3.4 - Market Structures Flashcards
What are the 4 types of efficiency?
- Allocative efficiency (MC=AR)
- Productive efficiency (MC=AC)
- X-efficiency/inefficiency
- Dynamic efficiency
What is the difference between allocative and productive efficiency? What type of efficiency are they?
- Static efficiency - efficiency at one point in time
- Productive efficiency: producing G&S with the optimal combination of inputs to produce maximum output for minimum cost-> when AC is at its lowest - firm produces where MC=AC
- Allocative efficiency: when resources are used to produce G&S which consumers want/value highly -> welfare is maximised - produce where MC=AR
What is the difference between x-inefficiency and dynamic efficiency?
- X-inefficiency: when for a given level of output, costs are above the AC curve
- Dynamic efficiency: how changing technology improves a firm’s output potential over time e.g. phones - firms must invest in R&D -> can only be done if making SNP
What are the characteristics of perfect competition?
- Many buyers and sellers - no one firm/customer is able to influence the market + no monopolies
- No barriers to entry/exit - no economies of scale, no sunk costs, no patents, etc - firms make normal profits in the LR
- Perfect knowledge - enables firms to know when other firms are making profits - attracts them to the market
4 Homogenous goods - identical - Firms are price-takers
Which 2 characterstics lead to normal profits
- No barriers to entry/exit
- Perfect knowledge
- New firms enter the market -> supply increases -> price pushes down -> normal profits
Describe the efficiency of firms in a perfect competitive market in the short-run and long-run
- In SR and LR perfect competition, firms are allocative efficient
- In SR perfect competition -> not productive efficient
- In LR perfect competition -> productive efficient - producing enough to take advantage of economies
- Perfect competitive firms are always X-efficient -> firms are price takers - cost minimisation is the only way to make money
- Dynamic efficiency: in SR - fixed capital, homogenous products, perfect knowledge -> no incentive due to copying (eval: time lag); in LR - normal profits -> nothing to reinvest in R&D
What are the characteristics of monopolistic competition? Give some real world examples.
- Many small buyers and sellers
- Low barriers to entry/exit
- Slightly differentiated market
- Examples: takeaway market - 10,000 takeaway companies in London
Explain the SR and LR monopolistic competition diagrams.
- SR: MR & AR are elastic (goods are close substitutes)
- SNP incentivises firms to join the market -> low barriers makes it easier -> customers are lost to competitors -> AR & MR of incumbent firms fall -> normal profits in the LR (AR tangent to AC)
What are the characteristics of oligopolies?
- High concentration ratio -> few large sellers
- High barriers to entry/exit e.g. brand loyalty to Coca Cola, R&D -> increased risk
- Differentiated goods - similar but different
- Interdependence - one firm’s actions will directly affect another firm
What is the formula for the n-concentration ratio?
Add up the market shares of the n largest firms
What is collusion?
When two firms agree to limit competition
What is the distinction between overt and tacit collusion?
- Overt collusion: a formal agreement between firms to limit competition e.g. contract
- Tacit collusion: an unspoken agreement between firms
What are the consequences of overt collusion?
- Higher prices for consumers
- Less output in the market
- Poor quality products or customer service
- Less investment in innovation
How does overt collusion occur?
- Price fixing
- Setting output quotas which limit supply & naturally -> price increases
- Agreements to block new firms from entering the industry
- Agreements to pay suppliers the same price thereby driving down prices in the supply chain (monopsony power)
What is a real world example of overt collusion?
- OECD - oil cartel of 13 countries e.g. Saudi Arabia, Columbia
- Fix oil prices high -> publicly
What is price leadership?
- Most common form of tacit collusion
- Occurs when firms monitor the price of the largest firm in the industry then adjust their prices to match
- Difficult for regulators to prove collusion occurred
What are the reasons for collusive behaviour?
- Few firms/competitor - easier for each firm to understand each others’ actions and responses, or to collaborate on prices/output
- Similar costs: firms face almost identical costs as any remaining competitors have all experienced EoS
- Similar revenue: competitors’ G&S sell for similar prices as there is little incentive to lower them - other firms respond by keeping their market share the same but decreasing the profits
- High barriers to entry
- Ineffective regulation: empowers firms to collude -> little consequence for their actions
- Brand loyalty: decreases benefits of competition
What is game theory?
- Game theory is a mathematical framework used by firms to ensure optimal decisions are made in a strategic setting where there is a high level of interdependence (oligopoly markets)
- Three elements: players (firms); strategies available to the players; payoffs
What are price wars?
Firms try to undercut each other with low prices to steal consumers
What is predatory pricing?
Firms cut prices below AVC to force out competitors e.g. takeaway market (below shutdown point)
What is limit pricing?
Incumbent firms set prices low enough to prevent new firms entering - use its economies of scale
What are the different types of non-price competition? Give examples.
1) Advertising e.g. Samsung’s ad campaign with olympic swimmers after apple was discovered to be non-waterproof -> creates an awareness of the company/product & can persuade a customer to purchase -> if successful, it can increase sales & market share -> long run increase in profits -> also make the demand more inelastic
2) Loyalty cards e.g. Tesco clubcard -> encourages repeat purchases by rewarding customers for their loyalty -> provides firms with lots of data on consumers’ buying habits, which the firm can use to increase sales
3) Branding e.g. Coco pops coco the monkey -> increase loyalty & repeat purchases -an established brand should find it easier to release new products
4) Quality - known for good quality -> charge higher prices, -> strong brand loyalty -> good reputation - competing in quality -> firms investing in R&D -> increased dynamic efficiency -> higher quality
What is the Nash Equilibrium?
- An idea in game theory - any situation where all of the participants in a game are pursuing their best possible strategy given the strategies of all of the other participants
- A rational equilibrium that can last in the long-term
What are the characteristics of a monopoly? Give a real world example.
- Only one firm dominating the market - Microsoft own 90% of ther operating system market
- Firms are profit maximisers
- High barriers to entry/exit e.g. Microsoft filed patents on all of its technology
- Differentiated goods -> firms are price makers
- Imperfect information