3.4

Question 1

List the characteristics of perfect competition + implication for firms or the wider industry

Answer 1

Assumption- Many insignificant firms
Implication- Firms cannot influence industry supply
Assumption- Homogenous goods
Implication- Firms are unable to differentiate their goods + there are very strong substitutes to firms goods
Assumption- No barriers to entry or exit
Implication- Firms can easily join or leave the industry + if abnormal profits are made in the short run, new entrants can easily join, so firms can earn abnormal profits in the long run- so only normal profits can be earned in the long run
Assumption- Perfect information
Implication- Little or no patenting or copywriting
Assumption- Short run profit maximising
Implication- Firms operate where MR=MC

Question 2

List the characterisitcs of a monopolistically competitive market and explain the behaviour of firms in this type of industry

Answer 2

Many buyers and sellers
Goods are differentiated
Firms are price makers facing downward sloping demand
There are low barriers to entry and exit
all firms aim to maximise profits
There is some brand loyalty but not strong brand names

Question 3

SImilarities between Monopolistic and perfect competition

Answer 3

Large number of firms, easy to enter and exit markets, both offer consumers choice

Question 4

Differences between Monopolistic and perfect competiton

Answer 4

Monopolistic goods differentiated while perfect homogenous,
Monopolisic has some degree of power in pricing decisions perfect has none
AR+MR coincide in Perfect but AR is greater than the MR in monopolistic

Question 5

Similarities between monopolisitic competition and monopoly

Answer 5

(1) Both in monopoly and monopolistic competition, the point of equilibrium is at the equality of MC and MR and the MC curve cuts the MR curve from below. (2) In both, the demand curve (AR) slopes downward to the right and the corresponding marginal revenue (MR) curve is below it.

Question 6

Differences between monopolisitic competition and monopoly

Answer 6

Long run monopolisitc firms make normal profit due to low barriers to entry and exit, more firms in monopolistic,

Question 7

Define concentrated ratio

Answer 7

The combined market share of the top few firms in a market
Eg The top 4 firm concentration of supermarkets in the UK in 2015 was 72.4%

Question 8

Explain the implications of High barriers to entry and exit of Oligopoly

Answer 8

Makes the market less competitive. Firms can make supernormal profits in the long run

Question 9

Explain the implications of High contentration ratio of Oligopoly

Answer 9

Only a few firms supply the whole market making the market less competitive

Question 10

Explain the implications of Interdependence of firms of Oligopoly

Answer 10

Firms are interdependent in an oligopoly. THis means the actions of one firm affect another firms behaviour

eg When one firm lowers its price, the rival firms may also lower the price.

Question 11

Explain the implications of Product differentiation of Oligopoly

Answer 11

Firms differentiate their products using branding

Question 12

Explain the reasons for collusion between firms

Answer 12

Firms may choose to set a price of fix the quantitiy of output they produce - which minimises the competitive pressures they face
Collusion leads to decreased consumer surplus, increased prices and increased profits for the colluding firms
Deters new entrents thus its anti competitive

Question 13

Explain how the kinked demand curve diagram shows the concept of interdependence + the concept of price rigidity

Answer 13

The elasticity of demand faced is different depending on whether a firm raises or lowers the price
- This is due to the possible reactions of other firms

Price rigidity- Changes to the marginal cost dont lead to a change in the equillibrium price (unless change to MC is very large). Additionally, the different elasticities that firms face when changing price means there is no incentive to depart from the ‘status quo’.

Question 14

Explain the factors which make collusion more likely

Answer 14

Collusive behaviour occurs if firms agree to work on something together
More likely when -
There are only a few firms
They face similar costs
There are high entry barriers
It is not easy to be caught
There is an ineffective competition policy

Question 15

Explain Overt collusion

Answer 15

When a formal agreement is made between firms. WOrks best when there are only a few dominant firms, so one does not refuse. Its illegal in the US,EU and other nations
Could be in the form of price fixing, which maximises their joint profits, cuts the cost of competition, such as preventing firms using wasteful advertising and reduces uncertainty

Question 16

Explain Tactic collusion

Answer 16

Occurs when there is no formal agreement, but collusion is implied. For example, UK supermarket industry, firms are competing in a price war. Price wars are harmful to supermarkets and their suppliers
Such as in 2014 where a price war caused Waitrose to see a 24.4% drop in operating profit

Question 17

Explain Cartel

Answer 17

Agreement of 2 or more firms not to compete
(either fix prices or fix quantities made)

Question 18

Explain Price leadership

Answer 18

The dominant firm (largest market share) Changes prices first, the rest to follow

Question 19

Do oligopolies had an incentive to collude or cheat

Answer 19

Higher incentive to cheat as can make more money if you did this price fixing may be an unstable relationship

Question 20

What is limit pricing

Answer 20

In order to prevent new entrants, firms will set prices low (the limit price). The price needs to be high enough for them to make at least a normal profit but low enough to discourage any other firm from entering the market. The greater the barriers to entry, the higher the limit price.
Its mainly used in contestable markets. Drawback of this is that it means firms cannot make profits as high as they would otherwise be able to

Question 21

6 types of non-price strategies

Answer 21

Advertising
Loyalty cards
Branding
Quality
Customer service
Product development

Question 22

List Characters of Monopoly + implications

Answer 22

One firms, price setter
There are high barriers to enter - E.OS, control over suppliers (exclusivity), legal - permit/ patent, brand/advertising, Supernormal profits in the long run
Differentiated product - Price setter as weak substitutions

Question 23

Explain what a natural monopoly is

Answer 23

Occurs when the long run average cost curve (LRAC) falls continuously over a large range of output.
Result may be that there’s only room in a market for one firm to fully exploit the economies of scale that are available and therefore achieve productive efficiency. In this situation, competition might actually increase costs and prices. A natural monopoly characterised by increasing returns to scale at all levels of output -thus LRAC will drift lower as production expands
LRAC is falling as long run marginal cost is below LRAC

Question 24

Costs and benefits of monopoly industries for The Monopoly firm

Answer 24

Charge higher prices leading to higher profit
Less competition so less advertisement cost higher profit

Absense of genuine market competition may lead to production inefficiencies
Monopoly may get too big - DES

Question 25

Costs and benefits of monopoly industries for consumers

Answer 25

Innovation, Monopoly may use its profits to develop new and better products
Lower prices- A monopoly may be able to produce at a lower average cost than firms competing in the same industry

Less choice
Higher prices, monopolies can restrict supply and raise prices to maximise their profits
Lower quality as less incentive for firms with no competition to produce high quality
Little efficiency results in higher costs for firm and customer

Question 26

Costs and benefits of monopoly industries for suppliers

Answer 26

Secure outlet for suppliers as likely to be steady demand

May be exploited
Overdependence, Supplier may have few other outlets for its products
Therefore, its success is dependent on the success of the monopoly

Question 27

What is limit pricing + why its used in contestable markets

Answer 27

In order to prevent new entrants, firms will set prices low (the limit price). The price needs to be high enough for them to make at least normal profit but low enough to
discourage any other firm from entering the market.
● The greater the barriers to entry, the higher the limit price. It is mainly used in
contestable markets.
● The drawback of this is that it means firms cannot make profits as high as they would
be otherwise be able to.

Question 28

What are price wars

Answer 28

These occur in markets where non-price competition is weak ; where goods have weak brands and consumers are price conscious. They also occur when it is difficult
to collude.
● A price war will drive prices down to levels where firms are frequently making losses. In the short term, firms will continue to produce if their AVC is below AR but in the long run, they will leave the market and prices will have to rise since supply falls.
● It lowers industry profits.
● Supermarkets are one example of an industry using heavy price wars, with firms
desperately trying to offer lower prices than their rivals.

Question 29

Explain the different type of non-price strategies that a business could use

Answer 29

Advertising: This creates an awareness of the company/product and can persuade
a customer to purchase the product. If advertising is successful, it can increase sales
and market share for a business which in the long run can increase profits.
Advertising can also make the demand for a product/service more inelastic.
● Loyalty cards: These encourage repeat purchases by rewarding customers for their
loyalty. They also provide firms with lots of data on consumers’ buying habits, which
the firm can use to increase sales.
● Branding: A successful brand can help increase loyalty and repeat purchases for a
business. People will trust the brand and the quality it represents so will more likely
keep buying from them. An established brand should find it easier to release new
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products.
● Quality: A firm that is known for good quality may be able to charge higher prices,
and is likely to have strong brand loyalty. They are likely to have good reputation and
benefit from positive recommendations,
● Customer service: This will encourage loyalty amongst customers and give the
business a more positive reputation.
● Product development: A business that invests in product development will have a
competitive advantage over rivals. If they’re the first firm to release a new product,
they would see an increase in sales and this is likely to help with branding

Question 30

Explain the characteristics of contestable markets

Answer 30

Low barriers to entry and exit, new firms entering or leaving the market, low sunk costs, low levels of supernormal profits, low levels of collusion or other signs of oligopoly

Question 31

What are the implications of contestable markets

Answer 31

Limit pricing, firms only able to make a normal profit, firms are productive and allocative efficient

Question 32

Explain the term ‘sunk costs’

Answer 32

Unrecoverable costs i.e costs that cant be recovered if the firm closes down

Question 33

Types of barrier to entry

Answer 33

Artificial (strategic) barriers - some are deliberately imposed and can be seen by the regulators as illegal anti-competitive measures eg predatory pricing, limit pricing, brand loyalty

Natural (structural) barriers- Many Barriers to entry exist simply due to the nature of the business or the market, for example: E.O.S, high start up costs, ownership of key resources

Legal barriers - Some barriers of entry are imposed by the authorities, in cases where too much competition might be seen as working against the interest of the consumer. These include; patents, state-owned (eg rail network), licenses to allow firms to operate

Question 34

Types of barriers of exist (often referred to as sunk costs)

Answer 34

Advertising - There are costs that have been incurred by the firm in promoting its products that cannot be recovered if the firm exists the market
Costs of closure- Could be redundancy cost, loans and costs of terminating contracts early
Specialised machinery- It’s unlikely that this could be transferrable to other industries, so it would be a barrier to exit

Question 35

Explain the characteristics and conditions necessary for a monopsony to operate

Answer 35

Only one buyer in the market, other than that same characteristics as monopoly
This can prevent new firms from entering the market, from entering the market
Pure monopsonies are rare but many firms experience monopsony power when they buy a large percentage of the market

Question 36

Explain the impact of a monopsony on consumers

Answer 36

Gain lower prices if reduced costs are passed on
Could lead to a fall in supply, since the business buys fewer imputs. The extent to which supply falls depends on the PES in the market
They may act as a counter-weight to monopolies
There may be a fall in quantity as prices are driven down

Question 37

Explain the impact of a monopsony on suppliers to the monopsony firm

Answer 37

Suppliers lose out as they will receive lower prices; less will be supplied leading to some firms leaving the market
If in the long term contract, guaranteed sales

Question 38

Explain the impact of a monopsony on the monopsony firm

Answer 38

Gain higher profits- can be used for R+D and leads to more return for shareholders.
Achieve purchasing economies of scale, which lower costs and increase profits

Question 39

3 examples of markets where monopsony power exists

Answer 39

NHS purchasing drugs
Supermarkets purchasing milk from dairy farmers
Amazons buying power in the retail book market

Question 40

Explain the conditions required for price discrimination

Answer 40

Market power, the firm must be able to set prices, ie it will be facing a downward sloping demand curve
Ability to separate markets: the firm must be able to identify different submarkets and be able to keep them seperate, ie must be impossible for consumers to switch between between submarkets
Price elasticity of demand- Must be different in different markets so firm can charge different prices in different submarkets
The costs of keeping the markets separate in less than the increased profits gained from price discrimination

Question 41

Costs and benefits to consumers of price discrimination

Answer 41

Higher prices for those in demand inelastic market, creates more unequal discrimination of income,
Lower prices for those in demand elastic market (helps consumers who otherwise couldn’t afford the product) , consumers may benefit from better-quality goods and services

Question 42

Costs and benefits to producers of price discrimination

Answer 42

Higher revenues and profits, enables firm to finance to finance and research and develeopment, may enable firm to provide product that wouldn’t otherwise be profitable without PD, firms could spread demand from peak demand (airlines), producers gain regular cashflow payments as can spread demand throughout the year

Cost involved in preventing seepage between markets might outweigh extra revenue gained from price discrimination, might create a poor image for the company