3.4 Market structures

Question 1

Efficiency

Answer 1

How well or productively a firm or organisation uses inputs. The more efficient you are, the cheaper it is to produce a particular quantity of goods.

Question 2

Productive efficiency

Answer 2

When firms produce at the lowest possible cost. This means production will be at the lowest point on the Average Cost curve.

Question 3

Allocative efficiency

Answer 3

When the cost of producing the good is well matched to how much a consumer is willing to pay for it. We find this when MC=P.

Question 4

X-inefficiency

Answer 4

X Inefficiency occurs when a firm lacks the incentive to control costs. This causes the average cost of production to be higher than necessary.

Question 5

Dynamic efficiency

Answer 5

The optimal rate of innovation and investment to improve production processes to reduce average cost.

Question 6

Perfect Competition

Answer 6

Many firms producing the same product. All firms are price takers and there are no barriers to entry. In LR, there are no supernormal profits

Question 7

Monopolistic Competition

Answer 7

Many firms, producing similar but differentiated products. Low barriers to entry. Supernormal profits in the SR, but firms lose market share and demand when new firms enter market. Normal profits in LR.

Question 8

Monopoly

Answer 8

A single seller, or when one firm is the whole market. Price maker. High barriers to entry. Will make supernormal profits in long and short run. Inefficient production and a deadweight loss to Society is likely.

Question 9

Monopsony

Answer 9

A single buyer in a market.

Question 10

Oligopoly

Answer 10

A market with a small number of interdependent firms with significant market share. Supernormal profits, strategic behaviour and collusion are likely.

Question 11

Interdependence

Answer 11

The behaviour of firms will influence each other – oligopoly.

Question 12

Natural Monopoly

Answer 12

A market where it is only possible for one firm to serve all consumers and make a normal profit. A market with extremely high fixed costs to establish a national network (railroads, telecoms, water supply).

Question 13

Homogenous Products

Answer 13

Goods sold by firms in the market are identical. All the firms are perfect substitutes for each other.

Question 14

Price takers

Answer 14

Each firm has a tiny market share and they cannot influence the market price of the good that they sell.

Question 15

No barriers to entry or exit

Answer 15

Firms can enter and leave the market very easily in response to the opportunity to make more profits or the potential for losses.

Question 16

Perfect information

Answer 16

All buyer and sellers have all the information and knowledge available about the goods available and the different firms.

Question 17

No transaction costs

Answer 17

There are no additional costs of buying and selling goods in this market.

Question 18

No externalities

Answer 18

There are no third party costs or benefits to consuming goods in a perfectly competitive market.

Question 19

Diminishing marginal product

Answer 19

As input increases, output initially increases. Over time the amount of additional output gained from from an additional worker/FofP will fall.

Question 20

Economies of Scale

Answer 20

Increasing the scale of production leads to lower costs per unit.

Question 21

Diseconomies of Scale

Answer 21

Increasing the scale of production leads to higher costs per unit. This is when large firms become inefficient.

Question 22

Minimum Efficient Scale (M.E.S)

Answer 22

The lowest point on the long run average cost curve.

Question 23

Collusive Oligopoly

Answer 23

When oligopolies collude (co-operate) to raise prices, reduce output and make sure they share supernormal profits.

Question 24

Non-collusive oligopoly

Answer 24

When oligopolies compete with each other, but they have to react to the decisions of their rivals.

Question 25

Formal Collusion

Answer 25

When companies make firm agreements to set up markets and earn higher profits. This could be by setting the prices or controlling the amount of output with quotas. Cartels. Illegal.

Question 26

Tacit Collusion

Answer 26

Where firms co-operate to earn higher profits, but nothing is written down or done officially – firms can predict what their rivals might do, so everyone can tacitly help each other. Hard to prove.

Question 27

Game theory

Answer 27

The study of the different strategies that firms may choose, depending on how they think about what their rivals might do – helps us to see when oligopolies will collude or compete.

Question 28

The Prisoners’ Dilemma

Answer 28

Example of Game theory where 2 players (the ‘prisoners’ or firms) will independently choose strategies that lead to a worse outcome than if they could trust each other and collaborate. Example of a Nash Eq.

Question 29

Maximax strategy

Answer 29

When you choose the strategy that has the very best possible outcome for you. When you’re optimistic or ‘go for broke’.

Question 30

Maximin strategy

Answer 30

When you choose the strategy where the worst outcome you could possibly get is ‘least bad’. When you’re pessimistic and you try to minimise your loss in any situation.

Question 31

Nash equilibrium

Answer 31

An outcome which is a stable equilibrium (won’t change) but is sub-optimal for both players – this is the most lilkely outcome in the prisoners’ dilemma or when oligopolies have a price war.

Question 32

Kinked Demand Curve

Answer 32

A theory of oligopoly. Firms can’t raise prices as their competitors will not follow - so demand is elastic heading upwards. Demand is inelastic heading downwards, as oligopolies will all cut prices together (price war) . So prices will probably STICK at the ‘kinked’ price.

Question 33

Price leadership

Answer 33

The biggest firm in a market sets its price to maximise profits – other firms match or follow this firm in price setting.

Question 34

Predatory Pricing

Answer 34

Big firm deliberately sets prices very low and makes a loss. But smaller firms cannot compete with this low price and are driven out of the market – destroys the competition. Often illegal.

Question 35

Limit Pricing

Answer 35

Big firms with economies of scale & low average costs sets prices just enough to make normal profits. But this is too low for smaller competitors to even enter the market and discourages them. A barrier to entry.

Question 36

Cost-Plus pricing

Answer 36

Firms set prices with a benchmark, such as cost + 10%.

Question 37

Price wars

Answer 37

Collusion breaks down. Firms try to undercut each other with price cuts. Supernormal profit is wiped out, but the consumer benefits.

Question 38

Non-price competition

Answer 38

Advertising and branding, service & after-sales support, quality, linked services/tie-ins. Ways of competing OR creating consumer-loyalty and barriers to entry.

Question 39

Product differentiation

Answer 39

Producing variations of a product – different features, styles or colours to appeal to different consumers.

Question 40

Sunk Costs

Answer 40

Costs that can never be got back– like fixed costs of machinery that cannot be sold on for another purpose.

Question 41

Price Discrimination

Answer 41

Where a firm sells the same product at different prices (to different people or at different times). This is a strategy monopoly and oligopoly firms can use to maximise their supernormal profits.

Question 42

Contestable Markets

Answer 42

Where there is free/costless entry into the market (no barriers). Monopolies will want to make markets less contestable through barriers.