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
- 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?
- Only one firm dominating the 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
What is the distinction between a pure and legal monopoly?
- Pure monopoly: only one firm in the market
- Legal monopoly: a firm with more than 25% market share
What is price discrimination?
When a firm charges different prices to different consumers for an identical G/S with no differences in cost of production
What are the conditions for price discrimination?
(include real-world examples)
- Market power - price-making ability without losing all of its customers
- Information to separate the market - e.g. Amazon uses data on age, gender etc to identify elastic & inelastic consumers
- Limit reselling - firms lose out on profit and can’t effectively PD -> market seepage
What is the difference between 1st degree and 2nd degree price discrimination?
- 1st degree: when consumers are charged the exact price they are willing and able to pay (CS->PS)
- 2nd degree: a firm with fixed capacity where it makes no sense to leave any capacity idle, lowers prices last minute to fill capacity + cover fixed costs (e.g. planes)
What is third degree price discrimination?
Occurs when a firm charges different prices to different consumers for the same good/service & markets are sub-divided based on time, age, income, location -> rail fares are priced differently depending on the time of travel
What are the advantages of price discrimination?
- Dynamic efficiency
- Economies of scale (2nd & 3rd) -> future lower prices
- Some consumers benefit (price elastic)
- Cross-subsidisation (profits -> loss-making g&s)
What are the disadvantages of price discrimination?
- Allocative inefficiency
- Inequalities
- Anti-competitive practices
What is a natural monopoly? (give an example)
- A natural monopoly is when it’s naturally most efficient if only one firm is in the market
- E.g. TFL, Thames water, NHS
What are the two reasons why a monopoly might be a natural monopoly?
- High sunk costs - e.g. TFL’s sunk costs worth £129bn : railway tracks, training etc
- Huge internal economies of scale - need to expand output to reach minimum efficient scale
What are the 5 main barriers to entry?
- Legal barriers
- Economies of scale
- Sunk costs
- Anti-competitive practices
- Brand loyalty
What is contestability?
- A market with low barriers to entry/exit & low sunk costs - it doesn’t matter how many firms are in the market e.g. mango market
- Long-run -> normal profits
- Short-run -> normal profit, SNP, loss
What is hit and run competition? How do firms get rid of new entrants?
- Incumbent firms are making SNP -> new firms enter (hit) -> undercut -> steal SNP
- Incumbent firm sets price = AC -> normal profit -> new firm leaves market (run)
How is vertical integration an anti-competitive practice?
Control scarce resources (vertical-backwards) -> refuse to let new firms use them ->stops them entering
What are the advantages of perfect competition?
- Firms make SNP (short-run) -> welfare gain for firms
- Static efficiency (long-run) -> productive & allocative
- Allocative efficiency -> maximise consumer surplus
- Consumers gain: greater choice, quality + low price
What are the disadvantages of perfect competition?
- Make normal profits in LR -> no money to re-invest or achieve dynamic efficiency -> higher prices over time
- Can’t access economies of scale -> higher prices than if a monopoly controlled the market
- Consumers lose out on quality (high competition) -less time spent on quality control
What are the impacts of an oligopoly market on consumers?
- If firms collude: market operates like a monopoly - higher prices, lower quality & choice -> consumer surplus isn’t maximised
- If collusion breaks down: market operates like a competitive market -> low prices, increased quantity supplied, increased consumer surplus
What are the advantages of monopolies for firms?
- Price-makers - set prices at profit max point + exploit consumer welfare to make large SNP e.g. Amazon - value of $1tn -> $87.4bn profit (2019)
- Dynamic efficiency strengthens a firm’s monopoly position - high barriers to entry (lower costs)
What are the advantages of monopolies for consumers?
- Monopolies make large SNP -> investment -> refine production process + invest in cost-saving technology
- Large -> economies of scale -> can reduce AC & MC -> cheaper + high quality products compared to perfect competition (too small for EoS)
What are the disadvantages of monopolies for firms?
- Few competitors -> wastage/X-inefficiency e.g. South Western Railway strike in 2019 (natural) + NHS -> legal monopoly -> increased costs -> x-inefficiency
- Monopolies exploit their position to drive competitors of the market -> complacency + wastage -> increased x-inefficiency -> increased costs -> increased prices + weaker monopoly position
What are the disadvantages of monopolies for consumers?
- Consumers lose out - don’t produce at allocatively efficient point (produce at profit max) -> consumers are better off in a perfectly competitive market
What is cross-subsidisation?
- Cross-subsidy: a situation in which one group of customers/clients is charged a higher price for a product/service in order to subsidise a lower price for another group - occurs in various industries e.g. transport, energy
- For example, in the energy sector, a utility company may charge higher rates to commercial & industrial customers in order to subsidize lower rates for residential customers -> affordability
What are the characteristics & conditions of a monopsony? Give an example.
- Only one buyer in the market + same basic characteristics as a monopoly
- Can prevent new firms entering & aim to profit maximise
- Pay suppliers the lowest price possible to minimise costs
- Produce where MC=AR at price P1Q1
- Example: NHS pay less for cancer drugs than other high income countries
What are the benefits of a monopsony?
- Customers gain from lower prices as reduced costs are passed on
- Monopsonists may pay higher wages as they’re making higher profits
- Supplier will supply less goods & employ less people while monopsonist may employ fewer more, or same amount of people since they have less inputs to use for production but costs are also lower
What are the costs of a monopsony?
- There may be a fall in quality as prices are driven down
- Could lead to a fall in supply -> business buys fewer inputs - the extent to which supply to customers falls depends on PES in the market -> if it’s inelastic -> little fall in supply
- Suppliers lose out as they will receive lower prices -> less will be supplied -> some firms may leave the market
Why might regulators not be able to protect consumers from oligopolies?
- Consumer inertia
- Habitual/computational weakness
- Collusion vs collaboration - prevent collaboration e.g. vaccines (many firms collaborated), electric cars (BMW, Jaguar, Land Rover)
What are the costs and benefits of collusion?
+ Increased prices -> increases profit -> increases quality -> increases consumer welfare
+ Increased price stability -> increases investment -> increased quality -> efficiency -> welfare
+ Survival - small firms with low profit margin -> increased choice
- Consumer behaviour
- Cost to the Gov
Why might the theory behind the kinked demand curve not hold? (eval)
- 80 year old diagram
- Assumes: no new entrants, that firms don’t talk to each other, costs are stable
Why might there actually not be an incentive to compete on non-price factors? (eval)
- Non-price competition e.g. advertising, loyalty cards -> increased MC & AC -> no incentive for firms to use non-price factors to compete -> lose out on profit as costs rise
