3.4 Market Structures Flashcards
What is efficiency?
Efficiency is a measure of how well the market allocates resources.
What are the 4 different types of efficiencies?
- Allocative efficiency
- Productive efficiency
- Dynamic efficiency
- X-efficiency
What is allocative efficiency?
Allocative efficiency is when resources follow consumer demand
What does allocative efficiency cause for producers?
Profit max point
- P = MC
Competitive Advantage
- Following consumer demand increases market share
What does allocative efficiency cause for consumers?
Consumer surplus
- Lower price; higher surplus
What is productive efficiency?
Productive efficiency is when output operates at lowest AC so they are using fewest resources to produce per unit by exploiting all EofS. P = MC
Where does productive efficiency occur?
Productive efficiency occurs at lowest average cost, AC=MC
What does productive efficiency cause to producers?
- Higher supernormal profits (AC lowest)
- Increase dynamic efficiency
- Economies of Scale
- Higher market share
What does productive efficiency cause to consumers?
- Lower price for consumers (only if PED elastic and firms passes on decrease in price)
- Increase consumer surplus
- Higher output; more choice (Has to be many firms operating productive efficiency
What is dynamic efficiency and where does it occur on the graph?
Dynamic efficiency is when LR supernormal profits are reinvested into the firm in forms such as R&D, new/updated capital, new tech, factory expansion. MR = MC
What can dynamic efficiency cause to consumers?
- Lower prices as firms increase efficiency and decrease costs
- Increase in quality and quantity of product
- Increase in consumer surplus
What can dynamic efficiency cause to producers?
- Create monopoly power; investment & R&D leads to patent/competitive advantage.
- Lower unit cost in LR; input more efficient
- Decrease in price, increase in demand, increase in market share
Evaluation points of dynamic efficiency
- Dependant on PED - if inelastic efficinecy won’t affect demand and profits much
- if reinvestment is successful
- Dividends for shareholders
- Objective of firm
- Level of supernormal profit
What is X-inefficiency and where does it occur on the graph?
X-inefficiency is when the firm produces some waste in forms of extra cost etc. Occurs when cost is anywhere above AC curve.
Why may a firm operate at X-inefficiency?
Reducing X-inefficiency may be hard to limit and unpopular; might mean decreasing wages, taking away perks etc
What types of firms may operate at X-inefficiency?
Monopolist; complacency due to lack of competitive drive; easier to let waste creep in
Public sector firms; Not profit motivated, only maximise social welfare, lack of profit drive, waste creeps in
Why may public sector firms be wasteful at times?
- Funding comes from government
- Objective of social welfare, not profit
- Principle-Agent problem
Evaluation of X-efficiency
- Too much focus on reducing costs –> other objectives ignored
Benefits of X-inefficiency
- Workers happier with perks, bonuses etc; comfortable workplace so productivity increase
- Allows focus on other objectives.
What is perfect competition?
Perfect competition is when demand for firm’s goods is perfectly elastic, prices are solely determined by interaction of D&S.
What are the conditions of Perfect competition?
- Many buyers and seller - no one firm/customer can influence market
- Homogeneous goods (identical goods) - firms are price takers- impossible to tell difference between one make and another; if firm raises price above competitors no one will buy.
- Firms are profit maximisers - firms produce at MC=MR
- No barriers to entry/exit - ease of moving markets, increasing competition
- Perfect information - customers aware of lowest priced good, firms aware of markets to create profit.
What is the profit maximising equilibrium?
Profit maximising equilibrium is when firms operate at output MC=MR
How efficient is a firm in perfect competition?
Perfect competition is:
- Productively efficient; produce at MC=AC
- Allocative efficient; produce at P=MC
- Static efficient
- Dynamic inefficient no supernormal profits made to reinvest.
How does the equilibrium in perfect competition change from short-run profits to long-run equilibrium?
In the short run, firms are making supernormal profits as they operate at profit max output (MC=MR).
In the long run, the equilibrium changes and firms make normal profits.
- New firms enter the firm as supernormal profits
- Supply increases; firms sell their goods at lower prices as they are price takers.
- Output of each firm decreases; smaller market share of larger industry
- Profit max level (MC=MR) is operating at AC=AR; normal profits made
How does the equilibrium in perfect competition change from short-run losses to long-run equilibrium?
In the short run, firms that make losses may leave the industry as no barriers to exit.
In the long run, the equilibrium changes to normal profits;
- Some firms making a loss leave the industry due to no barriers; market supply decreases
- Market quantity in industry decreases; market price increases
- Individual firms have to sell at higher price
- Firm output increases as individual firms have higher market share of smaller industry
- Profit max level (MC=MR) operates at same point as AC=MR; normal profits
Why does perfect competition in the long-run always make normal profit?
In the short run;
- If a firm is making short run profits, other firms are incentivised to join the industry; supply increases; price decreases; supernormal profits decrease; until normal profits made.
- If a firm is making short run losses, some firms may leave the industry; supply decreases; price increases; firm quantity increases; profits increase from subnormal to normal profits.
What is monopolistic competition?
Monopolistic competition is when there are many producers competing against eo but selling slightly differentiated goods
Characteristics of monopolistic competition
Monopolistic competition
- Produce at output of profit max at MC=MR
- large number of buyers and sellers
- No barriers to entry/exit
- Slightly differentiated/non-homogenous goods
- Firms are price makers
- Good information
- Non-price competition
How do firms in monopolistic competition make short-run profits?
Monopolistic short-run profits occur when AR>AC;
As firms in monopolistic competition have price setting power during to product differentiation, AR and MR are downwards sloping.
Profit max (MC=MR) produces supernormal profits; price is higher than cost
How do firms in monopolistic competition make short-run losses?
Monopolistic competition short-run losses occurs when AC>AR;
Profit max (MC=MR); Cost > Price; subnormal profits/losses
How does the equilibrium in monopolistic competition change from short-run profit to long-run equilibrium?
- Firms enter the market due to incentive from supernormal profits & no barriers
- Supply increases
- Demand/AR for individual firms decrease; as consumers shared across large number of firms
- Demand/AR curve decreases until AR=AC
- Supernormal profits eroded to normal profits
How does the equilibrium in monopolistic competition change from short-run losses to long-run equilibrium?
- Some firms making losses in the long run may shut down; due to low barriers
- Consumers have less firms to buy from
- Demand/AR for remaining firms increases until AR=AC
- Losses eliminated; normal profits made
How efficient are firms in monopolistic competition?
Allocative inefficient
- P≠MC; AE not achieved in LR
- Consumers exploited; prices>costs; output/choice restricted
Productive inefficient
- Not operating at lowest point of AC, no EofS
- Costs not minimised; Reason for higher prices
Dynamic inefficient
- No LR supernormal profits made; not enough profit to be reinvested
How does the efficiency of monopolistic competition compare to other types of firms? (Eval)
Allocative efficiency/monopoly
- Less price making ability/exploitation than monopoly firms
- Loss of consumer surplus higher in monopoly
Allocative efficiency/PC
- Homogenous goods in PC; consumer don’t desire this
- Consumers willing to pay extra for differentiated products
Productive efficiency/monopoly
- Monopolistic firms can’t afford to forgo EofS to same extent as monopoly due to substitutes.
Productive efficiency/PC
- Not much EofS
- Comes from desire for differentiated goods; consumers willing to pay extra for
Dynamic efficiency
- Reinvestment of normal profits; keep up with trends; get ahead of rivals
What are the characteristics of oligopoly?
- Few firms that dominate the market; high concentration ratio 7:70
- Differentiated goods
- High barriers to entry/exit
- Interdependence; firms actions depend on other firms actions
- Price rigidity; price doesn’t change much
- Non-price competition
- **Profit max not main objective; aim for higher market share
1) High Barriers to entry/exit
- Enterting industry difficult due to existing dominance of few firms
- Leaving industry difficult due to high level of sunk costs
2) High concentration ratio
- Reveals percentage of total market share owned by specific number of firms
3) Interdependence of firms
- Few competitors; firms study each other behaviours
- Firms actions are dependant on what other firms do
- Causes price rigidity
4) Product differentiation
- Highly differentiated; brand around product creates loyalty
Explain the kinked demand in oligopoly
Firms don’t want to change their price
Above P, price elastic curve
- Due to interdependence, if a firm increases their price, other firms won’t follow
- Their comparative lower price means they more competitive
- Lose market share
- Elastic since consumers buy from lower priced firms
Below P, price inelastic curve
- If one firm decreases price, other firms will too
- To remain competitive
- To protect market share
- TR falls; market share constant
- Inelastic as other firms lower price to so lower change in quantity for original firm
Causes price rigidity
What is collusive behaviour in oligopolies?
Collusive behaviour occurs when firms cooperate to fix prices & restrict output and disrupt market equilibrium to reduce competition.
What may encourage oligopolies take collusive behaviour?
Few firms/competitors
- Easy for firms to understand other firm’s actions to collaborate on prices/output
Similar costs
- Easier to organise price and quantities; more likely to agree
High entry barriers
- Supernormal profit made in collusive oligopoly will not attract entry of new firms
- Benefits of collusion last for the long term
Ineffective regulation
- Lack of regulation incentivises firms to collude due to little consequences
Consumer loyalty
- If firms choose to undercut and cheat, no benefit if consumers are loyal to rival firms
- Prevents cheating; collusion lasts in long term
Consumer inertia
- Consumers unwilling to switch suppliers
- Cheating won’t guarantee consumers will switch
- Prevents cheating; collusion last in long term
Eval points of monopoly outcomes
What is the difference between overt and tacit collusion?
Overt collusion is when firm come to a formal agreement to fix prices/quantities.
Tacit collusion means informal agreement not to engage in price wars; price leadership where smaller firms follow pricing decision of dominant company in the industry.
Explain what a cartel is.
A cartel is a group of firms providing the same products collude with incentive to improve their profits and dominate the market.
Why are cartels unstable?
Each firm has incentive to cheat to maximise their profits and outputs.
However, if all countries cheat, total output will be much higher; price will be lower
More rational to not cheat.
Imperfect information; each firm has incentive to cheat but is afraid of other firms cheating; outcome always non-cooperative.
Consequences of overt collusions
- Higher prices for consumers
- Less output in market
- Poor quality products/customer service; less incentive
- Less investment in innovation; less incentive due to restrictions
In which ways may overt collusion happen?
- Price fixing
- Setting output quotas; limit supply, increase price
- Agreements to block new firms from entering
How does tacit collusion work and why may a firm choose tacit?
Firms may choose tacit collusion to avoid legal issues.
Price leadership is
- when firms closely monitor price of largest firm
- firms match the biggest industries price.
Positive/Negative for tacit collusion
Advantage
- Difficult for regulators to prove collusion; safe from legal action
- Similar benefits to firms as overt collusion
- Consequences to consumers similar to overt but not to same degree
Disadvantages
- Consequences to consumers similar to overt
- Benefits to firms not to same degree as overt
What are the type of price competitions?
Price wars
- Predatory Pricing
- Limit Pricing
Explain how price wars work.
Price wars occur in markets where non-price competition is weak and goods have weak brands.
Price war drives prices down to levels where firms make losses.
In the short term, firms will continue to produce if AVC>AR
In the long run, these firms will leave the market
Prices have to increases as supply falls
Explain how predatory pricing works
- When incumbent firms are threatened by entrants
- Incumbent firm sets a low price so other firm is unable to make profit and is driven out of market
- Existing firm can then put their price back up
Explain limit pricing
- Incumbent firms set price low enough for normal profits
- Discourages new firms entering market
EVAL; firms cannot make profits as high as they could
What are the types of non-price competition?
Advertising
- Increases awareness of product to persuade consumer to purchase
Loyalty cards
- Encourage repeat purchases by rewards for loyalty
- Provide data on consumers’ buying habits
Branding
- Successful brand increases loyalty/repeat purchases
Quality
- Firm known for good quality can charge higher price due to customer loyalty
Customer service
- Good customer service encourages loyalty
- Positive reputation
Product Development
- First firms to release new products have competitive advantage over rivals
- Increases branding
How efficient are oligopolies?
Productive inefficient; not operating at lowest point on AC
Allocative inefficient
Dynamic efficient; oligopolies make supernormal profits which can be reinvested
What is a pure monopoly/a firm with monopoly power ?
A pure monopoly exists where one firm is the sole seller of a product in a market.
Monopoly power means a firm owns 25% or more of the market share.
What are the characteristics of monopoly?
- One firm dominating market (Monopoly power)
- Differentiated products
- Firm is price maker
- High barriers to entry/exit
- Imperfect information
- Firm is profit maximiser
What is price discrimination?
Price discrimination is when a firm charges different prices for the same product.
What is 3rd degree price discrimination?
3rd degree price discrimination is a strategy where seller charges different prices to different consumers.
How are consumers in 3rd degree price discrimination often divided?
- Time (Peak/off-peak)
- Age
- Income
- Location
What are 3 conditions for 3rd degree price discrimination?
Firm has market power
- Firm has ability to change prices/ no-few substitutes
Varying consumer PED
- Some consumers must be willing to pay more
- Firm should be able to identify different consumer groups
Ability to prevent resale of tickets
- Prevent customers from buying in low-price market and reselling
Benefits/costs of 3rd degree price discrimination on consumers
Adv
- Consumers may gain from higher prices as demand of product decreases; increases utility e.g higher prices on trains limits over-crowding
- Other consumers benefit from lower prices
Disadv
- Consumers pay higher prices; surplus decreases
Benefits/costs of 3rd price discrimination on producers
Adv
- Total revenue of producers increases; higher profits
- Increase producer surplus
Disadvantages
- Setting/enforcing price discrimination can increase average cost
- Consumer surplus decreases
Advantages of monopoly power
Firm
Supernormal profits generated
- investment in R&D; dynamic efficiency
Increase firm’s global competitiveness
Ability of EofS
- decreasing average cost
Producer surplus increase
- higher price means higher surplus
Workers
Higher wages
- Supernormal profits lead to higher wages
Product innovation
- supernormal profits; better quality products
Price fall
- if lower production cost is passed down
Disadvantages of monopoly power
Lack of competition
- less incentive to be efficient
- Having one dominant firm limits opportunity for employers to change employers
Lack of employers
- one dominant firm limits opportunity for employers to change employers
- no sub goods and price setting power
Worse customer service
- improvement incentive limited
Consumer surplus decreases
- Monopoly has power to dictate what price to pay supplier; supplier loses out
What is a natural monopoly?
A natural monopoly is a monopoly in a market with high barriers and extremely high start up costs that prevent rivals from entering.
What are the characteristics of natural monopoly?
- High fixed costs
- Massive potential for EofS
- Rational for 1 firm to supply entire market; undesirable competition
Why is the LRAC curve for natural monopolist downwards sloping?
Due to large fixed costs, an extremely high quantity is required to minimise AC. Creates huge potential for EofS.
Why is competition undesirable for natural monopoly?
Natural monopoly competition results in wasteful duplication of resources.
- First firm has EofS advantage
- Other firms wont have same advantage and will be priced out of market
- Creates sunk costs from all resources
Why are natural monopolies usually regulated?
Natural monopolies occur in essential utility industries. Regulation ensures consumers aren’t charged higher monopoly prices.
Benefits of monopoly to firms, employees, suppliers and consumers
Firms
- Monopolists huge potential to make huge profits for shareholders by profit max
- Supernormal profit means firms have money to re-invest
- Firms able to compete against large global organisation
- Large firms able to exploit EofS, reduce costs, increase profit
Employees
- Inefficiency of monopoly may mean employees receive higher wages.
- Profit satisficing / rev max means output is higher
Suppliers
- Stability with monopolists; long term contracts, guaranteed sales
Consumers
- Firms that exploit EofS, lower cost passed down by lower price; higher consumer surplus
Costs of monopoly to firms, employees, suppliers and consumers
Firms
- Lack of competition; low incentive for efficiency; increased cost
- Lack of innoavation
- Inefficient allocation of resources
Employees
- Monopolists produce at lower outputs; lower workers required
- Worse working conditions
Suppliers
- If monopoly buys all of suppliers’ goods, suppliers lose out on profit
Consumers
- Higher consumer price; price discrimination
- Lower consumer surplus; monopolies control price
- Lower quality products; lack of competition, incentive and innovation
- Less consumer choice; only one firm producing the specific product
What is a monopsony?
A monopsony is when there is a single buyer in the market. This allows them to negotiate and dictate supplier prices.
What are the 2 main characteristics of monopsonies?
- Firms are profit maximisers; aim to minimise costs and maximise profits by paying supplier less
- Purchase large portion of market supply from suppliers
Benefits/costs of monopsony on firms
Adv
Increased profits
- Lower AC; higher profits
Purchasing economy of scale
- Bulk buying; decrease AC; EoS
Disadv
Supply chain issue in LR
- Cheap prices may run suppliers out of business
Benefits/costs of monopsony on employees.
Adv
Higher wages
- Higher profits allow for firms to offer higher wages
Disadv
Supplier employees
- Suppliers make less profits; lower wages
Benefits/costs of monopsony on consumers.
Adv
Lower prices
- Lower price due to lower cost passed on
Disadv
Fall in supply
- It could lead to a fall in supply, since the business buys fewer inputs
Fall in quality
- There may be a fall in quality as prices are driven down.
Benefits/costs of monopsony on suppliers.
Adv
- Enhance supplier’s reputation; due to supplying a monopoly; open new opportunities
Disadv
Profits decrease
- Lower price for all products, profits decrease
Driven out of business
Negatives of monopsony on firms, employees, consumers, suppliers.
Firms
- Repetitional damage for the way they treat supplier
- Conflict between firms and suppliers; hard to manage
- May drive out suppliers due to way they are treated
Employees
- Less employees for suppliers; suppliers sell less goods; employ less
Suppliers
- Less profit for supplier; leave market
