4.1.5 Perfect competition, imperfectly competitive markets and monopoly Flashcards
Explain what the Business Objective of Profit Maximisation is.
MC=MR
Profit Maximisation: Firms seek to attain highest level of profit possible from production of goods + services
In traditional economic theory, always assume main objective of firms is to max profit.
Explain why a Firm may have the Objective of Profit Maximisation.
- Re-Investment- if business is making large profits, can re-invest that profit back into business in form of: new capital, upgraded capital, new tech, e.t.c.
- Greater Dividends for Shareholders: reward shareholders (owners) with a greater share of the profits
- Lower Costs + Lower Prices for Consumers- consumers + business benefits; market share increases
- Reward Entrepreneurship- reward for risk-taking activity when business starts up
Explain why a Firm may not have the Objective of Profit Maximisation.
- No knowledge of MC + MR
- Avoid scrutiny
- Key stakeholders may be harmed
- Other objectives may be more appropriate
Explain what the Business Objective of Profit Satisficing is.
- Sacrificing profit to satisfy as many key stakeholders as possible
- Occurs where firm isn’t operating at its profit maximising level
Explain why a Firm may have the Objective of Profit Satisficing.
If stakeholders aren’t happy with the Objective of Profit Maximisation:
- Consumers: If harming consumers, business may gain a bad reputation
- Workers/TU’s: if workers are harmed via profit maximisation- may strike
- Gov: if gov are unhappy, may investigate the business + outcomes may be very anti the business’ interests
- Environmental Groups: May protest if unhappy
Explain what the Business Objective of Revenue Maximisation.
MR = 0 (as firms can continuously increase revenues, as they can sell another unit for more than £0)
Explain why a Firm may have the Objective of Revenue Maximisation.
- Economies of Scale- Revenue maximisation quantity > profit maximisation quantity. Greater growth, greater economies of scale, lower AC, lower prices for consumers
- Predatory pricing- revenue maximisation pricing < profit max pricing; where a firm under-cuts a rival on purpose, sacrificing profit in order to drive competitors out of the market
- Principle Agent Problem- divorce between ownership + control; those who own don’t control. Managers whom control business may choose to revenue max, to use that as leverage to go to shareholders for greater perks in their job.
Explain what the Business Objective of Sales Maximisation is.
AC = AR
- Firms seek to max volume of units sold
- Business wants to become as large as they can be, without making a loss
Explain why a Firm may have the Objective of Sales Maximisation.
- To gain economies of scale
- Limit-Pricing- trying to limit competition, by pricing at break-even (normal profit) takes away incentive for new firms to enter market
- Principle Agent Problem- divorce between ownership + control; manager may se growth/sales as leverage when going to shareholders for greater perk in their job
- Flood Market- selling large amount of output, consumers become aware of your product- seeing it everywhere- develop loyalty to brand. Can then change objective to one such as profit max
Explain some other Objectives that a Firm might have.
- Survval- short-run objective business may use when entering a hyper-competitive market; aiming to stay in business by covering costs
- Quality- allowing firm to differentiate its product in market meaning it can charge higher prices
- Corporate Social Responsibility (CSR)- giving to charities, producing sustainably, paying workers + suppliers fairly, acting ethically
Define a Barrier to Entry.
- Any obstacle that prevents a new firm entering a market
State the different types of Barriers to Entry.
• Legal (e.g. patents, licences/permits, red tape (excessive paperwork), standards + regulations, insurance)
• Technical: industry specific barriers (e.g. start-up costs, sunk costs (costs which can’t be recovered when firm leaves market- such as advertising + specialist machinery), economies of scale, natural monopoly)
• Strategic: intimidatory tactics used by firms in the market (e.g. predatory pricing (pricing low purposefully to drive out competition), limit pricing (pricing at normal profit, limits competition + incentive for firms to enter), heavy advertising)
• Brand Loyalty
Define a Barrier to Exit.
- Any obstacle that prevents a firm leaving a market
State examples of Barriers to Exit.
• Under valuation of assets
• High redundancy costs: costs you have to pay to workers when shutting the business down
• Penalties for leaving contracts early: (e.g. contracts with supply, gas + electric contracts, e.t.c)
• High sunk costs
Define Perfect Competition.
- Market structure with numerous buyers + sellers, homogenous products, free entry + exit, perfect information.
State + explain the characteristics of a market in Perfect Condition.
- Many buyers + sellers (infinite, extreme competition)
- Firms selling homogenous goods (identical)- therefore firms are price takers (no ability to set price)
- No barriers to entry/exit
- Perfect information of market conditions- consumers know about prices + quality in market, producers know about prices, technology + costs)
- Firms are profit maximisers (MC = MR)
Explain why there is only Supernormal Profit in the SR for firms in Perfect Competition.
• This profit attracts new firms into the market- can easily enter as there’s no barrier to entry + perfect information.
* As new firms enter, S shifts right, P falls, until there’s no more incentive for firms to enter the market (i.e. all supernormal profit is taken away + normal profit is what’s left)
Explain why there is only Subnormal Profit in the SR for firms in Perfect Competition.
• Firms will be incentivised to leave market + produce their opportunity cost instead.
• Can easily leave market as there are no barriers to exit- as firms leave the market, S shifts left, P will be driven up in the market, until there is no more incentive to leave (i.e. till there’s normal profit left)
Analyse + evaluate Perfect Competition using Efficiency.
- Allocative efficiency: see if P is equal to MC, at Q2 in the long-run. Furthermore, if firms are allocatively efficient, it means they’re perfectly following consumer demand, prices low, consumer surplus high, Q high, choice high- consumers are benefiting from resources following their demand in the exact way in which they desire them to.
- Productive efficiency: at Q2, is the firm operating at the lowest point on the AC curve? If so, the firm is productively efficient, means there is full exploitation of any economies of scale.
- X efficiency: is firm producing on their AC curve? If so, firm is X efficient, minimising waste + cost.
- Therefore, in the LR firms in perfect competition are statically efficient.
- Firms cannot be dynamically efficient in the LR, as there’s no supernormal profit, therefore firms don’t have the profit in LR to re-invest back into the company- consumers may not see brand new innovative products over top, producers won’t be able to lower their costs through newer technologies.
State + explain the benefits of Competition for the Consumer.
- Lower Prices: increased competition means firms minimise costs + keep prices down to stay in business. No barriers to entry means when firms earn supernormal profits, over time new firms enter + this leads to a shift of the supply curve to the right, leading to a fall in market price.
- Increased Choice: Competition creates an increased range of products; improved allocation of resources, as firms are more likely to produce products that a variety of customers will wish to buy
- Improved quality: to maintain a customer base within a competitive market, firms strive to provide better quality products + customer service
Define Monopoly, Pure Monopoly, Legal Monopoly, Dominant Market Position + Monopoly Power.
- Monopoly: One seller dominating the market
- Pure Monopoly: one firm having 100% market share (e.g. National Grid, Water Companies- regional monopoly)
- Legal Monopoly: firm has more than 25% market share (e.g. Tesco, Coca-Cola)
- Dominant Market Position: firm has 40% or more of market share (e.g. Microsoft)
- Monopoly Power: Price setting power- able to raise + maintain prices above the price that would normally be charged in a competitive market.
State + explain the characteristics of a market in Monopoly.
- Differentiated Products- monopoly is a price maker.
- High barriers to entry/exit. Therefore, supernormal profits can persist overtime.
- Imperfect Information of market conditions.
- Firm is a profit maximiser- producing when MR = MC.
Analyse + evaluate Monopolies using Efficiency.
- Allocative Inefficiency: monopolies aren’t allocatively efficient as they are charging a price which is greater than MC, + in doing so, they are exploiting consumers with high prices, low consumer surplus, + restricting output (so that they can charge higher prices- reduces choices for consumers). Not following consumer demand at all.
- Productive Inefficiency: Not productively efficient, as they are voluntarily foregoing economies of scale, by not producing at the minimum point on their AC curve.
- X-Inefficiency: occurs when monopolies are producing above their AC curve. This happens due to monopolies become complacent with a lack of a competitive drive, also happens because it is difficult to reduce waste/cut down to costs, + if a firm doesn’t need to do so, then they’re not necessarily going to do so.
- Therefore, monopolies are statically inefficient.
- Dynamic Efficiency: potential for monopolies to be dynamically efficient, due to supernormal profits being made, no firms can enter market- due to high barriers to entry + imperfect information. Allows supernormal profits to persist in the LR, therefore the monopoly could re-invest these profits back into the company in the form of new technology, new capital, research + development, e.t.c.
State + explain why Monopolies are considered bad for Consumer.
- Monopolies can exploit consumer: charging high prices (even if the quality is poor), because consumers have no alternative.
- Lack of innovation
- Leads to inefficiencies.
Explain the conditions in which a Monopoly may be good for Consumers.
- The assurance of a consistent supply of a commodity that is too expensive to provide in a competitive market.
- Monopolies can gain economies of scale, passing this onto consumers via lower prices
Explain what Consumer Surplus is.
- Area of the demand curve above the equilibrium point + is the amount of people who are willing to pay more for the particular product.
- Firms would like to extract as much consumer surplus as possible by price discrimination + price skimming.
Explain the Significance of Consumer Surplus.
- In competitive markets, firms have to keep prices relatively low, enabling consumers to gain consumer surplus.
- If markets weren’t competitive, consumer surplus would be less + there would be greater inequality.
- A lower consumer surplus leads to higher producer surplus + greater inequality.
- Consumer surplus enables consumers to purchase a wider choice of goods.
Explain what Producer Surplus is.
- Area above the supply curve, but below the market equilibrium price.
- The number of firms who are willing to charge less for the product.
Define Deadweight Loss.
Also known as a loss of economic efficiency.
* Welfare lost due to inefficient allocation of resources in a market, often caused by monopolies.
* The reduction in consumer + producer surplus when output is restricted to less than the optimal level of output.
* A monopoly causes increased producer surplus, decreased consumer surplus + deadweight loss.
Define Price Discrimination.
- Where a firm charges different prices to different consumers for an identical goods/service with no differences in the CoPs.
- Example: airlines- charging different prices for the same ticket, depending on when they buy them/the season the ticket is booked for.
State + explain the conditions necessary for Price Discrimination (PD)
- Price making ability: need to be able to set price, in order to do this, firm must have monopoly power
- Information to Separate the Market: separate consumers via PED (e.g. need to identify consumers with price inelastic demand, so that they can charge higher prices, + identify consumers with price elastic demand, so they can charge lower prices, thus maximise profits in the process).
- Prevent Re-sale of Good (Market Seepage): Stop someone buying from where prices are lower + selling where prices are higher.
Explain what 1st Degree PD is.
- When each consumer is charged the exact price that they are willing + able to pay for a service
- Therefore eroding all consumer surplus in the market + converting it into producer surplus (i.e. monopolist will receive the entire surplus in each transaction with a consumer)
- Examples: auctioning items, buying houses, selling cars
Explain what 2nd Degree PD (Indirect PD) is.
- Charging consumers based on the quantity sold.
- One way to look at this is via excess capacity pricing- firm has fixed capacity + makes no sense to leave any of that capacity idle, as these companies have FC they need to pay (e.g. hotel).
- So firms lower their prices last minute, in order to fill that capacity + contribute towards their FC.
- As long as P > MC, firm can still make a profit
- More you use of a good/service, the less you pay
- Examples: mobile phones, gas, electricity
Explain 3rd Degree PD (Direct PD) is.
- Firm is able to segment market into different PEDs (split into groups based on: income, location, time, age)
- Same product/service is sold at different prices to different consumers.
- Examples: train fares, cinema tickets
State + explain the disadvantages of PD.
- Allocative Inefficiency: 1st degree + 3rd degree PD (inelastic segment), charging costs way beyond MC, exploiting consumers, bad for consumers.
- Inequalities: 1st degree PD, inelastic segment of 3rd degree PD, who are the consumers?- if they are those on lower incomes, may widen income inequality in society.
- Anti-Competitive Pricing: 3rd degree PD, elastic segment. If prices are driven down, these lower prices could drive out competitors, leaving the firm with pure monopoly market power.
State + explain the advantages of PD.
- Dynamic Efficiency: with greater profits, firm could re-invest, comes greater dynamic efficiency benefits.
- Economies of scale: due to greater quantity, 2nd + 3rd degree PD, greater economies of scale benefits, + potentially lower prices for consumers over time.
- Some consumers benefit: in 2nd degree + 3rd degree (elastic segment). However, don’t benefit as much as other consumers lose because of PD.
- Cross Subsidisation: higher profits firms make might be used to cross subsidise loss making goods/services elsewhere in the business
Define Monopolistic Competition.
- Market structure with many firms selling differentiated products, leading to some but not perfect competition.
- A competitive market, but with some characteristics of a monopoly.
State + explain the characteristics of a market in Monopolistic Competition.
- Many buyers + sellers
- Each firm is selling slightly differentiated goods- firms are price makers (only slightly, as there are similar, but no identical, substitutes), price elastic demand.
- Low barriers to entry/exit
- Good information of market conditions
- Non-Price Competition- as firms can’t raise price significantly to make high supernormal profits + exploit consumers.
- Firms are profit maximisers (producing where MC = MR)
State examples of markets in Monopolistic Competition.
- Clothing
- Fast-food
- Resturants
- Hairdressers/salons
- Bars/nightclubs
Explain why firms in Monopolistic Competition earn Supernormal Profit in the SR.
- In the SR, firms can exploit their price making power, given the fact they are producing a unique good- as a result can make supernormal profit.
- However, supernormal profit erodes in the LR.
Explain why firms in Monopolistic Competition earn Normal Profits in the LR.
- In LR, new firms enter due to supernormal profits- can enter, due to low barriers + good info.
- As new firms enter, demand for individual firms in the market shifts left, until normal profit is made; AC = AR
Analyse + evaluate Monopolistic Competition using Efficiency.
- Allocative Inefficiency: P is greater than MC, so allocative efficiency isn’t being achieved in the LR. Therefore, consumers are exploited, output is restricted, choices are restricted. However, there is competition in the market, therefore the price making abilities are lower + price exploitation/loss of consumer surplus is no where near as bad as a monopoly. In comparison, to PC- where there is allocative efficiency- there are homogenous goods- no variety for consumers. Furthermore, consumers may be attracted to pay slightly more for a range of goods in a market with monopolistic competition.
- Productive Inefficiency: none of the minimum points are on the AC curve, therefore firms are voluntarily foregoing economies of scale. In comparison to a monopoly, no where near as bad, as there are good substitutes. Allocative inefficiency in monopolistic completion, may be due to product differentiation demands of consumers.
- Dynamic Inefficiency: no LR supernormal profit being made- not enough profit to re-invest back into the capital. However, in a very competitive market, firms may have dynamic efficiency, via re-investing normal profit.
Define Oligopoly.
- Market structure with few large firms who compete or collude with each other.
Define Natural Monopoly.
As firm grows (output increases), costs continue to fall- continuous economies of scale
* Example: National Grid
State + explain why firms price discriminate.
- Extra revenue + profit: firms make more sales/get more customers then if they charged one price.
- Improved Cashflow: enables firms to bring in cash at times when sales may normally be low (e.g. off peak travel, out of season holidays)
- Uses up spare capacity: brings in additions to revenue that can contribute to covering FC, MC of extra sale is usually low (e.g. last minute airlines seats)
Explain why firms charge consumers in the price inelastic demand market a higher price in 3rd degree PD.
- In the price inelastic demand market- higher price (P2 is charged as these consumers have a lower PED + will be more willing to pay higher prices.
*Firm can earn more TR by charging this group a higher P than other groups. - Example: adult cinema tickets/rail travel
Explain why firms charge consumers in the price elastic demand market a lower price in 3rd degree PD.
- In PED market- lower price (P1) is charged as these consumers have less willingness o pay.
- Firm can earn more rev by charging this group a lower price + increasing its total sales.
- Example: student discounts on cinema tickets or rail travel. Firm can benefit from increased rev but also increase capacity utilisation + better cashflow by selling at a lower price to this group.
Evaluate how harmful PD is to consumer welfare.
The extent to which PD is considered harmful to consumer welfare depends on:
* Whether it leads to new consumers being able to buy a good/service that were previously unable to buy. Discounts for lower income groups can increase access to goods + consumer welfare- this group gains consumer surplus.
* Reduces waste by increasing capacity utilisation- better use of resources to sell off tickets at last minute than them not being used.
* Most firms are still monopolies + PD is about maximising profits- if this with very inelastic D are exploited through very targeted PD this likely leads to worse outcomes for consumers overall. Therefore, PD where there’s no choice for consumers (1st + to some extent 3rd) is worse than 2nd where consumers can to some extent choose their options.
State + explain the characteristics of an Oligopoly.
- Few firms dominating market: high concentration ratio (no more than 7 firms, 70% market share)
- Firms selling non-homogenous, differentiated goods: firms are price makers
- High barriers to entry/exit: high start-up costs (i.e. sunk costs, brand loyalty, etc)
- Interdependence: firms make decisions based on actions/reactions of rival firms. Because of this, often see price rigidity.
- Non-price competition: competition based on branding, advertising, quality of product/service.
- Profit max not sole objective: firms aim to achieve higher market share, so have whichever objective helps to earn them a higher market share.
State examples of Oligopoly markets.
Globally:
* Soft-Drink industry
* Car industry
* OPEC- legal oligopoly- petroleum exporting countries.
UK:
* Supermarket industry.
* Bus market
* Airline market.
State + explain the conclusions of Oligopolies.
- Price Competition: although raising/lowering price doesn’t make sense. Firms may try it to gain market share + outcompete rivals (price war). (e.g. in supermarket industry)
- Non-Price Competition: competition on branding, advertising, quality (e.g. soft-drink industry)
- Temptation To Collude: firms may break away from interdependence + collude together,not having to worry about how rivals react, what to do with price, etc. If colluded, firm can act like a monopoly, fix prices + make very high profits.
Explain Game Theory in relation to Oligopolies.
Oligopolistic market is like a prisoners dilemma game.
* What each firm does depends on actions of other firms.
* Nash equilibrium: rational equilibrium that can last in the long-term.
* Dominant Strategy: if both firms charge the same price, leads to the nash equilibrium.
State + explain the conclusions of Game Theory in Oligopolistic Markets.
- Price Rigidity (non-price competition): nash equilibrium (pricing strategies in the long-term), makes no sense for outcome to change- price rigidity. Firms compete on non-price factors (e.g. branding, advertising, quality of goods/services).
- Temptation To Collude: nash equilibrium isn’t the best outcome for both firms combined. If firms collude, higher price could be charged by both firms, to make supernormal profit.
- Incentive To Cheat On Collusive Agreement: other firm has incentive to cheat on collusive agreement + undercut to make higher supernormal profits. Thus, collusion may not last in the long-term.
Define Competitive Oligopolies.
- Could be based on price; where oligopolists engage in price wars.
- Could also be based on non-price factors where firms compete on branding, advertising, e.t.c.
State + explain the factors promoting a Competitive Oligopoly.
- Lots Of Firms In Market: not very concentrated, more likely to be a competitive oligopoly because organising collusion when there is lots of firms is much more difficult.
- New Market Entry Possible: making huge supernormal profits by colluding together isn’t very attractive, instead incentivises new firms to enter market + take supernormal profits away.
- One Firm With Significant Cost Advantage: makes it difficult to fix a price/quantity in collusion, promotes competitive oligopoly.
- Homogenous Goods: firms don’t have price making power to fix P.
- Saturated Market: lots of price wars/competition only way to get ahead of firms is to snatch market share, incentive to cheat on collusive agreements is very strong.
Define Collusive Oligopolies.
- Could be overt collusion (firms get together + decide to fix P/Q in formal agreements)
- Or tacit collusion (informal agreements not to engage in P wars or P leadership)
State + explain the factors promoting a Collusive Oligopoly.
• Small Number Of Firms: much easier for firms to get together + organise collusive agreements.
• Similar Costs: easy to organise + fix prices/quantities, given firms have similar cost conditions, therefore more likely to agree on P/Q.
• High Entry Barriers: supernormal profits being made when there’s collusive oligopoly, wont attract new entry into market, due to high barriers to entry, thus benefits of collusion can last long-term.
• Ineffective Competition Policy: firms can easily collude together + get away with it.
• Consumer Loyalty: cheating on collusive agreements is less likely to take place, as if firms undercut other firms it may not benefit them, if the consumers are loyal to competitiors.
• Consumer Inertia: consumers aren’t willing to switch suppliers (e.g. because they’re too lazy to switch, too difficult to switch- barriers to switching, e.t.c.), if firm cheats on agreement there’s no guarantee consumers will switch + buy your products instead, increasing your market share.
State how you should evaluate Competitive + Collusive Oligopolies.
- If evaluating a competitive oligopoly- then evaluate it as if you’re evaluating a competitive market (pros + cons of competitive market outcomes).
- If evaluating collusive oligopoly- evaluate pros + cons of monopoly outcomes.
State + explain the disadvantages of Monopolies.
- Allocative Inefficiency: P higher than MC, consumers exploited- paying more than cost to produce. Lower consumer surplus as a result. Monopolies restrict output, restrict choice, + potential quality issues.
- Productively Inefficient: voluntarily forego economies of scale, don’t minimise C by operating at lowest part on AC curve. P higher as a result, consumers also losing out.
- X-Inefficiency: allows for waste in production process, complacency due to a lack of competitive drive.
-
Inequalities In Necessity Markets: because of higher P, the poor could suffer the most if
monopolies are focused more in necessity markets (e.g. groceries, food + drink, e.t.c.)
State + explain the advantages of Monopolies.
- Dynamic Efficiency: being able to re-invest supernormal profits being made back into business. Good for consumers as they receive innovative, brand new products, with higher quality + potentially lower P over time. Firms could gain market share by beating rivals through innovation. Better tech also reduces C overtime. Good for consumers + firms.
- Greater Economies Of Scale: despite production inefficiencies of monopoly, can still exploit greater economies of scale, purely due to their size. As a result, firm is supplying a lower price + charging a higher Q (PM, QM), then a competitive firm being allocatively efficient.
- Natural Monopoly: regulated natural monopoly gives society desirable outcomes, as opposed to a natural monopoly market where there’s competition.
- Cross Subsidisation: use very high supernormal profits to subsidise a loss-making good/service they’re also producing that is socially desirable.
Evaluate Monopolies.
- Dynamic Efficiency: in theory will occur, but in reality so many other things can be done with profits monopolies make (e.g. give it to shareholders via higher dividends, save it, pay workers higher salaries, e.t.c.). Not a guarantee in reality.
- Economies/Diseconomies? Depends on size of firm.
- Objective Of Monopolist: assume its profit max which leads to outcomes of allocative inefficiency + price exploitation. But if objective is better for society (e.g. sales maximisation) may be allocatively efficient. Question objective of firms.
- Regulation: regulated monopoly can help reduce some inefficiencies.
- Price Discrimination: exaggerates negatives of monopoly- especially allocative inefficiencies + inequalities monopolies can create.
- Completion/threat? Pure monopoly isn’t realistic, more realistic that firms have monopoly power (legal monopoly)- could still be strong competition in industry (e.g. Tesco in supermarket industry). If market is contestable, that can be enough to reduce inefficiencies.
- Type Of Good/Service: if necessity, then being a monopoly has more negative implications. If it’s a luxury good (e.g. electronics) consumers don’t mind paying higher P, if there’s constant re-investment as a result of dynamic efficiency.
Define Allocative Efficiency.
Allocative Efficiency: occurs where D = S. Society surplus is being maximised- sum of producer + consumer surplus.
• P = MC, P = AR (D)
Analyse the implications of Allocative Efficiency on consumers.
• Resources are following consumer D: consumers are getting exactly what they want, at exactly the Q they want.
• Low P: maximisation of consumer surplus
• High Choice: Q in market is high- exactly what consumers desire.
• High Quality: competitive outcomes imply quality has to be high for firms to stay ahead of rivals.
Analyse the implications of Allocative Efficiency on producers.
• Retain/Increase Market Share
• Stay Ahead Of Rivals
• Increase Profits: by bringing more consumers to them.
Define Productive Efficiency.
Productive Efficiency: maximisation of output, at lowest possible AC. Full exploitation of economies of scale- max output at lowest possible AC.
• Occurs at lowest point of AC, where MC = AC.
Explain the implications of Productive Efficiency on consumers.
• Lower Prices: lower AC passed onto consumers via lower P
• High Consumer Surplus.
• Full Exploitation of EoS: firms operating at min point of AC curve.
Explain the implications of Productive Efficiency on producers.
• More production at lower AC.
• Higher Profit.
• Lower Prices + Greater Market Share: if pass lower C to consumers via lower P, can stay ahead of rivals + maintain/increase market share- good for LR position in industry.
Define Dynamic Efficiency.
Dynamic Efficiency: re-investing supernormal profit into innovation, R&D, + into new tech, to reduce LRAC.
• Occurs when there’s supernormal profit in LR.
Analyse the implications of Dynamic Efficiency on consumers.
• New Innovative Products: through re-investment.
• Lower Prices Overtime: due to new tech, new production techniques, new machinery, e.t.c. that lower AC for producer, that can be passed onto consumers via lower P over time. New producers might enter market, see greater competition, drive P down as well.
Analyse the implications of Dynamic Efficiency on producers.
• LR Profit Max: by continuously looking to innovate, spending on R&D, can stay ahead of rivals, keep high profits by coming up with innovative products, + keep P making ability.
• Lower Costs Overtime: keep P low, to increase profits overtime.
• Retain/Increase Market Share
• Stay Ahead Of Rivals: gain patents, copyrights, licenses- prevents competition copying you + allows you to get ahead of rivals, to create monopoly power, to boost profits.
Define X-Efficiency.
X-Efficiency: Production with no waste, no excess C above AC.
• Occurs when production takes place at any point on AC curve. Any Q producers are producing should be on AC curve- any point above would be wasteful.
Analyse the implications of X-Efficiency on consumers.
• Low Prices: if C are being minimised, consumers may get lower P, if C is passed onto consumers.
• Higher Consumer Surplus.
Analyse the implications of X-Efficiency on producers.
• Lower Costs.
• Higher Profits.
• Retain/Increase Market Share: by passing on lower C to consumers via lower P.
State + explain the advantages of Competitive Markets.
- Allocative Efficiency: firms charge P equal to MC- consumers pay what it costs to make. Lower P for consumers, higher consumer surplus, resources follow consumer D- higher Q, higher quality, better choice in market.
- Productively Efficiency: minimising AC, exploiting all economies of scale- passing on lower C to consumers via lower P.
- X-Efficiency: minimising any waste, producing on AC curve.
- Jobs: if Q is high, jobs created more frequently- labour as a derived D. Employment + living standards raised.
State + explain the disadvantages of Competitive Markets.
- Lack Of Dynamic Efficiency: normal profits- not enough to re-invest back into company, thus don’t see progress overtime (e.g. with tech, innovation, capital development, e.t.c). Therefore, consumers can lose from lack off innovation, new tech, lower P over time.
- Lack Of Economies Of Scale: even if productively efficient, may not have potential to have economies of scale like a monopoly. Firms in competitive markets are smaller, less economies of scale, higher costs, can’t charge as low as monopolies.
- **Cost-Cutting In Dangerous Areas: **is cost-cutting happening in areas consumers don’t want it to happen in (e.g. product safety, health + safety, environmental standards, e.t.c.)
- Creative Destruction: new firms enter creatively- beating firms with lower CoPs, or beating firms with brand new innovative products. Destroys pre-existing firms, therefore brings unemployment + issues with living standards.
Evaluate Competitive Markets.
- Could There Still Be Dynamic Efficiency In Comp Markets? Yes, still might have just enough to re-invest. Re-investment could also be part of the competition in these markets.
- Level of EOS: very important.
- Natural Monopoly: regulated monopoly makes more sense for allocation of resources.
- Where Is Cost-Cutting Taking Place? Don’t want it to be in dangerous areas.
- Role For Regulation? To ensure firms aren’t taking shortcuts in production- dangerous cost-cutting.
- Static Vs Dynamic Efficiency: what society wants depends on the type of good/service- if market is necessity- don’t want to see monopoly- rather have static benefits. However, in certain markets consumers are willing to pay higher P for innovation, product differentiation, re-investment, new tech, thus consumers would prefer dynamic efficiency over static efficiency (e.g. technology).
Explain the Concentration Ratio.
Measures the combined market share of the top ‘n’ firms in the industry.
* Usually look at the 3 firm concentration ratio, or the 5 firm concentration ratio.
• n: total market share of firms
• n = number of firms
• If it says others- don’t include in concentration ratio.
Examples:
1) A. 25%, B. 10%, C. 15%, D. 20%
4 : 70
2) Coca Cola. 49%, Pepsi. 22%, Others. 29%
2 : 71
3) British Gas. 24%, EDF. 16%, EON. 15%, Scottish Power. 14%, NPower. 13%, SSE. 8%, Others, 8%
6 : 92
State real-world examples of Natural Monopolies.
- Water distribution
- Gas + electricity distribution
- Internet distribution
- Rail-track providers.
State + explain the characteristics of Natural Monopolies.
- Huge Fixed Costs: especially start-up costs. (e.g. rail-track infrastructure- huge fixed costs, water distribution- pipe work- huge FC, e.t.c.).
- Enormous Potential For Economies Of Scale: to minimise AC, takes huge Q- enormous potential for economies of scale when there’s a natural monopoly market. MES, where all economies of scale are fully exploited, will occur at a very high Q level (Q*). Constantly downward sloping LRAC curve shows huge potential for EoS that a naturally monopoly has- no diseconomies of scale.
- Rational For 1 Firm To Supply Entire Market: competition is undesirable- competition would result in a wasteful duplication of resources- because first firm in market has EoS advantage, if any firm enters later wont have same EoS advantage, therefore will be priced out market- all of their infrastructure + resources will be left idol- wasteful- allocative inefficiency.
- Competition Would Result In Wasteful Duplication Of Resources + Non-Exploitation Of Full EoS: productive inefficiency- with competition firms aren’t going to reach the greatest size as if there was 1 firm dominating market- smaller firms can’t produce same Q as 1 firm dominating market- thus EoS not fully exploited + productive inefficiency.
State + explain the outcomes of Natural Monopolies.
- Very High P, Very Low Q: Q much lower + P much higher than if firms were operating at competitive outcomes.
- Regulators Unhappy: with high P + low Q (e.g. if for water, individuals may not be able to pay high P- no water?, or due to the low Q, individuals may not have access), regulators come in + regulate natural monopoly to allocatively efficient levels (Q, P) huge reduction in P + huge increase in Q.
- Subnormal Profit Being Made: at Q*, LRAC > AR- firms making a loss- unhappy.
- Subsidies Given By Regulator To Firms: to cover loss, subsidy would be equal to loss per unit (subsidy = ab per unit). At least allows firms to make normal profits + be allocatively + productively efficient.
- Even though we get society desirable outcomes, there’s very little incentive for private natural monopolists. Instead there’s usually state-run natural monopolies instead.
Define a Contestable Market.
- Where there’s a threat of competition- could be enough to affect behaviour of firms in market.
State + explain the characteristics of Contestable Markets.
- Low Barriers To Entry/Exit
- Large Pool Of Potential Workers
- Good Information Of Market Conditions: new firms looking to join market must know about C, new tech, e.t.c., so that if they were to enter market they’d be on a level playing field.
- Incumbent Firms (firms already in market) Subject To Hit + Run Competition: occurs because of low barriers to entry/exit. When new firms enter market quickly, snatch some supernormal profit, then leave market quickly before incumbent firms can react + lower their profit margins.
State + explain the impact of technology on the contestability of markets.
Contestability Of Markets Dramatically Increase, due to rise of tech over last few decades
* Massively reduced barriers to entry/exit: as businesses don’t have to be physical anymore- reduces start-up costs, sunk costs, firms need not hire as many workers, EoS easier to achieve (e.g. technical economies), advertising is easier- overcome brand loyalty easier.
* Increased pool of potential entrants: tech has allowed for greater innovation- therefore for new firms to come in with something brand new to disrupt market (e.g. Uber, air b&b), has also allowed firms to find cheaper ways of producing things- firms don’t necessarily have to offer something new because of tech, but has allowed to find lower CoP methods to disrupt existing firms, therefore increasing pool of potential entrants.
* Increased information: because of internet- firms can find out easier about C + tech in market, communication has also improved- easier to get key information.
State + explain the advantages of Contestability.
Static Efficiency Benefits- moving towards them.
* Allocative Efficiency: for consumers- lower P, higher consumer surplus, higher Q + quality- greater choice.
* Productive Efficiency: greater exploitation of EoS- lower C, lower P for consumers.
* X-Efficiency: minimising waste- lower C + P. As firms have to be prepared for competition.
* Job Creation: due to higher Q- labour as a derived demand.
State + explain the disadvantages of Contestability.
- Lack Of Dynamic Efficiency: due to lower profit margins, however if new firms come in with innovative ideas, than in itself is the benefit of dynamic efficiency (e.g. progress, innovation).
- Cost-Cutting Vs Dangerous Areas: is cost-cutting taking place in dangerous areas (e.g. health + safety, environmental standards, product safety, W, e.t.c) if that’s the case wont be desired in society.
- Creative Destruction: new firms come in + that innovation destroys existing firms, with that comes with job losses. However, if overall market is greater + new firms are very large in size, where firms have been destroyed + jobs have been lost, these workers can move to newer firms + get jobs in same industry.
- Anti-Competitive Strategies: in SR may be a contestable market + these benefits exist, however overtime if businesses use anti-competitive strategies (e.g. limit pricing, predatory pricing, flooding market, mergers) to limit threat, then maybe contestability wont last over time, anti-competitive strategies wont give us the static efficiencies they could in LR, resulting in static inefficiencies.
Evaluate Contestable Markets.
- Length Of Contestability: how long is market contestable for- if new tech/firms coming in can patent ideas, market wont be contestable over time. If firms using anti-competitive strategies, wont be contestable over time.
- Role Of Tech: although on one hand it could increase contestability, could also reduce it- especially because of patents, copyrights. However, can also improve information for firms in acquiring consumer data- therefore firms could actually practice 1st + 3rd degree PD- wont give us static efficiency benefits.
- Regulation: can minimise cost-cutting in dangerous areas + anti-competitive strategies. Regulation that protects protect standards, environmental standards, + health + Safety standards.
- Dynamic Efficiency: looking at innovation at first place in market.
Explain Hit + Run Entry Competition in relation to Contestability.
- In a perfectly contestable market, firms are vulnerable to hit + run entry by new firms.
- Where new firms are attracted by supernormal profits in market- enter market- take share of supernormal profits- leave market when P comes back down- links to the ready pool of new entrants.
- Threat will influence firms behaviour as they will keep P down + profits down to not be vulnerable to hit + run entry. Leads to pricing strategies such as limiting pricing- firms charge P = AC, not to make supernormal profits down + attract new firms.
