4.1.5 competition/ types of market Flashcards
4 main market types from LEAST to MOST competitive
perfect comeptition
monopolistic competition
oligopoly
monopoly
market structure is characterised by
number of firms
degree of product differentiation
degree of barriers to entry
homogoneous
products are all same
when do firms breakeven
TR=TC
profits increase when
MC<MR
profits decrease when
MR<MC
why do firms choose to profit maximise
increase wages
increase dividends for entrepreneurs
to finance investments
total profits are maximised when
marginal profits = 0
what is the principal-agent problem/ divorce of ownership from control
agent makes decisions for principle
agents acts in his own interests
eg when an owner sells shares they loose some control over the business
could lead to decreased wages for manager to increase dividends for shareholders
OTHER objectives of the firm
survival (esp in times of recession)
growth- so can take advantage of EoS
quality, to build a reputation
maximise sales revnue (when MR=0)
sales maximisation, until make a loss
environmentally friendly
what is the satisficing principle
earning just enough to keep shareholders happy
managers may satisfice by earning enough profits to keep shareholders happy whilst still meeting other objectives
this occurs when their is a divorce of owenership from control
characteristics of perfect competition (8)
many buyers and sellers
sellers are price takers
free entry and exit of the market
perfect knowledge
homogeneous goods
short run profit maximisers
factors of production are perfectly mobile
no externalities (negative or positive)
advantages of perfect competition (6)
perfect knowledge
no barriers meaning max choice for consumers
normal profits in LR so consumers aren’t exploited
max consumer welfare as P=MC
allocatively efficient as P=MC
productively efficeint as in LR MC=ATC
disadvantages of perfect competition (3)
unrealistic model
normal profits prevent dynamic efficiency
economies of scale not accounted for in model
explain how perfect competiion can ONLY make losses/profits in the SHORT RUN
if firms are making supernormal profit due to perfect knowledge and no barriers new firms will enter the market (supernormal profit is the incentive)
increased supply of the good which decreases prices and also decreaess D=AR=MR as firms are price takers
now AR=ATC so firms are making normal profit in LR
(same for loss but firms leave)
in the long run in perfect competition
MR=AR=MC=ATC
why are firms price takers in perfect competition
if decrease price, losses
increase price, lose all customers to competitors
why do only SOME firms leave a loss making industry
if AR<ATC>AVC, firms can remain in the market as they can cover their variable costs and can decrease AFC by increasing sales
but if AR<AVC this is the shutdown price and it is no longer profitable to remain in the market so firms must shutdown</ATC>
characteristics of monopolistic competition (8)
short run profit maximisers
product differentiation however lots of close substitutes
large number of buyers and sellers
dilluted market
compete based on non price factors
no barriers to entry or exit
some degree of price setting power
imperfect information
example of monopolistic competition market
hairdressers
monopolistic competition in short run
in SR firms profit maximise at MC=MR
at this point AR>ATC so supernormal profit
D is downward sloping as it has a degree of inelasticity due to non price factors
monopolistic competition in long run
firms are attracted to market by supernormal profits
makes firms D more elastic which shifts it left
AR=ATC so normal profits
H/E firms can influence their elastcity using non price factors which can make them profitable
advantages of monopolitic competition
firms can make profit so can reinvest, dynamic efficiency
more consumer choice
more realistic model than perfect competition
disadvantages of monopolistic compeition
low profits in LR so dynamic efficiency is limited
less productively efficient as aren’t at bottom of ATC
waste leading to neg externalities
characteristics of oligopoly
high barriers to entry and exit
high concentration ratio (5 firm over 60%)
interdependence of firms
differentiate products via branding
oligopoly characterised by market conduct
how they compete
how they set prices
oligopoly characterised by market structure
number of firms
conc ratio
product differentiation
concentration ratio
combined market share of top few firms in a market
higher conc ratio = less competitive market
collusion
2 or more firms work together to set price or output levels in an anti comptitive way
more likely happen when less firms and higher barriers
cooperation
where firms work together for mutual benefit that does not harm the consumer or market
tactic collusion
dont specifically agree to collude
eg price leadership
hard to prove
example of cartel
canadian maple syrup
price fix
why may a cartel collapse
although a cartel may maximise joint profits
individual firms could even further increase profits by expanding output and undercutting cartel by a small margin
thus cartels are usually undermined and collapse
is collusion illegal
yes
what do firms collude on
price eg cartel
output eg restrict to drive up privces
information eg customer details
fine for collusion
up to 10% of annual turnover
however whistle blowing firm receives no firm
collusion case study- public schools
50 schools including eton and harrow
schoolboys hacked computer and found emails about fee collusion
they had put cartel way above inflation
fined 0.7% of annual turnover
impact of collusion on consumer
regressive
loss of consumer welfare
lack of transparency
unstable markets
kinked demand/sticky price theory
discontinuous MR curve so MR is not set and can be anywhere between A and B
thus if MC (MC=MR is profit max) stays between A and B no need change prices which would be admin costs
cartel
group of 2+ firms control prices, limit output or prevent new entrants
price leadership
dominant firm changes prices and other firms follow to maintain market share
price wars
firms constantly cutting prices below competitors leading to more price cutting
aim of non price comp
make good more inelastic
factors influencing price in oligopoly
maker/taker
interdependence
PED
output (high means low price)
barriers (high means high price)
factors influencing output in oligopoly
market share of firm
scope for economies of scale
shape of ATC (L shaped)
factors influencing investment in oligopoly
importance of tech in industry
change in tastes
ability to access funds
interest rates
factors influencing expenditure on research in oligopoly
risk
need for development
skill of workforce
factors influencing advertisement in oligopoly
degree of product differentiation
value of branding
profits to fund it
cost effectiveness
game theory conclusions
price rigidity at lower price both firms choose thus leading to non price comptition
temptation to collude to max both profits
BUT also temptation to undermine collusion to max profit further
advantages of oligopoly
supernormal profits can lead to dynamic efficiency
profits can lead to corp tax revenues
collaboration can increase industry standards
large oligopolies can be productively efficient
disadvantages of oligopoly
misallocation of resources
loss of consumer surplus
collusion reduces consumer welfare
collusion can increase monopoly power of existing firms meaning less entrants less efficiency drives up ATC
Oligopoly case study- UK supermarkets
5 firm conc ratio of 66%
compete on non price eg clubcard
race to bottom as shown in adverts
what is a monopoly firm
firm with over 25% market share
eg Tesco
characteristics of a monopoly firm
one firm
limitted product differentiation
high barriers
supernormal short and long run profits
price maker
non price competition
low productive and allocative efficiency
inelastic demand due to lack of substitutes
imperfect knowledge
barriers in a monopoly market
- legal, patents to stop competitors entering a market
- high capital and sunk costs
- economies of scale prevent small firms from competing on price
- predatory and limit pricing (P<MC as they can subsidise using LR profits)
- marketing or brand image
pure monopoly
firm with 100% market share
natural monopoly
gov or cma allow 1 firm to naturally supply market
eg National Grid
disadvantages of monopolies
- lack allocative efficiency
- lack productive efficiency
- organisational slack so X inefficient
- internal diseconomies of scale
- inelastic demand and lack of substitutes so firms set high prices reducing consumer surplus
- workers may have weak bargaining power
- use profits to pay expensive consultants and thus avoid taxes
advantages of monoplies
- supernormal profits can be used to subsidise areas of the business that would otherwise be expensive for consumers
- economies of scale, reduced ATC, could reduce prices to increase consumer surplus
- may help keep the UK competitive internationally
- can absorb price changes so priced remain fairly stable
- supernormal profits can be reinvested to increase dynamic efficiency
- increased corp tax revenues for gov
how can a monopoly be more dynamically efficient than a perfect competition firm
monopolist exploits their economies of scale giving them a lower marginal cost and thus they could reduce prices to increase consumer surplus
this is known as a dynamic monopoly
x inefficiency
producing above the ATC curve because of organisational slack and complacency from supernormal profits
characteristics of a natural monopoly
high ratio of fixed costs to variable costs
competition may be inefficient and cause waste
london underground as a natural monopolu
50% of income is from revenue and other half is from gov subisidies
why do natural monoplies need a subsidy
when they operate at AR=LRMC they are making a loss
what is price discrimination
charging different prices to different customers for the same product or service with prices based on willingness to pay
conditions necessary for price discrimination
- must be able to identify segments without excessive admin costs
- at any particular price different PEDs must be present
- seepage must be prevented such as buying in one submarket and reselling in another, undercutting firm
first degree price discrimination
priced at what customer is willing and able to pay
takes away consumer surplus
requires knowledge of customers
eg painter may base price of how expensive your cars look
seconds degree price discrimination
- charged quantity based with blocks of consumption, eg Q1 minutes of phonecall at P1 and subsequent Q2 minutes at P2
- sell spare capacity off at cheaper price, eg trains, originally at MC= MR and spare at P=MC
third degree price discrimination
inelastic eg buying on day, charged high price as they have no time to consider alternatives
elastic eg buying in advance charged low price as they will choose cheapest option
advantages of price discrimination
if dilligent consumers can gain lower prices
less waste
revenue can be reinvested for dynamic efficiency
protects market share
cover large fixed costs
disadvantages of price discrimination
loss of consumer surplus
fairness
loose loyal customers
segment leakage
issues of bounded rationality
admin costs
careful to cover MC
loss of allocative efficiency
static efficiency
how efficient the market is at the current output level
dynamic efficiency
the extent efficiency can improve over time
can be product innovation or process innovation
influenced by R and D, human capital and technological change
productive efficiency
firm operating at the lowest possible ATC
allocative efficiency
where overall welfare is maximised
P=MC
efficiency of LR perfect competition
productive
allocative
not dynamic as normal profits
efficiency of SR monopolistic competition
not productive
not allocative
dynamic
efficiency of LR monopolistic competition
not productive
not allocative
not dynamic as normal profits
efficiency of monopoly
not allocative
not productive
dynamic
efficiency of natural monopoly
allocative
not productive as LRATC is l shaped
not dynamic as making loss
long run benefits of competition
more productively and allocatively efficient because they provide goods and services that consumers want and competitive pressures force them to lower their CoP
short run benefits of competition
might make supernormal profits which can be reinvested back into the firm increasing dynamic efficiency and reducing LRAC
what non price factors do producers compete on
improve products
improve services
reduce cost
how to new firms overcome large firms with monopoly power
innovating
creative destruction
joeseph schuempter: idea that new entrepreuners are innovative which challeneges existing firms in the market, most productive firms will grow, least productive are forced to leave increasing productive potential
eg netflix innovated dvd subscriptions
tech change leads to development of new products, development of existing markets and destruction of existing markets
contestable market
new firms can challenge the status quo of incumbent firms and thus their is both actual and potential competition
entrants have free access to production techniques and technology
no significant entry or exit barriers such as sunk costs
low consumer loyalty
implications of contestable markets for firm behaviour
more likely to be allocatively and productively efficient
firms very aware of hit and run competition
perfect competition style
supernormal in SR normal in LR however firms tend to earn normal in SR to prevent competition
barriers to entry
aim to block new entrants to the market
eg
- economies of scale
- legal barriers eg patents
- consumer loyalty or branding
- predatory pricing
- limit pricing
- vertical integration
- brand prolyeration
predatory pricing
low prices to drive out firms already in the industry, as the firms leave old firms regain revenue
limit pricing
p<ac of new firm
so new firms cannot compete
vertical integration
one firm gains control of stages of supply chain and prevents other frims from using it
brand proliferation
occurs when a large company acquires or absorbs multiple smaller brands in similar market areas so disguises customers from the saturation of the market
barriers to exit
prevent firms from leaving a market quickly and cheaply
- cost of writing of assets and primary leases as sometimes it would be cheaper due to contracts
- costs of redundancy
sunk costs
costs that cannot be recovered once spent eg advertising
consumer surplus
difference between what consumer is willing/able to pay vs the price
inelastic demand will increase
decrease in supply will increase
producer surplus
price their willing to charge vs what they charge
economic welfare
total benefit society recieves from an economic transaction
producer + consumer surplus
