Chapter 1 = Competition and market power

Question 1

Spectrum of competition

Answer 1

has perfect competition at one end and pure monopoly at the other. These are extreme situations and real world businesses are located in the space between them

Question 2

The closer a market is to a monopoly…

Answer 2

the more it takes on the characteristics of a monopoly and the less competitive it becomes

Question 3

The closer a market is towards perfect competition…

Answer 3

the more competitive it becomes and the closer it gets to the characteristics of perfect competition

Question 4

A legal monopoly

Answer 4

exists when a firm has 25% or more of its market

Question 5

Natural monopoly

Answer 5

this may exist when it would be wasteful to have more than one business providing a service eg water supply or rail networks

Question 6

characteristics of a monopoly

Answer 6

• have the ability to set either price or output levels
• prices tend to be higher
• considerable barriers to entry
• consumer choice may be restricted
• profits will be higher than in a competitive situation

Question 7

Monopoly power

Answer 7

is the ability to affect price levels; either to charge higher prices, or to lower them in order to take market share away from smaller rivals. It refers to the ability to restrict output, to affect outcomes in the market and dictate what happens

Question 8

duopoly

Answer 8

occurs where two large firms dominate the market

Question 9

Characteristics of an oligopoly

Answer 9

• considerable monopoly power
• oligopolies are often characterised by non-price competition
• competing on price is usually avoided as a price war can be damaging to profits
• although a few large firms dominate the market, there are likely to be many smaller firms often in niche markets
• always a danger of collusion
• high barriers to entry
• abnormal profits will be made

Question 10

collusion

Answer 10

illegally reaching an agreement to fix prices or control output at the expense of the consumer

Question 11

oligopoly

Answer 11

is said to exist when the concentration ratio shows that a specific number of firms in the market account for more than 60% of that market

Question 12

imperfect competition

Answer 12

is an umbrella term that covers all those situations where competition exists but is not as strong as as it might be. There will be distortions in the market preventing it being fully competitive and includes monopolistic competition.

Question 13

homogeneous products

Answer 13

meaning exactly the same so that it is impossible to tell the difference between products from different suppliers

Question 14

Features of perfect competition

Answer 14

• homogeneous products
• many buyers and sellers
• price takers, no control over price
• no barriers to entry or exit
• perfect knowledge, consumers and suppliers know about everything that happens
• only normal profit is made

Question 15

normal profit

Answer 15

is the amount of profit required for the firm to stay in business. Any less and it will be unable to cover all its costs.

Question 16

price takers

Answer 16

cannot choose the prices they charge- they must sell at the price prevailing in the market place because of strong competition.

Question 17

the impact of market structure based on pricing strategies

Answer 17

perfect competition will require competitive pricing.

businesses with monopoly have choices. For example, they can consider premium pricing or price skimming or penetration pricing.

Question 18

barriers to entry include…

Answer 18

all the difficulties that businesses are likely to face when they’re setting up. We define a market where businesses can easily set up as contestable.

Question 19

contestable markets

Answer 19

are those that have low barriers to entry - new entrants can set up in business without having to invest serious amounts of capital. This can make a market competitive even though there are relatively few sellers.

Question 20

barriers to entry definition

Answer 20

are the factors that prevent firms from entering the market. Where there are many barriers to entry, there will usually be less competition.

Question 21

Easy entry to a market means..

Answer 21

being able to start up a new business without having to invest vast sums of money or comply with difficult regulations.

Question 22

barriers to entry include:

Answer 22

product differentiation
branding and brand loyalty 
start up costs 
intellecutual property rights 
R&D

Question 23

Product differentiation

Answer 23

where competing products are both attractive and reasonably priced, a new product will either have to be carefully differentiated or have a price advantage. This will require some financing.

Question 24

branding and brand loyalty

Answer 24

Large, well established brands will be known by and trusted by their customers

Question 25

intellectual property rights

Answer 25

are based on new ideas and inventions that can be protected by patents and copyright. They are legal barriers to entry

Question 26

R&D and technology change

Answer 26

these need funding so small businesses may struggle to bring their products to market due to a lack of funding.

Question 27

impact of barriers to entry on market structure

Answer 27

barriers to entry will most likely lead markets to resemble oligopolies.

For natural monopolies there’s major barriers to entry as competition cannot reduce prices and costs

Question 28

concentration ratios

Answer 28

measures the extent to which a market or industry is dominated by a few leading firms. It is calculated by adding market shares of the biggest firms in the industry. Adding the three largest in the industry is the three firm concentration ratio.

Question 29

tacit agreement/collusion

Answer 29

refers to understanding that develops between competing businesses. There is no personal contact and no formal agreement. The parties involved simply take no action that might increase level of competition.

Question 30

marginal cost

Answer 30

is the cost of producing one more unit of output.

Question 31

marginal revenue

Answer 31

is the extra revenue that comes from selling one more unit of output.

Question 32

contribution

Answer 32

is the revenue from each extra unit sold minus its variable cost. It is the amount contributed to fixed costs by each additional sale. Is exactly like marginal revenue minus marginal cost.

Question 33

productive efficiency

Answer 33

means minimising production costs by using the least possible quantity of real resources. This keeps prices to a minimum and helps to achieve the best possible standard of living. It fits neatly with the idea of lean production, minimising waste.

Question 34

allocative efficiency

Answer 34

is about using resources in such a way that actual output is perfectly matched to consumer preferences. It involves responding to changes in consumer demand as quickly s possible. It’s achieved when resources are used to yield the maximum benefit to everyone.

Question 35

profit maximisation=

Answer 35

marginal revenue = marginal cost

Question 36

revenue maximisation=

Answer 36

marginal revenue = 0

Question 37

sales maximisation=

Answer 37

average revenue = average cost

Question 38

satisficing

Answer 38

any price> or = average cost but less than the profit maximising price

Question 39

limit pricing

Answer 39

the price at which a potential rival cannot make normal profit if they enter