3.4 - Market structures Flashcards
Allocative efficiency
MC = AR
Fulfilling wants of supply and demand where it maximises both producer and consumer surplus
Productive efficiency
Minimum efficient scale on the average cost (AC) curve
(operating at the lowest point of the AC curve)
Dynamic efficiency
Firm reinvesting profits into the business to improve quality or by making it more productively efficient (reducing costs)
X inefficiency
Lack of competition in the market, leads to a rise in costs due to complacency (lack of incentive to reduce costs)
What is perfect competition
A form of market structure which produces allocative and productive efficiency in the long run
Characteristics of PC (6)
- Large number of buyers and sellers
- Homogenous goods
- Firms are price takers - no influence over the price, the price is set by the market
- No barriers to entry / exit
- Short run profit max
- Perfect information
Diagram in SR
Diagram in LR
Characteristics of monopolistic competition (6)
- Large number of buyers and sellers
- Slight product differentiation (XED is high, meaning firms sell non-homogenous products due to branding)
- Firms are profit maximisers in the SR
- Imperfect information
- No barriers to entry / exit
E.g. hairdressers and pluming
Diagram in SR
Diagram in LR
Advantages of monopolistic competition? (3)
- Consumers have a variety of choice
- More realistic assumption / model than perfect competition market structure
- Dynamic efficiency can be exploited since firm make supernormal profits through investment
Disadvantages of monopolistic competition? (2)
- Dynamic efficiency may be limited due to firms only making normal profits in the LR
- Firms are not as efficient as perfect competition firms in the LR (not allocative and/or productive efficient)
What is an oligopoly?
A form of market structure where there are only a few dominant firms controlling the market
Characteristics of Oligopoly
- High barriers to entry / exit
- High concentration ratio
- Interdependence
- Product differentiation
What is n-firm concentration and what does it provide?
Measures the combined market share of largest firm in the industry
It gives an indication on the level of competition - gives a degree of the market power by largest firms and potential distrust concerns
What does high concentration mean?
More concentrated market with fewer dominant firms
What does low concentration mean?
More competitive market with many smaller number of firms
3 reasons for collusion?
- Maintaining high prices
- Market stability
- Avoids price wars
Reasons for non-collusive behaviour?
- Competition
- Legal restraints
- Different objectives
Overt collusion
When firm openly agrees to cooperate and set prices or output levels
This creates cartels - explicit agreements among firms to coordinate their actions
Tacit collusion
Involves a firm behaving in a similar manner that resembles collusion without any explicit agreement
Where one dominant firm sets the price and others follow in suit - by observing price patterns set by competitors or engage in price leadership
What is prisoners dilemma?
Game theory scenario where two firms make a decision that results in suboptimal outcomes
Both firms aggressively compete = price war = lower profits
Both firms collude = higher prices = higher profits
How does the dilemma arise?
The dilemma arises because each firm has an incentive to abandon the agreement in order to get a more favourable outcome (by gaining greater market share)
It is not in their interest because if both firms do then they will suffer in lower profits as prices will fall
Diagram for game theory
- shows price rigidity
- nash equilibrium (cell with two underlined numbers) - irrational equilibrium that can last in the LR
- dominant strategy (firm should always charge the lower price regardless of the behaviour of the other firm)
- shows temptation to collude
- shows that there is an incentive to break from the collusion agreement to gain greater profits (may not be the most optimal in the LR as other firm will reduce price, may engage in price wars, leading to further drop in TR)
What is the 3 different types of price competition?
- Price war
- Predatory pricing - drastically reduce the price in order erode competition, immediately raise prices after gaining the market share due to lack of competition
- Limit pricing - lower prices to a degree that would deter new firms from entering the market
5 types of non-pricing competition?
- Product differentiation
- Advertising
- Innovation
- Customer service
- Distribution services
Diagram for Kinked demand curve and what can it be used for?
Evaluation for interdependence - firms do not NEED and WANT to engage in price reduction
-> suggests that price rigidity in oligopoly
- strengthens the argument for collusion
Definition of monopoly
A form of market structure where there is one dominant seller in the industry
Characteristics of monopoly
- Single seller - one firm that dominates the whole market, there are no other substitutes
- High barriers to entry / exit - they are able to maintain market share due to economies of scale, control over essential resources, government regulation and patents
- Firm is price maker - they influence the price of the market due to possessing majority of market share
- Unique product - this allows firm for significant control over price due to lack of substitutes
- Market power - influence market conditions, restrict output and set higher prices compared to competitive market
- LR profitability - earn long run profits becuase of their ability to set prices above production costs
Diagram for monopoly
Definition of price discrimination
Selling the same good to consumers at a different price
Conditions for price discrimination (3)
- Market segmentation - firm must segment market into distinctive groups with different PED
- Price segmentation - ability to change different prices to each segment, those with high PED (elastic) would be charged lower
- No resale - discourage reselling of products
Definition of natural monopoly
Occurs when a firm can serve the entire market due to economies of scale
Features of natural monopoly
- High fixed cost
- Enormous potential for economies of scale
- It would be rational to have one firm supplying the entire market since competition will be undesirable
- Competition would result to a wasteful duplication of resources and non exploitation of full economies of scale - this would lead to allocative and productive inefficiency
-> any firms entering the market would be at a disadvantage due to not exploiting the economies of scale
Draw diagram for economies of scale and diagram for natural monopoly
-> the subsidy provided would be AB in order for the natural monopolist to be gaining normal profit (as they would be making subnormal profits if operating at allocative efficiency)
-> high opportunity cost for the government as they have to pay for the subsidy and impose regulation
What is the conclusion of natural monopolies and what can it be used for?
As an evaluation tool for monopoly
-> natural monopoly is desirable because it is allocative and productive efficient if it is regulated
Definition of monopsony
A form of market structure where there is only a single buyer - controls significant market power and share of total demand for a specific product or labour
Characteristics of monopsony
- Single buyer - limited options for sellers to find alternative customers
- Price makers - ability to set a price at which the firm is willing to pay for the good (monopsonist’s demand affects market price)
- High barriers to entry - high sunk costs, regulatory restrictions and lack of economies of scale
- Downward sloping supply curve - sellers are willing to provide good / services at lower price, giving power to negotiate lower prices for monopsonist
Diagram for monopsony and labour market
S = ACL
D = MRP
Qc > Qm
Wc > Wm
- workers are getting tougher deal under monopsony employer rather than from competitive firm
Evaluation diagram for monopsony and labour market (trade union)
Trade union will help increase wage and quantity of workers to a more competitive labour market outcome
Qm -> QTU
Wm -> WTU
STU = ACL instead of S = ACL
Costs / disadvantages of monopsony (3)
- Workers productivity may decline due to lower pay (this causes incentive to work to decrease)
- Producer surplus falls for farmers - monopsony power of supermarkets causes them to negotiate lower prices from farmers - this is done to lower their own prices against other supermarkets to stay more competitive
- Labour exploitation may occur as workers may have little choice / alternative over employment opportunities and therefore wages - however, this is now not the case due to well established trade unions who help negotiate better wage and good working conditions
Benefits / advantages of monopsony (2)
- E.g. NHS has monopsonist power over pharmaceutical companies meaning they are able to purchase drugs cheaper - the saved money can be used to invest into other aspects (e.g. R&D) and/or use the budget for more treatment in hospitals
- Monpsony power = better negotiation of lower prices = lower cost of production = lower prices for consumers = higher consumer surplus
Definition of contestable market
A form of market structure where there is a threat of competition that will affect the behaviour of the firm
Characteristics of contestability
- Low barriers to entry / exit
- Perfect information
- Incumbent firms will experience “hit and run” competition
Impact of technology on contestability
The rise in technology has positively affected the contestability in the market through 3 things:
- Reduced barriers to entry - firms do not need physical space which reduces high sunk cost, cost of labour and experience less government regulation (technical economies of scale made easier and advertising made easier which reduces brand loyalty)
- Increased pool of new entrants - increased innovation means firms can come up with something brand new and have cheaper cost of production = disrupting the market
- Improved information - they gain greater information on the costs in the market + communication has improved which means key information discovery of the market is going to be easier
Diagram of contestability and monopoly
Firm will engage in limit pricing to deter new firms from entering the market
This is done by reducing their profit margin (from supernormal profits to normal profits) - this will reduce the incentive for new entrants as they are less attracted by the profits being made
Operation will shift from MC = MR to AC = AR
- this will reduce the price and increase output
Why is it good for the firm to operate at AC = AR instead of profit max (MC = MR)
- Deter new firms from entering the market - by reducing profit margins it makes it less attractive for new entrants as their incentive will fall due to not seeing supernormal profits being made, but rather normal profits
- Increase preparedness if the competition actually takes place due to lower prices and higher quantity - this will make it more competitive among other firms in the market
Pros of contestability (4)
- Allocative efficiency - due to a fall in price, consumer surplus will rise as well as choice and quality due to being more competitive
- Productive efficiency - due to competition, greater exploitation of economies of scale means that there will be a fall in costs (which may lead to a fall in price = rise in consumer surplus)
- X efficiency
- Job creation - increased quantity means the demand of labour will rise (due to derived demand)
Evaluation of contestability (3)
- Length of contestability
- if firms use anti competitive strategies then market will not be contestable over time (e.g. engage in predatory pricing, limit pricing and mergers) - Role of technology
- patents and copyright will decrease contestability
- increased information = increased information on consumers = increased first and third degree price discrimination due to better segmentation of distinctive groups = reduce static efficiency = reduce effect of contestability - Regulation
- this will prevent firms from cutting costs from dangerous areas (e.g. health and safety, environmental standards and product safety)
- this will also prevent anti competitive strategies from offering
- these will allow static efficiencies to be taking place which will preserve its positive effect on consumers
