3.4 market structure Flashcards
what is allocative efficency?
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.
what is productive efficency?
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.
what is dynamic efficency?
This is achieved when resources are allocated efficiently over time. It is concerned with investment, which brings new products and new production
techniques.
what is static efficency?
efficiency at a set point in time. Allocative and productive efficiency are examples of static efficiency
which type of markets are dynamically efficient?
Dynamic efficiency will be achieved in markets where competition encourages innovation but where there are differences in products and copyright/patent laws.
why are copyright and patents necessary for a market to be dynamically efficent?
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
what is x-inefficency?
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.
how is x inefficiency shown on a graph?
it is shown by the actual average cost curve being above the potential average cost curve
what are the 4 main characteristics of an oligopoly?
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.
why is there a kinked demand curve for the oligopoly?
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
what is the result of the kinked demand curve?
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
what is the n concentration ratio?
the percentage of the total market that a particular number of firms have.
what is the formula for the n concentration ratio?
(total sales of n firms x100) / (total size of market)
what is collusion?
Collusion is when firms make collective agreements that reduce competition.
what is the name of the market structure where the oligopoly does not collude?
When firms don’t collude, this is a competitive oligopoly
what UK industry is suspected of colluding?
The UK energy market is an oligopoly that is
suspected of collusion.
what type of firms will not want to collude and why?
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.
when does collusion work best?
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.
what is the effect of collusion?
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.
what is overt collusion?
Overt collusion is when firms come to a formal agreement
what is tacit collusion?
tacit collusion means there is no formal agreement.
what is a cartel?
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.
what are the two ways a cartel can operate?
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.
what is the issue with cartels?
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.
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.
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.
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.
what is game theory?
Game theory explores the reactions of one player to changes in strategy by another player.
what are the two strategys a firm can take under game theory?
maximin or Maximax policies
what is a Maximax policy
the Maximax policy involves firms working out the policy with the best possible outcome.
what is a Maximin policy?
The maximin policy involves firms working out the strategy where the worst possible outcome is the least bad.
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.
what are the three main types of pricing competition?
price wars, predatory pricing and limit pricing
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
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
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
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.
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.
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.
what are price wars?
a period of fierce competition in which traders cut prices in an attempt to increase their share of the market.
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.
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
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.
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
