3.4 Market Structures Flashcards
Efficiency
used to judge how well the market allocates resources, and the relationship between scarce inputs and outputs
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.
Productive efficiency
- 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.
- This can only exist if firms produce at the bottom of the AC curve, in the short run this is where MC=AC.
Dynamic efficiency
This is achieved when resources are allocated efficiently over time. It is concerned with investment, which brings new products and new production techniques. The alternative is static efficiency: efficiency at a set point in time. Allocative and productive efficiency are examples of static efficiency.
X-inefficency
If a firm fails to minimise its average costs at a given level of output, it is X-inefficient and there is organisational slack. This is a specific type of productive inefficiency as it occurs when they fail to minimise their cost for that specific output.
X-inefficiency example
- The minimum point on the AC curve may be at 100 goods at a cost of £5 each. The firm is producing 125 goods and so is not productively efficient. It costs them £8 to produce each good, but they could produce 125 goods at £7.
- Therefore, they are X-inefficient since they are not producing on the lowest AC curve. It often
occurs where there is a lack of competition so firms have little incentive to cut costs.
Perfect competition
a market where there is a high degree of competition, but the word
‘perfect’ does not mean it maximises welfare or produces ideal results.
Charactersitics of perfect competition
- price takers
- many buyers and sellers
- freedom of entry and exit from the industry
- perfect knowledge
- homogenous goods
Profit in perfect competition
Short run = supernormal profit
Long run = normal profit as firms will enter the market.
Efficiency in perfect comeptition
- They are productively efficent and allocatively efficient.
- They are not dynamically efficent
- Competition keeps prices low so cannot benefit from economies of scale
Monopolitistic competition
a form of imperfect competition, with a downward sloping
demand curve. It lies in between the two extremes of perfect competition and monopoly, both of which rarely exist in a pure form in real life.
Characterisitics of monopoltistic competition
- large number of buyers and sellers
- no barriers to entry and exit
- differentiated, non-homogenous goods
Profit of monopolisitc competition
In the short run, firms can make supernormal profits, losses or normal profits. However, due to the lack of barriers to entry/exit, firms can only make normal profits in the long run.
Limitations of monopolistic competition
- 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.
Efficiency in monopolistic competition
- 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.
- They are dynamically efficient.
- less is sold at a higher price
- greater variety and economies of sclare
Oligopoly
there are a few firms that dominate the market and have the majority of
market share, although this does not mean there won’t be other firms in the market.
Characteristics of oligopoly
- high barrier to entry and exit
- high concentration ratio
- interdependence of firms
- production differentiation
concentration ratio
The percentage of the total market that a particular number of firms have.
concentration ratio calculations
total sales of n firms
——————————- x100
total size of markets
Collusion
When firms make collective agreements that reduce competition
Why do firms collude?
- maximise industry profits
- reduces the uncertainty firms face
Where 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.
two-types of collusion
- overt
- tacit
Overt collusion
when firms come to a formal agreement (cartel)
Tacit collusion
there is no formal agreement
two ways a cartel works
- agree on a price
- divide up the market
problem with cartel
- constant temptation to break the cartel.
price leadership
where one firm has advantages due to its size or costs and becomes the dominant firm.
Barometric firm price leadership
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.
Kinked demnad curve
- If a firm raises its price, other firms will not follow since they know their comparitovely lower prices means they are more competitive
- On the other hand, if a firm lowers price, other firms will follow since they want to remain competitive
Game theory
The reactions of one player to changes in strategy by another
player
The aim of Game Theory
To examine the best strategy a firm can adopt for each assumption about
its rival’s behaviour and it provides insight into interdependent decision making that occurs in competitive markets.
maximin policy
involves firms working out the strategy where the worst possible outcome is the least bad.
