3.4

Question 1

Allocative efficiency

Answer 1

When resources are used to produce goods and services that consumers want, maximising utility
Occurs at p=mc ( D=S)

Question 2

Productive efficiency

Answer 2

only exists when MC crosses AC at lowest point
Meaning the fewest resources are used to produce each product
This requires technical efficiency

Question 3

Dynamic efficiency

Answer 3

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

Question 4

X- inefficiency

Answer 4

Firm fails to minimise its average costs at level of output

Type of productive inefficiency

Question 5

Characteristics of perfect competition

Answer 5

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

Question 6

Is there supernormal profits in monopolistic competition, monopoly markets or oligopoly markets

Answer 6

Yes for monopoly and oligopoly

Only in short run for monopolistic

Question 7

Forms of non price competition

Answer 7

Innovation (quality of good) , costumer service, advertising , after sales service, loyalty bonuses, branding , packaging, promotions

Question 8

Efficiency in monopolistic competition

Answer 8

Never allocatively efficient because p>mc
Not productively efficient
Dynamically efficient due to consumer choice and innovation

Question 9

Explain Perfect competition graph

Answer 9

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

Question 10

Efficiency in perfect competition

Answer 10

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

Question 11

Characteristics of monopolistic competition

Answer 11

Form of imperfect competition
Large number of buyers and sellers - all relatively small
No barriers to entry
Differentiated goods , giving firms price setting power

Question 12

Describe the diagram in monopolistic competition

Answer 12

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

Question 13

Efficiency in monopolistic competition

Answer 13

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

Question 14

Characteristics of oligopoly

Answer 14

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

Question 15

Collusive behaviour

Answer 15

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

Question 16

Key assumptions about contestability

Answer 16

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

Question 17

What are sunk costs

Answer 17

Cannot be recovered when market is entered
Act as a barrier to entry as their is significant risk of making losses
E.g advertising

Question 18

Why would a firm not want to collude

Answer 18

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

Question 19

When does collusion work best

Answer 19

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

Question 20

Overt collusion

Answer 20

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

Question 21

Tacit collusion , examples

Answer 21

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

Question 22

Game theory

Answer 22

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

Question 23

Types of price competition

Answer 23

Price wars
Predatory pricing
Limit pricing

Question 24

When do Price wars occur and what effect do they have

Answer 24

• 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

Question 25

Predatory pricing

Answer 25

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

Question 26

Limit pricing

Answer 26

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

Question 27

Pure monopoly

Answer 27

Exists when one firm is the sole seller of a product in the market E.g google

Question 28

Factors for price discrimination to occur

Answer 28

- 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

Question 29

Diagram showing price discriminations

Answer 29

1 diagram 2 AR and 2 MR downwards sloping Rotated to show different elasticities

Question 30

Costs and benefits of price discrimination

Answer 30

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

Question 31

Third degree price discrimination

Answer 31

When monopolists charge different prices to different people for the same good E.g Uber, on/off peak train tickets, pensioners discount

Question 32

First degree price discrimination

Answer 32

When firms can charge different prices for every unit of the good and eliminate all consumer surplus Kingston market stall

Question 33

Second degree price discrimination

Answer 33

Charging different prices for different quantities such as bulk purchases

Question 34

Natural monopoly

Answer 34

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

Question 35

Costs and benefits to firms in a monopoly

Answer 35

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

Question 36

Costs and benefits to employees in monopoly market

Answer 36

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

Question 37

Costs and benefits to suppliers in a monopoly

Answer 37

Depends on how much the monopoly is a monopsonist | Monopsony power reduces suppliers profits as the monopolist can charge whatever rate they like

Question 38

Costs and benefits to consumers in a monopoly market

Answer 38

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

Question 39

Efficiency in monopolies

Answer 39

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

Question 40

Characteristics of a monopsony

Answer 40

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

Question 41

Costs and benefits in a to firms in monopsony

Answer 41

firm gains higher profits, increasing r+d Achieve purchasing economies of scale E.g NHS

Question 42

Costs and benefits in a to consumers in monopsony

Answer 42

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)

Question 43

Costs and benefits in a to employees in monopsony

Answer 43

Dependant on how many goods supplier sells | Monopsonist may pay higher wages if they are making higher profits

Question 44

Costs and benefits in a to suppliers in monopsony

Answer 44

Suppliers will lose out as they receive lower prices | May have to pay to trade giving them larger market share in the companies profits

Question 45

Characteristics of contestable markets

Answer 45

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

Question 46

Implications due to characteristics of contestable market

Answer 46

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

Question 47

Types of barriers to entry and exist

Answer 47

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