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
How do PC firms go from SR SNP to LR NP
SR SNP signals to other firms to enter the market (perfect competition + no barriers) so they enter causing a shift out in supply of the industry so firms have to sell at a lower and lower price (price-taker) until SNP disappears
How do PC firms go from SR subnormal profits (loss) to LR NP
PC firms will know they are making a loss and leave to produce their opportunity cost (no barriers to exit). This causes a shift in of supply in the firm causing firms to increase their price ( price taker ) until there is no loss and normal profit is left
When drawing PC market structures what do you always have to includes
The market (s+d diagram) because firms are price takers
How would you evaluate the PC model
- Most firms have some amount of price-setting power – they are price makers not price takers!
- Dominance in real world markets of differentiated / branded products
- Highly complex products, there always information gaps facing
consumers - Impossible to avoid search costs even with the spread of digital/web technology
- Patents, control of intellectual property, control of key inputs are all ignored by the competitive model
- Rare for entry and exit in an industry to be costless
What are the characteristics of Monopolistic Competition
● There must be a large number of small, independent buyers so no one buyer or seller has a large price setting power.
● There are no barriers to entry or exit
● The difference is that in monopolistic competition firms produce differentiated, non-homogenous goods or services.
* The entrepreneur has a more significant role than in firms that are perfectly competitive because of the increased risks associated with decision making.
How do MC profit maximise in the short-run
Firms are assumed to be short run profit maximisers
As a result, they produce Q1 at MC=MR and make a supernormal profit
Why do MC produce normal profits in the long run
new firms will enter the industry as they know that supernormal profits are being earnt.
This will cause demand for the individual firm to decrease and therefore the AR and MR curves will shift to the lift and so the firm is making normal profits.
If the firm was making a loss, firms would leave the industry and thus demand for the individual firm would increase as they had less competition. This would lead to normal profits in the long run.
What are the limitations of the MC model
- that information may be imperfect and so firms will not enter the market as predicted as they are unaware of the existence of abnormal profits.
- firms are likely to be different in their size and cost structure as well as in their products, which may allow some firms to maintain supernormal profits because firms cannot compete on equal terms.
What are the efficiencies of the MC model
● Since they can only make normal profit in the long run, AC=AR and since they profit maximise, MR=MC. Therefore, the firm will not be allocatively or productively efficient, as MR does not equal AR so AC cannot equal MC and AC cannot equal MR.
● They are** likely to be dynamically efficient** since there are differentiated products and so know that innovative products will give them an edge over their competitors and enable them to make supernormal profits in the short run.
However, since the firms are small they may struggle to receive finance or have the retained profits necessary to invest.
● In monopolistic competition compared to perfect competition, less is sold at a higher price and firms may not necessarily be producing at the lowest cost. However, the market will offer greater variety and may be able to enjoy some degree of economies of scale.
What are some advantages of monopolistic competition
· There are no significant barriers to entry; therefore markets are relatively contestable.
· Differentiation creates diversity, choice and utility.
The market is more efficient than monopoly but less efficient than perfect competition - less allocatively and less productively efficient.
What are the disadvantages of monopolistic competition
· Some differentiation does not create utility but generates unnecessary waste, such as excess packaging. Advertising may also be considered wasteful, though most is informative rather than persuasive.
· there is allocative inefficiency in both the long and short run. This is because price is above marginal cost in both cases.
In the long run the firm is less allocatively inefficient, but it is still inefficient.
There may be a lack of dynamic efficiency in the long run due to the absence of long run abnormal profit
Why is there a tendency for excess capacity in MC
- There is a tendency for excess capacity because firms can never fully exploit their fixed factors because mass production is difficult. This means they are productively inefficient in both the long and short run.
What are the characteristics of an oligopoly
- products are generally differentiated
- supply in the industry must be concentrated in the hands of a relatively small number of firms
- firms must be interdependent so the actions of one firm will directly affect another
- there are barriers to entry.
Explain the kinked demand curve theory
· At P1 if one firm increased their price, other firms would not follow suits. Consumers would buy from the other firms therefore the firms raising price would face a PED elastic response on the AR curve would lose a large share of the market, revenue and likely profit
· If one firms cut price then they could gain a big increase in market share, however it is unlikely that firms will allow this. Therefore, other firms follow suit and cut price as well. Therefore demand will only increase by a small amount: Demand is inelastic for a price cut and revenue would fall for all firms
· This model suggests price will be rigid because there is no incentive for firms to change the price, they are risk averse.
What are the limitations of the kinked demand theory
- It assumes there is an intial price set
- It does explain why prices tend to be stable
What was the n-firm conc. ratio
total sales of n firms x100 /total size of market
What is collusion
- Collusion is when firms make collective agreements that reduce competition .
- When firms don’t collude, this is a competitive oligopoly.
What are the advantages of collusion
● if they work together, they could maximise 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 are the disavantages of collusion
● collusion is illegal and due to the risks of collusion , such as other firms breaking the cartel or prices being set where they don’t want it.
● 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
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 are the 2 types of collusion
overt and tacit collusion.
Overt collusion is when firms come to a formal agreement whilst tacit collusion means there is no formal agreement.
What is a cartel
A formal collusive agreement is called a cartel, which is 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 2 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
2) agree to divide up the market according to the present market share of each business.
What are the problems with cartels
● 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.
● Since collusion is illegal, firms may be involved in tacit collusion such as price leadership and barometric firm.
What is price leadership
Price leadership is where one firm has advantages due to its size or costs and becomes the dominant firm to set the price
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.
What is barometric 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 are 2 strategies a firm can take
- MaxiMin Policy - firms working out the strategy where the worst possible outcome is the least bad (minimising losses)
- MaxiMax Policy - firms working out the policy with the best possible outcome.
If Minimax policy and Maximax policy are the same what is this strategy
Dominant Strategy
What is a Nash Equilibrium
where neither player is able to improve their position and has optimised their outcome based on the other players expected decision.
They have no incentive to change behaviour, unless someone else changes theirs.
Use a Game Theory matrix to explain why oligopolies have stable prices
What does the prisoners dilema show about the Nash Equilibrium
What are the types of price competition
- Price Wars
- Predatory Pricing
- Limit Pricing
What are price wars and when do they 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.
● 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 predatory pricing
●Threat of Competition means Firms sets such a lower price so firms are unable to make a profit
● This is illegal and only works when one firm is large enough to be able to have low prices and sustain losses.
What is **limit pricing **
● In order to prevent new entrants, firms will set prices at AC=AR to ensure normal profits
● 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.
What is cost plus pricing
`
Firms add on a percentage increase to their average costs; doesn’t consider the market
What is pychological pricing
Firms utilising non-rounded prices to given an impression that the price is cheaper than it is
What is market led pricing
Firms follow pricing set by other firms; ignores cost
What is price skimming
new products can have high prices to cover R+D and supress demand
This can be lowered over time
What is penetration pricing
New products at low price so people get used to it and gain brand loyaly so firm can increase price
(opposite of price skimming)
What are common examples of non-price competition
- Advertising/ Branding; lower PED
- Loyalty Cards
- Quality
- Customer Service
- R+D
What is the issue with non-price competition
They are often expensive and so firms need the money before they are able to undertake the competition
What efficiencies do oligopolies have
● Firms will be statically inefficient, since they are not productively or allocative efficient.
● They are likely to be dynamically efficient; SNP + threat of comeptition incentivies DE
● They will be able to exploit economies of scale, lowering costs.
Draw a Cartel Firm’s SNP when staying within the quota of output
Draw the incentive to cheat shown by a Cartel Firm’s SNP
What are the costs of collusive behaviour
1) Damages consumer welfare
○ Higher prices / lost consumer surplus ○ Loss of allocative efficiency ○ Hits lower income families – i.e. has a regressive impact lack of choice due to high conc. 2) Absence of competition hits efficiency ○ X-inefficiencies leads to higher unit costs ○ Less incentive to innovate / loss of dynamic efficiency * Output quotas penalise firms who want to expand
3) Reinforces the cartel’s monopoly power
Harder for new businesses to enter the market – this reduces market contestability
What are the potential consumer gains from collusive behaviour
- Period of relative price stability
- A reduction of some of the wasteful costs of advertising and marketing if producers co-operate rather than compete with each-other
- Guaranteed supply from the producer cartel
What are the potential producer gains
- Producer cartels may be successful in raising the price of exported commodities
○ May help to fund higher levels of capital investment
Boost to export revenues for countries with a high dependency on exports of primary commodities
What does the discontinued MR curve illustrate
As long as the Firms MC curve lies in this area MC=MR this will be the best strategy for the individual firm
What are the limitations of the kinked demand curve
· No explanation of how the original price was arrived at.
· The theory only deals with price competition not non price competition
· It ignores certain practices such as interest free credit
· In a recession competition may increase
What are the limitations of the kinked demand curve
· No explanation of how the original price was arrived at.
· The theory only deals with price competition not non price competition
· It ignores certain practices such as interest free credit
· In a recession competition may increase
When are Cartels more likely to survive and occur
· Barriers to entry are high
· Govt regulation is weak
· Demand is stable
Price and output are easily monitored
how do you work out N-Firm conc. ratios
using the formula: total sales of N firms / total size of market
Whatt is CMA and its role
The CMA is now the UK’s key competition regulator, combining the competition elements of the OFT and Competition commission.
- Investigate mergers which could restrict competition where there may be breaches of UK or EU law against anti-competitive agreements and abuses of dominant positions
- Bring criminal proceedings against individuals who commit a cartel offence
- Cooperate with sector regulators (such as Ofcom) and encouraging them to use their competition powers considering regulatory references and appeals
What is regulatory capture and the issues associated with it
where the regulator is captured or hijacked by the regulated.
the regulated develop a deep understanding of the details of the regulation and can learn how to ‘play the system’ OR increased exposure of regulators to the regulated encourages them to ‘see things from their perspective’
How did Pfizer and Flynn Pharma collude illegaly
Aug 2015: Pfizer and a UK company called Flynn Pharma found to have charged “excessive and unfair prices” for an anti-epilepsy drug — phenytoin sodium — inflating the annual NHS drugs bill by tens of millions of pounds
What is the cheating of the RBS and Barclays Cartel
RBS admitted that staff involved in making loans to big law and accounting firms had illegally given pricing data to corresponding staff at Barclays.
** RBS fined £28 million**
**No action is to be taken against Barclays, **as a reward for having acted as an informant within the industry, voluntarily disclosing its part in the affair to the competition authorities.
What is the difference between overt and tacit collusion
- Overt is illegal and a fomal agreement
- Tacit is legally grey and an unwritten agreement
In what forms does tacit collusion come in
· Price leadership where the dominant firm in the industry changes its prices and all others follow
· Firms monitoring each others behaviour closely and** unwritten rules developing**. Eg all following certain principles
· Barometric price leadership
What is collaboration
· Firms working together, perhaps even encouraged by the government.
· There could be significant benefits to society of such sharing of info and ideas. (+externalities of improved medical treatments)
· There is a danger though that collusion may be the result and also monopoly power
What are the various methods of collusion
- Monopsony pricing – where retailers collude to reduce the amount paid to suppliers.
- Collusion between existing firms in an industry to exclude new firms from deals
- Sticking to output quotas and higher prices.
- Collusive tendering. For example, ‘cover prices’ for competitive tendering in bidding for public construction contracts.
How do people justify collusion in bad conditons
collusion may be a way to try to save the industry and prevent firms from going out of business, which would not be in the long-term consumer interest.
Dairy suppliers tried to use this justification in 2002/03 after problems from foot and mouth disease led to a decline in farm incomes.
What is an example of cover pricing - collusive tendering
Firms would decide which contracts they wanted, and rivals would bid purposefully high price. This is a practice known as “Cover pricing”. Successful companies would often reward rivals with a secret payment for avoiding competition.
During the investigation, the OFT found 199 offences where the 103 companies artificially inflated £200m worth of work. Companies were fined a total of £129.5m by the OFT.
How are Australian Supermarkets an oligopoly
90% market share in the hands of just four supermarkets so farmers are presssured by extreme barganing power meant farmers’ margins have been squeezed
Regulators have failed to curb this excessive power.
In the long term, consumers will be worse off through less choice and innovation in products, less efficiency and productivity
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.
● 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.
What is a good example of lobbying in regulation : Australian Banks
Bank lobbyists are seeking to water down a new Financial Accountability Regime proposed by Australia’s Treasury, which includes A$1m fine for executives who breach accountability obligations.
What is the Quebec Maple Syrup Cartel and what does it show about the weaknesses of oligopolies
Federation of Quebec Maple Syrup Producers (FPAQ) produce 70% of world supply of maple
insist that the majority of members benefit from quotas, a 2016 study by the independent Montreal Economic Institute disagreed. Quebec sold 78% of the world’s maple syrup, that percentage has already fallen to 69% due to it giving price stability to it’s competitors
How does OFGEM show regulatory failure
many suppliers lacked the financial resilience to deal with the six-fold increase in wholesale prices seen last year, the NAO said.
“By allowing so many suppliers with weak finances to enter the market, and by failing to imagine that there could be a long period of volatility in energy prices, Ofgem allowed a market to develop that was vulnerable to large-scale shocks,” said Gareth Davies, head of the NAO.
What is a pure monopolist
a single supplier that dominates the entire market – the market has 100% concentration
What is a working monopoly
A working monopoly is any firm with greater than 25% of the industries’ total sales
What is a dominant firm
A dominant firm is a firm that has at least 40% market share
Draw a monopoly market
What is third degree price discrimination
This is when monopolists charge different prices to different people for the same good or service
What are the conditions for price discrimination
- the firm must be able to clearly separate the market into groups of buyers
- the customers must have different elasticities of demand
- they must be able to control supply and prevent resale
Draw a diagram for 3rd degree price discrimination based on separation by PED
The diagram shows the seperate markets for separate groups: those with inelastic demand and those with elastic demand. Assumption of constant cost
This shows that by price discriminating and having two separate markets, the inelastic market and the elastic market, rather than a combined market, the firm can make higher profits. The orange area plus the purple area is larger than the yellow area.
Draw a diagram for 3rd degree price discrimination based on separation by PED
The diagram shows the seperate markets for separate groups: those with inelastic demand and those with elastic demand. Assumption of constant cost
This shows that by price discriminating and having two separate markets, the inelastic market and the elastic market, rather than a combined market, the firm can make higher profits. The orange area plus the purple area is larger than the yellow area.
What is a natural monopoly
the economies of scale are so large that even a single producer is not able to fully exploit all of them (decreasing cost industries)
when the most efficient number of firms in the industry is one.
A natural monopoly will typically have very high fixed costs meaning that it is impractical to have more than one firm producing the good.
Draw a natural monopoly
Why is it pointless to encourage competition in natural monopolies
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.
● Natural monopolies tend to be found in industries with very high fixed costs , such as railways.
What are the costs and benefits of monpolies on firms
● Monopolists have the potential to make huge profits for their shareholders through profit maximisation.
● The existence of supernormal profits so finance for investments and will be able to build up reserves to overcome short term difficulties.
● Large firms will be able to maximise economies of scale, reducing costs and increasing profit further.
● However, firms may not always choose to profit maximise because of X-inefficiencies, sales or revenue maximising, profit satisficing or contestability leading to limit pricing.
In the long run, the lack of competition may mean that firms become complacent and so they may not make maximum profits.
What are the costs and benefits of monopolies on employees
● Monopolists produce at lower outputs, so will employ fewer workers.
● However, the inefficiency of the monopoly may mean employees receive higher wages, particularly directors and senior managers. Profit satisficing or sales/revenue maximising may mean output is higher and so more employees are employed.
What are the costs and benefits of monopolies on suppliers
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.
What are the costs and benefits of monopolies on consumers
● With a natural monopoly, consumers tend to be better off than if there was competition.
● When firms enjoy economies of scale = higher consumer surplus
● Monopolists may produce more choice due to **cross subsidisation. **
● The use of price discrimination will allow for survival of a product or service , and benefits some customers (those in the cheap market) whilst is negative for others. For example, it is said that economy class flights are funded by business class flights
● Consumers may pay higher prices and see a poorer quality service , due to a lack of competition.
● There is less choice for consumers, since there is only one firm producing the good.
What efficiencies does a monopoly have
● A monopoly is productively inefficient, since they don’t produce at MC=AC. They are also not allocative efficient as P>MC.
● 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.
Draw the Williamson trade off and describe the areas of DWL, falls in consumer surplus, gains in producer surplus
What is the Williamson trade off
A diagram that shows the effect of a monopolist compared to perfect compeittion; assumed that industry is a constant cost where AC=MC
Analyse this diagram
- As a profit maximiser the monopoly will restrict output to Q1 in order to achieve MC=MR.
- Consumers suffer through a lack of choice but also high prices reducing surplus to [5,6,7].
- Producer benefits by capturing surplus from the consumer, a transfer in welfare [1,2,11,12]. Total producer surplus is now [1,2,13,14].
- The monopoly is not allocatively efficient as P≠MC, This creates a welfare loss of [8,9,10] made up of lost consumer and producer surplus.
- The firm is not productively efficient it doesn’t not produce at the lowest point of the AC curve
- there is likely to be a degree of x-inefficiency. This results in higher AC, higher prices and poor service.
- The monopoly does not fully exploit its EoS on the graph as it does not produce at the MES point since it restricts output.
What are the general disadvantgaes of a monopoly
· lower consumper surplus and restricted choice for consumers.
· Allocative and productively inefficient.
· Welfare loss leads to a market failure.
· Likely to be** x-inefficient **due to a lack of competition.
· Not fully exploiting Economies of Scale as not producing at the MES point.
· Protected by high barriers to entry, could lead to a lack of dynamic efficiency (no incentive to innovate).
· They may suffer from Dis-economies of scale and higher AC.
Price discrimination can lead to some consumers having to pay more than others
What are the advantages of a monopoly
· A monopoly will be able to use its size to benefit from Economies of Scale so lower average costs which could be passed onto consumers.
· Dynamic efficiency will benefit consumes in the long-run, more so than perfect competition.
Monopolies can compete on an international scale due to their EoS. This benefits the economy on a macro-level with output, employment, exports, tax revenue etc.
On a micro-level, in a local community suppliers and local shops benefit and there are positive externalities of employment.
What di Schumpeter argue about monopolies
- Firms would fear Creative Destruction, where new firms enter the market with technological advancement a force out existing firms.
- They invest therefore in R and D and this is likely to come in the form of the product/process.
What is the dynamic efficiency of the product
The product:
· Scarce resources are effectively allocated to meet consumer needs and wants.
· Consumers utility is met/improved and although consumers may face higher prices
· This is to the benefit of consumers compared to competitive markets.
What is dynamic efficiency of the process
The process:
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. **
What is price discrimination and how many types are there
3 (only need to know 3rd)
This involves charging different prices for different groups of consumers for the same good or service, for reasons not associated with cost.
What are the conditions necessary for price discrimination
- Monopoly Power
- The ability to prevent market seepage (second hand arbitrage/resale).
- Ability to split the market into segments through PED. This is usually done through time or geography.
What is 1st Degree Price Discrimination (Perfect Price Discrimination)
- Each consumer in theory is charged the maximum they individually are willing to pay so extracts all consumer surplus.
- In reality, this is an unrealistic theory as consumers are unlikely to reveal their true preferences
What is second degree price discrimination
- Excess capacity pricing exists when sellers try to off-load their spare output to buyers
- This involves charging different prices depending upon the choices of consumer. For example quantity, time period, collecting coupons
e.g. · Early Bird Discount – Creates cash flow, and ensures they can run the flight
Buying in Bulk – e.g. if you buy 100 units then they are £10 each, if you buy 500 units then they are £8 each. Diagram:
What is third degree price discrimination (direct price discrimination)
This involves charging different prices to different groups of people
What are the advantages for consumers for price discrimination
· Cross Subsidisation
o This is where unprofitable routes are subsided and ran because of the profitable routes which are engaging in price discrimination.
Some consumers benefit from lower prices,
Some consumers have access to services which they otherwise would not be able to afford. These last minute deals are second degree price discrimination.
What are the **disadvantages ** for consumers for price discrimination
· Certain consumers will pay higher prices, due to the extraction of consumer surplus by firms.
· Some groups, for example graduates travelling to work, are particularly penalised.
· As monopoly power is needed for price discrimination to be possible, monopoly arguments can be used here too
x-inefficiency. This leads to higher costs/inertia-consumers may suffer
Dis. EOS – higher average costs, meaning higher final prices for the consumer.
What are the advantages for producers for price discrimination
· In first/third degree, producer surplus is increased so higher SNP
· Dynamic efficiency means that barriers to entry for potential entrants to the market increase.
· Economies of scale provide barriers to entry for the monopoly.
Provides profits to engage in anti-competitive strategies– for example predatory pricing.
What are the disadvantages for producers from price discrimination
· Monopoly inertia
· Creative destruction
Dis EOS harms producers as well as consumers
What is the evaluation for price discrimination
· The key word in the question is “always”.
o Price discrimination is not bad for all consumers
o It is also not always good for producers, due to government regulation and monopoly inertia.
· There may be an asymmetric impact between regions, some being cheaper and some more expensive.
· Dynamic efficiency – does the monopoly invest in R + D, or do profits go into ‘back pocket’?
What is the importance of marginal cost in price discrimination
In markets where the marginal cost of an extra passenger is very low, the firm has an incentive to use price discrimination to sell all the tickets.
Draw a predatory pricing diagram
What is an example of predatory pricing in the Darlington Bus War
Busways a new entrant into the deregulated bus markets, offered free bus travel to try and force the rival Darlington Bus company out of business.
The result was that Darlington Transport Company (DTC) went out of business leading to monopoly power for the remaining Busways Company.
“It was the combination of Busways’ actions in recruiting so many of DTC’s drivers so quickly, registering services on all its routes and running free services which caused DTC’s final collapse. We find these actions to be predatory, deplorable and against the public interest.”
Since bus deregulation, bus use in Darlington has fallen from 10 million journeys a year (2001) to 6.6 million (2014).
Draw a limit pricing diagram
Evaluate limit pricing
- A large multinational may be willing to enter a market – even if it is unprofitable in the short-term.
- Limit pricing will be more effective in industries with substantial economies of scale
For industries, with few economies of scale, such as restaurants and bars, limit pricing will not be effective
What is a monopsony
This is where there is only one buyer of labour or products in the market,
How does the NHS use monospony power
One example could be the NHS, who pay less for cancer drugs than a number of other high-income countries.
How do monopsonies use their buying power in product markets
They will pay their suppliers the lowest price possible to minimise their costs and make the most of their position as the only buyer.
e.g. Requiring suppliers to cover costs such as delivery
Forcing suppliers to make lump sum payments to the monopsonist, for example, for access to particular positions in stores and outlets
Delaying payments to suppliers to improve the monopsonist’s cash flow.
Draw a monopsony diagram
They will produce where the cost to them (MC) is equal to the value they get (AR). Hence, they will produce where MC=D.
What are the costs and benefits to firms from monopsony power
● The monopsony gains higher profits by being able to buy at lower prices.
● They achieve purchasing economies of scale, which will lower costs and increase profits.
●More investment and DE
What are the costs and benefits to consumers from monopsony power
● Customers may gain from lower prices as reduced costs are passed on.
● It could lead to a fall in supply, since the business buys fewer inputs. Dependent on PES of supplier
● They may act as a** counter-weight to monopolists. **
● There may be a** fall in quality** as prices are driven down
What are the costs and benefits to employees from monopsony power
● The supplier will sell less goods and so employ less people whilst the monopsonist may employ fewer, more or the same amount of people since they have less inputs to use for production but their costs are also lower.
● Monopsonists** may pay higher wages** as they are making higher profits.
What are the costs and benefits to suppliers from monopsony power
● Suppliers will lose out as they will receive lower prices ; less will be supplied leading to some firms leaving the market
What are government attempts to control monopsony power
- Setting up a specific regulator to monitor the activities of firms with monopsony power, such as the UK’s Groceries Code Adjudicator (GCA).
- Controlling prices paid to suppliers – such as setting minimum prices.
- Subsidising suppliers who are adversely affected by the exertion of monopsony power.
- Legislate against late payments.
- Prevent further monopsony power by blocking mergers or by forcing firms to divest outlets or divisions of their business.
- encourage new entrants into the industry.
How do suppliers combat monospony power
- Establishing **producer cooperatives **as a counter-balance to monopsony buyers
- Using technology for suppliers to sell directly to consumers
What are some examples of producer cooperatives
Arla Foods is a global dairy company and cooperative owned by 9,700 dairy farmers with 2,100 of whom are British.
- Ormoia Coffee Union in Ethiopia over 20,000 farmers.
What are the characteristics of a contestable market
· This means there are no barriers to entry and no barriers to exit, such as sunk costs, economies of scale and contractual agreements.
· No brand loyalty
· Perfect information.
What are the implications of a contestable market
● Hit and run competition; only way to prevent this is by using limit pricing, which reduces the incentive for firms to enter the market.
● In a perfectly contestable market, firms will only be able to make normal profits and produce where AC=AR
● Firms are likely to be productive and allocative efficient.
- The threat of contestability is sufficient for economic efficiency, all markets may be efficient provided there is contestability.· Potential competition may be as important as actual competition for economic efficiency.
· It shifts the emphasis of govt policy away from the number of firms to barriers to entry.
· The absence of competition does not necessarily mean a lack of contestability.
· Nobody entering the market may just be out of fear for the incumbent’s efficiency
What are some innocent entry barriers (natural barriers)
- Economies of Scale of existing firms
- Network effect
- High r+d costs
- High set-up costs
- Ownership of key resources or raw materials
What are some Artificial (Strategic) barriers to entry
- Predatory pricing, as well as an acquisition.
- Limit pricing
- Advertising and brand
- Contracts, patents, and licenses
- Loyalty schemes
- Switching costs discourage new entrants
What are the barriers to entry for all the 4 market structures
Perfect competition: Zero barriers to entry
Monopolistic competition: Medium barriers to entry
Oligopoly: High barriers to entry
Monopoly: Very high to absolute barriers to entry
What are barriers to exit
obstacles or impediments that** prevent a company from exiting a market i**n which it is considering cessation of operations, or from which it wishes to separate.
What are some barriers to exit
highly specialized assets, which may be difficult to sell or relocate, and high exit costs, such as asset write-offs and closure costs. A common barrier to exit can also be the loss of customer goodwill.
- Highly specialised assets that are hard to sell off
- Tax breaks and regulation
- Costly Equipment
- Impact on the Enviroment
How can high barriers to exit be an opportunity for new entrants
A new company could buy up the assets of a company wishing to exit at a favourable price. Or a competitor could do this
What is a sunk cost
A sunk cost is a fixed cost that a business cannot recover if it leaves the industry
How is the degree of contestability measured
Etent to which the gains from market entry for a firm exceed the costs of entering the market, A market with no sunk costs and no barriers to entry and exit is a perfectly contestable market
What are reasons for increasing contestability nowadays
- Deregulation of markets allowed for a reduction of barriers to entry
- Competition policy means firms can no longer use predatory pricing/cartels
- Globalisation has allowed for more firms to enter
- Technology (internet shopping) reduced entry capital costs
What are policies to increase contestability
- Deregulation of an industry
- Open up networks of monopolies
- Tough rules on predatory pricing
- Encouraging international trade
What is hit and run competition
When a business enters an industry to take advantage of temporarily high (supernormal) market profits.
Draw the effect of contestability
· There is downward pressure on prices because high prices and profits act as incentives for new producers to compete away monopoly profit.
· Normal profit will occur AC=AR (link to alternative objectives)
· An improvement in c/s and welfare will occur.
What are sone examples of contestable market
- the taxi industry, with the introduction of Uber
- the hotel market, with AirBnB
- Ocado, who are set to replace M&S in the FTSE 100 (2018), showing the new replacing the old.
How has globalisation led to greater contestability (synoptic point)
- Greater access to relecommuncations had reduced barriers to entry and incrased information
- European single market has opened up new market for firms and so these firms can enter into the market easily
