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Economics > 3.4 Market structures > Flashcards

3.4 Market structures Flashcards

1
Q

Productive efficiency

A

The ability of a firm to produce goods and services at the lowest possible cost, given the level of output and the available technology.
This means that a firm is using all its resources in the most efficient way possible, producing maximum output with min input

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2
Q

Where is firm productively efficient on graph

A

At the lowest point of the AR curve
If it is performing above, it is not productively efficient as it could produce the same output at a lower price

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3
Q

Allocative efficiency

A

Occurs when resources are allocated in a way that maximises overall societal welfare or utility (socially optimal level of output)

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4
Q

Condition for allocative efficiency

A

MC=AR
At this output, the cost of producing each additional unit is equal to the value that consumers place on the product, reflected in the price they are willing to pay for it

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5
Q

X-inefficiency

A

Aka organisational slack is inefficiency arising because a firm fails to minimise its average costs at the given level of output

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6
Q

X-inefficiency on graph

A

Any outcome that is not on the AC curve

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7
Q

Dynamic efficiency

A

Occurs over time and is strongly linked to the pace of innovation within a market and improvements in the range of choice for consumers and the performance/reliability/quality of products

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8
Q

Market structure

A

The characteristics of a market that will determine firms behaviour

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9
Q

Determinants of market structure (1,2 and 3)

A

Number of firms in the market and their relative size (ceteris paribus - more firms means more competition)

No of firms that could potentially enter market (could depend on profits made by existing firms which attract more firms)

Barriers to entry (ease or difficulty of entry)
Cet par the easier to enter, the more firms there will be

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10
Q

Determinants of market structure

A

Extent to which goods are similar (homogeneous)
Cet par goods with close substitutes will face greater comp

Extent to which all firms share same knowledge (Cet par firms with superior private knowledge will have cost advantages/ superior quality goods -> less competition)

Extent to which firms actions affect one another (interdependence)

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11
Q

Competition

A

Refers to the degree of rivalry among sellers

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12
Q

The 4 market structures

A

Perfect competition (most competitive)
Monopolistic competition (2nd most competitive)
Oligopoly (2nd least competitive)
Monopoly (least competitive)

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13
Q

Natural cost advantage (BTE)

A

Some firms have a natural advantage take for example geographical location

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14
Q

Legal barriers (BTE)

A

Some firms may have legal advantages such as a patent that forbids other firms from producing a similar good

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15
Q

Marketing barriers (BTE)

A

Markets where there are huge levels of marketing act as a deterrent for firms to enter the market

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16
Q

Limit pricing (BTE)

A

Some firms purposely set low prices which reduce their level of profits. this is to not attract any new firms to the industry which in the long term will reduce their profits

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17
Q

Anti competitive pricing

A

Firms can deliberately restrict competition through restrictive practicing

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18
Q

Capital costs (BTE)

A

Some industries require immense expensive capital to enter the market e.g a larger car plant requires specialist machinery which acts as a high barrier to entry

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19
Q

Sunk costs

A

Costs that cannot be recovered if the firm exits the market. when sunk costs are high, this acts as a deterrent to a firm to enter the market because the risks associated with failure is high

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20
Q

Scale economies

A

An existing and established firm in the market may have developed EOS over time, that allows it to change a lower price and produce more output whilst still maximising profits. new firms that do not have EOS cannot charge these lower prices so therefore cannot compete

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21
Q

Markets associated with perfect competition

A

Agricultural markets
Many farmers produce essentially the same product and no single farmer can influence the overall market price

Commodities markets
e.g gold, natural gas
Can have features of perfect comp given they are standardised products with many ppts in trading

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22
Q

Assumptions of monopolistic competition

A

Many buyers and sellers in this market, with low barriers to entry and exit so there is intense comp
Products are heterogeneous (differentiated from rival firms)
Firms have small degree of monopoly power and customers display certain amount of brand loyalty to different firms

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23
Q

Assumptions of monopolistic comp pt2

A

Demand curve is downwards sloping and demand is relatively price elastic. Small change in p = large changes in QD as consumers switch to close substitutes
To small extent, these firms are price makers rather than price takers
Firms aim to profit maximise

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24
Q

Supernormal profits with monopolistic comp

A

Short run - Yes
Long run - No

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25
Q

Allocative efficient with monopolistic competition

A

Short run - no
Long run - no

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26
Q

Productively efficient in monopolistic competition

A

Short run - no
Long run - no

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27
Q

Dynamic efficient in monopolistic competition

A

Short run - limited
Long run - no

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28
Q

Characteristics of oligopoly

A

High barriers to entry and exit
these include high capital requirements, EOS, patents and gov regulations

High concentration ratio

Interdependence of firms
Oligopolistic firms are highly aware of actions and decisions of competitors. Must consider how their own choices such as pricing and marketing strategies will affect the behaviour and reactions of rival firms

Product differentiation
Distinguishes their offerings from competitors inc. branding and advertising to create brand loyalty

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29
Q

Concentration ratio

A

Measures the market share held by the largest firms in the industry. e.g 4-firm concentration ratio of 60% shows that the 4 largest firms in the industry have a combined market share of 60%.

The higher the %, the higher the market power of those firms

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30
Q

Oligopoly examples

A

The big six energy companies (British Gas, SSE, EDF, e.on, Scottish power, power) 71% market share

The big four (KMPG, EY, PWC, Deloitte) 99.7 market share of S&P 500

Fast food outlets (McDonald’s, Burger King, KFC)

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31
Q

Collusion

A

When firms make collective agreements by setting prices or output

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32
Q

Tacit collusion

A

When there is no formal agreement or communication between firms, they follow the prices and output set by the price maker

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33
Q

Overt collusion

A

When firms make a formal agreement to stick to high prices

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34
Q

Cartel

A

Occurs when two or more firms enter into agreements to restrict the supply or fix the price of a good in a particular industry - type of collusion

35
Q

When is cartel legal vs illegal

A

Cartel of firms - illegal
Cartel of countries - legal

36
Q

Exp of cartels

A

OPEC (Organisation of the Petroleum Exporting Countries) - has significant influence over global oil prices

European Cement Cartel
Uncovered in 2002 - massive fines imposed on the companies involved

37
Q

Economic benefits of engaging in collusion

A

When firms engage in price fixing, the main aim is to increase profits for all firms involved. By working together to set high prices, they can ensure that they don’t have to compete on price, which can lead to a more stable and predictable market. Can also be used to deter new entrants as low prices associated with comp can be difficult for new firms to match.
Key concept with price collusion is joint profit maximisation

38
Q

Goal of price fixing cartels

A

Maximise joint profits for all firms involved. In economic terms, the cartel is trying to maximise the total profit for the entire industry rather than maximising individual firms profits

39
Q

Costs of collusive behaviour

A

Damages consumer welfare
Higher prices + lost consumer surplus
Loss of allocative efficiency
Regressive impact (hits lower income families)

Absence of competition = inefficiency
X inefficiency leads to higher unit costs = less incentive to innovate = loss of dynamic efficiency
Output quotas penalise firms who want to expand

Reinforces the cartels monopoly power
harder for new businesses to enter the market = reduced market contest-ability

40
Q

Reasons for Cheating

A

If there is lack of trust between firms in cartel (or past conflicts), firms may feel that cheating is justified or inevitable.
If one firm has cheated before without facing penalties, other may follow suit

41
Q

How does cheating work

A

Firm may lower its price or increase its output in order to capture a larger market share = short term profits (especially if firm believes it can attract customers away from other colluding firms without triggering an immediate response from cartel)

42
Q

How does game theory influence oligopolistic businesses

A

Firms are interdependent
Changing prices can be risky
Using non-price techniques is a better way of competing
Fixing prices or colluding in a good strategy
There are always incentives to cheat
In real life, firms will respond to each others behaviour

43
Q

Objectives of non collusive competition in oligopoly

A

Maintaining a satisfactory profit (minimum normal profit)
Protecting their market share from established competitors
Growing their user base of customers / EOS
Reacting to the decisions of rival firms / new entrants

44
Q

Price wars

A

Price competition where firms decrease prices lower than competitors in order to gain market share.
Can lead to short run increase in sales and market share = consumers benefit + managers hit targets

45
Q

Eval of price wars

A

End result is all firms decreasing prices so market share stays somewhat same and long run profits decrease
If prices below AVC, then firm can shutdown
Shareholders will suffer from lower returns

46
Q

Predatory pricing

A

Occurs when an existing firm is threatened by a new firm that has entered the market
Existing market will temporarily set prices below AC consequently making a loss, assuming they have retained profits that they can fall back on
New firm cannot set prices this low so will then exit market
When new firms leave the existing firm will put prices back up e.g Darlington bus wars 1994

47
Q

Aim of predatory pricing

A

Reduce comp and increase monopoly power + profits of firms who benefit from it

48
Q

Successful predatory pricing outcome

A

Monopoly power is built up and the firm can then use their market dominance to increase prices in the long run to achieve higher levels of supernormal profits.
As a result they are likely to pick up a lot of extra market share from other suppliers in market

49
Q

Eval of predatory pricing

A

Illegal - heavy fines imposed
Depends on whether firm has retained profits to fall back on

50
Q

Limit pricing

A

Used by firms to deter entry into a market by potential competitors
Incumbent firm sets its prices at a level that is low enough to discourage new firms from entering the market, but high enough to still be profitable for incumbent firm
Can be effective if incumbent firm has a significant cost advantage over potential competitors or if market is not very price sensitive

51
Q

Successful limit pricing outcome

A

Market will remain highly concentrated in the hands of one or a small number of dominant, businesses who can continue to earn supernormal profits with P>AC
As a result the potential rival firm may decide that risks of entering the industry are too high - they may make a sizeable loss and might not have the resources to sustain those losses until they can reach a competitive level of average cost through scale economies

52
Q

Game theory

A

Explores the reactions of one player to changes in strategy by another player.

53
Q

Aim of game theory

A

To examine best strategy a firm can adopt for each assumption about its rival’s behaviour and provides insight into independent decision making that occurs in competitive markets

54
Q

Application of game theory

A

Used to describe the oligopolistic decision making process but has broader application e.g tariff wars and anywhere there is a strategic interaction

55
Q
A
56
Q

Non price competition

A

Feature of oligopolistic markets
Methods designed to lower the XED of a firms produce :
Product differentiation
Branding (associated with exclusivity)
Loyalty schemes
Sales promotions
High level of advertising and promotion

57
Q

Monopoly

A

A single dominant supplier in the market
CMA states that a monopoly exists when a firm has 25% or more market share

58
Q

Features of monopoly

A

High barriers to entry/exit
Imperfect information
Differentiated goods
Price makers

59
Q

Working monopoly

A

25% market share
e.g Tesco

60
Q

Dominant monopoly

A

40% market share
e.g Google

61
Q

Natural (Pure) monopoly

A

100% market share
e.g National grid

62
Q

Benefits to firm (monopoly)

A

EOS since firm is producing on a huge scale, leads to supernormal profits
Can invest in long run R&D since there is dynamic efficiency and there is no competitive threat

63
Q

Costs to firm (monopoly)

A

CMA investigation for anti competitive practices
Absence of competition leads to organisational slack (x-inefficieny) - AC curve is higher than it should be, waste of resources
Can experience DEOS through large scale production

64
Q

Benefits to consumers (monopoly)

A

EOS leads to lower prices for consumers
Innovation through R&D = higher quality product for consumers
Domestic monopoly may face more comp from abroad - has to improve efficiency
Monopoly could cross subsidise one area to another

65
Q

Costs of consumers (monopoly)

A

Price originally set where P>MC so consumers face higher costs
Lack of choice for consumers
Deadweight loss to society
No guarantee of investment into R&D since no competition = profits can be paid to shareholders as dividends
Lack of incentives to improve products services

66
Q

Costs to suppliers (monopoly)

A

Monopoly could squeeze prices from suppliers since its the only buyer of supplies in the market

67
Q

Key points about natural monopoly

A

Significant internal economies of scale
Minimum efficient scale is very high relative to market demand
Productively efficient for one firm to operate industry
Pricing for allocative efficiency might lead to losses
Case for government ownership or subsidy/tight regulation

68
Q

Monopsony

A

Exists when there is one buyer in a market e.g Network rail is a dominant buyer of railway maintenance services

69
Q

Monopsonist characteristics

A

Sole buyer in the market
Sellers cannot sell their products to other firms outside the market - only to monopsonist
Profit maximisers who aim to minimise costs by paying their suppliers the lowest price possible

70
Q

Exp of monopsonies

A

Tesco
Walmart (USA)
NHS

71
Q

Impact of monopsony (supplier)

A

Receives lower price shift in the left of AR and MR
Decrease in supernormal profits
If AR falls below AVC, then the supplier will shut down

72
Q

Impact of monopsony (firm)

A

Pays lower price so decrease in variable costs
Leads to lower AC and MC
Increase in supernormal profits
Can achieve productive efficiency by minimising costs
Can achieve dynamic efficiency through increased supernormal profits
Purchasing EOS

73
Q

Impact of monopsony (consumer)

A

Can pay lower prices if the monopsony passes lower costs onto consumers
Can lead to higher consumer surplus = increased consumer welfare
Allocative efficiency can be achieved
If dynamic efficiency, firm can reinvest to make better quality goods benefiting customers

74
Q

Contestable market

A

A market in which there are low barriers to entry and exit and low sunk costs
This means that the market is open to new entrants who can easily enter and leave the market

75
Q

Contestability

A

A measure of the ability of new firms to enter or leave a market

75
Q

Market structures and contestability

A

More contestable
Perfect competition
Monopolistic competition
Oligopoly
Monopoly
Less contestable

75
Q

Low/ no barriers to entry or exit (contestable)

A

Includes barriers such as adverting, branding, patents, start up costs, legal and sunk costs

75
Q

Large number of new firms entering the market (contestable)

A

If firms in a contestable market are making supernormal profits, new firms will enter. If only making normal profit, this may not happen

75
Q

Hit and run profits (contestable)

A

In a contestable market, any SNR profits being made will attract new entrants into the market. They will enter the market to quickly absorb the SNR profits and then leave the market when only normal profits are being made

76
Q

Profit satisficing / normal profits

A

Firms may choose lower profits so that it doesn’t attract new entrants and hit and run comp. This means that they produce at an output level other than profit maximising output
A contestable market will often have normal profits being made since new firms will have entered the market and removed all the SNR profit

76
Q

Limit pricing / price taker (contestable)

A

Firms may purposefully keep prices low in order to keep new entrants from entering the market (limit pricing)
Otherwise, firms in a contestable market will be price takers. If you increase their prices, new firms may enter the market since there will be an opportunity to make supernormal profits

77
Q
A
77
Q

Factors decreasing contestability

A

Mergers and takeovers in many industries e.g Neto purchased by Morrisons
The banking crisis has reduced the access to credit for many smaller businesses who may with to enter a market

Economics (15 decks)

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