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Economics A2 6EC03 > 6EC03 - Theory Of The Firm > Flashcards

6EC03 - Theory Of The Firm Flashcards

0
Q

What is n-firm concentration ratio? And give an example.

A

The market share controlled by ‘n’ largest firms,

e.g if the 4 firm concentration ratio is 80% this means the largest firms have 80% of the sales in the market combined

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1
Q

What is market concentration?

A

The degree to which the output of an industry is dominated by its largest producers

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2
Q

What is a market share?

A

The proportion of sales in a market taken by a firm or group of firms

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3
Q

Give an example of a highly concentrated ratio market.

A

Oligopoly

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4
Q

Give an example of a low concentration ratio market.

A

A monopolistically competitive market

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5
Q

What are homogeneous goods?

A

Goods made by different firms but which are identical

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6
Q

What is imperfect competition?

A

Market structure where there’s several or relatively large number of firms in industry,
Each with ability to control price that it sets for its products

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7
Q

What is market structure?

A

The characteristics of a market which determine the behaviour of firms within the market

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8
Q

What is a natural monopoly? And give an example.

A

Exists when an industry can only support one firm,
Always enjoy lower costs of production than any other potential competitor,
Typical of industry which has:
- High sunk costs
- Requires large levels of output to exploit economies of scale
e.g BT, southern rail

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9
Q

What are non-homogeneous goods? Give an example.

A

Goods which are similar but not identical,
Made by different firms,
e.g branded goods

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10
Q

What is perfect knowledge or information?

A

Exists if all buyers in market awfully informs of prices & quantities for sale,
While producers have equal access to information about production techniques

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11
Q

What are the assumptions of perfect competition?

A

1) Many buyers & sellers
2) Perfect information
3) Homogeneous product
4) No barriers to entry
5) Producers have similar technology & perfectly mobile rap itches (1 firm cannot maintain advantage over another)

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12
Q

In a perfect competitive market, are firms price takers or price makers? And explain.

A

Price takers,
Neither buyers nor sellers can influence the price,
Firms face a horizontal demand curve: AR = MR,
If one firm changes output there’s no shirt in industry supply curve,
However if whole industry’s output changes then supply will shift and price will change,
So firms can sell all it wants at given market price

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13
Q

What type of profits do firms in perfectly competitive markets make in the SR?

A

Supernormal profits or losses

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14
Q

What type of profits do firms in perfectly competitive markets make in the LR?

A

Normal profits

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15
Q

What happens if firms are making supernormal profits in a perfectly competitive market?

A

Other firms will enter the market in the LR,
Shift supply to right,
Lead to fall in price,
Continue until normal profits earned

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16
Q

What happens if firms are making losses in a perfectly competitive market?

A

They will leave the industry,
Shifting supply to the left,
Cause price to increase,
Continue until firms left in industry make normal profit,

However, for individual firm the output will actually rise,
Because fewer firms in market & each one makes just a little more,
Allowing MC to rise as MR rises,
MC always = MR

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17
Q

Does the firm in perfect competition automatically shut down when it makes a loss?

A

No barriers to exit so sensible for firm to leave industry straight away,
Before considered look at SR:
- perfectly competitive firm have fixed costs in SR
- FC must be paid even if firm shuts down immediately
- question whether larger loss made by shutting down (paying FCs) LR waiting until FCs become variable

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18
Q

What is the shut-down point in perfect competition?

A

When firm is not covering AVC,

It is better to shut down straight away, as make less of a loss if doesn’t product at all

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19
Q

What is a pure monopoly?

A

Involves one firm alone dominating the market

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20
Q

What is a legal monopoly?

A

Where one firm dominates 25% or more of the market

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21
Q

What are the assumptions of a monopoly market?

A

1) Single seller
2) Price maker (monopolist faces downward sloping demand can set price or output but not both)
3) Non-homogeneous product
4) Imperfect knowledge
5) Barriers to entry high
6) Short run profit maximiser

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22
Q

What are the benefits of monopoly for consumers?

A

Innovation - bringing new ideas & processes, & being able to take risks of new ideas
Research & development - large firms plough back enormous sums into high-risk enterprise; research more often leads to failure do only monopoly profits can afford to take the risk
Investment - large-scale firms can afford to invest, as have confidence they’ll still be in existence to reap rewards

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23
Q

What are the benefits of monopolies for firms?

A

Offer secure outlet for suppliers,
e.g of company makes car tyres then monopoly car producer could keep the orders rolling in
Firms which buy from monopolies more likely to have consistent quality,
Not worth taking risks with quality of well-known brand, as too much to lose

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24
Q

What are the costs of monopolies for consumers?

A

Less choice - large firms keep to the brand that makes most profit, unprofitable brands soon come off shelves
Higher prices - monopolists can increase price to maximise their profits
Lower quality - firms with no competition may not have incentive to produce better goods or services & after-care service might be limited

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25
Q

What are the costs of monopolies for firms?

A

Firms which buy from monopolies can be exploited,
e.g small computer outlets have no choice when buying apple products,
Other firms deliberately forced out market (limit/ predatory pricing) as not yet had chance to establish themselves

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26
Q

What are the disadvantages of supernormal profit with monopoly power?

A

Less incentive to be efficient & to develop new products,

The existence of resources to protect dominance by raising barriers to entry

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27
Q

What are the disadvantages of monopoly power?

A

Higher prices & lower output for domestic consumers,
May waste resources by undertaking cross-subsidisation using profits from 1 sector to finance losses in another sector,
Don’t produce at most productive efficient pint of output,
Monopolists can be complacent & develop x-inefficiencies

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28
Q

What are the advantages of supernormal profit with monopoly power?

A

Finance for investment to maintain competitive edge,
Firms can also create reserves to overcome ST difficulties, giving stability to employment,
Funds for research & development

29
Q

What are the advantages of monopoly power?

A

Firms will have the financial power to match large overseas competitors,
Take advantage of economies of scale meaning AC may be lower than those of competitive firm at its most efficient position

30
Q

What is price discrimination?

A

Involves charging different prices for the same good or service which have the same cost of production

31
Q

Who uses price discrimination?

A

Firms with monopoly power,
To increase profits & reduce consumer surplus,
This is possible because of high barriers to entry & exit

32
Q

What conditions will price discrimination be successful?

A

1) High barriers to entry & degree of monopoly power
2) At least 2 separate markets with differing PEDs
3) Markets can be kept separate at a cost that’s lower than the gain in profits

33
Q

Why is price discrimination focused on markets with monopoly power?

A

If there’s no monopoly power:
New firms could enter industry & exploit supernormal profits available when price discriminator charges higher price to consumer with lower PED

34
Q

What is product discrimination?

A

Where different prices are charged for slightly different products
e.g Heathrow more expensive than gatwick or kids meals half price adults full at Ikea

35
Q

Give 5 examples of methods of price discrimination.

A 
Status - members of a club,
Time - rail fares,
Age - U16 or overs,
Geography - rates in different regions,
Branding - e.g Tesco basic to Tesco finest
36
Q

Why is perfect competition more desirable than monopoly? (In terms of efficiency)

A

Competition drives down both costs & prices,
Consumers benefit - goods & services cheaper which not restricted by firms to make supernormal profit,
Leads to productive & allocative efficiency
However, in LR abnormal profits aren’t made so can’t afford research & development

37
Q

What type of efficiency can a perfectly competitive market make? And why?

A

Productive efficiency - produce at minimum point of AC curve,
Allocative efficiency - P=MC,
LR firm cannot earn abnormal profit,
If firm becomes more efficient than others:
Supernormal profit can be earned in SR; incentive for firms to innovate & become more efficient,

38
Q

Compare the efficiencies in perfect competition and monopoly.

A 
PC - produce where D=S (P=MC),
M - produce where MC=MR,
Concluding for monopolies: 
- output lower
- price higher 
- allocatively inefficient  
- x-inefficiency may kick in
39
Q

What is monopsony power? And give examples.

A

Exists when there’s only 1 buyer in the market,

e.g NHS, supermarket industry major retailers join to exploit sellers, Network Rail

40
Q

What are the necessary conditions for a monopsony to operate?

A

Sellers in market must not be able to sell their product to other firms outside the market,
Profit maximisers - minimise costs by paying suppliers lowest price possible

41
Q

What are the benefits of monopsony?

A

The monopolist - gains higher profits by buying at lower prices as suppliers can’t overcharge, lower AC production,
- can use profits to innovate & invest
Customers - part of lower costs for monopsonist likely to be passed onto customers in lower prices

42
Q

What are the costs of monopsony?

A

Suppliers - prices paid for goods/ services will fall, therefore can be squeezed out of business,
Consumers - choice limited as monopsony acts as barrier to entry for new firms,
Monopsonist - firms investigated by competition authorities & higher profits can mean inequality

43
Q

What is an oligopoly? Give examples.

A

Occurs when a few firms dominate a market

e.g newspaper industry, supermarkets, airlines

44
Q

What is interdependence?

A

Where the actions of one agent depends upon the actions of another

45
Q

What are the assumptions of oligopoly?

A

1) Few firms dominate the market (concentration ratios high)
2) High barriers to entry & exit
3) Goods with similar characteristics but brand loyalty strong
4) Imperfect knowledge
5) Can price set but may decide agreed price-fixing deals with rivals to avoid competition

46
Q

In an oligopolistic market what does firms interdependency lead to?

A

Firms behaviour will depend on what it thinks others are going to do

47
Q

As there are only a few firms in an oligopolistic market, the actions of one firm does what to others?

A

Has a significant effect in the behaviour of the other,

There’s no one price & output outcome in oligopoly

48
Q

What are the 2 conflicting aims in oligopoly?

A

1) To collude with other firms to maximise their combined profits
2) To compete with other firms to take business away from them & make more profit independently

49
Q

How do price wars occur?

A

When firms in an oligopoly try to undercut each other by cutting price,
Aim to gain sales from competition,
Others tend to follow to avoid losing market share,
Can lead to further cuts,
Often happens when overcapacity in industry e.g cars, PCs

50
Q

What is collusion?

A

An agreement between 2 or more firms to limit competition

- (divide market, set prices/ output, increase welfare gains)

51
Q

What is tacit collusion? Give an example.

A

Occurs when firms collide without any formal agreement being reached or even without any communication between them,
Illegal but v.hard for competition authorites to control

52
Q

What is overt collusion?

A

Where firms openly fix prices, output, marketing or sharing out of customers,
It’s illegal & easier to detect than tacit
e.g extreme firm of overt collusion is forming a cartel

53
Q

What is non-collusive behaviour?

A

Occurs when firms act in a way that doesn’t involve collaboration with other players in the market

54
Q

What is a cartel? And what are reasons for them?

A

Involves firms acting as one through an agreement,
Fix a profit maximising price & output for industry & give each other quotas,
Maximises industry’s profits,
e.g OPEC

55
Q

What is price leadership?

A

Sometimes in oligopoly there’s a clear price leader,

i.e all firms follow pricing decisions of one of other firms

56
Q

What makes collusion more likely? (4 points)

A

1) If there’s only a few firms, easier to check on each other & share info
2) Effective communication & monitoring systems means any cheating can be identified early on
3) Stable cost & demand conditions mean quotas easy to allocate & measure & policy easy to administer
4) Similar production costs so make similar profits

57
Q

What is game theory?

A

The analysis of situations in which players are interdependent

58
Q

What is prisoners’ dilemma?

A

Model used in game theory to question whether firms might not collide, even if it appears that it is in their best interests to do so, or vice versa

59
Q

What is a pay-off matrix?

A

A simple two-firm, two-outcome model

60
Q

What is the maximum strategy?

A

Where the firm maximises its own minimum pay off,

Due to lack of trust between firms, any collusive agreement is likely to be broken

61
Q

What are the characteristics of monopolistic competition?

A

1) Many small firms
2) Non-homogeneous products
3) Imperfect knowledge
4) Low barriers to entry/ exit
5) Firms can set prices to an extend (because will produce goods which are slightly different from rival firms’ goods)

62
Q

What sort of profit do the firms of a monopolistic competition market make in the SR? And why?

A

Abnormal profits,
They have some control over market as products different in some way,
e.g better location, design or new technology

63
Q

What happens in the LR for monopolistic competition?

A

Other firms will be attracted by supernormal profits,
Demand for any 1 firm will fall until normal profits made,
Allocatively inefficient - (P>MC) price consumer willing to pay > extra cost of production,
Productively inefficient - firm not producing at minimum point of AC

64
Q

Why firms under monopolistic competition stay in business in the LR, given they can’t make abnormal profits?

A

Firms still make normal profit,

Which is defined as ‘just enough profit to keep factors in their current use’

65
Q

Give examples of monopolistic competition. Explain the demand.

A 
Restaurants,
Hairdressers,
Nail bars,
Demand curve not perfectly price elastic,
Close quickly if demand falls
66
Q

What is contestability?

A

A measure of the ease with which firms can enter or exit an industry

67
Q

What are the assumptions of a contest able market?

A

1) Freedom of entry & exit
2) Number or firms competing will vary e.g may be a monopoly at one time & may be many other firms competing at other times
3) Firms compete (rather than collude)
4) Perfect knowledge
5) Homogeneous good or branded goods, can be either

68
Q

What is a perfectly contestable market?

A 
Costs of entry & exit are zero,
High degree of pressure on firms to act competitively,
Abnormal profits act as incentive to bring in more firms,
Entry likely to lead to:
- lower prices
- better quality service
- more choice
- higher output
e.g banking changes in technology
69
Q

A market will be more contestable if:

A

Profits are high - incentive to enter,
Barriers to entry & exit low - relatively easy to join market & leave if needed
- industry may suffer from hit & run competition
- firms enter when profits high
- firms leave when profits fall

70
Q

In the short term, for contestable markets what sort of profits are made?

A

Supernormal

Economics A2 6EC03 (5 decks)

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