3.4 market structures, contestability Flashcards
four characteristics of a perfectly competitive market
- homogenous goods
- perfect knowledge amongst consumers and producers
- no barriers to entry
- large number of buyers and sellers
give two examples of markets that are perfectly competitive
- foreign currency
- commodities
what other assumptions do we make about firms in competitive markets
there are no economies of scale and no externalities
draw a diagram showing a firm in a perfectly competitive market in the short run and long run
SHORT RUN:
diagram one on left:
S, D diagram with price level through equilibrium
second diagram:
same price level
MC going up, intersects AR = MR at A
ATC curve
supernormal profits labelled from bottom of ATC curve to Price level
LONG RUN:
1st diagram - 1 D curve, two S curves shifting outwards. New equilbrium is new price level (AR = MR)1.
2nd diagram - same as short run but with AR = MR shifting downwards. P shifts down to p1. ATC, Mc curve as normal
two reasons why perfect competition is thought to be the most desirable market structure
in perfect competition the consumers have perfect choice and low prices. firms in perfect competition are efficient as they are competing against many other firms all selling identical products
two reasons why the assumptions behind the model of perfect competition are unrealistic
- there is no such thing as perfect knowledge
- economies of scale might exist to some extent
- externalities might exist to some extent.
there will therefore be some barriers to entry no matter how big they are
in what circumstances might perfect competition not be desirable
in markets where research and development are important e.g. in tech or pharmacy industries. the fact that only normal profits are made will be an issue as there will be no funds available for investment, making dynamic efficiency impossible.
also, in markets where EOS are so great that no firm can fully exploit them it will be more efficient for there to be only one firm rather than many small firms
define monopolistic competition
when a market is close to perfect competition, but products are slightly differentiated
name 4 assumptions associated with a monopolistic market structure
- differentiated products
- large number of buyers and sellers
- near perfect information amongst byers and sellers
- low barriers to entry
can firms in a monopolistic market structure make supernormal profits in the long run and short run?
firms can make supernormal profits in the short, but not in the long run as firms will enter the market due to low entry barriers, and compete away all the profits
are firms in monopolistic competition productively and allocatively efficient in the short and long run
neither
draw a diagram showing the short run and long run equilibrium under monopolistic competition
diagram in notes
what is meant by a 3-firm concentration ratio
the total market share of the 3 largest firms in a market
what does it mean if a firm has a high concentration ratio
the market power is concentrated amongst a few larger firms, so the market is therefore less competitive
3 examples of markets with high concentration ratios
the telecoms, banking and electricity ratios e.g. monopoly, duopoly and oligopoly markets have high market concentration
how do you calculate a concentration ratio
if waitrose has 25% market share, Morissons have 30% market share and Tesco has 15%, the 3 firm conc. ratio is 70%
what is meant by product differentiation
when a firm makes its product design, features, or brand perception slightly different from its rivals
in what way is a pizza hut pizza differentiated from a pizza express pizza
pizza express has more special ingredients and products than pizza hut, it is targeted at more affluent consumers
in what way is an iphone differentiated from a nokia
sleeker design, different design features branding to make products distinctive
define oligopoly
a market structure with a few large firms dominating a market
give 4 examples of 4 oligopolistic firms and name the main companies
- Banks (Lloyds, Barclays, Natwest, HSBC)
- Airlines (British Airways, Virgin, Quantas, American Airlines)
- Supermarkets (tesco, sains, morrisons, waitrose)
- mobile phone (apple, samsung, nokia, sony)
is the concentration ratio in an oligopolistic market high or low
high
characteristics of oligopolistic market
- interdependence
- high concentration ratio
- differentiated goods
- high barriers to entry
- few firms
behaviours observed in an oligopolistic market
non-price competition and collusion
what is meant by non price competition and what are 3 types of it
competing but avoiding direct price comparisons. e.g. advertising, comparisons in quality of product, collusion
whats a cartel
when more than one firm get together and behave as if they were one firm
example of a cartel
OPEC (oil and petrol exporting countries)
what is meant by price leadership
when one firm is dominant in a market and when it changes price, all other competitors follwo them regardless of whether it is a price rise or price fall.
give an example of price leadership
British Gas - when they raise prices, other companies in the UK energy sector follow suit
what is meant by collusion
when firms share information and agree not to compete
name 2 different ways firms can collude
price collusion or output collusion e.g. all agree to keep prices high, or agree to carve up the market for a product by agreeing who gets which customers
give 2 examples of firms found guilty of collusion
Virgin and BA colluded on the fuel surcharge on flights ,and the main supermarkets colluded on the price of cheese and other dairy products
why is collusion against the public interest
as firms are explicitly agreeing not to compete with each other which can means a higher price for consumers, or lower quality products/services and less choice
what factors increase the likelihood of collusion in an industry
- the fewer the firms in the industry, the easier it is to come to an agreement
- the more mature the industry, the more likely the employees at different firms will know each other and collude
what is meant by a price war
When one company drops price, and others follow suit, causing the first firm to drop price again and the process continues until either all companies give up, thus returning to the original price, or one/many companies surrender. a price war is generally damaging to all firms and they usually seek to avoid it.
what does interdependence mean
when the actions of one firm in a market affects the other firms in that market
how does interdependence create uncertainty in oligopolistic markets
because it means that firms are unsure about the outcome of actions that they take, as they cannot be sure what their competitors reactions will be. this makes firms seek low risk strategies such as competing using non-price methods.
what are the assumptions behind the kinked demand curve
assumes interdependence, and that when a firm raises price, others don’t follow suit, but when a firm drops price, others do follow suit.
draw a kinked demand curve
in notes
use the kinked demand curve theory to explain why prices tend to be stable in an oligopolistic market
if one firm raises price, others wont. this firm loses market share and revenue as demand is elastic for a price rise, meaning consumers will switch to another firm. if one firm reduces price, others will too, so the firm does not gain market share and will lose revenue as demand is inelastic here. therefore the best option is to keep prices stable
what is game theory
the study of strategies used to make decisions. it is used to analyse and evaluate the actions of firms in an oligopoly e.g. price levels or advertising.
how can game theory be used to explain why firms in an oligopoly:
- keep prices stable
- undertake seperate research and development projects
- both undertake big advertising campaigns
as seen in the matrix, the best outcome is if both firms charge a high price (bottom right corner). however there is an incentive to cheat on the arrangement for short run profits
according to game theory, how might co-operation and collusion improve the outcome for firms
if firms collude then they can formally agree to maintain the bottom left corner so that the best option can be maintained
with reference to game theory, explain why collusive agreements often break down
there is always an incentive to make short run profits by undercutting or breaking the agreement, particularly if they are a whistleblower. if they act as a whistle blower, they can often avoid a fine, so they can access the high payoff in the short run without financial penalty. however, this still does not solve the issue that when the collusion breaks down, both firms end up in the top left quadrant.
what is meant by a price maker
a firm that has some control over the price they charge because they have differentiated products
give 3 examples of firms considered price makers
coca cola
apple
microsoft
what is meant by a price taker
a firm that has no control over the price as they must charge the market price for a homogenous product
give 3 examples of firms considered price takers
farmers, currency dealers, mines selling raw materials
4 characteristics of a monopoly market
- price makers -> as the product is unique, then they have control over the market price
- very high barriers to entry -> new firms find it hard to enter the market meaning the monopoly is able to make supernormal profits
- products are unique -> they are the only (or dominant) firm in the market
- only one firm in the market -> 25% market share and no close rivals. or in a pure monopoly, they are the only company
3 examples of monopoly markets
1st and 2nd class mail in UK
water companies such as Affinity water
Train operating companies such as SE trains
draw a diagram and explain how output and pricing decisions are made in a monopoly market
diagram in notes (microsoft onenote)
MC, ATC, AR and MR curves with supernormal profit area labelled
give three reasons why monopolies are opposed
- they exploit customers and charge a higher price than competitive firms, causing a loss in consumer surplus
- they are not productively efficient due to high barreirs to entry and there is only one firm in the market, so they don’t have to keep their costs low. (both above inefficiencies lead to a deadweight loss of monopoly as seen in notes, showing the loss in consumer surplus as a result of higher prices)
- monopolies don’t have incentive to offer choice or good customer service, meaning customers don’t have good welfare
define price discrimination
when a firm charges a different price for the same product in a different market.
3 examples of price discrimination
- peak and off-peak rail travel
- discounts for students and senior citizens in shops
- retail outlets at motorway service stations charging more for products than on the high street
3 conditions for successful price discrimination
- must have different elasticities in each sub-market
- must be able to prevent arbitrage between each sub market.
- > markets can be seperated by time (peak and off peak)
- > age
- > gender
- > geography
- must be able to identify which market each customer is in in order to charge the appropriate tariff
draw a diagram and use it to explain why a profit maximising monopolist will price discriminate.
diagrams in notes.
inelastic submarket -> elastic submarket -> industry
a profit maximising monopolist will price discriminate as the total profit in the two sub-markets adds up to more than the profit made without splitting the market. this is because a price rise in an inelastic market will increase revenue, and a price fall in the elastic market will also increase revenue, leading to more profit overall
identify and explain 2 benefits to producers from price discrimination
- increased profit as the sum of the profits in the two sub-markets adds up to more than the profit in the combined market
- increased revenue as there is a price rise in an inelastic market and a price fall in an elastic market. consumer surplus is taken away and converted into producer surplus as each consumer pays closer to the maximum they are willing to pay
identify and explain 2 benefits to consumers from price discrimination
- lower prices in the elastic market will increase the consumer surplus in this market
- some loss making services can be continued by using the profit in the inelastic market to cross-subsidise the elastic market allowing some customers to continue to enjoy the good/service even though it is loss making.
define consumer surplus
the difference between what the consumer wouldve paid and the amount they actually pay (area below demand curve and above equilibrium price)
define producer surplus
difference between what a producer would have accepted and what they actually received (Area above S curve and below eq price)
draw a diagram to illustrate consumer and producer surplus
consumer on top
producer on bottom
what is the impact on consumer and producer surplus of price discrimination
it converts consumer surplus into producer surplus
what is the impact on consumer surplus of monopoly compared to competitive markets
as monopoly results in higher prices for consumers, this means that consumer surplus is lower in monopoly markets than in competitive markets
define and give 3 examples on natural monopoly
when economies of scale are so great that no single firm can fully exploit them. examples are water companies, phone and mobile phone networks, rail networks
draw a diagram to illustrate the cost and revenue curves of a natural monopoly
in. notes
is it efficient for the to be only one firm in a natural monopoly
in a natural monopoly it is most efficient for there to be only one firm in the market
what should the role of the government be in intervening in these markets
in a natural monopoly, the government should allow these monopolies to continue, but regulate them so they arent exploiting customers.
what is a contestable market
one where the barriers to entry and the cost of exit are low - new firms can enter and leave the market with ease
what impact does contestability have on performance of firms in an industry
if a market is perfectly contestable then incumbent firms will have to remain efficient in order to protect themselves from ‘hit and run’ competition. these firms are therefore more productively and allocatively efficient, and will only make normal profits in the long run to deter entrants
what is meant by sunk costs
costs that cannot be recovered upon exiting a market. this increases the risk of entering a market if there are high sunk costs as there is a high cost of failure.
give two examples of sunk costs
advertising
rent
what is meant by ‘hit and run competition’
disruptive firms who enter a market to take advantage of supernormal profits, undercut the current firms and then leave once the supernormal profits have been eroded.
if a market if perfectly contestable, what can be seen here
- low levels of supernormal profit
- high degree of price competition
- low brand loyalty
- cost cutting activities
- new firms joining and existing firms leaving the industry
what factors make a supermarket industry contestable
some price competition e..g from ALdi
new firms have entered the market
falling profits
what factors make a supermarket industry less contestable
some brand loyalty
relatively high profits still being made
high barriers to entry such as purchasing economies of scale.
what is meant by a barrier to entry
something that makes it more difficult for a firm to enter a market
name 5 different barriers to scale and how they’re effective
- economies of scale - as new firms would have to enter a market on a high level of output to compete on costs, which is difficult
- brand loyalty - new firms would find it hard to tempt customers away from the incumbent firms
- high start up costs - new firms may find it hard to secure finance to fund the start up costs
- patents - new firms cannot copy the product and so are blocked from entering the market legally
- regulations - these can increase start-up costs and put people off entering the market, especially if the regulations are changed regularly. also, the number of firms in the market may be limited so new firms may not be able to enter
- limit pricing - incumbent firms who are enjoying large economies of scale can choose a price that allows them to make a supernormal profit, but is low enough that new firms entering the market could not compete on price unless they enter the market on a high level of output.
