4.1.5 Perfect competition, imperfectly competitive markets and monopoly Flashcards
What do we assume is the main objective of firms?
Profit maximising
At what quantity is profit maximised?
MC=MR
How is SNP calculated on a monopoly diagram?
- TR - TC
- (Q profit maximisation * P where Q=AR) - (Q pm * P Q=AC)
What other objectives might firms have?
Revenue maximising or sales maximising
At what quantity is revenue maximised?
MR=0
At what quantity are sales maximised?
AC=AR (normal profit made)
What is the satisficing principle?
When firms may accept lower profit to satisfy a broader range of objectives, often considering all stakeholders
What is the principle agent problem?
- Can managers be trusted to work in favour of corporate objectives that are generally seen through the perspective of the shareholders
- Possibly resolved by bonuses or giving staff shares of business
How many firms/buyers are in perfect competition?
Very many
What is the level of barriers to entry/exit in perfect competition?
No barriers
What type of product is in perfect competition?
Homogenous (interchangeable)
How is information distributed in perfect competition?
There is perfect information between buyers and sellers
What profit do firms in perfect competition gain in the short and long run?
- Possible supernormal profit in the short run
- Normal profit in the long run
Are firms price makers or takers in perfect competition?
Takers
In what ways are firms in perfect competition efficient?
- Allocatively efficient
- Productively efficient
- X-efficient
What is the elasticity of the D/AR curve in perfect competition?
Perfectly elastic
How many firms are in monopolistic competition?
Many
What is the level of barriers to entry/exit in monopolistic competition?
Low barriers
What type of product is in monopolistic competition?
Differentiated products, through limited advertising, customer service and relations, or different products.
How is information distributed in monopolistic competition?
Equal information between buyers and sellers
What profit do firms in monopolistic competition gain in the short and long run?
- Possible supernormal profit in the short run
- Normal profit in the long run
Are firms price makers or takers in monopolistic competition?
Takers
In what ways are firms in monopolistic competition efficient?
X-efficient
What is the elasticity of the D/AR curve in monopolistic competition?
Elastic
How many firms are in an oligopoly?
Several or a few
What is the level of barriers to entry/exit in an oligopoly?
High barriers
What type of product is in an oligopoly?
Homogenous or differentiated
How is information distributed in an oligopoly?
Information is asymmetric, as firms have more than consumers.
What profit do firms gain in an oligopoly?
Possible supernormal profit
Are firms price makers or takers in an oligopoly?
Takers, but can be makers in the long run due to high barriers to entry and exit
In what ways are firms in an oligopoly efficient?
Dynamically efficient
What is the elasticity of the D/AR curve in an oligopoly?
Kinked demand curve:
- Elastic at Q < equilibrium
- Inelastic at Q > equilibrium
How many firms are in a monopoly?
One
What is the level of barriers to entry/exit in a monopoly?
Very high, essentially insurmountable
What type of product is in a monopoly?
Unique
How is information distributed in a monopoly?
Asymmetric, as firms have more
What profit does a monopoly gain?
Supernormal profit
Are firms price makers or takers in a monopoly?
Makers
In what ways are firms in a monopoly efficient?
Dynamically efficient
What is the elasticity of the D/AR curve in a monopoly?
Elastic at Q < equilibrium
Inelastic at Q > equilibrium
What are examples of perfectly competitive markets?
Fruit sellers or the stock market.
What are examples of monopolistically competitive markets?
Hairdressers, restaurants, takeaways
What are examples of oligopolies?
Supermarkets, Google, Apple, Samsung, car companies, airline companies
What are examples of monopolies?
Severn Trent, National Grid
How will perfectly competitive firms making supernormal profit in the short run always make normal profit in the long run?
- Firms produce at Q where MC=MR to maximise profit
- Firm makes supernormal profit
- Price acts as a single for other firms to join industry
- As firms join, supply shifts right
- Price decreases until all SNP has been competed away
How do firms in perfect competition making a loss in the short run reach market equilibrium in the long run?
- At MC > MR firm makes a loss
- Firms leave market until there is no loss (supply shifts left)
- Market and firm reach normal profit in the long run
- Leading to long run equilibrium where MC=AC=AR, and S=D
What about perfect competition benefits society?
- Firms are productively efficient
- Firms are allocatively efficient
- Firms are X-efficient, resulting in no waste
What are the costs of perfect competition to society?
- Not dynamically efficient, as there is no supernormal profit available in the long run to innovate or improve production
- Less variety and choice of goods and services
How do firms in monopolistic competition make normal profit in the long run?
- In the short run, supernormal profit can be gained
- Price acts as a signal for firms to join industry
- Supply increases, price decreases
- AR and MR for firms both decrease
- So in the long run firms make normal profit
What are the benefits of monopolistic competition for society?
- More variety for customers, and a better choice of goods and services
- Goods and services of a high quality
- X-efficiency, resulting in limited waste of scarce resource
What are the costs of monopolistic competition to society?
- Quantity produced is below productive efficiency
- Quantity produced is below allocatively efficiency
- Lack of supernormal profit for investment and innovation, so there is no dynamic efficiency
What is the main characteristic of an oligopoly that makes it different to other market structures?
There is interdependence between firms, meaning they must consider the actions of other firms when making decisions
What are the 2 different characterisations of oligopolies?
- Competitive
- Collusive
What is a competitive oligopoly?
- An oligopoly where the firms produce differentiated products
- There is research and development to drive innovation, branding and advertising, and different target markets
What is a collusive oligopoly?
An oligopoly where the firms work together to act as a monopoly by agreeing to restrict output as a cartel so they make supernormal profit at the expense of consumer welfare.
What does the kinked demand curve explain?
Price stability, so firms must differentiate products
What are the benefits of oligopolies for society?
- There is product differentiation - some variety, higher quality, better technology
- Supernormal profit can be invested (into above), meaning there is dynamic efficiency
What are the negatives of oligopolies for society?
- Not allocatively efficient - underproducing
- Not productively efficient - P > MC=AC
- Not price competitive - not at lowest cost
- X-inefficient - wasteful
What is deadweight loss?
The loss of economic efficiency when the equilibrium price and quantity is not achieved, such as higher prices due to monopoly power, which could lead to a net deadweight loss to society.
What are the barriers to entry in a monopoly?
- Expensive capital cost, as utilities need infrastructure/capital
- Large MES high due to big economies of scale
- Branding/advertising
- Patent/copyright
- Ownership of supply chain
- Levels of technology
- Geographical situation - e.g. next to customers or FoP e.g. raw material
What are the barriers to exit in a monopoly?
- Sunk costs
- Contractional obligations
What are the benefits of monopolies for society?
- Economies of scale, making best use of limited resource, and decreasing average costs from efficiency
- Dynamic efficiency - they have funding to keep ahead of competition in product and production, profit can be invested into local infrastructure or research and development for innovation/invention
- National level monopolies can compete with other big companies and provide jobs/ tax revenue
- Cross subsidisation - they can use profit from one part of the business to support non-profitable parts of the business, extending service
What are the negatives of monopolies for society?
- May abuse excessive market power, by limiting quantity or increasing prices
- Not productively efficient
- Not allocatively efficient
- X-inefficient, as supernormal profit is assured so they may not operate at lowest average cost
- Less choice and variety for consumers
- Possible diseconomies of scale
What does the extent of the impact of a monopoly on society and the economy depend on?
- Nature of industry, such as if it is a natural monopoly
- If there is any government control, such as regulation or price gaps
- Corporate objectives, if are they profit maximised or satisficing
- If the product is a necessity or luxury, as necessities need more control
- Level of research and development and technology improvement
- Level of exportation, as they can benefit the domestic economy by reducing trade deficit
- If nationalised, it should aim to help society
What is allocative efficiency?
- When resources are distributed to the goods and services that consumers want, therefore where S=D, and P=MC, maximising utility
- Means consumers pay for the value of the marginal utility they derive from consuming the good or service
What is productive efficiency?
When a firm minimises their average total costs, where MC = AC
What is dynamic efficiency?
Where supernormal profit is invested into human and non-human capital, research and development, and technological change, which can lead to lower costs of production in the future, or the creation of new products.
What is X-inefficiency?
When a firm is producing within the AC boundary, so costs are higher than they would be with competition in the market.
What is price discrimination?
When a firm charges different customers different prices for the same product
What is the purpose of price discrimination?
To take as much of the consumer surplus as possible
What are the 3 conditions needed for a firm to price discriminate profitably?
- Seller must have monopoly power
- Resale by customers must not be possible
- The market must be separable into customer groups with different PEDs
What is an example of 3rd degree price discrimination?
Train tickets are separated into child and adult tickets, with child tickets being more elastic and adult tickets being more inelastic, as adults may need train tickets at short notice due to business meetings etc.
What are the benefits of price discrimination?
- Cheaper prices may be available for those with less money
- Cross-subsidising is possible, making the product more accessible
What is contestability?
The extent to which firms are believed to be able to enter a market making incumbent firms reduce price as a deterrent to entrants
What is market structure decided by?
Barriers to entry and exit
What are examples of barriers to entry?
- High startup costs, such as expensive infrastructure and capital
- Research and development costs
- Level of technology needed
- Level of information
- Patents/copyright/IPR/license
- Resource and supply chain ownership
- Brand name/image
- Economies of scale (MES for natural monopolies)
What are examples of barriers to exit?
- Sunk costs
- Contractual obligations to workers/suppliers/customers/government
What are sunk costs?
Money that has already been spent and cannot be recovered
Why is perception of barriers important in determining contestability?
It makes firms try to prevent other firms from entering a market or industry, otherwise known as rent-seeking behaviour
What are methods firms can use to prevent other firms from joining their industry?
- Increasing barriers to entry, such as buying potential competitors
- Producing at Q > MR=MC to lower profit - firms will increase Q to Q where AC=AR (sales maximising), removing SNP, deterring entry as it stops a high price acting as a signal for firms to join industry, preventing ‘hit and run’ entry to industry
What is hit and run competition?
When firms enter and exit a market quickly, selling their product for a short period of time and then leaving, making supernormal profit in the short run
What is the impact of contestability on policy making?
There is less need for strict regulation if a market is contestable, so there is no need for restricting mergers, worrying about licensing, breaking up big corporations, or controlling prices.
What are the short run benefits which are likely to result from competition?
Firms may get super normal profit in the short run, so dynamic efficiency is possible
What are the long run benefits which are likely to result from competition?
- Production at lowest price at productive efficiency, where MC=AC at the lowest ATC
- Production of quantity at allocative efficiency where MC=AR, balancing limited resource and unlimited wants, solving the economic problem
- X-efficiency - no waste of resource
Why may firms compete in non-price competition or have product differentiation?
To improve products, reduce costs and improve the quality of the service provided
What are examples of product differentiation?
Branding, promotion, customer and after sales service, improved technology, better design, high quality packaging, exclusivity, loyalty schemes, online marketing, increased product availability
What are examples of anti-competitive behaviour?
Buying up the supply chain, increasing barriers to entry, mergers and takeovers (buying competitors)
What is the process of creative destruction also known as?
Rent-seeking behaviour
What is the process of creative destruction?
As new ideas occur, old industries and technology becomes obsolete and firms/workers in the industry lose out or become structurally unemployed and new production and products become dominant
What is economic welfare?
- The total benefit society receives from an economic transaction
- The total areas of the consumer and producer surplus
What is static efficiency?
Describes the level of efficiency at one point in time, such as productive and allocative efficiency.
What is the difference between static and dynamic efficiency?
- Static efficiency describes the level of efficiency at one point in time, such as productive and allocative efficiency
- Dynamic efficiency is concerned with new technology and increases in productivity, causing efficiency to increase over a period of time
What makes a market dynamically efficient?
- If all resources are allocated efficiently over time, and the rate of innovation is at the optimum level, leading to falling long run average costs
- If consumers needs and wants are met as time goes on
What is dynamic efficiency affected by?
Short run factors such as demand, interest rates and past profitability.
What might be needed to cause long run costs to fall to be dynamically efficient?
Short run costs might be increased.
How can dynamic efficiency be evaluated?
- There is a long time lag between making an investment and having falling average costs, considering how factors change in the long run
- Some firms will face a trade-off between giving their shareholders dividends and making an investment
How does X-inefficiency occur?
Possibly due to organisational slack, a waste in the production process, poor management, or laziness.
Why do firms with monopoly power tend to be X-inefficient?
They have little incentive to lower their average costs because of the lack of competition they face.
When are consumer and producer surplus both maximised?
At the free market equilibrium.
Why does an inelastic demand give a larger consumer surplus?
Consumers are willing to pay a much higher price to consume the good.
How does consumer surplus increase?
From an increase in demand.
How does consumer surplus decrease?
A decrease in supply.
How does producer surplus increase?
An increase in supply or demand.
