4.1.1 spectrum of competition Flashcards
What are the characteristics of a monopoly? [5]
- Profit maximisation. A monopoly earns supernormal profits in both the short run and the long run
- Sole seller in a market (pure monopoly)
- High barriers to entry
- Price maker
- Price discrimination
When does a firm in the UK have monopoly power?
When they dominate the market with more than 25% market share.
What is monopoly power influenced by? [4]
- Barriers to entry
- Number of competitors
- Advertising
- Degree of product differentiation
What are some barriers to entry that influence monopoly power? [6]
- Economies of scale; large firms have cost advantage and deters firms from entering the market
- Limit pricing; existing firm setting price of good below production costs of new entrants to make sure they cannot enter profitably
- Owning a resource; early entrants can establish monopoly power by gaining control of a resource
- Sunk costs; if these are high, new firms will be deterred
- Brand loyalty; consumers who are loyal to a brand makes it difficult for new firms to gain market share
- Set up costs; if it is expensive to establish a firm, then new firms will be unlikely to enter the market
How do barriers to entry influence monopoly power?
The higher the barriers to entry, the easier it is for firms to maintain monopoly power.
How do number of competitors influence monopoly power?
The fewer the number of firms, the greater potential for a firm to exert monopoly power as there is less pressure to lower prices.
How does advertising influence monopoly power?
Can increase consumer loyalty, making PED inelastic and creating a barrier to entry.
What are the characteristics of an oligopoly? [6]
- High barriers to entry + exit
- High concentration ratio
- Interdependence of firms
- Product differentiation
- Heterogenous goods
- Potential for collusion
What is the characteristics of a perfectly competitive market? [7]
- Many buyers and sellers
- Sellers are price takers
- Free entry to and exit from the market
- Perfect knowledge
- Homogeneous goods
- Firms are short run profit maximisers
- Factors of production are perfectly mobile
Why are profits likely to be lower in a competitive market?
Because each firm has a very small market share, and so market power is very small. If firms make a profit, new firms will enter due to low barriers to entry and the incentive of a profitable market. The new firms will increase supply in the market, lowering average price.
In the short run they can make supernormal profits, but in the long run they are competed away and so only normal profits are made.
What are the advantages of a perfectly competitive market? [3]
- Long run there is a lower price. P = MC so there is allocative efficiency
-Since firms produce at the bottom of the AC curve, there is productive efficency - Supernormal profits produced in the short run might decrease dynamic efficiency through investment
What are the disadvantages of a perfectly competitive market? [3]
- In the long run, dynamic efficiency might be limited due to lack of supernormal profits
- Since firms are small, few or no economies of scale
- Assumption of the model rarely apply in real life. In reality, branding, product differentiation, adverts and positive and negative externalities mean competition is imperfect
What are some pricing strategies? [6]
- Cost plus
- Price skimming
- Penetration
- Predatory
- Competitive
- Psychological
What is cost plus pricing?
Calculating price based on the mark up on unit cost.
When might a retailer use cost plus pricing?
When a retailer wants to know the gross profit margin of a sale in advance.
What is a benefit of cost plus pricing?
Retailer reduces the uncertainty of profits, since they know costs will be covered if they can sell the good.
What is a negative of cost plus pricing?
It could lead to a fall in the quantity, the revenues and profits and market share of the firm since the price is uncompetitive.
What is price skimming?
Setting a high price temporarily before competitors enter the market, and then decreasing it once the market becomes more concentrated.
When is price skimming most commonly used?
When a new product is launched, mostly in technology where it has changed or a product is more distinctive.
Why is price skimming only used in the short term?
Because the high profits earned in the market act as a signal to other firms to enter the market, so competition increases.
What is penetration pricing?
Setting a low price initially, below the intentional price, in order to attract customers.
What does penetration pricing aim to encourage?
Customers to switch to the brand since the price is low, and once consumer loyalty is gained, and price is increased again.
What is predatory pricing?
Setting low prices to drive out firms already in the industry. In the short run it leads to them making losses, but as firms leave the remaining firms raise their prices to regain revenue.
This reduces contestability.
What type of firms are most likely to use predatory pricing?
Firms with monopoly power to weaken potential competitors.
When is competitive pricing used?
When the products are similar.
What are some factors that determine the most appropriate pricing strategy? [3]
- Number of USPs
- PED
- Stage in product life cycle
