4.1.5 Perfect Competition, Imperfect Competition and Monopoly Flashcards
What is each market characterised by?
- number of firms in market
- level of knowledge
- barriers to entry
- degree of product differentiation
Barriers to entry
Things which prevent potential competitors from joining an industry
Types of barriers to entry
- sunk costs
- capital costs
- scale economies
- legal barriers
- marketing barriers
- limit pricing
Barriers to exit
Things which prevent firms from leaving an industry
Types of barriers to exit
- cost and time of making employees redundant
- selling premises and stock
- notifying customers and suppliers
- might be in contract right another firm
Why do firms profit maximise?
- provides greater wages and dividends for entrepreneurs
- retained profits are a cheap source of finance
- in the SR the interest of the shareholders is important
Where does profit maximising occur?
Where MC=MR
Divorce of ownership and control
This is where the people running the business have conflicting views on the objectives of the firm
Where does sales maximisation occur?
When AC= AR
Where does revenue maximisation occur?
Where MR=0
How might owners try to get managers to profit maximise
Give them a profit related bonus or give them shares in the business
Profit satisficing
When the managers earn just enough profit to keep the shareholders happy
Characteristics of perfect competition
- no barriers to entry
- homogeneous goods
- lots of tiny firms
- perfect knowledge
Advantages of perfect competition
+in the LR there is a lower price, so there is allocative efficiency
+there is productive efficiency
+abnormal profits in SR might increase dynamic efficiency through investment
Disadvantages of perfect competition
- in the LR dynamic efficiency might be limited due to lack of abnormal profits
- subdues firms are small there are no economies of scale
- perfect competition never acc occurs
Explain how a firm in perfect competition receiving abnormal profits would do in the long run
- in the SR the firm makes abnormal profits
- new forms are incentivised to enter the industry
- they enter due to lack of barriers
- this causes supply in the industry to shift right
- this drops price
- firms are price takers so must take it
- a new demand curve is created
- profit is now normal
Characteristics of monopolistic competition
- low barriers to entry
- lots of small firms
- good knowledge
- some product differentiation
Explain what happens to a firm making abnormal profits in the SR in monopolistic competition
- in the SR abnormal profits are made
- firms are attracted to the market
- they enter due to low barriers
- this shifts the other firms demand curves inwards since they have a smaller market share
- AR now =AC so normal profits are made
How might a firm in a monopolistic market try to keep abnormal profits in the long run
By differentiating their product and branding (non price competition)
Characteristics of oligopoly
- high barriers to entry
- imperfect knowledge
- a few dominant firms
- differentiated product with strong branding
Collusion
When firms agree to work together to set prices or restrict output
Overt collusion
Formal agreement between firms
Covert collusion
No formal agreement but collusion is implied
Explain why the oligopoly demand curve is kinked
A raise in price has an elastic response in demand because other firms keep their price low.
A cut in price has inelastic response in demand because other firms follow
Why don’t oligopolists price compete?
Because of the kinked demand curve, changing price causes a loss in total revenue
Advantages of oligopoly
- abnormal profits can be reinvested and make firms dynamically efficient in LR
- firms are more likely to innovate if they can protect their ideas
- higher profits could be a source of government taxation
- firms can collaborate on technology
- economies of scale could lower prices
Monopoly characteristics
- high barriers to entry
- single firm in the market
- only product in market
- low levels of knowledge
How is monopoly power gained?
- barriers to entry
- number of competitors
- advertising
- product differentiation
Disadvantages of oligopoly
- higher prices and inefficiency lead to misallocation of resources
- if firms collude there is a loss of consumer welfare
- collusion could lead to monopoly power and so less competition and less efficiency
Disadvantages of monopoly
- misallocation of resources
- monopolies could exploit consumers by charging higher prices, the food is under consumed and there’s a market failure
- monopolies have no incentive to innovate
- loss of consumer surplus
- no choice for consumers
Advantages of monopoly
- abnormal profits could be used in research and development to make the firm dynamically efficient
- firms are more likely to innovate if they can protect their ideas
- if there is a natural monopoly it is more efficient than having more firms
- economies of scale
- high profits could be a source of government revenue through taxation
Price discrimination
When the monopolist sells identical goods or services to different customers for different prices, for reasons not associated with cost
Conditions necessary for price discrimination
- Firm must have a degree of monopoly power
- Monopolist must be able to segment the market and prevent buying and selling between segments
- The different segments just have differing elasticities of demand
1st degree price discrimination
When each consumer is charge a different price
2nd degree price discrimination
Selling of excess capacity
3rd degree price discrimination
Charging different prices for different segments
Costs and benefits of price discrimination for consumers
+consumers could benefit from net welfare gain as a result of criss subsidisation
+some consumers who previously couldn’t afford the good now can
- price discrimination usually results in loss of consumer surplus
- it strengthens the monopoly power in firms which could result in higher prices in the LR
Costs and benefits of price discrimination for producers
+producers make better use of spare capacity
+higher abnormal profits could help stimulate investment
- if it is used as predatory pricing method the firm could face investigation
- it might cost the firm to divide the market
Benefits which result from competition
- in LR firms are more productively and allocative you efficient
- in SR firms might make abnormal profits which can be reinvested, increasing dynamic efficiency
- consumers get lots of choice of high quality goods
Examples of non price competition
- improve products
- reduce costs
- customer service
Characteristics of contestable markets
- face actual competition
- entrants have access to production techniques
- no significant barriers to entry
- low consumer loyalty
- number of firms in market varies
Hit and run competition
Firms can enter the market take abnormal profits and then leave due to the low barriers of entry
How do firms behave in a contestable market?
- they are allocatively efficient and productively efficient in LR
- threat of new entrants means existing firms only make normal profits so they don’t attract other firms
Vertical integration
When one firms gains control of more if the market and could gain control of important technology. This might prevent other firms entering the market and is a barrier to entry
Brand proliferation
When firms saturate the market with their goods but disguise them so consumers don’t know the actual market concentration. (The many brands of laundry soap are provided by only a few large conglomerates)
Static efficiency
Describes the efficiency at one point in time
Dynamic efficiency
New technology and increases in productivity which causes efficiency to increase over a period of time
Productive efficiency
When firms minimise their average total costs (when AC=MC)
Allocative efficiency
When resources are distributed to the goods and services that consumers want. This maximises utility. (When P=MC)
X inefficient
When firms have average costs over the level they should (monopolies tend to be x inefficient)
Where is consumer surplus on a diagram
Above the market price and below the demand curve
What does an outward shift to demand do to consumer surplus
Increase it
What does an inward shift in supply do to consumer surplus
Decrease it
Where is producer surplus on a diagram
The area below market price and a over the supply curve
What does an outward shift in supply do to producer surplus
Increase it
What does an outward shift in demand do to producer surplus
Increase it
Economic welfare
Producer surplus + consumer surplus
