5. Perfect competition, imperfectly competitive markets and monopoly Flashcards
What is a market structure?
The organisational and other characteristics of a market
What are some important features of market structure include?
- The number of firms in the market
- The market share of the largest firms, which as we later explain can be measured with the use of concentration ratios
- The nature of the costs incurred by the firms in the market
- The nature of the sales revenue earned by firms in the market
- The extent to which there are barriers to entry to, and exit from, the market
- Ease of access to information about what is going on in the market
- The extent to which firms in the market undertake product differentiation and adopt
different price-setting procedures - The ways, if any, in which firms are affected by buyers’ behaviour in the market
What are entry barriers?
Obstacles that make it difficult for a new firm to enter a market
What are exit barriers?
Obstacles that make it difficult for an established firm to leave a market
What is product differentiation?
The marketing of generally similar products with minor variations or the marketing of a range of different products
What are the two main types of entry barriers making it difficult or preventing a new firm from entering a market?
Natural barriers and artificial (or man-made) barriers
What is the divorce of ownership from control?
The owners and those who control the firm (managers) are different groups with different objectives
What is satisficing?
Achieving a satisfactory outcome rather than the best possible outcome
What is productive efficiency?
For the economy as a whole occurs when it is impossible to produce more of one good without producing less of another. For a firm it occurs when the average total cost of production is minimised
What is allocative efficiency?
Occurs when it is impossible to improve overall economic welfare by reallocating resources between markets. In the whole economy, price must equal marginal cost (P = MC) in every market
When does productive efficiency combine with allocative efficiency?
- All the firms in the market benefit from all the available economies of scale. This is unlikely because each firm produces only a tiny part of total market output. Each firm is likely to be well below minimum efficient scale (MES)
- There are perfectly competitive markets for all goods and services, including future markets, and P = MC simultaneously in each and every market. To take this point further, every firm in every market throughout the world must even if all the conditions of perfect competition could be met
- There are no externalities, negative or positive
What is allocative inefficiency?
Occurs when P > MC, in which case too little of a good is produced and consumed, and when P < MC, in which case too much of a good is produced and consumed
What do firms do in a perfect competition short-run equilibrium?
Firms make abnormal or supernormal profits
What happens in a perfect competition short-run equilibrium?
The entry of new firms has brought the price down until surviving firms make normal profits only
What is a monopoly?
One firm only in a market
What is monopoly power (market power)?
The ability of a monopoly to raise and maintain price above the level that would prevail under perfect competition. Market power can also be exercised, usually to a lesser degree, by firms in oligopoly and monopolistic competition
What are natural barriers?
Barriers to market entry caused by geography.
For example, if one firm has control of a resource essential for a certain industry, other firms are unable to complete in the industry
What are sunk costs?
Costs that have already been incurred and cannot be recovered
What are artificial barriers (strategic barriers)?
‘Man-made’ barriers to market entry, e.g. patent protection
What type of curve does a monopoly face?
A downward-sloping demand curve (the market demand curve), which is the monopoly’s average revenue (AR) curve
What are the possible advantages of a monopoly?
- Monopolies can gain the benefits of economies of scale. Economies of scale are shown by a falling long-run average cost curve
- Monopoly profit can be used to finance Research & Development with the result that monopolies can be dynamically efficient
What are the possible disadvantages of a monopoly?
It may lead to productive and allocative inefficiency and the latter results in resource misallocation
How does Monopolistic competition resemble perfect competition?
In that abnormal profits can be made in the short run but not in the long run
How does Monopolistic competition resemble monopoly?
Each firm faces a downward-sloping demand curve (and AR curve)
How are firms in imperfectly competitive markets, both in monopolistic competition and in oligopoly, are likely to undertake various forms of non-price competition?
What is Monopolistic competition?
‘Imperfect competition among the many’
What is a concentration ratio?
Measures the market share (percentage of the total market) of the biggest firms in the market.
For example, a five-firm concentration ratio measures the aggregate market share of the largest five firms
What is market conduct?
The pricing and marketing policies pursued by firms. This is also known as market behaviour, but is not to be confused with market performance, which refers to the end results of these policies
What is a cartel?
A collusive agreement by firms, usually to fix prices. Sometimes there is also an agreement to restrict output and to deter the entry of new firms
What are the possible advantages of oligopoly?
- Just like a monopoly, firms benefit from economies of scale in oligopoly, which means they can become more dynamically efficient and can pass on cost cuts as low prices to consumers
- Provided that there is a degree of competition, oligopolies continuously innovate and develop new and better products
What are the possible disadvantages of oligopoly?
- Just like monopoly, oligopolies restrict output and raise prices (and profit), compared to a more competitive market. Firms may sacrifice, content with an easy life
- Collusive oligopoly in the form of a cartel is a bad form of market structure, combining the disadvantages monopoly (high prices, productive and allocative inefficiency, and lack of choice) with few if any of the benefits
What is price leadership?
The setting of prices in a market, usually by a dominant firm, which is then followed by other firms in the same market
What is a price agreement?
An agreement between a firm, similar firms, suppliers or customers regarding the pricing of a good or service
What is a price war?
Occurs when rival firms continuously lower prices to undercut each other
What is price discrimination?
Charging different prices to different customers for the same product or service, with the prices based on different willingness to pay
What are the conditions for there to be successful price discrimination?
- It must be possible to identify different groups of customers or sub-markets for the product
- At any particular price, the different groups of customers must have different price elasticities of demand
- The markets must be separated to prevent seepage
What is a contestable market?
A market in which the potential exists for new firms to enter the market. A perfectly contestable market has no entry or exit barriers and no entry or exit barriers and no sunk costs, and both incumbent firms and new entrants have access to the same level of technology
What is hit-and-run competition?
Occurs when a new entrant can ‘hit’ the market, make profits and then ‘run’, given that there are no or low barriers to exit
In a contestable market theory, what is monopoly power dependent on?
The ease or difficulty with which new firms may enter the market
What is static efficiency?
Efficiency (e.g. productive and allocative efficiency) at a particular point in time
What is dynamic efficiency?
Improvements in productive efficiency occurring over time
What is consumer surplus?
A measure of the economic welfare enjoyed by consumers: surplus utility received over and above the price paid for a good
What is producer surplus?
A measure of the economic welfare enjoyed by firms or producers: the difference between the price a firm succeeds in charging and the minimum price it would be prepared to accept
