Chapter 1 = Competition and market power Flashcards
Spectrum of competition
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
The closer a market is to a monopoly…
the more it takes on the characteristics of a monopoly and the less competitive it becomes
The closer a market is towards perfect competition…
the more competitive it becomes and the closer it gets to the characteristics of perfect competition
A legal monopoly
exists when a firm has 25% or more of its market
Natural monopoly
this may exist when it would be wasteful to have more than one business providing a service eg water supply or rail networks
characteristics of a monopoly
- 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
Monopoly power
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
duopoly
occurs where two large firms dominate the market
Characteristics of an oligopoly
- 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
collusion
illegally reaching an agreement to fix prices or control output at the expense of the consumer
oligopoly
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
imperfect competition
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.
homogeneous products
meaning exactly the same so that it is impossible to tell the difference between products from different suppliers
Features of perfect competition
- 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
normal profit
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.
price takers
cannot choose the prices they charge- they must sell at the price prevailing in the market place because of strong competition.
the impact of market structure based on pricing strategies
perfect competition will require competitive pricing.
businesses with monopoly have choices. For example, they can consider premium pricing or price skimming or penetration pricing.
barriers to entry include…
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.
contestable markets
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.
barriers to entry definition
are the factors that prevent firms from entering the market. Where there are many barriers to entry, there will usually be less competition.
Easy entry to a market means..
being able to start up a new business without having to invest vast sums of money or comply with difficult regulations.
barriers to entry include:
product differentiation branding and brand loyalty start up costs intellecutual property rights R&D
Product differentiation
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.
branding and brand loyalty
Large, well established brands will be known by and trusted by their customers
intellectual property rights
are based on new ideas and inventions that can be protected by patents and copyright. They are legal barriers to entry
R&D and technology change
these need funding so small businesses may struggle to bring their products to market due to a lack of funding.
impact of barriers to entry on market structure
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
concentration ratios
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.
tacit agreement/collusion
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.
marginal cost
is the cost of producing one more unit of output.
marginal revenue
is the extra revenue that comes from selling one more unit of output.
contribution
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.
productive efficiency
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.
allocative efficiency
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.
profit maximisation=
marginal revenue = marginal cost
revenue maximisation=
marginal revenue = 0
sales maximisation=
average revenue = average cost
satisficing
any price> or = average cost but less than the profit maximising price
limit pricing
the price at which a potential rival cannot make normal profit if they enter
