3.4 Market Structures Flashcards
What is allocative efficiency?
Achieved when resources are used to produce goods and services which consumers want and value most highly, maximizing social welfare where P=MC
P=MC means price equals marginal cost, indicating optimal resource allocation.
Define productive efficiency.
A firm has productive efficiency when its products are produced at the lowest average cost, using the fewest resources for maximum output
This occurs when firms produce at the bottom of the AC curve.
What is dynamic efficiency?
Achieved when resources are allocated efficiently over time, focusing on investment that brings new products and production techniques
In contrast, static efficiency refers to efficiency at a set point in time.
What is X-inefficiency?
Occurs when a firm fails to minimize its average costs at a given level of output, resulting in organizational slack
Example: Producing 125 goods at £8 each instead of £7 each indicates X-inefficiency.
List the four key characteristics of perfect competition.
- Many buyers and sellers
- Freedom of entry and exit
- Perfect knowledge
- Homogenous products
These characteristics ensure firms are price takers.
What is the profit-maximizing equilibrium in perfect competition?
Firms produce where MC=MR, leading to normal profit in the long run
In the short run, firms can make supernormal profit.
Is perfect competition dynamically efficient?
No, perfect competition is not dynamically efficient due to lack of resources for research and development
Firms lack the incentive for innovation as supernormal profits are quickly eroded by new entrants.
Define monopolistic competition.
A form of imperfect competition with many firms producing differentiated products, leading to a downward sloping demand curve
Examples include hairdressers, estate agents, and restaurants.
How do firms in monopolistic competition maximize profits in the short run?
By producing where MC=MR, allowing for supernormal profits until new firms enter the market
In the long run, firms can only make normal profits.
What is the primary difference between monopolistic competition and perfect competition?
Monopolistic competition involves differentiated products, while perfect competition involves homogenous products
This allows firms in monopolistic competition some price-setting power.
List the four key characteristics of oligopoly.
- Few firms dominate the market
- Products are generally differentiated
- Firms are interdependent
- Barriers to entry exist
These characteristics lead to strategic behavior among firms.
What is the concentration ratio in oligopoly?
Measures the percentage of the total market held by a certain number of firms, like the 3-firm or 4-firm concentration ratio
It indicates market dominance by a few firms.
What are the two main types of collusion?
- Overt collusion
- Tacit collusion
Overt collusion involves formal agreements, while tacit collusion does not.
What is a cartel?
A formal collusive agreement among firms to set prices or market shares
Cartels are illegal in many jurisdictions due to anti-competitive practices.
What is price leadership in non-collusive oligopoly?
A situation where one dominant firm sets prices that other firms follow to avoid price wars
This allows the dominant firm to control market pricing.
What role does game theory play in non-collusive oligopoly?
Examines the reactions of one firm to changes in strategy by another, aiding in strategic decision-making
It helps firms understand interdependent behavior in competitive markets.
What is a non-collusive oligopoly?
The behaviour of a firm under non-collusive oligopoly depends on how it thinks other firms will react to its policies.
What is game theory?
Game theory explores the reactions of one player to changes in strategy by another player, examining the best strategy a firm can adopt for each assumption about its rival’s behaviour.
What are the two strategies a firm could take in game theory?
- Maximin policy
- Maximax policy
What is a dominant strategy?
When maximin and maximax strategies end up with the same solution.
What is Nash Equilibrium?
A situation where neither player can improve their position and has optimized their outcome based on the other player’s expected decision.
How does game theory explain stable prices in oligopoly?
Firms often adopt a maximin strategy, keeping prices unchanged to avoid losses.
What is a price war?
A price war occurs in markets with weak non-price competition, driving prices down to levels where firms frequently make losses.
What is predatory pricing?
When an established firm sets such a low price that other firms cannot make a profit, driving them out of the market.
What is limit pricing?
Setting prices low enough to prevent new entrants while still making at least normal profit.
What are types of non-price competition in oligopolistic markets?
- Advertising
- Loyalty cards
- Branding
- Quality
- Customer service
- Product development
What is static inefficiency in firms?
Firms in oligopoly are statically inefficient, as they are not productively or allocatively efficient.
What characterizes a pure monopoly?
A pure monopoly exists where one firm is the sole seller of a product in a market.
What is third degree price discrimination?
Charging different prices to different people for the same good or service based on different market segments.
What are the benefits of price discrimination?
- Increases profits for firms
- Allows lower prices for some consumers
- Can increase equality by providing access to goods
What defines a natural monopoly?
Industries where economies of scale are so large that a single producer cannot fully exploit them.
What is the impact of monopolists on employees?
Monopolists may produce at lower outputs, employing fewer workers, but may offer higher wages due to inefficiency.
What is allocative efficiency?
A market condition where resources are distributed in a way that maximizes total welfare, typically where P=MC.
What is dynamic efficiency?
The efficiency achieved when firms invest in innovation and improvements over time, often due to supernormal profits.
What is X-inefficiency?
Inefficiency that occurs when a firm fails to minimize costs due to a lack of competitive pressure.
What are the consumer impacts of a monopoly?
- Higher prices
- Less choice
- Potentially poorer quality service
What is deadweight loss in the context of monopoly?
The loss of economic efficiency when equilibrium for a good or service is not achieved or is not achievable.
What is the relationship between supernormal profits and competition?
Supernormal profits incentivize other firms to enter the market, potentially breaking down the monopoly.
What is the main characteristic of a monopoly?
A monopoly exists when there is only one producer or seller in the market.
What are the benefits of monopolies in terms of efficiency?
Monopolies can be more productively efficient, allocatively efficient, and dynamically efficient.
What is cross subsidisation and why can it waste resources?
Cross subsidisation occurs when profits from one sector finance losses in another, potentially leading to misallocation of resources.
Why are permanent monopolies rare?
Supernormal profits incentivize other firms to enter the market, leading to a process of creative destruction.
What is a monopsony?
A monopsony is a market structure where there is only one buyer.
What is an example of a monopsonist buyer?
The NHS acts as a monopsonist buyer of pharmaceuticals.
How do monopsonists typically affect supplier prices?
Monopsonists pay their suppliers the lowest price possible to minimize costs.
What are the potential benefits of monopsony for firms?
Higher profits, increased funding for research and development, and purchasing economies of scale.
What are the implications of a contestable market?
Firms will enter the market if they see abnormal profits, leading to competitive pricing and efficiency.
List characteristics of contestable markets.
- Perfect knowledge
- Freedom of entry and exit
- Low product loyalty
- Absence of sunk costs
What can prevent firms from entering a market?
Barriers to entry such as patents, high entry costs, and marketing barriers.
What is a sunk cost?
A sunk cost is a fixed cost that cannot be recovered if a business exits the industry.
Fill in the blank: In a monopsony, firms produce where _______ equals _______.
MC = AR
True or False: In a perfectly contestable market, firms can make supernormal profits in the long run.
False
What is the relationship between average cost (AC), marginal cost (MC), and average revenue (AR) in a contestable market?
AC = MC = AR
What kind of pricing strategy might firms use to deter new entrants in a contestable market?
Limit pricing.
What happens to supply when a monopsonist buys fewer inputs?
It may lead to a fall in supply.
What is one negative effect of monopsony on suppliers?
Suppliers receive lower prices, leading to some firms potentially leaving the market.
List some barriers to exit that firms may face.
- Costs to write off assets
- Pay leases
- Make workers redundant
How does product loyalty affect contestability?
High product loyalty makes it less likely for consumers to switch brands, creating a barrier for new entrants.
What is the significance of economies of scale in relation to contestable markets?
They can create a cost disadvantage for new firms, making it hard to compete with larger incumbents.
Fill in the blank: The degree of contestability is measured by the extent to which the gains from market entry exceed the _______.
costs of entering the market
