3.4 market structure Flashcards
1
Q
what is allocative efficency?
A
This is achieved when resources are used to produce goods and services which consumers want and value most highly and social welfare is maximised. It will occur when the value to society from consumption is equal to the marginal cost of production, where P=MC.
2
Q
what is productive efficency?
A
A firm has productive efficiency when its products are produced at the lowest average cost so the fewest resources are used to produce each product. The minimum resources are used to produce the maximum output.
3
Q
what is dynamic efficency?
A
This is achieved when resources are allocated efficiently over time. It is concerned with investment, which brings new products and new production
techniques.
4
Q
what is static efficency?
A
efficiency at a set point in time. Allocative and productive efficiency are examples of static efficiency
5
Q
which type of markets are dynamically efficient?
A
Dynamic efficiency will be achieved in markets where competition encourages innovation but where there are differences in products and copyright/patent laws.
6
Q
why are copyright and patents necessary for a market to be dynamically efficent?
A
it encourages investment into research and development and it prevents a third party gaining positive production externality from the money you spent. as a result, only your company gets the productivity boost
7
Q
what is x-inefficency?
A
If a firm fails to minimize its average costs at a given level of output, it is X-inefficient and there is organizational slack. This is a specific type of productive inefficiency as it occurs when they fail to minimize their cost for that specific output.
8
Q
how is x inefficiency shown on a graph?
A
it is shown by the actual average cost curve being above the potential average cost curve
9
Q
what are the 4 main characteristics of an oligopoly?
A
1) products are generally differentiated; 2) supply in the
industry must be concentrated in the hands of a relatively small number of firms, meaning
there is a high concentration ratio; 3) firms must be interdependent (so the actions of one
firm will directly affect another); 4) there are barriers to entry.
10
Q
why is there a kinked demand curve for the oligopoly?
A
it assumes the original price is on the kink. if a firm increases its price, the others will stay at original price due to the fact they will have a comparatively lower price making them more competitive. however if a firm chooses to decrease their price, other firms will follow since they want to remain competitive. as a result above the original price the demand curve is elastic, and below original price the demand curve is inelastic
11
Q
what is the result of the kinked demand curve?
A
the prices remain stable due to the fact that a rise in prices will decrease profit as consumers will switch to other firms, and decreasing the price will just lead to a fall in revenue for all firms. so there is no incentive to change
12
Q
what is the n concentration ratio?
A
the percentage of the total market that a particular number of firms have.
13
Q
what is the formula for the n concentration ratio?
A
(total sales of n firms x100) / (total size of market)
14
Q
what is collusion?
A
Collusion is when firms make collective agreements that reduce competition.
15
Q
what is the name of the market structure where the oligopoly does not collude?
A
When firms don’t collude, this is a competitive oligopoly
16
Q
what UK industry is suspected of colluding?
A
The UK energy market is an oligopoly that is
suspected of collusion.
17
Q
what type of firms will not want to collude and why?
A
A firm with a strong business model and something that sets it apart from other firms will not want to collude if they feel they can increase market share and/or charge higher prices than competitors.
18
Q
when does collusion work best?
A
Collusion between firms works best when: there are a few firms which are all well known to each other; the firms are not secretive about costs and production methods and the costs and production methods are similar; they produce similar products; there is a dominant firm which the others are happy to follow; the market is relatively stable; and there are high barriers to entry.
19
Q
what is the effect of collusion?
A
it maximizes industry profits. Collusion reduces the uncertainty firms face and reduces the fear of engaging in competitive price cutting or advertising, which will reduce industry profits.
20
Q
what is overt collusion?
A
Overt collusion is when firms come to a formal agreement
21
Q
what is tacit collusion?
A
tacit collusion means there is no formal agreement.
22
Q
what is a cartel?
A
A formal collusive agreement. a group of firms who enter into agreement to mutually set prices. The rules will be laid out in a formal document which may be legally enforced and fines will be charged for firms who break these rules.
23
Q
what are the two ways a cartel can operate?
A
1) agree on a price for the goods and then compete freely using non-price competition to maximise their market share; or 2) agree to divide up the market according to the present market share of each business.
24
Q
what is the issue with cartels?
A
The problem with any cartel is that no firm is likely to set their prices/output at the level they would not ideally choose and there is constant temptation to break the cartel. The more successful the cartel, the greater the incentive to break it; it is important for firms to be the first to break it and not the firm who is left to deal with the after effects.
25
what is price leadership?
Price leadership is where one firm has advantages due to its size or costs and becomes the dominant firm. Other firms will tend to follow this firm because they
would be fearful of taking on the firm on in any form of price war. As a result, the dominant firm will decide the price and allow the other firms to supply as much as
they wish at this price.
26
what is a barometric firm price leadership?
Barometric firm price leadership is where a firm develops a reputation for being good at predicting the next move in the industry and other firms decide to follow their leader.
27
what effects the behavior of a non collusive oligopoly?
The behavior of a firm under non-collusive oligopoly will depend on how it thinks other firms will react to its policies.
28
what is game theory?
Game theory explores the reactions of one player to changes in strategy by another player.
29
what are the two strategys a firm can take under game theory?
maximin or Maximax policies
30
what is a Maximax policy
the Maximax policy involves firms working out the policy with the best possible outcome.
31
what is a Maximin policy?
The maximin policy involves firms working out the strategy where the worst possible outcome is the least bad.
32
what is the Nash equilibirium?
there is a Nash Equilibrium where neither player is able to improve their position and has optimized their outcome based on the other players expected decision. They have no incentive to change behavior, unless someone else changes theirs.
33
what are the three main types of pricing competition?
price wars, predatory pricing and limit pricing
34
what is 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. The established firm will set such a low price that other firms are unable to make a profit and so will be driven out the market. The existing firm is then able to put the price back up
35
what is the effect of predatory pricing for consumers?
in the short run consumers benefit from the lower price, however in the long run the dominant firm will have greater market power so will likely set the price higher as a result causing a fall in consumer welfare
36
what are the problems with predatory problem for the dominant firm?
it is illegal and only works when the firm is large enough to able to sustain losses and lower prices
37
what is limit pricing?
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.
38
what is the relationship between the barriers to entry and the limit price?
The greater the barriers to entry, the higher the limit price. It is mainly used in contestable markets.
39
what are the issues with limit pricing?
The drawback of this is that it means firms cannot make profits as high as they would be otherwise be able to.
40
what are price wars?
a period of fierce competition in which traders cut prices in an attempt to increase their share of the market.
41
what types of markets do price wars usually occur?
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.
42
what is the effect of a price war?
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
43
what is an example of a price war in the uk?
Supermarkets are one example of an industry using heavy price wars, with firms desperately trying to offer lower prices than their rivals.
44
what is phycological pricing?
this is where firms use non rounded prices such as £9.99 as to give the impression that the good is cheaper. the aim is for consumers to believe that they can afford the good and so be encouraged to buy it
45
what is cost plus pricing?
this is where firms calculate the average costs then add a mark up to these costs for example 20%. the markup determines the amount of profit they will make.
46
what does the size of the mark up in a cost plus pricing strategy depend on?
the barriers to entry in the market
47
what is the issue with cost plus pricing?
it doesnt take into account the actions of other firms
48
what is market led pricing?
when firms set prices just by looking at what the competition is charging for prices. they will price it similar as they believe that the other firms have discovered its the profit maximization point
49
what is penetration pricing?
when a product is first introduced, the firm will set prices lower to encourage people to use it for the first time and for the firm to build a customer base. after this they can then try to gradually rise the price
50
what are types of non price competition?
advertising, loyalty cards, branding, quality, customer service, product development
51
how is advertising a form of non price competition?
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.
52
how is loyalty cards a form of non price competition?
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.
53
how is branding a form of non price competition?
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 products.
54
how is quality a form of non price competition?
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.
55
how is customer service a form of non price competition?
This will encourage loyalty amongst customers and give the business a more positive reputation.
56
how is product development a form of non price competiton?
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
57
what are the issues with non pricing strategies?
The problem with these methods is that they are often expensive and so firms need the money before they are able to undertake the competition. Similarly, only large firms will be able to do large scale advertising, research and development etc.. There is no guarantee
that it will be successful.
58
are oligopolies statically efficient?
Firms will be statically inefficient, since they are not productively or allocative efficient.
59
are oligopolies dynamically efficent?
They are likely to be dynamically efficient. They make supernormal profits, so have the funds to invest, and they have an incentive to invest, due to competition.
However, some may just share its profits with its shareholders or decide not to invest. It will depend on the market.
60
do oligopolies benefit from economies of scale?
They will be able to exploit economies of scale, lowering costs
61
what is a pure monopoly?
Pure monopoly exists where one firm is the sole seller of a product in a market .
62
what firm is one of the closest example of pure monopoly?
One of the closest examples to a pure monopoly is Google, who have 88% of the market.
63
what is a legal monopoly?
a firm that has more than 25% of the market share.
64
what are the characteristics of a monopoly?
The model assumes there is only one firm in the industry, they short run profit maximise and there are high barriers to entry
65
what is an example of a legal monopoly?
Tesco is a legal monopoly as it has 28% of the
| market.
66
what are a natural monopoly?
In these industries, the economies of scale are so large that even a single producer is not able to fully exploit all of them. they have huge capital start up costs
67
what are close examples to a natural monopoly?
the National Grid, Royal Mail and National Rail.
68
what is third degree price discrimination?
This is when monopolists charge different prices to different people for the same good or service
69
what are the criteria for price discrimination to occur?
the firm must be able to clearly separate the market into groups of buyers; the customers must have different elasticities of demand; and they must be able to control supply and prevent buyers from the expensive market from buying in the cheaper market.
70
what are examples of third degree price discrimination?
peak and off-peak train times; different prices indifferent places, such as between London and smaller towns; and between different incomes, for example discounts for elderly people
71
what are the benefits of price discrimination?
Firms benefit since they are able to increase their profits. This can go into research and development, improving dynamic efficiency. Those in the elastic market gain as they are able to pay a lower price than they otherwise would; they benefit from cross subsidization. These consumers may have been unable to access the good if it were not for the price discrimination and so this may increase equality
72
what are the costs of price discrimination?
Consumers lose some of their consumer surplus to the producers and some consumers have to pay a higher price.
73
what is first degree price discrimination?
this occurs when a firm can charge a different price for every unit of a good selling at the maximum price consumers are willing to pay as a result transferring all consumer surplus into monopoly profit?
74
what is the requirement for first degree price discrimination to occur and what is the result of this?
this requires perfect information about the consumers so as result it is extremely hard to occur in real life scenarios
75
what is second degree pricing?
this is when you sell different prices depending on the different quantities for example bulk buying
76
is competition good in a natural monopoly?
It would be pointless to encourage competition since it would raise average costs for the industry. If any new firm enters the market, they will be easily priced out as
their costs will be so much higher.
77
are natural monopolies allocatively efficient or productively efficient or neither when run in the free market?
These firms are neither allocative nor productively efficient as there is no minimum on the AC curve and at allocative efficiency there would be a loss.
78
what are the benefits to firms of being a monopoly?
they can make huge profits for the shareholders through profit maximization. the existence of supernormal profits means that they have retained profits to invest and can build up reserves for short term difficulties. firms with monopoly power will be able to compete with transnational firms overseas. they will also be able to benefit from the economies of scale meaning they gain lower average costs
79
what are the costs to firm of being a monopoly?
In the long run, the lack of competition may mean that firms become complacent and inefficent so they may not make maximum profits.
80
what are the costs to workers of a monopoly?
Monopolists produce at lower outputs, so will employ fewer workers.
81
what are the benefits to workers of a monopoly?
the inefficiency of the monopoly may mean employees receive higher wages, particularly directors and senior managers. Profit satisficing or sales/revenue maximizing may mean output is higher and so more employees are employed.
82
what is the effect of a monopolist on suppliers?
For suppliers, the impact of a monopolist will depend on the extent to which the monopolist is also a monopsonist . If the monopolist buys all or most of the suppliers’ goods (so is a monopsonist), it will reduce the suppliers’ profits as the monopolist will decrease prices.
83
what is the benefits to consumers from a monopolist?
With a natural monopoly, consumers tend to be better off than if there was competition. firms enjoy economies of scale which will reduce costs, these may be passed down to the consumer ( this also depends on fact that the MC=MR for monopoly is at a lower price then the AR=AC for a competitive market), may provide wider range of goods through cross subsidizing and also through price discrimination, those in the cheaper price group could benefit from lower prices
84
what are the costs to consumers of a monopolist?
there may be reduced quality and a higher price due to the lack of competition making monopoly's complacent. there may be less choice as there is only one firm providing the good. those in the higher price group during price discrimination are worse off
85
what are the benefits to efficiency of a monopolist?
Since a monopolist is likely to make supernormal profits, they will be dynamically efficient. However, if there is no competition, they may have no incentive to invest.
86
what are the costs to efficiency of a monopolist?
A monopoly is productively inefficient, since they don’t produce at MC=AC. They are also not allocative efficient as P>MC.
87
what is creative destruction?
the deliberate dismantling of established processes in order to make way for improved methods of production.
88
how is creative destruction linked to duration of monopolies?
There are few permanent monopolies since supernormal profits give an incentive for other firms to break down the monopoly through a process of creative destruction.
89
how does the benefits of a monopoly depend on the industry?
The effects of a monopoly will depend on the industry : in industries with high fixed costs, the gains from economies of scale will be higher.
90
what is the Williamson trade off curve?
it is a diagram that shows the effect of a monopoly against perfect competition. the industry is assumed to be a constant cost where AC=MC and the AR curve is downward sloping. if industry had competition it would work at AC=AR where if it was monopoly it would work at MC=MR. the shift from PC to M would result in fall in quantity so less resources are used creating deadweight loss of the triangle above cost curve and between the two prices.
91
what is a contestable market?
A contestable market is one with a high threat of new entrants, which keeps firms producing at a competitive level.
92
what are the characteristics of a contestable market?
perfect knowledge, freedom of entry and exit, relative absence of sunk costs, firms are legally and able to use best technology available, low product loyalty, short run profit maximisers and do not collude
93
what are examples of contestable markets?
the taxi industry, with the introduction of Uber; the hotel market, with AirBnB; and fast food, due to Five Guys . Another example of contestability is Ocado, who are set to replace M&S in the FTSE 100 (2018), showing the new replacing the old.
94
what is in the implication of the firms being able to use the best technology in the market?
Firms will be able to and have the legal right to use the best available technology, meaning their average cost curve will be the same as the original firms’.
95
what is the implication of perfect knowledge in the contestable market?
Within a contestable market there is perfect knowledge so if one firm is making abnormal profits, other firms will enter the market.
96
what is the implication of the low product loyalty in contestable markets?
There will be low product loyalty, meaning people don’t consistently use one brand and are happy to switch if a new one enters the market
97
what is the efficiency of firms in the long run for a contestable market?
Firms are likely to be productive and allocative efficient. If they are not producing at the lowest point on their AC curve (i.e. not productively efficient), new firms can enter the market and undercut them by offering lower prices. Due to this, and the fact
they can only make normal profits in the long run, they must also be allocative efficient.
98
what are the types of barriers to entry in a market?
legal barriers (patents), marketing barriers (advertising) pricing strategies of incumbent firms ( predatory pricing), high capital start up costs, sunk costs, economies of scale,
99
what are types of barriers to exit into a market?
cost to write off assets, pay leases and make workers redundant.
100
how do legal barriers make it harder to enter a market?
Laws are put in place which make it more difficult for firms to enter the market, or explicitly mean they
cannot enter. For example, patents and exclusive rights to production (such as with television) mean other firms cannot enter the market. Some industries, such as the taxi industry, gain market licenses to operate.
101
how do marketing barriers make it harder to enter a market?
High levels of advertising build up consumer loyalty, so demand becomes more price inelastic, and consumers are less likely to try other brands. Sometimes a brand can become associated with a product, such as ‘Hoover’ with vacuum cleaners. New firms entering the industry are unlikely to have the funds to undertake large scale advertising so struggle to compete with
the incumbent firms.
102
how does the pricing decisions of incumbent firms maker it harder to enter a market?
Predatory pricing means prices are so low that firms are driven out of the market, and so it would be extremely difficult for new firms to enter. Limit pricing discourages the entry of other firms as prices are set at a level to prevent new entrants. Some firms might
employ anti-competitive practices, such as refusing to supply retailers which stock competitors.
103
how does economies of scale make it harder for new firms to enter a market?
Economies of scale mean that new firms are unable to produce on the same AC curve as large, incumbent firms. If they were to enter the industry, their costs would be higher and so prices would be higher and they would be unable to compete.
104
what is a sunk cost?
A sunk cost is a fixed cost that a business cannot recover if it leaves the industry.
105
what are examples of sunk costs?
It includes property (if the lease is longer than it is actually used for), machinery and equipment that cannot be resold, and advertising.
106
what is the degree of contestability measured by?
The degree of contestability is measured by the extent to which the gains from market entry for a firm exceed the costs of entering the market .
107
what affects the degree of contestability?
the degree of contestability is affected by the barriers to entry and sunk costs. A market with no sunk costs and no barriers to entry and exit is a perfectly contestable market.
108
what is the relationship between the degree of contestability and the stableness of the market?
The more contestable a market, the more unstable it will be as there can be regular hit and run competition.
109
what are reasons for increasing contestability?
deregulation of markets has reduced the barrier to entry in some industries such as telecommunications. competition policy has made pricing strategies such as predatory pricing illegal. recessions have changed market structures for example Aldi and Lidl offer lower prices and gained greater market share. European single market has increased the competition and allowed new firms to join market. changes in technology has reduced entry cost as capital is more mobile, and has provided new market place for firms on the internet
110
how has the internet increased contestability?`
it provides new points of entry into market ( the creation of online banks) which means firms can get around the usual high entry costs/ fixed cost ( setting up a network of Highstreet banks). there is greater information so consumers will be able to quickly figure the lowest prices, this will encourage firms to compete the supernormal profits of other firms away. also gives better information to firms about the cheapest suppliers and most efficient technology on market. reduced the sunk cost of starting business, creating online business has lower sunk cost then a brick and mortar type business.
111
what is a brick and mortar business?
The term "brick-and-mortar" refers to a traditional street-side business that offers products and services to its customers face-to-face in an office or store that the business owns or rents.
112
what are evaluation points to the extent the internet has increased contestability?
The internet works better for some industries than others. ( clothing people like to try on clothes whereas plane tickets people are just interested in the lowest price). the internet creates its own barriers to entry for example it is difficult to get a high google ranking unless you are already established or have lots of resources. the internet creates its only monopoly's such as amazon, people may not trust new online businesses. people tend to gravitate to what is popular so company with strong brand image will get large customer base
