Competition and Markets Flashcards
What are the different degrees of competition by which we classify markets?
Number of firms
Conditions of entry/exit to industry
Nature of Product
Information available to buyers and sellers
How does the number of firms affect competition?
More firms in a market, greater amount of competition
How do the conditions of entry/exit to industry affect competition?
○ E.g. easy market to get into, more likely to have a high no. of firms, more competition
More barriers to entry, difficult for firms to set up, low no. of firms
Firms may have a patent, so other firms find it difficult to enter
Ease of exit depends on ease of entry
How does the nature of Product affect competition?
○ Unique product; similar yet different characteristics; homogenous products
○ More differentiated/unique product is, less competition you’re likely to have
How does the information available to buyers and sellers affect competition?
○ Perfect, imperfect or asymmetric information.
○ More info there is, better the info, greater the degree of competition
Easier for firms to set up and enter market
Types of Market
Perfect Competition (most competitive)
Monopolistic Competition
Oligopoly
Monopoly (Least competitive)
Characteristics of a Perfect Market
No. of firms
-infinitely many
Freedom of entry
-unrestricted
Nature of product
- homogenous (undifferentiated)
Examples
-cabbages, carrots (approx.)
Implication for demand curve
- horizontal
- firm is a price taker
Characteristics of a Monopolistic Market
No. of firms
-many/several
Freedom of entry
-unrestricted
Nature of product
-differentiated
Examples
-hairdressers, restaurants
Implications for demand curve
- downward sloping
- relatively elastic
n.b.some control over price- most common
Characteristics of a Oligopoly Market
No. of firms
-small number of large firms
Freedom of entry
-restricted
Nature of product
-undifferentiated or differentiated
Examples
-petrol, banking, supermarkets
Implications for demand curve
- downward sloping
- relatively inelastic (shape depends on the reaction of rivals)
n.b. interdependence
Characteristics of a Monopoly Market
No. of firms
-one
Freedom of entry
-restricted or completely blocked
Nature of product
-unique
Examples
-local water company, train operators (over particular routes)
Implication for demand curve
- downward sloping
- more inelastic than oligopoly
- firm has considerable control over price
n. b. freedom of entry restricted
- 25% of market share, or more
What is Accounting profit?
• Accounting Profit = Revenues - Costs
○ Costs: rent for land and capital and wages for labour
○ Revenue = Costs - breaking even
What is economic profit?
• Economic Profit: Revenues – Costs
○ BUT: Costs also include opportunity cost
○ Revenue = Costs - making a normal level of profit
define normal profits
minimum profit necessary to attract and retain a company.
Accounting: breaking even
define supernormal profits
financial returns greater than normal profits.
§ Accounting: profits
define fixed costs
costs that do not vary with output
define variable costs
costs that change with the level of output
define total costs
total cost of producing some output, Q
TC = FC + VC
define average cost
cost per unit of output
AC = TC/Q
define marginal cost
cost of producing one additional unit
MC = change in TC / Change in Q
Characteristics of perfectly competitive firms
-individual demand is perfectly elastic
- firm is a price taker, no control over market price
• Marginal revenue line is also perfectly elastic
○ Equal to average revenue & demand curve
• Maximize profit when marginal cost equals marginal revenue
○ MR = MC
§ This is the profit maximising point for all firms
if short-run supernormal profits occur, what happens in the long-run?
○ Profits are known to potential entrants
○ Supernormal profits attract firms
○ Entry eliminates supernormal profits
In long-run equilibrium, what happens when profit increases?
○ Increased profits attract new businesses into the market.
○ The market equilibrium price drops until AR = AC and only normal profits are earned.
What is productive efficiency?
occurs when the firm is operating at the minimum point on its long-run average cost curve
i.e. producing at most cost efficient level, at min LRAC
Are perfectly competitive firms productively efficient?
○ In the short run? No
○ In the long run? They are
goods are being produced and sold at the lowest possible average cost.
What is allocative efficiency
P = MC
price paid for good = benefit to society/ how much people are willing to pay
Producing right amount of the good, firms allocate resources as efficient as possible,
maximises Total welfare of society
Why do firms want to avoid perfect competition?
cannot make supernormal profits
so they can have some control over price
How can firms avoid perfect competition?
○ offering differentiated products
○ Introducing barriers to entry
What does avoiding perfect competition imply for prices and profits
- supernormal profits provide finance for research & development
0in long-run only normal profits are made, less innovation
define natural monopoly
when most efficient number firms in the industry is one
implications of a monopoly
• Lower output and higher prices than Perfect Competition
○ Hence, society welfare not maximised
• Supernormal profits even in long-run
○ Can be used for R&D
• Firms as allocatively efficient
• Economies of scale
if significant, monopolies can benefit from lower average costs, lower prices for consumers
• Natural Monopoly
- very high fixed costs
feature of monopolistic competition
• Many firms with freedom of entry and exit
• Differentiated products
• Firms face a downward-sloping demand curve
○ Fairly elastic at any price
If a firm makes supernormal profits, what happens in the long-run?
○ New entrants come into the market.
○ Established firms lose some customers, demand decreases, demand curve shifts inwards
§ Keeps shifting until normal profit is being made
○ Entry stops when each firm is breaking even.
○ New demand curve is at a tangent to AC
○ Earn normal profits because AR - AC = 0
perfect and monopolistic competition
Firms have excess capacity: firms could increase output and reduce costs
Firms have market power because P > MC.
○ Always willing to sell one more unit
○ Willing to engage in advertising activities
what is interdependence for an oligopoly
• High degree of interdependence between firms
-Before I act, how will other firms react, and hence how will this affect my firm
○ Profits of firm i depend on competitors behaviour:
Strategic interdependence πi (qi, qj)
define interdependence
the behviour of one firm will affect other firms
The four outcomes in Game Theory
- both firms discount
- both firms don’t discount
- Firm A discounts and Firm B doesn’t
- Firm B discounts and Firm A doesn’t
What is a dominant strategy game?
- no matter what the other firm does, the best response remains the same
- both firms have a strategy that dominates, hence always play no matter what other firm does
What is a Nash equilibrium
- when both firms are best responding to each other and neither has an incentive to deviate
i. e. both firms choose one strategy
What is the prisoners dilemma?
- both firms better off if they stop playing i.e. both stop discounting
- neither firm has the incentive to play this strategy
- nash equilibrium is hence inefficient as firms forced to accept a mutually bad outcome
define collusion
agreement between two or more firms to limit open competition
define collusive agreement
leads to competition in the market being restricted
i.e. agreeing prices or quotas
what happens when you engage in a collusive agreement?
- a firm aims to become a monopolist- a firm with market power
i. e. rather than individual firms competing to maximise their own profits, they act as if they are collectively a profit maximising monopolist- increases industry profit
