3.4 Market Structures Flashcards
What is efficiency
Efficiency can be used to judge how well the market allocated resources, and the relationship between scarce inputs and outputs.
Allocative efficiency
Achieved when resources are used to produce goods and services which consumers want and value most highly and social welfare is maximised. It will occur when the value to society from consumption is equal to the marginal cost of production, where P=MC
Productive efficiency
A firm has productive efficiency when its products are produced at the lowest average cost so the fewest resources are used to produce each product. The minimum resources are used to produce the max output.
This can only exist if firms produce at the bottom of the AC curve where MC=AC.
Dynamic efficiency
Achieved when resources are allocated efficiently over time. Concerned with investment, which brings new products and new production techniques.
When SNP is reinvested into RND
X-inefficiency
If a firm fails to minimise its AC at a given level of output, it is x-inefficient and there is organisational slack.
Characteristics of perfect competition markets
• many buyers and sellers
• freedom of entry and exit from the industry
• perfect knowledge
• homogenous goods
Profits in perfect competition markets
In the short run, firms can make normal profit, supernormal profit or a loss
In the long run firms can only make normal profits
Pricing strategy in perfect competition
Profit maximisation at MC=MR
Efficiency in perfect competition
Productively efficient since they produce where MC=AC
Allocatively efficient as they produce where P=MC
Not dynamic efficient
Characteristics of monopolistic competition
• large number of buyers and sellers
• no barriers to entry or exit
• differentiated, non homogenous goods
• firms have some price setting power
Profits in monopolistic comp
In the short run, can make supernormal, normal, or losses
In the long run, can only make normal profits
Pricing strategy in monopolistic competition
Short run profit maximisers producing at MC=MR
Limitations for firms in monopolistic competition
Information may be imperfect so firms will not enter the market as predicted as they are unaware of the abnormal profits
Efficiency in monopolistic competition
Since can only make normal profit in the long run, AC=AR and since they profit maximise, MC=MR. Therefore, they will not be allocatively or productively efficiently
Likely to be dynamically efficient as differentiated products.
Characteristics of oligopoly
• few firms dominate the market
• differentiated products
• high concentration ratio
• firms interdependent (actions of one directly effects other)
• barriers to entry
Kinked demand curve
If a firm raises its price, competitors won’t as they’ll be comparatively lower
If a firm lowers its prices, competitors will lower as they’ll be comparatively more expensive
Therefore, assume price starts at p1 (at the kink)
Above p1 is elastic and below p1 it’s inelastic
Result is a kink in demand.
N firm concentration ratios
Measures the percentage of the total market that a particular number of firms have.
3 firm shows the market share held by biggest 3 firms
4 for the biggest 4 firms.
N firm concentration ratio equation
Total sales of n firms
—————————— X100
Total size of the market
What is collusion
When firms make collective agreements that reduce competition
Benefits for firms to collide and when does it work best
They could maximise industry profits by keeping higher prices
Reduce the uncertainty firms face and reduces fear of engaging in competitive price cutting or advertising
Works best when there are a few firms which are all well known to eachother, not secretive about costs and production methods and they are similar
What is overt collusion
When there is a formal agreement between firms
What is tacit collusion
No formal agreement
What is a cartel
A formal collusive agreement is called a cartel, a group of firms which enter into an agreement to mutually set prices.
Rules laid out in a formal document
How could a cartel operate
Agree on a price for goods and the compete freely using non-price competition to maximise their market share
Agree to divide up the market according to present market share of each business
What is price leadership
Where one firm has advantages due to its size or costs and becomes the dominant firm. Other firms will tend to follow this because they would be fearful of taking on the firm in a price war
What is game theory
Explores the reactions of one player to changes in strategy by another player, the aim is to examine the best strategy a firm can adopt for each assumption about its rivals behaviour and it provides insight into interdependent decision making that occurs in competitive markets
What is the maximin game theory policy
Where the firm works out the strategy where the worst possible outcome is the least bad
What is the minimax policy in game theory
Involves the firm working out the policy with the best possible outcome
What is dominant strategy
A situation where one player has a superior tactic regardless of how the other players act
If the maximin and minimax strategies end up with the same solution, this is the dominant strategy
However, are not common irl.
What is Nash equilibrium
Where neither player is able to improve their position and has optimised their outcome based on other players expected decision.
What are price wars
Example
Occur in markets where non-price competition is weak, where goods have weak brands and consumers are price conscious, also occur when it is difficult to collude
Will drive price down to levels where firms are frequently making losses
Lowers industry profits
Supermarkets with firms desperately trying to lower orices
What is predatory pricing
Occurs when an established firm is threatened by a new entrant or if one firm feels that another is gaining too much market share
The firm will set such a low price that other firms are unable to make a profit and so will be driven out of the market
The existing firm will then put their prices back up
This is illegal
What is limit pricing
In order to prevent new entrant, firms will set low prices. They need to be high enough to make at least a normal profit but low enough to discourage any other firm entering market
Mainly used in contestable markets
What is cost plus pricing
Where firms simply work out their average costs and add a percentage increase, which determines the level of profit they make
Market-led pricing
Firms can set prices simply by looking at prices charged by competition they price their goods close to other firms.
Problem is that there is no consideration of costs
What is price skimming
When a product is initially launched, firms set very high prices to cover RND costs and keep demand at manageable levels.
Mainly used by tech firms
What is penetration pricing
When product first introduced, firm will set prices low to encourage people lot use it for the first time. When they come back for another, price is higher
Types of non-price competition
Advertising - creates an awareness of the company and can persuade customer to purchase
Loyalty cards - encourage repeat purchases by rewarding customer for their loyalty
Branding - successful brand can help increase loyalty and repeat purchases for a business
Quality - firm known for good quality can charge higher prices
Customer service
Product development
Efficiencies in oligopolies
Statically inefficient; not productively or allocatively efficient
Likely to be dynamically efficient
Able to exploit economies of scale.
What is a pure monopoly with a close example
Where one firm is the sole seller of a product in the market
Google, 88% of the market
Legal monopoly threshold
Example
25% or more market share is classed as a legal monopoly.
Tesco is a legal monopoly as it has 28% of the market.
What is price discrimination
Examples
When monopolists charge different prices to different people for the same good or service
Different times of the day, peak vs off peak train times
How can a monopoly ensure price discrimination can occur
The firm must be able to clearly separate the market into groups of buyers, they must have different elasticities of enemies, must be able to control supply and prevent buyers in the expensive market buying in the cheap
Benefits of price discrimination
Firms benefit as increase profits
Those in elastic market fins as they can play a lower price
Drawback of price discrimination
Consumers lose some of their consumer surplus to the producers and some consumers have to pay a higher price
Natural monopolies
Examples
In these industries, the economies of scale are so large that even a single producer is not able to exploit all of them
An industry where it makes sense to only have one firm
National grid, water, railways
Why do natural monopolies exist
It would be pointless to encourage competition since it would raise average costs for the industry
Tend to be found in industries with very high fixed costs
Benefits of monopolies for the monopoly firm
• Make huge profits
• supernormal profits mean firms will have finance for investments and build reserves to overcome difficulties
• monopoly firms can compete against large overseas corporations
• maximise economies of scale
Costs of monopolies on firms
Firms may not always choose to profit maximise because of x-inefficiencies, sales or revenue maximisation. Lack of competition may means firms become complacent
Costs and benefits of monopolies on employees
Will employ fewer workers as produce at lower outputs
However, the inefficiency of monopolies may means employees get paid more etc…
Cost/benefit of monopolies on suppliers
The impact of a monopolist will depend on the extent to which the monopolist is also a monopsonist.
Benefits of monopolies consumers
• Natural, consumers tend to be better off than if there was competition
• when firms enjoy economies of scale, more efficient and customers will enjoy higher consumer surplus
• monopolists may produce an increased range of goods or services
• price discrimination benefits some consumers
Monopolies efficiencies
Productively inefficient as don’t produce at MC=AC
Not allocatively efficient as P>MC
Dynamic efficient
Characteristics of monopsony
• Only one buyer in the market
• other than one buyer, it has the same characteristics as monopolies
Example of a monopsony
NHS, who pay less for cancer drugs than a number of other high-income countries
Prices in monopsony
The firm will pay the supplier the lowest possible price to minimise their costs and make the most of their position as the only buyer. This enables them to maximise their profit
Benefits of monopsony for the buying firm
Gains higher profits by being able to buy at lower prices
Achieve purchasing economies of scale, lowering costs and profits.
Benefits of monopsonies for consumers
May Gain from lower prices as reduced costs are passed on.
May act as a counterweight to monopolists
Costs of monopsonies for consumers
Fall in supply if the firm buys less
Fall in quality as prices are driven down
Cost and benefit of monopsonies on employees
Benefit: may pay higher wages
Costs: supplier will sell less goods so employ less people
Cost of monopsonies for suppliers
Will lose out as they will receive lower prices.
What is a contestable market
A contestable market is one with a high threat of new entrants, which keeps firms producing at a competitive level.
Characteristics of contestable markets
• Perfect knowledge
• freedom of entry and exit
• relative absence of sunk costs
• firms will have the best technology available.
• low product loyalty
Examples of contestable markets
Taxi industry with the intro of Uber, hotel market with Airbnb
Implications of contestable markets
• Limit pricing, reduces incentive for firms to enter the market
• firms will only be able to make normal profits
• likely to be productive and allocatively efficient
Barrie’s to entry and exit
• legal barriers making it difficult to enter. For example, patents and exclusive rights to production.
• marketing barriers from high amounts of brand loyalty for other firms as a result of great advertising from other firms.
• the pricing decisions of incumbent firms. For example, predatory pricing.
• start up costs and high sunk costs as a result
• economies of scale of others may make it hard to enter
• barriers to exit like costs to write off assets, pay leases and make workers redundant
What is a sunk cost
A sunk cost is a fixed cost that a business cannot recover if it leaves for industry. It included property.
