3.4 Market Structures Flashcards
What are the 4 types of efficiency
- allocative efficiency
- productive efficiency
- dynamic efficiency
- x-inefficiency
what is allocative efficiency
- occurs at the level of output where AR=MC
- resources are allocated in a way that consumers and producers get maximum possible benefits
- no one can be made better off without making someone else worse off
- no excess demand or supply
What is productive efficiency?
- occurs at the level of output where MC = AC
- at this point AC is minimised
- no wastage of scarce resources and a high level of factor productivity
What is dynamic efficiency?
- long term efficiency is a result of innovation as a firm reinvests its profits
- it results in improvement to manufacturing methods
- this lowers both the short run and long run ATC
What is X - inefficiency?
- occurs when a firm lacks the incentive to control production costs
- ATC is higher than it should be
- often occurs due o a lack of competition in industry or ni a firm that has no consequences for making a loss
What are market structures
the characteristics of the market in which a firm or industry operates
what are some different characteristics of market structures? 7
- number of buyers
- number and size of firms
- types of product in the marker
- homogenous
- differentiated
- barriers to entry and exit
- degrees of competition
how can market structures be separated
as perfect or imperfect competition
What are some od the imperfect competition market structures
- monopolistic
- oligopoly
- monopoly
what are the characteristics of perfect competition?
- there are many buyers and sellers
- there are no barriers to entry and exit from the industry
- buyers and sellers possess perfect knowledge of prices
- the products are homogenous
traits of profit maximising equilibrium in the short and long run in perfect competition
- firms produce up to the level of output where mc=mr
- price taker due to large number of sellers
What profit can firms make in the short run in perfect competition?
- supernormal profit
- losses
What profit can firms make in the long run in perfect competition?
normal profit
How does short run profit maximisation reflect graphically in perfect competition?
- the firm produces at the profit maximisation level of output where mc=mr
- AR>AC
- firm makes supernormal profit
how does short run profit reflect diagrammatically in perfect competition
AR<AC
Why does perfect competition move from short run profits to long run equilibrium?
- making supernormal profit in the short run attracts new entrants into the industry
- incentivised by the opportunity to make supernormal profit, no barriers to entry thus easy to join the industry
how does perfect competition move from short run profits to long run equilibrium on a diagram?
- firm initially produces profit max level of output where MC=Mr
- incentivised by profit new entrants join industry and supply increases causing price to fall
- firm now has to sell at the reduced price
- the firm is now producing at the point where AR=AC, making normal profit
What happens to firms in perfect competition in the long run
- firms making a less leave the industrty
- firms making supernormal profit lose profit as new firms join the industry
What are the characterises of monopolistic markets?
- large number of small firms
- low barriers to entry and exit
- products are slightly differentiated
- low degree if market power
What model is used in monopolistic competition and why?
price maker model
- has some market power, able to influence the price&quantity
- due to the fact they have a differentiated product that is desirable certain consumers
in monopolistic competition, how does a form return to long run equilibrium position?
- inhability to defend against new competitors who enter the market, copying the product of existing sellers increases the supply
- firms attempt to find new ways to deffrentitate their product to prolong the period of supernormal profit
How does short run profit maximisation reflect graphically in monopolistic competition?
- able to make supernormal profit in the short run
- AR curve is demand curve
- firm has some market power due to the level of product differentiation
= to sell an additional unit of output, the firm will have to decrease its price
How is short run profit maximisation in monopolistic competition show diagrammaticaly
- point where MC =. MR
on a price maker level
How is short run losses in monopolistic competition show diagrammaticaly
- the point of profit maximisation when AR>AC
How do firms move from supernormal to normal profit in monopolistic competition?
- new entrants are attracted to the industry and the number of sellers increase
- they’re incentivised by the opportunity to make supernormal profit
- low barriers to entry make it easier to join the industry
- supernormal profit will be eroded and the firm will return to the long run equilibrium making normal profit
How do firms move from losses to normal profit in monopolistic competition?
- if monopolistic competition makes losses in the short run, some will shut down
- the shut down rule determines which firms shut down
- low barriers to exit make it easier to leave the industry
- for remaining firms losses will be eliminated and the firm will return the long run equilibrium position of making normal profit
- thus making a normal profit as firms making a loss leave the industry
What is an Oligopoly?
A market structure where a few large firms dominate the market
What are the characteristics of an Oligopoly?
- most markets are imperfectly competitive
- high barriers to entry and exit
- high concentration ratio
- interdependence of firms
- product differentiation
What are high barriers to entry and exit in an oligopoly?
- difficult to enter industry due to existing dominance
- high start up costs make it inaccessible for new firms
- leaving is difficult due to sunk costs
What are sunk costs?
An investment made that cannot be recovered
- e.g. advertisement
What is the concentration ratio?
reveals what percentage of the the total market share a specific number of firms have
What is the concentration ratio in an oligopoly?
high concentration means a higher value of shares and a lower number of firms
- the more concentrated the market power in the industry
What is the interdependence of firms in an oligopoly?- products are highly differentiated
- with few competitors firms study each others behaviour to determine the effects they will have on the firm
- uses game theory
What is product differentiation in oligopoly?
- [roducts tend to be highly differentiated
- the brand around the product is very different causing consumers to perceive it as different creating brand loyalty
What is collusive behaviour?
when firms cooperate to fix prices and restrict output
what is non collusive behaviour?
when firms actively compete to maintain andor increase market share
When does non-collusive behaviour occur in an oligopoly
usually when one firm believes they have a cost advantage and tries to drive out another firm from the market leaving the remaining firm more dominant.
- aiming to achieve a monopoly power
how do non collusive firms compete in non-price ways?
- engaging in advertisement
-to strengthen then brand
-diffferentiate products from competitiors - makes demand for the product more price elastic as brand loyalty is encouraged
- allowing oligopolists to raise price to increase revenue and profit as demand falls by a smaller proportion
What is wrong with non collusive oligopolists using advertisement to increase competitioon
- can be expensive
-adds to firms sunk costs
-easier to accommodate if the firm is large and benefits from marketing economies of scale
What are reasons for collusion?
- few competitions/firms
- similar costs
- similar revenue
- high barriers to entry
- ineffective regulation
- brand loyalty
How is a few firms/competitiors a reason for collusion?
Makes it easy for each firm:
- to understand other competitors actions & responses
- or to collaborate of prices/ output
How are similar costs a reason for collusion?
firms face almost identical costs as any remaining competition have experienced economies of scale
How is similar revenue a reason for collusion?
competition sell for similar prices due to little incentive to lower them
- cuz other firms would respond by keeping their market share the same but decreasing the profit
How does high barriers to entry a reason for collusion?
make it unlikely that new entrants will emerge to disrupt the status quo
How does ineffective rergulation a reason for collusion?
- lack of regulation empowers firms to collude was there is little consequence for their actions
How is brand loyalty a reason for collusion?
high brand loyalty due to established market share
- decreases benefits of competition as consumers are unlikely to change brands
What are the types of collusion
- Overt
- Tacit
What is Overt collusion
occur when firms agree to limit competition or raise prices
- a cartel is the most restrictive form and is illegal in most countries
What is a cartel?
when a group of firms join together to limit output and increase prices
What are the consequences of overt collusion?
- higher prices for consumers
- less output in the market
- for quality products+/ customer serves
- less investment innovation
How can Overt collusion occur?
- price fixing
- setting output quotas that limit supply and naturally result in price increases
- agreement to block new firms from entering the industry
- agreements to pay suppliers the same price thereby driving prices down in the supply chain
What is price fixing?
competitions agree a fixed price for all there competitions products
- the price would normally be higher than the market equilibrium price
When does tacit collusion occur?
when firms avoid formal agreements but closely monitors each others behaviour usually following the lead of the largest firm in the industry
What is the most common form of tacit collusion?
price leadership
What is price leadership?
- when firms monitor the price of the largest firm in the industry& adjust their prices to match
- difficult;t for regulators to prove it has occured
- similar benefits to firms as overt collusion
- similar consequences for consumers as overt collusio
What is game thoery
mathematical framework used by firms to ensure optimal decisions are made in a strategic setting where there is a high level of interdependence
What are the elements of game theory
- players; firms
- strategies available to the players
- the payoffs that each player receives for each combination of strategies
What is the prisoners dilemma
2 criminals are caught after a train robbery
- the prosecutor does not have much evidence
- the criminals are guilty but have agreed with each other that they will deny all involvement
- the prosecutor wants one or both to confess
- the strategies and payoffs available to the prisoners are presented in a payoff matrix
What are methods firm uses game theory?
when making decisions about
- raising or lowering prices
- new advertisement and branding initiatives
- investment in product innovation
- product bundling; combing phone and broadband packages
What are the 3 types of price competition
- price wars
- predatory pricing
- limit pricing
What are price wars
- occur when competitors repeatedly lower prices to undercut each other in an attempt to gain or increase market share
- often occurs when there are lower levels of non price competition where firms find it difficult to collude
What is predatory pricing
- lowering prices when a new competitor joins industry to drive them out
- lowered below cost of production
- once they leave prices are raised again
- normally illegal as it is anticompetitive
What is limit pricing
occurs when firms set a limit on how high the price will go in the industry
- a lower price reduces the profit disincentivising new firms from joining industry
- the greater barriers to entry the higher the limit price is likely to be as firms are already disincentivised.
What is non price competition
competition on branding/ advertisement etc
What is the aim of non price competition
- to increase product differentiation,
- develop or increase brand loyalty
- increase market share
What are some strategies of non-price competition
- loyalty cards and rewards
- corporate sponsorship
- branding
- packaging
- after sakes service
- endorsements
- delivery policies
- product warranties
Characteristics of a Monopoly
- single seller
- no substitutes
- complete market power, allowing maximisation of supernormal profit in short run
- high barriers to entry exit
- defined as having more than 25% market share in the UK
profit max equilibrium characteristics of a monopoly
- single seller of goods/services, the firm in a monopoly market is also the entire market
- no differentiation between the firm and industry
- price maker model
What is price discrimination
when a firm charges a different price for the same good/service to maximise its revenue
What is 3rd degree price discrimination
when a firm charges different prices to different consumers for the same good or service
What conditions must be met for third degree price discrimination to occur
- market power
- varying consumer PED
- ability to precent resale
Why is market power a condition for price discrimination
firm must have the ability to change prices
- works best when there are low or no substitutes
Why is varying consumer PED a condition for price discrimination
some consumers must be willing to pay more
- the firm must be able to indentifiy these consumer groups to allocate different prices to them
Why is prevention of resale tickets a condition for price discrimination
must be able to prevent consumers buyng in the low price submarket and reselling in high ones
How is price discrimination shown diagrammatically
combination of submarkets
- one market inelastic with a larger profit
- one elastic with less profit
combined through a kinked demand curve on price maker model
benefits of price discrimination to consumers
- will be able to take advantage of lower prices
- higher orchid decreases the demand causing an increase in consumer utility
costs of price discrimination to consumers
many will lose out as they pay higher prices
benefits of price discrimination to producers
- TR increases leading to greater profits
- increase producer surplus at the expense of decreased consumer surplus
costs of price discrimination to producers
enforcing price discrimination can increase average costs
What are the advantages of monopoly for the firm
- supernormal profit generates money for continued investment in technology and product innovation
- market power enables an increase in global competitiovienes
- economies of scale benefits
producer surplus increases - price discrimination can increase revenue
What are the disadvantages of monopoly for the firm
- lack of competition causing reduced incentive to be efficient
- cross subsidisation can create inefficiences
- monopolies lead to misallocation of resource; the price above the OC of providing goods
- innovation can lack due to less competition
What are the advantages of monopoly for employees
supernormal profits result in higher wages
What are the disadvantages of monopoly for employees
having only one suppler in the industry limits the opportunity to change employers
What are the advantages of monopoly for consumers
- product innovation may result in better product quality; due to supernormal profit
- cross sub can lower prices on profucts
- prices may fall if firms pass other cost savings, due to ec of scale, as lower product prices
What are the disadvantages of monopoly for consumers
- higher prices as no subs due to less competition
- no product innovation from less competition; can get worse quality over time
- may experience worse customer service; incentive to improve is limited
- cross subsidisation can increase prices on some products offered by firm
- consumer surplus decreases
What are the advantages of monopoly for suppliers
increased sales volume for some
- they’re able to supply products distributed nationally/internationally
What are the disadvantages of monopoly for suppliers
- less competition for their products and a monopoly has the power to dictate what price they will pay to suppliers
- this may not be profitable in the long run
What is a natural monopoloy
when the most efficient umber of firms in the industry is one
Why do natural monopolies occur
- associated infrastructure issues; easier to have all the pipes in a city to be the same brand
- significant cost generated when entering industries; excessive sunk costs
- economies of scales lowering prices for consumers
Where do natural monopolies occur normally
in utility industries, regulated by the government to ensure that consumers are not charged higher monopoly prices
- often as maximum price
What is Monopsony power
- a market dominated by a single buyer
- has buying or bargaining power in their market
- this power means that a monoposonist can exploit their bargaining power with a supplier to negotiate lower prices
- reduced cost of purchasing inputs increases their profit margins
- monopsony exists in both product and labour markets
What are examples of monopsony power
- electricity generators
- food retailers/supermarkets
- car rental firms
- low cost airlines
- british sugar
- Amazon
- government
- NHS
What are the benefits of monopsony power for firms
- allows bigger firms to achieve purchasing economies of scale. leading to low long run average costs
- lower purchase costs bring about higher profits and increased returns for shareholders
- the extra profit might be used to find capital investment or research and development
What are the disadvantages of monopsony power
- firms use buying power to squeeze lower prices out of suppliers
-reducing the profit. of firms in the supply chain and causes lower incomes - Krugman is critical of the monopsony power of amazon in the book industry
benefits of monotony fro consumers
- may gain from lower prices
-supermarkets negotiate better prices from manufacturers that are then passed on to consumers - improved value for money
- a monopsonist is a counter-weight to the market power of a monopolist helping to protect the interests of consumers
