3.4 Market Structures Flashcards
What is **allocative efficiency **
when the value to society from consumption is equal to the marginal cost of production, where P=MC.
What is productive efficiency
firms produce at the bottom of the AC curve, in the short run this is where MC=AC, has to be technically efficient
What is **dynamic efficiency **
his is achieved when resources are allocated efficiently over time. It is concerned with investment,will be achieved in markets where competition encourages innovation but where there are differences in products and copyright/patent laws.
Supernormal profit is required to provide firms with the incentive to invest and the ability to do so.
What is static efficiency
oncerned with the most efficient combination of existing resources at a given point in time.
Allocative + prod effieiencies
What is a x-inefficiency
If a firm fails to minimise its average costs at a given level of output, it is X-inefficient and there is organisational slack. It often occurs where there is a lack of competition so firms have little incentive to cut costs.
What are the 2 types of dynamic efficiency
- Cost Reducing Innovation
- Creative Destruction
What makes up cost reducing innovation
* Product innovation
○ Small-scale and frequent subtle changes to the characteristics and performance of a good or a service
* Process innovation
○ Changes to the way in which production takes place or is organised
○ Changes in business models and pricing strategies
Innovation has demand and supply-side effects in markets and the economy as a whole
What is social efficiency
- The socially efficient level of output and/or consumption occurs when marginal social benefit (MSB) = marginal social cost (MSC)
What are the impacts of Monopoly allocative inefficiency
- The monopolist will seek to extract a price from consumers above the cost of resources used in making the product.
Higher prices mean that consumers’ needs and wants are not being satisfied, as the product is being under-consumed.
Higher prices cause a loss of consumer surplus & welfare and will disproportionately affect lower income families.
What effiencies does Perfect Competition have
- Allocative efficiency: In both the short and long run, price is equal to marginal cost (P=MC)
- Productive efficiency: in the long run
so static efficiency
Dynamic efficiency: no room to innovate because homogeneity or enough for R+D
● Competition should keep costs, and therefore prices, low. However, firms will be unable to benefit from economies of scale and this may mean costs are higher than they otherwise could be.
What efficiencies does Monopolistic Competition have
- Prices are above marginal cost – meaning that the equilibrium is not allocatively efficient
- Saturation of the market may lead to businesses being unable to exploit fully economies of scale - causing average cost to be higher – therefore not productively efficient
- Debate over the social costs of packaging and negative externalities is linked to monopolistic competition
Monopolistic competition associated with extensive consumer choice and innovation – good for dynamic efficiency
Do takeovers boost economic efficiency
- Economies of scale from horizontal integration (productive efficiency)
- Higher supernormal profits leads to increased R&D spending and more innovation (dynamic efficiency)
Firms with monopoly power still face competition in contestable markets (allocatively efficient prices)
Do takeovers boost economic efficiency
- Increased market power can lead to X-inefficiency (managerial slack, waste)
- Risks of diseconomies of scale (rising long run AC)
- Many takeovers fail to achieve forecast cost gains
Growing number of de-mergers points to limited impact of takeovers on overall economic efficiency
Economic case against monopolies
- Prices are higher than under competitive conditions
Leads to a loss of allocative efficiency (price > MC)
**Regressive effects **on lower-income households - Absence of genuine market competition may lead to production inefficiencies
○ X-Inefficiencies such as wasteful production and advertising spending
○ Higher prices can limit the final output in a market and lead to fewer economies of scale being exploited - Protected markets – perhaps less drive to innovate
Monopoly may get too big – diseconomies of scale
What is the economic case for monopoly power
High market concentration does not always signal absence of competition; can reflect the success of firms in providing better-quality products, more efficiently, than their rivals.
- Profits used to fund investment & research
- Natural monopoly – economies of scale
- Domestic monopoly faces global competition
- Monopolistic firms can be regulated – i.e. industry regulator acting as a proxy consumer
- Price discrimination may help some consumers (cross-subsidisation)
What did Schumpeter argue about monopolies and creative destruction
· Schumpeter argued that firms have a very real incentive to invest in R and D,
· He stated that firms would fear Creative Destruction. Where new firms enter the market with technological advancement a force out existing firms. Incumbents fear this.
* They invest therefore in R and D and this is likely to come in the **form of the product/process. **
What does investment in the product result in (quality)
· Scarce resources are effectively allocated to meet consumer needs and wants.
· Consumers utility is met/improved and although consumers may face higher prices one could argue this level of product development and meeting the consumers’ needs is not possible in a competitive market due the absence of abnormal profit in the long run.
What does investment in the process result in (cost)
Investment in production-invention or innovation.
Investment in process is an example of technological EOS and the impact of tech improvement will drive down average and marginal cost. This can be shown. (see diagram)
What are the 4 key characteristics of a perfectly competitive market
1.There must be many buyers and sellers. This means that no one will be able to influence the market
2. freedom of entry and exit from the industry
3. There must be** perfect knowledge**
4. Homogenous products
Why must there be freedom of entry and exit for a perfectly competitive market
when a business is making profits anyone can enter that market and start producing that product for themselves.
As a result, business are unable to make SNP in the long run and if they are making losses they are able to leave. In the long run, they make normal profits.
Why must there be perfect information for a perfectly competitive market
This enables firms to know when other firms are making profits which will attract them to join the market. Moreover, all firms have the same costs as they can use the same production techniques.
It also means that any attempt to raise prices above the level determined by the market will lead to no sales, as customers will be aware they can buy the same good for a lower price and firms know there is no point lowering the price as they will sell all their goods at the higher price determined by the market.
Why must there be homogeneity for a perfectly competitive market
it means if a firm raises it price above the competitors’ no one will buy it and they will not gain from lowering their price because they can sell all of your product at the same price as everyone else.
What possibilities are there for perfectly competitive firms in the short run
Firms are assumed to short run profit maximise and so the firm will produce at MC=MR. In the short run, it is possible for the firm to make a normal profit, a supernormal profit or a loss
What possibilities are there for perfectly competitive firms in the long run
Only normal profits :0