Chapter 23: Market structure

Question 1

Behaviour of competitive firms

Answer 1

• PRessure to keep prices low
• Seek to gain advantage by improving their products
• Likely to respond quickly and fully to any changes in demand
• Firms probably earn relatively low profits in the long run because of easy barriers to entry and exit
• In the short run, firms may earn more or less profit than the level of profit in the long run - normal profit
• If demand for the product rises, the firms will make higher than normal profit - supernormal profit - will attract new firms into the industry causing an increase in supply which will return profit to normal level
• If demand falls, firms would initially make a loss - force some firms out of the industry and resotre normal profits

Question 2

Performance of competitive firms

Answer 2

• High level of competition usually promotes efficiency
• Provides firms with incentive and threat to produce according to consumers’ wants at the lowest possible cost
• High level of competition may drive the price down to a level which just covers the cost

Question 3

Reasons to monopolies arising

Answer 3

• Firm may have been successful in cutting costs and responding to changes in consumer tastes, driving out rivals
• Mergers and takeovers
• One firm may have been grated monopolistic powers by the government
• One firm may exist from the start
• Patent stops other firms

Question 4

Behaviours of monopoly

Answer 4

• Monopolies can earn supernormal profits in the long run
• Monopolies have control voer the supply of product
• If monopoly chooses to sell a given quantity, the price will be determined by what consumers are prepared to pay

Question 5

Continuation of monopolies

Answer 5

• Barriers to entry and exit
• Legal barrier - patent or government
• Scale of production
• Excpensive to set up a new firm if large capital equipment is required
• Brand loyalty through branding
• Monopoly’s access to resources and retail outlets
• Long term contract to provide a product - firms reluctant to undertake the commitment
• Sunk costs - costs which cannot be recoverted if the firm leaves the industry

Question 6

Performance of a monopoly

Answer 6

• Absence of competition may lead to inefficiency
• Monopoly may restrict supply to push up prices and may produce poor quality
• Monopolies may fail to respond to changes in consumer tastes and develop new products
• If a monopoly produces on a large scale, its unit cost and price mayt be lower than that in a more competitive market
• Monopoly’s high profits would enable it to spend on research and development
• To overcome barriers, the monopoly may encourage firms outside the industry to try and develop a better product