Chapter 5 Flashcards
Define market structure
The organisational and other characteristics of a market
Explain the spectrum of market structures
Perfect competition Monopolistic competition Oligopoly Duopoly Monopoly
Define market entry and exit barriers
Obstacles that make it difficult for a firm to enter a market
Obstacles that make it difficult for a firm to exit a market
What is a firms objective
Profit maximisation
Equation for total profit
Total profit= Total revenue - Total cost
What is profit maximising in perfect competition
Marginal revenue = marginal cost
Draw an MR=MC curve
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Explain the divorce of ownership from control
Agent - Directors
Principal- Shareholders
Agents don’t have the same objectives like principles. Principals objectives are profit maximisation.
Agent takes risk for principle but does not receive the same full benefit of their actions so would rather not do it again
Who is principal and agent
Agent- Director
Principal- Shareholder
Why can agent get away with not acting in the interest of the principal
- Cost of sacking agent to principal is higher than benefit received
- Informational asymmetry, the principal does not know if agent is acting in their best interest
Business objectives other than profit maximisation…
- Growth maximisation and survival
- Revenue maximisation
Explain the satisfying principle
Achieving a satisfying outcome rather than the best possible outcome
Setting minimum rather than maximum targets
Draw short run profit maximisation in perfect competition
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Draw long run perfect competition where abnormal profit is being utilised
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Explain the role of abnormal profit in the long run of perfect competition
Abnormal profit draws firms into a market.
When too many enter some leave and abnormal profit is no longer made
Define productively efficient
Impossible to produce more of one good without less of another
Define allocative efficiency
Impossible to improve overall economic welfare
Relationship between perfect competition and allocative efficiency
When MR=D allocative efficiency has been achieved
Conditions where perfect competition can achieve allocative efficiency
- All markets benefit from available economies of scale
- Perfectly competitive for all firms
- No externalities, positive or negative
Allocative efficiency:
Explain P>MC and P
Price is higher than cost of production so consumers will be discouraged from spending. So the good will be underproduced and under consumed.
Price is lower than MC, welfare is high but then will begin to fall and equalise.
Define allocative inefficiency
P>MC good is underproduced and underconsumed
P
Define monopoly
One firm in a market
Draw monopoly profit maximisation
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Why is short run and long run profit maximisation in monopolies the same
Because monopolies are protected by barriers to entry, preventing new firms from entering the firm and sharing the abnormal profit.
Define monopoly power
Monopolies can preserve profit by keeping competitors out
What are the advantages of monopolies
- Economies of scale
- Dynamic efficiency
- Use it’s abnormal profit to better production of product
What are the disadvantages of monopolies
- Productive inefficiency
- Allocative inefficiency
- Profit satisfice instead of profit maximise so absence of benefits from economies of scale and innovation
Monopolistic competition characteristics:
- Large number of firms
- LR no barriers to entry or exit
- So firms will enter to gain abnormal profit
- Slightly different product, not perfect substitutes
- MR is below AR still
Draw short run monopolistic competition profit maximisation
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Draw long run monopolistic competition profit maximisation
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Why is AR below MR=D in monopolies
Because in order to make more profit by selling additional units , firms must lower their price
Difference between informative and persuasive advertising and saturation advertising
Informative- increases competition ,provides useful information about the good or service
Persuasive- reduces competition ,little information on the good but persuades for specific product
Saturation- monopolies prevent small firms to enter as they cannot afford the minimum level of advertising
Define price competition
Reducing the price causes firms to leave other markets and other similar firms to one specific firm
Examples of non price competition
- marketing, obtaining exclusive outlets
- Persuasive advertising
- Quality competition
What is a market concentration ratio
Measures the market share of the biggest firms in the market
What does oligopoly mean
Market containing a few firm
Difference between oligopoly and monopolistic competition
Oligopoly- in one market
Monopolistic competition- many monopolies with somewhat substitutes, more like perfect competition
Can oligopolies affect its rivals profits
Yes
Define market conduct
Pricing and marketing policies pursued by firms
Are oligopolies uncertain
Yes due to interdependence
Difference between collusive and non collusive oligopolies
Collusive- where they work together such as cartel
Non collusive- oligopolies not working together and in fact competing
Define cartel
A collusive agreement by firms usually to fix prices and perhaps reduce output and deter entry of new firms
Are cartels / collusion’s of oligopolies good for consumers
Normally not but sometimes good
Two types of collusion
Covert collusion- In secret agreement
Tacit collusion- ‘understanding’ between firms without an explicit agreement
Why is the oligopoly demand curve kinked
Oligopolies are affected by rivals reaction to output and price changes (estimate of how demand changes to a change of price)
Draw the kinked demand curve
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Criticisms of the kinked demand curve
- Does not explain how and why firms decide to change their price
- Firms will normally test markets and adjust
Advantages of oligopolies
- Economies of scale and dynamically efficient
- Only a few firms making it easier for consumers to choose
- Due to competition constantly innovating and developing better products
Disadvantages of oligopolies
- May restrict output and raise prices like monopolies
- Cartels
- Small firms may find it hard to enter
- Producer sovereignty
3 ways in which oligopolies can adjust their prices
-Price leadership
One firm becomes market leader and other firms follow its pricing examples
-Price agreements
Cartel agreements
-Price wars
Rival firms continuously lose prices to undercut each other and consumer ends up benefitting from cheaper products
Define price discrimination
Charging different prices to different customers for the same product, with the prices based on different willingness to buy
Draw two price discrimination graphs
Why is MC the same
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Because it costs the same as it is price discrimination
What are the conditions of price discrimination
- Identifiable groups
- These groups must have different elastic i ties of demand
- Prevent seepage (paying off to others)
Difference between contestable and non contestable markets
Contestable - Market with potential for new markets to enter (No entry/exit barriers, no sunk costs, same technology)
Non contestable - opposite of contestable
Define sunk cost
Costs incurred from entering a market that are unrecoverable
Example of a sunk cost
Rent
What do sunk costs do to hit and run competition
Discourage it
Define hit and run competition
A new entrant can ‘hit’ the marker, make profits then ‘run’ due to low entry and exit barriers
Define static efficiency
Efficiency at a particular point
Define dynamic efficiency
In particular productive efficiency occurring over time which results from technical progress and innovation
Define consumer surplus and when is maximisation of welfare
Define producer surplus
Consumer surplus: difference between maximum prices a consumer is prepared to pay and actual price. MW is when the triangle expands e.g when prices fall
Producer surplus: Difference between minimum price a firm is prepared to charge for a good and actual price charged.
What does consumer and producer surplus measure
Welfare
Draw consumer and producer surplus
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Define deadweight welfare
The loss of economic welfare when the maximum attainable level of total welfare is not achieved
Draw Consumer surplus and producer surplus in monopoly
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Why does price discrimination benefit firms
Because it allows firms to increase profit by taking consumer surplus away from consumers and converting it into additional abnormal profit. Consumers suffer and firms benefit
