4.1.5 Market Structures Flashcards
What is a barrier to entry?
Any obstacle that prevents a new firm entering a market.
What are the 6 barriers to entry?
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Economies of Scale - A new firm can be priced out by large firms experiencing EOS as they have much higher costs
High Start Up Costs - Deterring new firms to take the risk
High Sunk Costs - These are the costs that are not recoverable when the firm leaves the market, this can act as a deterrant, reducing competition
Legal Barriers - I.E Patents, regulations etc.. the higher the legal barriers, the lower the inscentive
Strategic Barriers - For example predatory pricing, where incumbent firms charge lower prices (maybe even loss making) for a short period of time in order to drive out new compeition. As the larger firm can afford to do so.
The existence of a threat of such strategies acts as a deterrant.
Brand Loyalty - It is risky to enter a market where consumers are loyal to big brands. Newer, smaller firms may not be able to compete with the same scale of marketing to create awareness for their own products.
What are the 3 barriers to exit?
Sunk Costs - Such as redundancy costs, it may prevent a firm leaving an industry and choose to continue operating instead
Sale of Assets - If a firm is unable to sell assetts at an adequate price, they may chose to continue operating to minimise costs.
Contractual agreements - Firms contracts for water, gas and electric may come with large cancellation fees therefore a firm may continue operating until the contracts are through.
What is profit maximisation?
Profit maximisation occurs where Marginal Cost is equal to Marginal Revenue, this will be at the level of output where total cost - total revenue is at its greatest.
It is assumed to be the primary objective of private busineses in a market economy.
Why is profit maximisation assumed to be the primary objective of private businesses in a market economy?
Because of IRBP without the P.
Roles of profit =
Investment = Profit acts as both an inscentive to invest and a means of investment.
Retained profit - Investment - Furhter improvement of profitability - Dynamic Efficiency - Macro benefits -SR/LR growth - providing jobs - improve international competitiveness.
Reward = Profit rewards risk taking entrepeneurial behaviour and shareholders. Benefits economy as entrepreneurs create jobs, new products, competition etc..and shareholders keep investing their money into business, improving profitability etc..etc.
Benefit Consumers = Profit motivated business aim to minimise costs, increase x efficiency, meet consumers wants and needs, exploit EOS, promote dynamic efficiency….Consumers gain from lower prices, higher consumer surplus and greater quantity and quality.
What are the 3 evaluation points when assessing the view that profit maximisation should be the main objective of private businesses in a market economy?
see essay plan on ‘Objectives of firms’ for full detail
1) Knowledge of MC and MR may be imperfect, however diff strategies can be used to attempt profit maximisation such as ‘cost plus pricing’
2) Large supernormal profits may lead to investigations by regulatory bodies
3) Might not be best strategy as business may have other goals that require different objectives in the SR
For an essay on The Objectives of a Firm, what 1 primary and 4 alternative objectives will you talk about?
-Profit maximisation
-Profit satisficing
-Revenue maximisation
-Sales maximisation
-Allocative Efficiency
What is profit satisficing? Why would it be used?
Sacrificing profits in order to satisfy as many stakeholders as possible, as profit maximisation can benefit stakeholders such as shareholders but can harm other key stakeholder groups:
Consumers, workers, enviromental groups, governments.
A firm may choose to sacrifice some supernormal profits in order to avoid costly disputes in the future.
What is revenue maximisation? Why would it be used?
Revenue maximisation is producing where MR = 0. Would be used for:
- Predatory pricing
-Producing at higher quanitity to gain EOS, lower AC and in the future maintain these lower prices and increase market share whilst making profit
-Divorce between ownership and control - managers may wish to maximise revenue to gain beenfits from their work as on paper high revenue figures reflect well on manager
What is sales maximisation? Why would it be used? (6 reasons)
Producing where AC = AR
Supplying largets output possible while earning at least normal profit.
1) Flood the market, increase brand awareness / loyalty
2) Achieve EOS, lower AC
3) Divorce of ownership and control
4) Limit pricing to disinscentivise competition
5) Survival
6) CSR, improve brand reputation
What is Allocative Efficiency and why would it be an alternate objective of a firm?
AE = Producing where price (AR) = MC, so where Demnd = Supply meaning consumers are getting goods/services at the exact quantity they desire.
-This would be done to meet consumer needs perfectly and get ahead of rivals, increasing market share and eventually switching back to profit maximisation
On a diagram, where does the following occur: (objectives of firms essay)
-Profit Maximisation
-Revenue Maximisation
-Allocative Effeciency
-Sales Maximisation
-Profit Satisficing
-Profit Maximisation: MC=MR
-Revenue Maximisation: MR=0
-Allocative Effeciency: AR=MC
-Sales Maximisation: AC=AR
-Profit Satisficing: Along the AR curve between Profit Maximisation and Sales Maximisation
What is Allocative Efficiency? What are its benefits?7 points.
- Where AR (price) = MC / where supply meets demand
- Maximising the sum of both producer and consumer surplus
- Feature of a highly competitive industry
- Consumers are getting what they demand at the exact quantity they desire, resources are being allocated with consumer demand
-Consumer choise is high, prices are low, increasing consumer surplus
-Quality is also high to meet the needs and wants of consumer - Producers benefit from getting ahead of rivals
What is Productive Efficiency? What are its benefits? 5 points.
- Lowest point on AC curve, so where MC = AC
- Means all possible EOS are being exploited as firms cannot increase output and lower AC any further
- Lower AC may translate into lower prices for consumers, greater consumer surplus
- Lower AC will lead to higher levels of supernormal profit over time for the producer
- Can lead to increases in market share if EOS allow out pricing of rivals
What is Dynamic Efficiency? What are its benefits? 6 points.
-DE occurs when a firm is making supernormal profits in the long run and is able to reinvest those profits back into the business in the form of technology advances, innovation and RnD.
-Beneficial for consumers as they get better products over time
-Beneficial for consumers as they may pay lower prices if advances in technology can reduce costs of production and the firm passes these lower costs onto consumers
-Beneficial for conusmers as they have more choice
-Beneficial for producers as they can gain monopoly power through patents, increasing profit, and innovative products can increase market share
-Beneficial for producers as new technology can reduce costs of production and they can become more profitable
What is X Efficiency? What are its benefits? 4 points
- X Efficiency refers to waste, it occurs when a firm is producing on the average cost curve at any given quantity level
- They are minimising there unit costs and there is no waste in production
- For highly compettive firms, being X-efficient is crucial to keep costs down and charge lowest prices, increasing consumer surplus
- Lower AC can lead to greater supernormal profits made overtime and increases in market share if lower prices are charged than rivals
What are consequences of Allocative Inefficiency? (4 points)
-Charging prices greater than marginal cost
-Resources are not allocated according to conusmer demand, getting a lower Q than they desire
-Consumer choice is restricted and prices are high, reducing consumer surplus
-Quality may suffer if there is a lack of competitive forces
What are consequences of Productive Inefficiency? (3 points)
-Not producing at min.point on AC curve, voluntarily forgoing EOS
-Consumers suffer from higher prices and lower consumer surplus than if all EOS were exploited
-Lack of competition in a market allows firms to get away with it
What are consequences of Dynamic Inefficiency? (5 points)
-When supernormal profits are not being made to be reinvested back into the business
-Over time consumers lose out with no technology advances or innovative new products, reducing their choice and preventing price falls in the future
-For producers, their profit making potential reduces withou RnD and innovation as new products could have been patentable granting monopoly power.
-New products could have increased market share, crucial in a competitive industry
-Better production technology could have reduced costs of production over time
What are consequences of X Inefficiency? (3 points)
-Allowing waste in the production process, cost in excess of AC
-Consumers suffer from higher prices and lower consumer surplus than if all waste was erradicated
-This occurs when the reality of minimising waste is tedious for a business and there is a lack of competition in the market
What 7 points do we cover on an essay question about Perfect Competition?
- Characteristics
-SR = supernormal profits / LR = normal profits
-Why SR wont last
-Shutdown condition
-Pros of LR
-Cons of LR
-Evaluation of LR
What are the characteristics of perfect competition? (5)
-Infinite buyers and sellers
-Homogenous goods and services, price takers
-No barriers to entry and exit
-Perfect information for consumers and producers
-Firms are profit maximisers
Difference between SR and LR in perfect competition
SR = Supernormal or subnormla profits are being made
LR = Normal profits are being made
Why wont supernormal profit last in perfect competition?
essay plan
essay plan
INCLUDE LR STABLE EQUILIBRIUM
Why wont subnormal profit last in perfect competition?
essay plan
essay plan
What is the basic shutdown condition in perfect competition?
If a firms AVC > AR they should shut down
If a firms AR > AVC they should continue producing
Explain the shutdown condition in perfect competition using a diagram.
essay plan
essay plan
What are the long run performance pros of perfect competition? (3)
-AE
-PE
-XE
What are the long run performance cons of perfect competition? (4)
Explain each one using essay plan
-DIE
-Lack of EOS
-Cutting costs in undesirable areas
-Creative destruction
What are the evaluation points for perfect competitions long run performance? (2)
-Static VS Dynamic Efficiency, maybe DE and product differentiation is prefered?
-There may actually be DE, as firms may be forced to re-invest profits in order to compete
