatively efficient as there would be a loss
Costs and benefits to firms in a monopoly
Potential to make huge profits for shareholders
Existence of supernormal profits means firms will have money for investments and reserves to overcome short term difficulties
Be able to compete against international organisations
Maximise economies of scale reducing costs and increasing profits
Firms may not always choose to profit maximise due to: lack of competition, x inefficiencies, sales or revenue maximising (manager objectives), profit satisficing
Costs and benefits to employees in monopoly market
Inefficient of the monopoly may mean that employees receive higher wages, ( especially directors and managers)
Produce at lower outputs therefore employ less workers unless sales or revenue maximising then more employees
Costs and benefits to suppliers in a monopoly
Depends on how much the monopoly is a monopsonist
Monopsony power reduces suppliers profits as the monopolist can charge whatever rate they like
Costs and benefits to consumers in a monopoly market
Firms enjoy economies of scale, they will be more efficient lead to more consumer surplus
Use of price discrimination allows survival of product
Increased range of goods due to cross subsidisation
Higher prices lower quality services and less choice due to lack of competition
Efficiency in monopolies
Productively inefficient mc doesn’t equal ac
Not allocatively efficient as p>mc
Since a monopolist is likely to make super normal profits they will be dynamically efficient however their is no incentive to invest
Characteristics of a monopsony
few big buyers in the market
They pay suppliers lowest cost possible and since suppliers can only sell to them they have lots of power
Costs and benefits in a to firms in monopsony
firm gains higher profits, increasing r+d
Achieve purchasing economies of scale
E.g NHS
Costs and benefits in a to consumers in monopsony
May gain lower prices passed on from firm
May be able to influence firm ( only buy certain products, as long as suppliers are not exploited)
May be a fall in quality as prices are driven down ( suppliers supplying lower quality goods)
Costs and benefits in a to employees in monopsony
Dependant on how many goods supplier sells
Monopsonist may pay higher wages if they are making higher profits
Costs and benefits in a to suppliers in monopsony
Suppliers will lose out as they receive lower prices
May have to pay to trade giving them larger market share in the companies profits
Characteristics of contestable markets
Perfect knowledge about what other firms in market are doing
Freedom of entry and exist
Few Absence of sunk costs
Firms have best technology available
Low loyalty in market
Firms are profit maximising and do not collude
E.g taxi - Uber
Implications due to characteristics of contestable market
New Firms will enter the market if they see other firms making supernormal profits
Only way to prevent this is limit pricing
In perfectly contestable market only normal profits are available
Firms are likely to be productively and allocatively efficient
Types of barriers to entry and exist
Legal barriers e.g patents and licensing
Other firms can put up marketing barriers, e,g high levels of advertising building consumer loyalty
Pricing decisions of incumbent firms e.g predatory and limit pricing
High start up costs and sunk costs
Economies of scale make it difficult for new firms to produce on the same ac curve that established firms produce on
Barriers to exist include: costs to write of assets, leases , making workers redundant
