3.4 Market Structures Flashcards
What is allocative efficiency?
It is when production is at the point which maximizes social welfare, P=MC
What is productive efficiency?
It is when a firm is able to produce at the lowest average cost. MC=AC or the lowest point of the AC curve.
What is dynamic efficiency?
It is the long term reinvestment of supernormal profits into innovation and research.
What is X-Inefficiency?
This is when a firm does not minimize its costs due to a lack of incentive and competition
What are the characteristics of a perfectly competitive market?
Many buyers and sellers
Homogenous Goods
Perfect Knowledge
No barriers to entry or exit
Firms are price takers
Firms are profit maximizers
Why can firms in perfect competition make supernormal profit in the short run but not in the long run?
If firms are making profit, then other firms will know as there is perfect knowledge, as all firms are profit maximizers they will enter the market as there are no barrier to entry or exit and thus the new firms will shift the supply (cost curves) up until there is no profit being made in the industry.
What efficiency is present in a perfectly competitive market?
They are statically efficient (allocative and productive) but not dynamically efficient as they do not earn supernormal profit in the long run, so they cannot reinvest.
What are characteristics of firms in a monopolistically market?
Many firms
No barriers to entry or exit
Slightly differentiated goods
Some degree of price setting power
Perfect
Why are the revenue curves in a monopolistic market downward sloping?
As goods are somewhat differentiated, in the short run the firm with the best profit will have price setting power, thus demand will not be perfectly elastic
What efficiencies are present in a monopolistic market?
Firms are not statically efficient but they are likely to be dynamically efficient. This is because by being dynamically efficient they will be able to earn short term super normal profit
What is an oligopoly?
This is where a few firms control most of the market share in an industry
What are the characteristics of an oligopoly?
Differentiated goods
Interdependence
Barriers to entry
high concentration ratio
Why is there a kink in the demand curve for oligopolies?
Oligopolies have a kink in their demand curve because when price is set at a certain point, if a firm was to increase its prices, they would be less price competitive so they would get outcompete so the proportional change in price will be smaller than the change in quantity demand, so the curve is elastic above the set price. But below this point, when a firm reduces its price, other firms will follow so there will be a minimal rise in QD therefore the proportional change in price will be larger than the change in QD so the demand curve is inelastic beyond this point. This explains why prices remain stable in an oligopoly.
What is the n-firm concentration ratio?
It is the percentage of market share the ānā largest firms in an industry own.
What is collusion?
This is when firms make agreements to reduce competition. When there is no collision it is a competitive oligopoly.
Why do firms wish to collude and why may some firms not collude?
Rather than being competitive, if firms come together and collude, they can maximise industry profits. In addition, it reduces uncertainty for firms as they know that they dont need to engage in price wars. Some firms may not wish to collude as collusion is illegal and if they have a unique business idea that sets them apart, they have a non price competitiveness over other firms, so they have no incentive to collude.
When does collusion work well?
Few firms
Stable market
Similar costs structures
Similar products
One distinct leader
High barriers to entry
What is the difference between overt and tacit collusion?
Overt collusion is when firms come to a formal agreement(cartel) , but tacit is when it is implied and there is no formal agreement.
How do cartels work?
Firms have the option of making agreements on price, or dividing up the market, however the more successful a cartel gets, the more tempting it is to cheat and break the cartels structure as large supernormal profits can be made by doing this.
What are the two ways tacit cartels work?
Price leadership and Barometric firm price leadership.
What is price leadership?
This is when there is one dominant firm, due to size or costs. in an industry that every other firm follows the dominant firm, as they do not wish to engage in price wars with this firm because they will loose.
What is barometric firm price leadership?
This is when one firm has a good ability to predict and track market trends so any decisions they make, other firms make as well.
What economic theory supports non collusive oligopolies?
Game theory
What is the Nash Equilibrium?
This is when both firms are in a better position than if they were to choose a different strategy but they could be in a better position if the other firm would change their strategy. This means neither firm has an incentive to change strategies and therefore prices remain stable.
What types of price competition exist?
Price wars
Predatory Pricing
Limit Pricing
What is a price war?
This occurs when non price competition is low and collusion is also difficult. Therefore firms frequently undercut each other.
What is predatory pricing?
This is when an incumbent firm sets their price deliberately lower than their costs to drive new firms out of the market, after which they will raise their prices. This is illegal and only works if the firm is large enough to sustain losses.
What is limit pricing?
This is when firms set their prices low, at a point between them making at least normal profit and a point where new firms are not able to set their prices at this level.
What are some non price factors?
Advertising
Brand Image
Loyalty Cards
Product Development
Customer Service
Quality
What efficiencies are present in an oligopoly?
Firms are likely to be statically inefficient but dynamically efficient
What is a monopoly?
A pure monopoly is when there is one sole seller of a good in an industry. A legal monopoly has at least 25% market share.
What are the characteristics of monopolies?
One firm has over 25% market share
High barriers to entry.
What is third degree price discrimination?
This is when a firm is able to divide a markets based on varying elasticities and charging different prices to different segments to maximize profit.
What are the costs and benefits of price discrimination?
Firms earn more profit
Consumers in the elastic market pay lower prices
Reduce inequality as without it they may not be able to afford the good or service
It reduces some consumer surplus
What is a natural monopoly?
A natural monopoly is one in which the economies of scale in an industry are so large that not even one firm can fully exploit them
What kind of efficiencies are present in a natural monopoly?
Not static but dynamic is possible if the firms want to reinvest
What are the cost and benefits of a natural monopoly on the firm?
They will have large amounts of profit
They will be able to exploit economies of scale and therefore have lower costs
Their size will allow them to be competitive overseas
They have supernormal profit for investment which can get them out of any short term financial struggles
However, the lack of competition may cause them to be X-inefficient
What are the costs and benefits of a natural monopoly on consumers?
The efficiency gains from economies of scale can get passed onto the consumer so they can benefit from lower prices
