Chapter 5 Flashcards
Define perfect competition.
There are very many firms competing. Each firm is so small relative to the whole industry that it has no power to influence price. It is a price taker.
Define monopolistic competition.
There are quite a lot of firms competing and there is freedom for new firms to enter the industry.
Define a monopoly.
Just one firm in the industry and hence no competition from within the industry.
Define an oligopoly.
There are only a few firms and where entry of new firms is restricted.
Which 3 factors should you consider to help distinguish between competition?
- How freely can firms enter the industry?
- The nature of the product (e.g., identical or different brands/models?)
- The degree of control the firm has over price. (i.e., what is the nature of the demand curve it faces?)
How does the market structure a firm operates in affect its behaviour and performance?
The market structure will affect the firms behaviour (i.e., “conduct”) which will then affect the firm’s performance: e.g., prices, profits, etc. It can also affect the performance of other firms. Thus, structure -> conduct performance.
Define imperfect competition.
The collective name for monopolistic competition and oligopoly.
What are the four assumptions of perfect competition?
- Firms are price takers and have no ability to affect the price of the product. Firms face a horizontal demand curve at the market price.
- There is complete freedom of entry. Setting up in business takes time however, so freedom of entry applies in the long run.
- All firms produce an identical product. There is therefore no branding or advertising.
- Producers and consumers have perfect knowledge of the market.
This is a very rare market. Certain agricultural markets perhaps come close to this.
Define the short run under perfect competition.
We assume the number of firms in the industry cannot be increased: there is simply not time for new firms to enter the market.
What is the short-run supply curve under perfect competition?
The firms short-run supply curve will be its (short-run) marginal cost curve. But why? A supply curve shows how much will be supplied at each price: it relates quantity to price. The marginal cost curve relates quantity to marginal cost. But, under perfect competition, given that P = MR and MR = MC, P must equal MC. Thus, the supply curve and the MC curve will follow the same line. So, under perfect competition, the firm’s supply curve depends entirely on production costs. This demonstrates why the firm’s supply curve is upward sloping. Since marginal costs rise as output rises (due to diminishing marginal returns), a higher price is necessary to induce the firm to increase its output. Note that the firm will not produce at a price below average variable cost (AVC). Thus, the supply curve is only that portion of the MC curve above point e. What will be the short-run supply curve of the whole industry? This is simply the sum of the short-run supply curves (and hence MC curves) of all the firms in the industry. Graphically, it will be a horizontal sum, since it is quantities that are being added.
Define the long run under perfect competition.
In the long-run under perfect competition, if typical firms are making supernormal profits, new firms will be attracted to the industry. Also, if existing firms can make more profit by increasing their size they will. The effect of this is to increase industry supply. The industry supply curve will thus shift to the right has new firms enter. This can cause prices to fall. Supply will go on increasing and prices falling until firms are only making normal prices. This will be when the price has fallen to the point where the demand curve for the firm just touches the bottom of its long-run average cost curve.
Why is perfect competition and economies of scale so incompatible?
- Firms have to be quite large if they are to experience the full potential economies of scale. But perfect competition requires there to be many firms.
- Once a firm expands sufficiently to achieve economies of scale, it will usually gain market power. Thus, it can undercut the prices of smaller firms, which will be driven out of business. Thus, perfect competition is destroyed.
Therefore, perfect competition can only exist in any industry if there are no economies of scale.
What are 3 things that make perfect competition good for consumers?
- Price equals marginal cost. This means production levels are “just right”.
- The combination of (long-run) production being at a minimum average cost and the firm making only normal profit keeps price at a minimum.
- Perfect competition is a case of “survival of the fittest”. This encourages firms to be efficient & to invest in new, improved technology where possible.
Describe the assumptions of perfect competition in relation to e-commerce.
- Large number of firms – the reach of the internet is global. Firms’ demand curves are thus becoming very elastic.
- Perfect knowledge. E-commerce adds to the consumers knowledge (e.g., there is greater price transparency, with consumers able to compare prices online).
- Freedom of entry – internet companies often have lower start up costs than their conventional rivals. Marketing costs can also be relatively low. Internet companies are often smaller and more specialist, relying on Internet “outsourcing”. They are also more likely to use delivery firms than having their own transport fleet.
Why is it difficult to determine if a firm is a monopoly?
To some extent, the boundaries of an industry are arbitrary (e.g., an industry has a monopoly on certain types of fabric, but not on fabrics in general). It is more important to consider the amount of monopoly power a firm has, and that depends on the closeness or substitutes produced by rival industries (e.g., electricity is a monopoly).