3.4 market structures Flashcards

Question

Why are prices higher in monopolistically competitive martkets than perfectly competitive markets?

Answer 1

Unlike in perfect competition, in monopolistic competition the firm is not producing at the lowest point on the AC curve. These different positions on the AC curve mean that prices in monopolistic competition tend to be higher than in perfect competition This is also because firms in monopolistic competition need to spend money on differentiating their product (e.g. by advertising) and creating brand loyalty

Answer 2

They do not make losses in the long run because, there are low barriers of exit which means firms making losses can just quickly leave the industry

Answer 3

Because there is no supernormal profits in the long run, so firms are unlikely to invest a lot of money in innovation Also, there would not be much money for investment as there is little supernormal profits

Answer 4

- The market is dominated by few large firms e.g. Microsoft Windows and Mac OS - There are high barriers to entry (so new entrants can't easily compete away supernormal profits) - Firms offer differentiated products (i.e. products are similar but not identical). - Firms are interdependent to each other (the actions of 1 firm can effect another firm e.g. lowering prices) - There is imperfect market knowledge - Oligopolies can set price but generally tend to limit /fix price to eliminate competitors (collusive strategies)

Answer 5

* economies of scale * limit pricing * patents * branding * sunk costs * legal

Answer 6

* Economies of scale could be a barrier because existing firms are able to produce at a lower average cost than those starting up * Large firms can hide supernormal profits by limiting their prices by economies of scale to deter new entrants (predatory pricing) * The big firms can agree to limit prices in an act of collusion

Answer 7

An innovative new product or service can give a firm a head start over its rivals which can be difficult for a new entrant to overcome. If the new technology is also patented then other firms can't simply copy the new design — it's legally protected. e.g. Microsoft Windows

Answer 8

* Strong branding means that some products are very well known to consumers. The familiarity of the product often makes it a consumer's first choice, and puts new entrants to a market at a disadvantage. * A strong brand can be the result of a firm making genuinely better products than the competition, or by effective advertising. This makes it difficult for new firms to attract competiition

Answer 9

* If investments can't be recovered when a firm decides to leave a market, then that may make any attempt to break into a market very risky and unappealing so deter new firms. In this case, the barriers of exit act as a barrier of entry

Answer 10

* If an activity requires a licence, then this restricts the number and speed of entry of new firms coming into a market. For example, pubs, pharmacists, food outlets, dentists and taxis all require licences before they can operate. * New factories may need planning permission before they can be built.

Answer 11

This is when the various firms cooperate with each other, especially over what prices are charged. * Formal/overt collusion involves an agreement between the firms — i.e. they form a cartel. This is usually illegal. * Informal/tacit collusion — it happens without any kind of agreement. This happens when each firm knows it's in their best interests not to compete... as long as all the other firms do the same. It's also illegal e.g. Airline ticket pricing.

Answer 12

A formal agreement between firms to limit competition by limiting output or price

Answer 13

* The firms all have similar costs. * There are relatively few firms in the market (so it's easier to check what other firms are charging, etc.). * 'Brand loyalty' means customers are less likely to buy from a different firm, even when their prices are lower. * Barriers to entry are high

Answer 14

* One firm has lower costs than the others. * There's a relatively large number of big firms in the market (making it harder to know what everyone else is doing). * The firms produce products that are very similar. * Barriers to entry are relatively low

Answer 15

* Game theory is a branch of maths. * It's all to do with analysing situations where two or more 'players' (e.g. people, firms, etc.) are each trying to work out what to do to further their own interests. * The fate of each of the players depends on their own decisions, and the decisions of everyone else. So all the players are interdependent. This is why it's often used to analyse situations in economics

Answer 16

If 2 firms, firms X and Y collude to set high price levels at $500 They can both make $100 profit However, if Firm Y breaks the agreement and lowers the price, more people will buy Firm Y's product getting them more profit ($200) and Firm X will have low profit ($50) Firm X could also do the same and break the collusion giving them more profit These situations all end in both firms lowering price, so both firms will be making equal but less profit ($25) than if they kept the agreement The theory of first-mover advantage shows why cartels can be unstable — every firm knows they can get an advantage if they break the agreement first

Answer 17

For example, suppose several firms are all deciding whether to launch a new type of product into a market. * The 'first mover' could make a huge profit by winning a large market share very early. * However, if they've overestimated the demand for the product, they may make huge losses

Answer 18

You can understand some outcomes from certain oligopolistic markets by 'playing the game' from each firm's perspective. For example, the model of the kinked demand curve illustrates why prices are often quite stable, even in some competitive oligopolies

Answer 19

* If one firm raises its prices, then the other firms will not raise theirs this is because when 1 firm increases prices, demand falls, so consumers will switch to other firms products - when price is increased, demand is elastic - So the firms that raises prices loses out and its TR falls

Answer 20

A firm which lowers its prices will not gain any market share (although the overall size of the market may increase slightly, given that all the firms will have lowered their prices). In other words: When price is increased, demand is price elastic This means any firm that reduces prices will lose out — they won't gain market share but the average price for their products will have fallen.

Answer 21

The outcome is that firms have no incentive to change prices. If they either raise or lower prices, they will lose out as a result. The result is price stability for prolonged periods of time.

Answer 22

If 1 firm increases prices, all the other firms will follow the leader and increase prices as well. so prices remain at similar levels to each other

Answer 23

* price wars e.g. Apple introducing a $400 phone * predatory pricing e.g. Airline ticket price * limit pricing i.e. to stop competition

Answer 24

Collusive oligopolies generally lead to higher prices and restricted output (and underconsumption), as well as allocative and productive inefficiency. Firms in collusive oligopolies often have the resources to invest in more efficient production methods and achieve dynamic efficiency, but there's not always an incentive for them to do so. So collusive oligopolies can lead to market failure This means CONSUMERS have to pay higher prices

Answer 25

- *predatory pricing and barriers of entry & exit* makes it hard for new producers to enter - Consumers face *high prices*

Answer 26

- *predatory pricing and barriers of entry & exit* makes it easy for big producers to strive

Answer 27

* *advertising and branding* * *quality* * endorsement * product placement * after-sales service

Answer 28

- Only *1 large firm* which owns *100% of market share* - *Products are unique* (no close substitutes e.g. oil) - There is *imperfect knowledge* - There are *very high barriers of entry* and exit - The firm is the *price maker* e.g. the US oil industry in the 1910s (all owned by 1 company) Even though *firms with monopoly power are price makers,* *consumers can still choose whether or not to buy their products*. So *demand will still depend on the price* — as always, the higher the price, the lower the demand will be.

Answer 29

- Monopolies make a supernormal profit in the *short and long run* as there are high *barriers of entry* that prevent competitors from entering, so *no supernormal profits can be competed away* - Therefore, monopolies *maximise profit at the output level where MC = MR* - If the firm produces a quantity QM, the *demand (or AR) curve* shows the *price the firm can set* — PM. - At this output the a*verage cost (AC) of producing each unit is ACM.* The *difference between ACM and PM is the supernormal profit per unit*. So the *total supernormal profit is shown by the green area.*

Answer 30

The firm is *not operating at its lowest point of the AC curve* (where MC = AC) so monopolies *aren't productively efficient* The *price charged by the firm is greater than MC (P>MC)*. This means that a monopoly market is not allocatively efficient. Producers are being 'over-rewarded' for the products they're providing. This means there's a *deadweight welfare loss too*

Answer 31

* Supernormal profit means *less incentive to be efficient and innovative* - *X inefficiencies* * *Consumer choice is restricted*, since there are no alternative products. * *Consumer have to pay higher prices* * Monopolists may undertake *price discrimination to raise producer surplus and decrease consumer surplus* * *Monopsonist power* may also be used to *exploit suppliers.*

Answer 32

- Supernormal profit means *finance fro investment and R & D* - Firms have *international competitiveness* - Increased *range of goods available for consumers* - *economies of scale means greater efficiency*

Answer 33

* Industries where there are *high fixed costs* and/or there are *large economies of scale* lead to *natural monopolies*. This gives them *HIGH MONOPOLY POWER* * In this case, a *monopoly might be more efficient than having lots of firms competing*. For example, the *supply of water/gas/electricity* is a natural monopoly — it makes no sense for competing firms to all lay separate pipes/pylons. * If there was *more than one firm* in the industry, then they would all have the *same high fixed cost*s. This would lead to *higher costs per customer* than could be obtained by a single firm

Answer 34

A natural monopoly will have *continuous economies of scale* — i.e. *LRAC always falls as output increases* (meaning MC is always below AC - fixed costs). A government may be *reluctant to break up a natural monopoly* as it *reduces efficiency* However, it might want to provide *subsidies* to the *natural monopoly* so that it *increases output* to the point where* demand (AR) = supply (MC)* This will also *reduce prices*

Answer 35

The security a monopolist has in the market (as well as the *supernormal profits*) means it can take a long-term view and *invest in developing and improving products* for the future — this can lead to *dynamic efficiency.*

Answer 36

*Price discrimination* is when a seller *charges different prices* to *different customers* for the *exact same product.* this is to *maximise profits* e.g. * *Flight tickets that have been earlier booked are (a lot) cheaper than those that are booked just before departure*. * Apple's student discount for their products. * Pharmaceutical drugs may be sold at different prices in different countries.

Answer 37

1) The seller must have *price making power* (monopoly power) 2) The firm must be able to *distinguish separate groups* of customers who have *different price elasticities of demand (PED)* 3) The seller can prevent *seepage* which is customers *reselling their products at a higher price to other customers*

Answer 38

It *converts consumer surplus* (difference between the actual selling price of a product and the price a consumer would have been willing to pay) to *producer surplus.* This is so *profits can be maximised*

Answer 39

* First degree price discrimination is where each *individual customer is charged the maximum they would be willing to pay*. * This would *turn all the consumer surplus into extra revenue for the seller.* * However, the *cost of gathering* the required *information *to do this, and the difficulty in *preventing seepage*, makes this method *unlikely to be used* in practice

Answer 40

* buyers who *buy in larger volumes get lower prices* (*wholesale*) * This *turns some of the consumer surplus into revenue* for the seller, and *encourages larger orders*.

Answer 41

Firms *charge different amounts* for *different segments* of the market e.g: − customers of different *ages* — for example, a leisure center might have *different prices for adults, children* and pensioners. − customers who buy at *different times* — for example, a telephone company might charge *different amounts for phone calls* made *during office hours and phone calls made in the evening*. − customers in *different places* — for example, a *pharmaceutical company* might *sell its goods (drugs)* at *different prices in different countries.*

Answer 42

For example, a seller can identify two groups of customers (Group A and Group B) with *different price elasticities of demand* (PED), as in these diagrams To maximise profit, the seller would set the price for each group at a level where MC = MR. This means: − it will *charge a higher price* to the group with a more *inelastic PED*. − It will *charge a lower price* to the group with a more *elastic PED* (e.g. PB for Group B). * The *green areas represent the supernormal profit* earned from each group. This total *supernormal profit is greater than if the same price* were *charged to everyone.*

Answer 43

- The consumer has *less consumer surplus* - In all cases, the *average revenue is greater than MC* — so price discrimination does *not lead to allocative efficiency*, because *allocative efficiency occurs when P = MC* - Consumers are *not treated equally*

Answer 44

- The *extra revenue* generated by the firm can be used to *improve the quality of the product* or *invest in productive methods* which results in *lower cost for consumer* - Sellers get *higher profits* - This can be more *equal* as people who pay more *(rich) subsidise people who can't afford it*

Answer 45

A monopsony is a situation when a *single buyer dominates a market.* *A monopsonist* can act as a *price maker,* and *drive down prices* For example, *supermarkets* are sometimes accused of acting as *monopsonists when buying from their suppliers* Some people claim *supermarkets unfairly use their market powe*r to *force suppliers to sell* their products at a *loss*

Answer 46

- The government is the *only buyer of defense in a country* so can *drive down prices* - *Lower prices are passed on to consumers* - *High quality goods* - *Monopsony prices can drive down monopoly prices*

Answer 47

- This *exploits suppliers* which may make a *loss* - If a firm is the *single buyer of labor* in a market, it can exploit its power & *lower the wages* of its employees.

Answer 48

Contestability refers to *how open a market is to new competitors* (i.e. *potential competition*): In a contestable market: * The *barriers to entry and exit are low*. So if excess profits are made by incumbent firms, new firms will enter. * *Supernormal profits* can potentially be *made by new firms* (at least in the *short term*) These factors mean that *incumbent firms* always face the *threat of increased competition*. So, incumbent firms have an *incentive to set prices at a level* that *won't generate vast supernormal profits*

Answer 49

*HIGH barriers of entry and exit* e.g. * There are *patents on products or production methods* * *Advertising* by *incumbent firms* has already created *strong brand loyalty* * There's a threat of *limit pricing (i.e. predatory pricing*) tactics by the *incumbent firms* * *Trade restrictions* don't allow foreign entrants * *Sunk costs are high* (Barriers of exit)

Answer 50

*LOW barriers of entry and exit*: e.g. - *low fixed costs* e.g. low levels of capital - *low sunk costs* - *weak brand names/few patents* - *low potential profitability in the long run*

Answer 51

Because of *low barriers of entry and exit*: * This means *entering* a market *while supernormal profits* can be made... * ...and then *leaving the market once prices have been driven down to normal-profit* levels

Answer 52

A range of markets have recently become contestable e.g. The Airline industry: New budget airlines like *Ryanair and EasyJet* have joined by *leasing airplanes and flying to small airports* to reduce costs. They became very *established over the years*

Answer 53

Set up barriers to prevent entry - e.g. by *driving down supernormal profits in the short run* to *avoid attracting new entrants*. This may be the *best way to maximise profit in the long run.* - *Advertising* to create *brand loyalty* - *Predatory pricing* to shoo away competition

Answer 54

- Risks firms *going out of business* or making only *normal profits in the long run* - Less monopoly power, *more competition*, so *lower prices for consumers*

Answer 55

- Easy way for firms to make a *quick profit*