4.1.5 Perfect Competition , imperfectly competitive markets and monopoly Flashcards
Define perfect competition
Is a market structure with a large number of buyers and sellers who have perfect information in the market
What are the assumptions about perfect competition
Homogenous products (all the same products + perfect substitutes)
All firms have access to factors of production
Large number of buyers and sellers
Free entry into the market (no barriers of entry)
Perfectly elastic demand curve (firms are price takers)
Perfect knowledge (for buyers and sellers)
Profit maximisation
Describe a perfectly competitive market graph in the short term
Supply and demand causes a price determination
This price is sold at, no higher or lower as the firms are price takers
The demand is constant meaning it is the marginal revenue and average revenue curve
The AC curve is below
Where the MC curve cuts the MR curve is the profit maximisation, before it cuts profit is made and after profit is lost
The point below the MR curve and cut at AC curve is the area of supernormal profit
Define profit maximisation
Explain it on a graph
Is a output where marginal cost = marginal revenue
This is because it is the furthest distance between Total revenue and Total Costs
Any point where the Marginal revenue is greater than the marginal cost is marginal profit
After MC = MR a loss of profit occurs as MC is greater than MR
Define marginal profit
Is the addition to a firms profit from producing an additional unit of output
Explain perfectly competitive market graphs in the long run
As a business is making a supernormal profit other firms enter the market as there are no barriers to entry
As more firms supply there becomes an increase
This decreases the overall price
The price is on the minimum level of average costs
The point where MC cuts through the MR a normal profit is being made . This is where enough revenue per unit is made to cover the cost per unit
Define a price taker
What market does it occur in
A firm that is unable to influence the market price and therefore accepts it
Found in a perfectly competitive market where products are exact substitutes
Describe the role of productive efficiency in perfectly competitive markets
Is producing for the minimum possible average costs with no waste in production
It is the point on the graph where marginal cost cuts the average cost
Describe the role of allocative efficiency in perfectly competitive markets
Measures the goods which best meet the needs and wants of society
Seen when consumer and producer surplus are at its highest, maximum total welfare in the market
Describe the role of static efficiency in a perfectly competitive market
Is the efficiency measured at a point in time, comprising productive efficiency and allocative efficiency
What is a subnormal profit
Is where a firm is making a profit below normal profit. The firm are making an economic loss and look to exit the market.
What is the role of profit in a market society
Return for entrepreneurship
An indicator of efficiency
Rising profits send signals to other producers in the market
Used for improvements in research and development
What is dynamic efficiency
Is the changes in choice available in a market as well as changes in quality of products
What were Joseph Schumpter’s thoughts on dynamic efficiency
He believed profits were important in a perfectly competitive market to be able to have dynamic efficiency and therefore stay competitive. Profits were used for research and development.
Why is it difficult to have dynamic efficiency in a perfectly competitive market
As there is perfect knowledge meaning innovation will be copied quickly
What are advantages of perfectly competitive markets
There is no asymmetric information
No advertising costs as there is perfect knowledge
Maximum consumer surplus
Allocative and productive efficiency
What is the disadvantage of a perfectly competitive market
They are not realistic and do not take place
What is monopoly power
Is the power of a firm in a market to act as a price maker
What is a pure monopolist
Is a single supplier that dominates the entire market (100% market share)
What is a working monopoly
Is a firm with a market share of 25% or over
What are ways of achieving monopoly power
Merger and takeover : two firms become one, less choice for customer allowing the firm to raise the price
Statutory monopoly : when a firm is given monopoly status by the government (water companies).
Internal expansion : firm grows and generates more sales
Branding : a firm achieves high brand loyalty
Cost barriers : firm achieves economies of scale and lower average costs
What are assumptions of monopoly markets
Firms are price makers (downwards sloping demand curve)
High barriers to entry and exit
Small number of firms in the market
How does a monopoly graph look
Has a AR and MR curve.
Average cost curve cuts through AR curve
Where MC curve cuts through MR curve is the profit maximising level of output
The price at this level of output is the demand curve vertically up from MR curve
Firm makes a supernormal profit
What is the efficiency of a firm in a monopoly
Monopoly markets are not productively efficient or allocatively efficient
Firms can be dynamically efficient as they make supernormal profits so can invest in research and development if they want to.
What is X- Inefficiency
Where monopolies may allow average costs to be higher than they could be , because they face no pressure from competitors
What are the advantages of a monopoly
Economies of scale : produce for lowest possible average costs
Innovation : make supernormal profits so can invest in research and development
Making a supernormal proft
What are the disadvantages of being a monopoly
Productive and allocative inefficiency
X- Inefficiency
What are the types of barrier to entry/exit
Natural barriers : geographical factors which make a product hard to replicate
Economies of scale : firms have lower AC and can lower prices to deter competitors
Legal barriers : Includes Patents and Trademarks which means a product cannot be copied
Product differentiation : firm builds up a strong brand loyalty and marketing profile , making it hard for new competitors to attract customers
Sunk costs : costs that cannot be recovered if a firm has to exit the market, deterring new firms
What is the differences in economies of scale between a perfectly competitive market and a monopoly
Monopolies can fully exploit economies to scale and have increasing returns to scale, due to having less competitors
A firm in a perfectly competitive market have a lower economies of scale and a higher average costs, due to a high number of competitors with perfect knowledge
What is a natural monopoly
Is a market where a single firm with large scales of production allows them to benefit from continuous economies to scale and decreasing average costs
What type of businesses are natural monopolies
Businesses to do with infrastructure , electric and gas firms
What does a natural monopolies graph look like
Marginal and average revenue
Decreasing LRMC due to economies of scale
Decreasing LRAC above LRMC curve
Profit maximisation is the point where MR curve and MC curve meet , price point is vertical where the AR curve is
Explain a Monopolies costs and why
Have extremely high fixed costs due to cost of infrastructure
Have low variable costs due to exploiting economies of scale
Why may a natural monopoly be good for a market
Means less duplication of infrastructure
Less pipes and cables
Why may a natural monopoly become regulated
What is the effect on the firm
To make sure the firm provides the allocatively efficient level of output for essential services
Means a firm makes subnormal profit as the AC is higher than the AR
What is corporate social responsibility
Involves firms acting in a sustainable way whilst trying to make a supernormal profit
What is monopolistic competition
Is a low concentration market structure with many competing firms each supplying a slightly differentiated product
What are assumptions of monopolistic competition
There are many producers and consumers
Non-price competition is strong
Firms are price makers (higher elasticities of demand than a monopoly)
Low barriers to entry and exit
Explain a monopolistic competition graph in the short run
Less steep MR and AR curves than a monopoly
The point where MR = MC is the price and quantity the firm sell at
Firms in monopolistic competition make supernormal due to first mover advantage
What happens with monopolistic competition in the long run
A existing firm is making supernormal profits
This acts as a signal for new firms to enter the market
Demand for the existing good decreases and a firm makes normal
profit
Explain a monopolistic competition graph in the long run
Supernormal profit acts as a signal to attract new producers
The demand decreases reducing the MR and AR curves
The point where AC= AR is the point of normal profit
What is the efficiency of a firm in monopolistic competition
Is not allocatively or productively efficient
Is dynamically efficient due to extensive consumer choice and innovation
What ate the similarities between Monopoly and monopolistic competition firm
Both firms have price making power
Both make supernormal profit in the long run
What are the differences between a monopoly and monopolistic competition firms
A monopoly makes supernormal profit in the long run , monopolistic competition makes normal profit.
High barrier to entry in a monopoly, low/no barriers to entry in monopolistic competition
Define Oligopoly
A market structure dominated by a small number of powerful firms
What are the characteristics of an oligopoly
Few firms in the market High barriers to entry / exit in the long run Firms are price makers Firms are interdependent Collusion in the market
What are examples of oligopolies
Petrol (BP, Shell, Texaco)
Newspapers (The Sun, Daily mail)
What is the concentration ratio
Measurement of how concentrated a market is - the total market share held by the largest firms in the market
Can be a ratio or a percentage
What is the 5 firm concentration ratio for the cinema market when : Market share: Odeon = 17.14% Vue= 11.4% Empire = 3.4% Cineworld = 22.85% Curzon= 7.14%
5 firm concentration ratio = 62.2%
How can you see if a firm is in an oligopoly
If the concentration ratio is over 60% the market is an oligopoly
The behaviour of a firm also needs to be looked at
What is a collusion
Occurs when firms work together to determine price and output
What is a cartel
Is a collusive agreement among a group of oligopoly firms to fix price and output between themselves
What is a Tacit Collusion
A collusive relationship between firms without any formal agreement
What is a Overt Collusion
A collusive relationship between firms involving an open agreement
What does collusion do for a firm
Maximises Joint profits
Reduces competition costs
Reduces uncertainty in the market
Explain a graph for a firm in an oligopoly
Firms have price setting power
Collusion means firms produce at a certain price and quantity (MR=MC)
This price allows all firms to make supernormal profits (AR>AC)
Firms have higher producer surplus due to their monopoly power and there is less consumer surplus
What are the reasons for possible breakdowns of cartels (4)
Enforcement problems : may become a struggle to enforce quotas
Falling market demand : puts pressures of firm to discount price
Successful entry pf non cartel firms : undermines a cartels control in the market
Exposure by market regulators (competition market authority)
What is the efficiency of firms in an Oligopoly market
Not productively efficient as they don’t produce at the min AC
Not allocatively efficient as they don’t produce where MC=AR
Can be dynamically efficient as they make supernormal profits
What are the benefits from Collusion
Can bring social benefits , faster development of new technology
Allows smaller firms to compete with monopoly firms
Profits can be used for research and development -> dynamic efficiency
What are the drawbacks from Collusion
Loss of allocative efficiency
Less consumer surplus (less total welfare)
X inefficiencies and less dynamic efficiency
Less market contestability
Output quotas penalise firms who want to expand
What is the incentive for a firm to collude
There is an incentive to make a collusion to make supernormal profits
However there is an incentive to break the collusion and therefore experience the benefit from first mover advantage and expand production
Prisoners Dilemma
What is a kinked demand curve
Draw it out
Where firms are non-collusive and therefore compete on price and quantity, directly effected by other firms in the oligopolies
What is the efficiency of firms in a non- collusive agreement
Are not allocatively efficient or productively efficient
Can be dynamically efficient as they make supernormal profit
What are examples of non price competition
Innovation Quality of service Loyalty schemes Branding Sales promotions
Define Price Discrimination
Is when a business charges different consumers different prices for the same product
State and explain the different types of price discrimination
1st degree - charging each different consumer the maximum they would be willing to pay for it
2nd degree- price varying by quantity sold and time of purchase
3rd degree - charging different prices to groups of customers (age, income ect)
What are the aims of price discrimination
Extra revenue
Increased profit
More balanced cash flow
Uses spare capacity
What are the conditions for price discrimination
Firms must have sufficient monopoly power
Identifying and separating different groups
Ability to prevent re-sale
What is an incumbent firm
A firm that is already operating in the market
Define Seepage
The movement of a product from a high price market to a low price market , reducing profits from price discrimination
Define Cross- subsidisation
High price group fund low price group , 3rd degree price discrimination
What is a contestable market
Is a market with freedom of entry and exit
Often have high dynamic efficiency and changing barriers to entry
What are sunk costs
Give examples
Are costs which cannot be recovered if a business decides to leave an industry , makes the market less contestable
Asset write offs, closure or project cancellation costs , loss of business reputation
What is hit and run competition
Occurs in a contestable market where new entrants have a share of the supernormal profits and then exit the industry
What are the conditions of a contestable market
A number of new businesses who are willing to enter the market
No significant entry or exit
Equal access to technology
High rates of consumer switching
Define divorce of ownership from control
Is the separation that exists between owners of the firm and managers
Define satisficing
Is making do with a satisfactory sub-optimal level of profit
What are the objectives of a firm
Sales maximisation Survival Growth Increasing market share Stakeholder objectives Profit maximisation
What can a contestable market do in terms of competition
If markets are contestable the threat of competition will ensure the incumbent firms behave in an economically beneficial manner (dynamic efficiency and free market price) in the long run
