3.4 Market Structures Flashcards
When is 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
When does a firm have productive efficiency?
When its products are produced at the lowest average cost - meaning it is maximising output from its inputs. This can only exist if firms produce at the bottom of the AC curve. It is only possible if there is technical efficiency, where the firm uses the most efficient combination of resources
When does a firm achieve dynamic efficiency?
When a firm improves efficiency over time through investment, innovation and technological progress. The alternative is static efficiency: efficiency at a set point in time, e.g allocative and productive efficiency. Dynamic efficiency will be achieved in markets where competition encourages innovation but where there are differences in products and copyright/patent laws. Supernormal profit is required to provide firms with the incentive to invest and the ability to do so
What is X-inefficiency?
● X-inefficiency happens when a firm produces at a higher cost than necessary. The firm is inside the AC curve, not on it
● Caused by waste, poor management, lack of motivation
● Often occurs in monopolies or firms with little competitive pressure, where there’s no incentive to cut costs
What determines prices for goods in a perfectly competitive market?
Demand for the firm’s goods is perfectly elastic, prices are solely determined by interaction of demand and supply; the firms are price takers.
What are four key characteristics of a perfectly competitive market?
● There must be many buyers and sellers
● There must be freedom of entry and exit from the industry
● There must be perfect knowledge
● The product must be homogenous
How much do firms in perfect competition make in the long run?
Firms in perfect competition can only make normal profit in the long run
What type of efficiency is seen in a market with perfect competition?
Perfect competition is productively efficient, since they produce where MC=AC. They are also allocative efficient since they produce where P=MC
However, they are not dynamic efficient. No single firm will have enough for research and development. The existence of perfect information also means one firms’ invention will be adopted by another firm and so the investment will give the firm no competitive benefit. Governments tend to have to do all the research
What is monopolistic competition?
A market structure that combines features of both perfect competition and monopoly
It’s common in real-world markets, e.g. restaurants, clothing brands, hairdressers
What are characteristics of monopolistic competition?
● A large number of buyers and sellers in the market, each of whom are relatively small and act independently, no one buyer or seller has a large price setting power
● There are no barriers to entry or exit, new firms can enter when supernormal profits are being made and leave in the case of losses. As a result, only normal profits are made in the long run.
● Firms produce differentiated, non-homogenous goods or services. This means that individual firms do have some price setting power, and so the curve is downward sloping
● Imperfect information. Consumers don’t have perfect knowledge, often influenced by advertising, branding
What is an oligopoly?
Where there are a few firms that dominate the market and have the majority of market share. There is a high concentration ratio
What are four characteristics of an oligopoly?
● Products are generally differentiated
● Firms must be interdependent (the actions of one firm will directly affect another);
● There are barriers to entry
● Supply in the industry is concentrated in the hands of a relatively small number of firms, meaning there is a high concentration ratio
What does concentration ratio measure?
The percentage of the total market that a particular number of firms have
What is an equation to calculate concentration ratio?
What is collusion?
When firms make collective agreements that reduce competition
When firms don’t collude, this is a competitive oligopoly
Why might firms want to collude?
● If they work together, they could maximise industry profits.
● Collusion reduces the uncertainty firms face and reduces the fear of engaging in competitive price cutting or advertising, which will reduce industry profits.
Why might firms not want to collude?
● Since collusion is illegal and due to the risks of collusion, such as other firms breaking the cartel or prices being set where they don’t want it
● A firm with a strong business model and something that sets it apart from other firms will not want to collude if they feel they can increase market share and/or charge higher prices than competitors
When does collusion work best?
● When there are a few firms which are all well known to each other
● The firms are not secretive about costs and production methods and the costs and production methods are similar
● They produce similar products
● There is a dominant firm which the others are happy to follow
● The market is relatively stable
● There are high barriers to entry
What is the difference between overt and tacit collusion?
Overt collusion is when firms come to a formal agreement whilst tacit collusion means there is no formal agreement
What is a formal collusive agreement called?
A cartel
What is a cartel?
A group of firms who enter into agreement to mutually set prices. The rules will be laid out in a formal document. Firms who break these rules will experience retaliation from the other members: price wars, charge fines (informally) cutting them out of future deals etc
What are the two ways that cartels could operate?
● Agree on a price for the goods and then compete freely using non-price competition to maximise their market share
● Agree to divide up the market according to the present market share of each business (limit the quantity of goods/services they produce/supply to create artificial scarcity)
What is a major problem in cartels?
There is constant temptation to break the cartel. The more successful the cartel, the greater the incentive to break it; it is important for firms to be the first to break it and not the firm who is left to deal with the after effects
As collusion is illegal, what might many firms be involved in instead of a cartel?
Tacit collusion such as price leadership and following a barometric firm
