3.4 Flashcards
1
Q
What is economic efficiency?
A
- It is about society making optimal use of scarce resources to help satisfy changing wants and needs.
- There are several meaning of efficiency, but they all basically link to how well a market system allocates our scarce resources to satisfy consumers.
- Normally the market mechanism is good at allocating inputs, but there are occasions when markets can fail.
2
Q
What is allocative efficiency?
A
- It occurs when the value that consumers place on a good or service, equals the cost of the factor resources used up in production.
- The main condition required for allocative efficiency in a market is that market price= marginal cost of supply/ AR=MC
3
Q
What is productive efficiency?
A
- A fir is productively efficient when it is operating at the lowest point on its average cost curve i.e. unit costs have been minimised.
- Productive efficiency exists when producers minimise the wastage of resources.
- It relates to when an economy is on their productive possibility frontier.
- An economy is productively efficient if it can produce more of one good only by producing less of another.
4
Q
What is social efficiency?
A
- The socially efficient level of output and/or consumption occurs when marginal social benefit= marginal social cost. Same as allocative efficiency.
- The existence of negative and positive externalities means that the private level of consumption or production differs from social optimum.
- The price mechanism doesn’t always consider social costs and benefits.
5
Q
What is dynamic efficiency?
A
- It occurs when businesses supplying a market successfully meets our changing needs and wants over time. Crucial dynamic efficiency is whether the market generates rapid innovation both in the processes of supply and the range of products available.
6
Q
What is product and process innovation?
A
Product innovation is small- scale and subtle changes to the characteristics and performance of a good or a service.
Process innovation is changes in the way in which production takes place or is organised. It could be changes in business models and pricing strategies.
7
Q
What is perfect competition?
A
It describes a market structure who’s assumptions are strong and therefore unlikely to exist in the vast majority of real-world markets.
8
Q
What are the assumptions of a perfectly competitive market?
A
- Homogenous products- there is no product differentiation at all
- All firms have access to the same quality factors of production
- Large number of buyers and sellers and all sellers act independently i.e. no price collusion.
- free entry into and exit from the market i.e. no barriers to entry and exit
- Perfect knowledge/ information for buyers and sellers.
- Profit maximisation is assumed as the key objective of firms- and consumers are assumed to be utility maximisers when making their purchasing decisions.
9
Q
Explain allocative efficiency in perfect competition.
A
In both the SR and the LR, price is equal to marginal cost and thus, allocative efficiency is achieved.
10
Q
What is productive efficiency like in perfect competition?
A
It occurs when the equilibrium profit maximising output is supplied at minimum average cost. This is attained in the LR for a competitive market.
Output is at lowest point of AC. If a firm is producing at the lowest point of their AC curve, this also means that the firm must be X efficient.
11
Q
Why are competitive markets good for economic efficiency?
A
- lower prices as lots of firms competing. XED will be high.
- low barriers for entry- the entry of new firms provide competition and ensures prices are kept low.
- Lower total profits and profit margins than in monopoly
- Greater entrepreneurial activity. Needs genuine desire to innovate and invent to drive markets.
- competition will ensure that firms move towards productive efficiency and avoid X inefficiency.
- The threat of competition should lead to a faster rate of technological diffusion, as firms have to be responsive to the changing needs of consumers. Dynamic efficiency.
12
Q
Evaluate the assumptions of the perfect competition model.
A
- Most firms have some amount of price setting power- they are price makers
- Dominance in real world markets of differentiated/ branded products
- Highly complex products, there are always information gaps between buyers and sellers.
- It is impossible to avoid search costs even with the spread of digital/ web technology
- Parents, control of intellectual property control of key inputs are all ignored by the perfect competition model
- Rare for entry and exit in an industry to be costless.
- It assumes that there are no externalities; in reality, there are often 3rd party effects of every market.
13
Q
What are the pros of perfectly competitive markets?
A
- Consumers aren’t exploited by firms, in terms of higher prices.
- Equality- products are the same regardless of where they are bought, so all consumers are able to buy the same products.
- No ‘wasted’ costs in terms of advertising ect.
14
Q
What are the cons of perfectly competitive markets?
A
- Consumers lack choice and cannot necessarily find a product that perfectly meets their needs.
- Firms are unlikely to be able to grow large enough to benefit from economies of scale.
15
Q
What is monopolisitic competition?
A
- It is a form of imperfect competition and can be found in many real world markets e.g. sandwich bars and coffee stores in a busy town centre.
- It is similar to perfect competition, some economists believe that it is more realistic as the products are differentiated.
- Product differentiation means that businesses have some control over their products, it implies that firms have some price setting power i.e. the AR curve slopes downwards.
16
Q
What are the key assumptions with monopolistic competition?
A
- Many buyers and sellers, the industry conc. is low
- Perfect information
- Very low barriers to entry and exit, this allows firms to respond to profit signals
- All products are in the same market but are slightly differentiated i.e. consumers think that there are some ‘non-price’ differences between products
- Firms aim to maximise profit; consumers aim to maximise utility
- Firms have little price-making power over their own brand.
17
Q
To what extent does monopolistic competition lead to economically efficient outcomes?
A
- Prices are above marginal cost- meaning that the market equilibrium is not allocatively efficient
- Saturation of the market may lead to businesses being unable to exploit fully international economies of scale - causing LR average costs to be higher- not productively efficient
- Critics of heavy spending on marketing and advertising argue that this spending is wasteful and an inefficient use of scarce resources
- Debate over the social costs of packaging and negative externalities from packaging waste is linked to monopolistic competition.
- monopolistic competition associated with extensive consumer choice and innovation; this is good for dynamic efficiency although lower profit margins may reduce the funds available for research and innovation.
18
Q
What are different types of non price competition that retail companies can use to drive sales and protect market share?
A
- Efficiency and ease of use of online ordering, collection and delivery
- Making clothing available in a wider range of sizing
- customisation of product
- Returns policies for customers wishing to bring back purchases
- Outlet shops to offer some excess stock at discounted prices
- Effective use of social media
- Taking steps to address corporate social responsibility including waste associated with fast fashion.
19
Q
What are the characteristics of oligopoly?
A
- An oligopoly is an imperfectly competitive industry where there is a high level of market concentration
- It is best defined by the actual conduct of firms within a market
- An oligopoly exists when when the top 5 firms in the market account for more than 60% of market sales
- Key features include price rigidity, lots of non-price competition, interdependent decision making, and some attempts to collude and fix price or perhaps share out the market.
20
Q
What are the key assumptions of an oligopoly?
A
- Market dominated by a few large firms each with significant market share
- high market conc. ratio
- each firm supplies branded products, which may or may not be properly differentiated.
- high barriers to entry and exit
- interdependent strategic decisions by firms
21
Q
What is strategic interdependence?
A
- Means that one firm’s output and price decisions are influenced by the likely behaviour of competitors
- Because there are few sellers, each firm is likely to be aware of the actions of the others
- Decisions of one firm influence and are influenced by, the decisions of other firms
- This causes oligopolistic industries to be at risk of tactic of collusion which can lead to allegations of anti-competitive behaviour
- There is always a high level of uncertainty.
22
Q
What can be the main objectives of an oligopolistic firm?
A
- Maintaining a satisfactory rate of profitability
- protecting market share
- growing their user base
- reacting to the decisions of rival firms
23
Q
What non-price factors can oligopolistic firms use to compete?
A
- Innovation
- quality of service including after-sales service
- Free upgrades to products
- Exclusivity/ loyalty schemes
- Branding and advertising
- sales promotions
24
Q
What non-price factors will oligopolistic firms focus on to increase their competitiveness?
A
- Quality of product
- design look and feel
- environmental impact
- after sales services/ availability and costs of replacement parts
- other marketing factors e.g. branding and advertising.
25
Q
What are the types of collusion that can happen between firms?
A
- Horizontal; between firms at the same stage of production
- Vertical; between businesses at different stages of production
- Explicit v tactic collusion ( open v quiet collusion)
26
Q
What are the key aims of business collusion in an oligopoly?
A
- Businesses in a cartel recognise their interdependence and act together- the aim is to maximise joint profits
- It lowers the costs of competition e.g. wasteful marketing wars which can run into millions of £s
- Reduces uncertainty- higher profits increases producer surplus/ shareholder value- leading to higher share prices
27
Q
What are the legal forms of business collusion?
A
- Practices aren’t prohibited if the respective agreements contribute to improving the production or distribution of goods or to promoting technical progress in a marker.
- Development of improved industry standards of production and safety which benefit the consumer e.g. joint industry standards for phone chargers.
- Information sharing designed to give better information to consumers
- Research joint ventures and know-how agreements which seek to promote innovative and inventive behaviour in a market. The EU has introduced R&D Block Exemption Regulation for this situation.
28
Q
What is open (formal) collusion?
A
- Overt means spoken, open or traceable i.e. firms actively agree to collude
- Explained by the desire to achieve joint-profit maximisation within a market or prevent price and revenue instability within an industry
- Price fixing represents an attempt by suppliers to control supply and fix price at a level close to the level we would expect from a monopoly.
- To collude on price, producers need some control over market supply and have strong price making power.
29
Q
When is collusion through price fixing easier to achieve?
A
- Industry regulators are ineffective- an example of regulatory failure.
- Penalties for collusion are low relative to the gain in profits- fines therefore don’t act as a deterrent.
- Few firms in the market and price inelasticity of demand - higher prices then lead to increased revenues
- Participating firms have a high percentage of total sales - this allows them to control market supply
- Firms can communicate well and trust each other - this is helped by having similar strategic objectives.
- Products are standardised and output within the cartel is easily measurable so that supply can be controlled.
- Brands are strong so that consumers will not switch demand when collusion raises prices
- There are some strong barriers that precent consumers from switching to other products/ alternatives.
30
Q
What are the 3 main reasons that cartels eventually break down?
A
- Enforcement issues; The cartel aims to restrict production to maximise total profits. Each individual seller finds it profitable to
expand their production. Other firms who are not members of the cartel may take a free ride by selling under the cartel price. - Falling market demand; e.g. during a recession. This creates excess capacity in the industry and then this puts downward pressure on profits and cash-flow cartel.
- The successful entry of non-cartel firms into an industry undermines a cartel’s control of the markets
- The exposure of price-fixing by whistle-blowing firms i.e. firms engaged in a cartel that pass on information to the competition authorities in the hope of more lenient treatment from the regulatory competition authorities.
31
Q
What are the penalties for UK businesses found to be engaged in collusion?
A
- Businesses in breach of competition law can face fines of up to 10% of their world wide turnover.
- Those convicted of a cartel offence can face up to 5 years imprisonment, unlimited fines, director disqualification for a period of up to 15 years and potential confiscation of their assets.
32
Q
What are the costs of collusive behaviour?
A
- Damages to consumer welfare ; higher prices, loss of allocative efficiency, hits lower income families i.e. has a regressive impact
- Absence of competition his efficiency ; X-inefficiencies leads to higher unit costs, less incentive to innovate/ loss of dynamic efficiency, output quotas penalise firms who want to expand
- Reinforces the cartel’s monopoly power ; harder for new businesses to enter the market- this reduces market contestability.
33
Q
What are the potential benefits of collusion?
A
- General industry standards can bring social benefits from pharmaceutical research and improved car safety technology.
- Fairer prices for producer coops in lower and middle income developing countries; competing more effectively with powerful corporations who have monopsony power, this may help in reducing rates of extreme income poverty.
- Profits have higher values; can be used for R and D, leading to dynamic efficiency, and higher wages for employees, leading to increased consumption.
34
Q
What is game theory?
A
- Oligopoly theory often makes heavy use of game theory to model the actual behaviour of businesses in concentrated markets. It studies how people and businesses behave in strategic situations i.e. when they consider the effect of other peoples responses to their own actions.
35
Q
What is the prisoners dilemma?
A
It is a game that illustrates why it is difficult to cooperate, even when in the best interests of both parties
- Both players are assumed to select their own dominant strategies for personal gain.
Prisoner A; confesses Prisoner B confesses; 3y,3y
A confess B deny; 10y,1y
A deny B confess; 1y,10y
A deny B deny; 2y,2y
36
Q
Evaluate the relevance of game theory.
A
- It becomes relevant to analysing business decision making when there are relatively few firms
- Standard game theory assumes rational agents are looking to maximise their own self-interest.
- More complex game theory reveals that people/businesses can develop coop and or collaborative behaviours e.g. joint ventures
- Game theory can over simplify complex decisions, and when there are more than 2 rival firms in a market the degree of complexity increases. Many firms fall back on rules of thumb when making decisions on price, advertising budgets, production levels and much more.
37
Q
What is a dominant strategy?
A
Where a single strategy is best for a player regardless of what strategy other players in the game decide to use.
38
Q
What is nash equilibrium?
A
Any situation where all participants in a game are pursuing their best possible strategy given all the strategies of all of the other participants.
39
Q
What is tactic collusion?
A
Where firms undertake actions that are likely to minimise a competitive response e.g. avoid price cutting and not attacking each others markets OR
Firms may end up raising prices but without ever having discussed it or reached a formal collusive agreement.
40
Q
What is whistle blowing?
A
- When one or more agents in a collusive agreement report it to authorities
41
Q
What is zero sum game?
A
An economic transaction in which whatever is gained by one party must be lost by the other.
42
Q
Who benefit from price wars?
A
- regular consumers who will see an -increase in consumer surplus
- Managers- sales revenues will increase if demand is price elastic which might lead to higher sales bonuses.
43
Q
Who loses out from price wars?
A
- Shareholders- if prolonged price wars lead to lower profits.
- Suppliers who may get squeezed if a firm uses monopsony power to lower the prices of their supplies
- smaller firms who may not be able to absorb possible losses from an intense price war
- The government if lower profits cause a decline in corporation tax revenues.
44
Q
What is break even price?
A
P=AC
45
Q
What is cost-plus pricing?
A
Where a firm fixes the price by adding a fixed percentage profit margin to the AC of production.
46
Q
What is limit pricing?
A
It is pricing by a firm to deter entry or the expansion of fringe firms. The limit price is below the SR profit maximising price but above the competitive level.
47
Q
What is peak pricing?
A
When a business raises its prices at a time when demand has reached a peak might be justified due to higher marginal costs of supply at peak times.
48
Q
What is penetration pricing?
A
Pricing policy used to enter a new market, usually setting a low price
49
Q
What is predatory pricing?
A
It is a deliberate strategy of driving competitors out of the market by setting low prices or selling below average cost.
50
Q
What is altruism?
A
- Disinterested and selfless concern for the wellbeing of others
51
Q
What are the characteristics of a monopoly?
A
- A pure monopolist is a single supplier that dominates the entire market.
- In reality- the UK CMA deems that; a working monopoly is any firm with greater than 25% of the industry’s total sales. A dominant monopoly is a firm that has at least 40% market share.
- Price making power is available to any business with a downward-sloping demand curve.
- High barriers to entry and exit
- Firms in a monopoly aim to maximise profit MR=MC
- If AR is falling, MR is below AR
52
Q
What is a natural monopoly?
A
- It occurs when a large business can supply a market at a lower price than smaller ones. It is a situation in which there cannot be more than one efficient provider of a good. It is an industry where the minimum efficient scale is a large share of market demand.
53
Q
What is a natural monopoly characterised by?
A
- Increasing returns to scale at all levels of output.
- Thus, the long run cost er unit will drift lower as production expands.
- LRAC is falling because LR MC is always below LRAC
- There may be some room only for one supplier to fully exploit economies of scale, reach the minimum efficient scale and achieve productive efficiency.
54
Q
How is a natural monopoly different from other industries?
A
- It is a special case where one large business can supply the entire market at a lower unit cost than multiple providers.
- This is because of the nature of costs in a natural monopoly industry. Typically there are very high fixed costs and low marginal costs.
- E.g. The supply of water is a natural monopoly as it needs immense amounts of expensive infrastructure.
- As a result, fixed costs are enormous, but the marginal cost of adding an extra user is very low.
- Therefore the average total cost will continue to fall as extra users are added to the network. This is an internal economy of scale.
- This means that long run average cost may fall across all ranges of output. Only one firm might reach the minimum efficient scale.
55
Q
What is price discrimination?
A
It is when a business charges different consumers different prices for the same good or service.
The variations in price do not fully reflect the marginal cost of supplying a product e.g. higher costs for parcels delivered over short and long haul distances in the UK and overseas might be built into price.
56
Q
What are the aims of price discrimination?
A
- To increase total revenue by extracting consumer surplus and turning it into producer surplus
- To increase total profit providing the marginal profit from selling to consumers is positive.
- To generate cash-flow especially during a recession.
- To increase market share and build consumer loyalty.
- To make more efficient use of a firm’s spare capacity.
- To reduce the amount of waste and cut the costs of keeping products in stock/storage.
57
Q
What is third degree price discrimination?
A
It is when firms charge different prices to groups of consumers segmented by price elasticity of demand, income, age and sex.
58
Q
What are the conditions required for a firm to use third degree price discrimination?
A
- Firms have sufficient monopoly power; monopolists always have pricing power i.e. they are price makers
- Identifying different market segments; i.e. groups of consumers with different PEDs.
- Ability to separate different groups; requires information/sufficient market intelligence on the purchasing behaviour of consumers.
- Ability to prevent resale; No secondary markets where arbitrage can take place at intermediate prices e.g. limiting sales, age-restrictions, compulsory use of ID cards.
59
Q
How can consumers benefit from price discrimination?
A
- Price discrimination is the charging of different prices to different groups of consumers on the basis of variations in people’s ability to pay.
- One way that some groups of consumers may benefit comes from third degree discrimination pricing based on age or income.
- E.g. a bus company may charge students a lower price. Students typically have lower incomes so their demand is more price elastic.
- This means that student passengers get a discounted ticket price which has the effect of increasing their real purchasing power.
- As a result, they can afford to travel more regularly within their budget constraint. It might make attending collage more affordable.
- The consequence can be an increase in consumer surplus which is one measure of economic welfare from market activity.
60
Q
What are the possible disadvantages of price discrimination?
A
- Higher prices for some consumers leading to a loss of consumer surplus and a reduction in allocative efficiency, if P>MC; the consumer surplus is reallocated into producer surplus.
- Can increase regional inequality if some consumers can only access goods/ services at higher prices
- There may be an increase in transaction costs or administrative costs for businesses, as they have to ensure that the market is sub-divided and consumers in each group are kept separate e.g. checking ID documents for age. This can reduce profits.
- Groupings of consumers is not perfect e.g. relatively well off adults taking night-school courses may have a student card and be able to access student discounts.
- Additional profits earned as a result of price discrimination may allow incumbent firms to adopt anti-competitive practices e.g. predatory pricing and high advertising costs.
61
Q
What are the possible advantages of price discrimination?
A
- Lower prices for some groups of consumers, who might not otherwise be able to afford the good/service in question, therefore widening market access.
- More profits for the business can result in higher dividends for shareholders and a positive wealth effect
- More profits can lead to reinvestment/ business growth as well as R and D.
- Businesses can make better use of spare capacity, increasing demand in quieter times and reducing overcrowding/excess demand at leak times.
62
Q
What are general evaluation points for price discrimination?
A
- The impact depends on the extent to which price discrimination is used.
- The impact depends on how businesses choose to use profits
- It is very difficult in practice to agree on a ‘fair price’- it is a matter of perspective.
63
Q
What is the economic case against monopoly?
A
- Prices are higher than under competitive conditions. This leads to loss of allocative efficiency. Higher prices can have a regressive effect on lower income households
- Absence of genuine market competition can lead to production inefficiencies e.g. wasteful production and advertising spending.
- Higher prices can limit output in a market and lead to fewer economies of scale being exploited.
- Protected markets mean that perhaps there is less drive to innovate- leading to less dynamic efficiency.
- Monopoly may get too big- causing one or more diseconomies of scale- leading to rising long run AC.
64
Q
What is the economic advantages for monopoly power?
A
- Profits can be used to fund investment and research
- Natural monopoly allows for the applications of EoS which leads to lower prices
- Domestic monopoly businesses often face global competition.
- Monopolistic firms can be regulated- i.e. an industry regulator acting as a proxy consumer
- Price discrimination may help some consumers if charged a lower price than the usual monopoly price.
65
Q
Evaluate monopoly power.
A
- Natural monopoly- it may be more productively efficient to have a monopoly supplier.
- Competition in the supply chain- possible to introduce competition at different stages to the supply chain e.g. via competitive tendering
- Contestability- the threat of entry into a market can be a powerful influence on firms with monopoly power.
- Definition of the market- a business might have monopoly power in the domestic market but face significant international competition.
66
Q
What is monopsony power in product markets?
A
- A monopsony has buying or bargaining power in their market. It is different to a monopoly which has dominant selling power.
- This buying power means that a monopsony can exploit their bargaining power with a supplier to negotiate lower prices.
- This reduced costs of purchasing inputs increases their profit margins.
- E.g. Electricity generators negotiate lower prices for coal contracts. Food retailers have power when sourcing/purchasing supplies direct from farmers, milk producers wine growers and other suppliers.
67
Q
Explain the effect of monopsony power on consumer welfare.
A
- A monopsony has buying or bargaining power.
- This means that a monopsony can use their purchasing power to negotiate lower prices for raw materials and other inputs.
- As a result, their variable costs of production will be lower and this will lead to a decrease in marginal cost and average total costs.
- If the monopoly is a profit maximising firm, then a fall in AR and MC will lead to lower equilibrium price.
- In this way, final consumers may benefit from lower prices which will therefore increase their consumer surplus and economic welfare.
- This assumes that the price paid by the consumer is the main determinant of their welfare. This may not be the case in reality.
68
Q
What are the benefits to firms of being a monopsony power?
A
- Monopsony power allows bigger firms to achieve purchasing economies of scale leading to lower long run AC.
- Lower purchase costs bring about higher profits and increased returns for shareholders.
3.The extra profit might be used to find capital investment or research and develop.
69
Q
What are the benefits of firms having monopsony power to consumers?
A
- Consumers gain from lower prices e.g. supermarkets negotiate better prices from manufacturers that are then passed onto consumers
- Improved value for money- e.g. the NHS can use its wage bargaining power to cut the prices of drugs used in treatment- cost savings allow for more treatments within the NHS budget.
70
Q
What are the drawbacks of monopsony power?
A
- Businesses may use their buying power to squeeze lower prices out of suppliers. This reduces the profits of firms in the supply chain and causes lower incomes.
- e.g. milk farmers battling to get higher prices from supermarkets that covers the AC of milk.
- Consumers may be faced with less choice or higher prices in the LR if some suppliers leave the market.
71
Q
What are the characteristics of a contestable market?
A
- They exist when there are low barriers to entry and exit, allowing new suppliers to come into a market and provide fresh competition to established businesses.
- For a perfectly contestable market, entry into and exit out must be costless. This can have implications for the behaviour of existing firms and then affects the performance of a market in terms of allocative, productive and dynamic efficiency.
- A contestable or competitive environment is common in most industries even when there appears to be one or more dominant businesses with significant market power.
72
Q
What are the conditions required for market contestability?
A
- A pool of new businesses who are willing and ready to enter the market
- No significant entry or exit costs- this lowers the risks of market entry.
- Equal access for incumbent firms and potential entrant firms to available industry technologies.
- Higher rates of consumer switching i.e. relatively low brand loyalty.
73
Q
What are the key exam points about contestable markets?
A
- The threat of entry affects the day to day behaviour of firms
- Firms making supernormal profits are vulnerable to hit and run competition.
- This means that they are likely to behave more competitively i.e. not earn supernormal profits, in order to discourage new firms from entering.
- The outcome in a highly contestable market will resemble perfect competition, regardless of the number of firms, since incumbents behave as if there were intense competition.
- Competition policies such as liberalisation of a market that help to open up an industry to new suppliers or persuade consumers to switch in greater numbers to help increase contestability.
74
Q
How might firms be affected by increased contestability?
A
- A contestable market exists where there is freedom of entry and exit into an industry and there are limited or no sunk costs of production.
- In the absence of actual competition or threat of a rival entering a market, an unregulated firm could maximise profit where MR=MC.
- But if a market becomes more contestable- e.g. through a policy of liberalization, then competitive pressures will keep prices down.
- Instead of profit maximising, existing firms would have an incentive to cut prices perhaps to a level where normal profit is made.
- This is an output where AR=AC. Firms are making enough profit to stay in the market without attracting rivals.
- Actual and threatened competition intensifies incentives for businesses to control their unit costs by avoiding any X-inefficiencies.
75
Q
Give examples of strategic entry deterrences that firms may use to keep new entrants out.
A
- Hostile takeovers and acquisitions- i.e. taking a stake in a rival firm or buying it up completely.
- Price differentiation through brand proliferation i.e. developing new products and spending on marketing and advertising to reinforce brand loyalty.
- Capacity expansions designed to achieve lower unit costs from exploiting internal economies of scale.
- Predatory pricing; this happens when a dominant company sustains losses in the SR in the knowledge it can recoup them and raise prices if competition is forced to exit.
76
Q
Give examples of sunk costs.
A
- Asset-write-offs e.g. writing off the value of plant and machinery, stocks and the good will of a brand
- Closure or project cancellation costs including redundancy costs, bad debts, contracts with suppliers and the penalty costs from ending leases for property and equipment.
- The loss of business reputation and goodwill- a decision to leave a market can damage goodwill among previous consumers, not least those who have bought a product which is then withdrawn.
77
Q
Give an example of when a market has become more contestable as a result of more regulation.
A
- some markets become more contestable as a result of there being more regulation on incumbent firms.
e.g. access for electricity providers/ broadband providers to existing networks. This is because it reduces the sunk costs for new firms who no longer have to provide a large network before being able to offer a service.
78
Q
Give an example of where a market has become more contestable as a result of less regulation.
A
- Parcel delivery: EU directives meant that parcel delivery had to be opened up to competition by 2011, and could no longer be controlled by a government monopoly i.e. the legal statutory barrier for entry was removed.
- However, removing the legal barrier to entry was only part of the reason for growth in this area. Delivery firms needed there to be enough deliveries in certain geographical areas to justify operating the service. Helpfully, the rise of internet shopping meant that ever more householders were buying online and needed parcel delivery.
- i.e. removing barriers to entry will only make a market truly more contestable if there is enough demand to justify the need for new entrants.
79
Q
Give examples of regulation/ competition policy that can increase contestability.
A
- Banning cross-subsidisation i.e. a firm using profits in one part of their firm to subsidise entry into a new market.
- Requiring incumbent firs to provide ‘network access’
- Removing legal barriers to entry
- preventing mergers and acquisitions especially vertical integration that reduces access to supply chains for new firms (only 12 have been blocked in the UK between 2004 and 2018).
- Reducing protectionist measures.
