3.4 Market Structures Flashcards
What is allocative efficiency
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 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. It is only possible if there is technical efficiency, where a given output is produced with minimum inputs- but not all technically efficient firms are productively efficient.
What is dynamic efficiency and static 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. Dynamic efficiency 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 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. This is a specific type of productive inefficiency as it occurs when they fail to minimise their cost for that specific output. For 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.
What is perfect competition
Perfect competition is a market where there is a high degree of competition, but the word ‘perfect’ does not mean it maximises welfare or produces ideal results.
What is an example of an industry which fits perfect competition
There are few industries which fit this type of market structure, one example may be agriculture but government interferences may prevent it from being so. In reality, the assumptions made rarely hold and no market is completely perfectly competitive.
What are the four key characteristics of perfect competition
- There must be many buyers and sellers
- There must be freedom of entry and exit from the industry
- There must be perfect knowledge
- The product must be homogenous
What does there must be many buyers and sellers means as a characteristic of perfect competition
This means that no one firm or customer will be able to influence the market. For example, the decision of one firm to double their output or the decision of one buyer to double their consumption will have no effect. If the firm did manage to have an effect, this would mean the market was no longer perfectly competitive as there would be one large firm and other smaller firms, or one large buyer and other smaller buyers.
What does there must be freedom of entry and exit from the industry mean as a characteristic of perfect competition
This is important as it means that 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 huge profits in the long run and if they are making losses they are able to leave. In the long run, they make normal profits.
What does there must be perfect knowledge mean as a characteristic of perfect competition
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.
What does the products must be homogenous mean as a characteristic of perfect competition
where they are identical so it is impossible to tell the difference between one make and another e.g. semi-skimmed milk. This is important because 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.
Draw and explain the two diagrams which illustrate why a firm in perfect competion can only make normal profit in the long run
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Are firms in perfect competition efficient
● Perfect competition is productively efficient, since they produce where MC=AC. They are also allocative efficient since they produce where P=MC. Thus, they are static efficient.
● However, they are not dynamic efficient. No single firm will have enough for research and development and small firms struggle to receive finance. The existence of perfect information also means one firms’ invention will be adopted by another firm and so the investment will give the firm no competitive benefit. Governments tend to have to do all the research.
● 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 is monopolistic competition
Monopolistic competition is a form of imperfect competition, with a downward sloping demand curve.
What are some examples of monopolistic competition in the real world
It lies in between the two extremes of perfect competition and monopoly, both of which rarely exist in a pure form in real life. Some examples of firms in monopolistic competition are hairdressers, estate agents and restaurants.
What are the three characteristics of monopolistic competition
- There must be large number of buyers and sellers
- No barriers to enter or exit
- Differentiated, non-homogenous goods
What does there much be a large number of buyers and sellers mean as a characteristic of monopolistic competition
There must be a large number of buyers and sellers in the market, each of whom are relatively small and act independently. This means that no one buyer or seller has a large price setting power.
What does there must be no Barriers to enter of exit mean as a characteristic of monopolistic competition
There are no barriers to entry or exit, allowing new firms to enter when supernormal profits are being made and some to leave in the case of losses. As a result, only normal profits can be made in the long run.
What does there must be differentiated, non-homogenous goods mean as a characteristic of monopolistic competition
The difference between monopolistic competition and perfect competition is that in monopolistic competition firms produce differentiated, non-homogenous goods or services. This means that individual firms do have some price setting power, and so the curve is downward sloping.
Draw a and explain diagram which illustrates why firms in monolithic competition can only make normal profits in the long run
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Are firms in monopolistic competition productively, allocative, static or dynamic efficient
● 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.
What is the difference between monopolistic and perfect competition
● 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 characteristics of an oligopoly
Oligopoly is where 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. There are four key characteristics of oligopoly: products are generally differentiated; supply in the industry must be concentrated in the hands of a relatively small number of firms, meaning there is a high concentration ratio; firms must be interdependent (so the actions of one firm will directly affect another); and there are barriers to entry.
Draw and explain the kinked demand curve theory
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What are concentration rations in oligopoly
The concentration of supply in the industry can be indicated by the concentration ratio which measures the percentage of the total market that a particular number of firms have. The 3 firm concentration ratio shows the percentage of the total market held by the three biggest firms, whilst the 4 firm ratio shows the percentage by the four biggest firms and so on.
How are concentration ratios calculated in oligopoly
It is worked out by adding the percentages of market share for the firms or using the formula:
total sales of n firms/total size of market x 100
What is collusion
Collusion is when firms make collective agreements that reduce competition. When firms don’t collude, this is a competitive oligopoly.
What is example of an oligopoly w
The UK energy market is an oligopoly that is suspected of collusion.
