Competitive Markets Flashcards
What is revenue maximising condition?
When MR = 0
MR > 0:
Increasing output increases revenue
MR < 0:
Decreasing output increases revenue
Where MR is positive, TR is rising.
Where MR is negative, TR is falling
Where MR = 0, TR is at a maximum
How many firms has perfect competition market structure got?
Infinitely many firms
How many firms has monopolsitic competition market structure got?
Lots of firms
How many firms has oligopoly market structure got?
Few firms
How many firms has monopoly market structure got?
One firm
What are the assumptions of perfect competition?
- Many buyers and sellers
- Perfect information
- Homogenous product
- No barriers to entry or exit
What does homogenous product mean?
All firms sell the same product.
What are the implications of perfect competition?
Firms are price takers:
- Firms accept the market price
- Can sell as much as they want at this market price
- Prices are perfectly elastic
- In the long-run firms make only normal profit
Therefore, if a firm charges more than market price then customers will buy from other firms. They also have no reason to sell below market price because they can already sell as much as they want at market price.
Why does perfect information cause firms to only make normal profit in the long-run?
Economic loss, then firms will leave market, leading to normal profit levels.
Supernormal profit, then firms will enter market, pushing profits back to normal profit.
This happens because there are no barriers to entry or exit.
What is productive efficiency?
Producing at the lowest possible average cost. Bottom of the AC curve.
Minimising costs.
What is allocative efficiency?
Occurs where there is an optimal allocation of resources. Occurs where P = MC
Does perfect competition encourage long-run economic growth?
- R&D promotes innovation and invention
- Which drives long-run economic growth
- Firms make only normal profits
- Little money for R&D
- P.C may not encourage innovation and invention
- May not drive long-run growth
Non-competitive market traits
- Market power
- Few sellers
- Unique goods
- Imperfect info
- Supernormal profits
Pure monopoly
Competitive market traits
- Lots of buyers
- Lots of sellers
- Same goods
- Perfect info
- Normal profits in LR
Perfect competition
What is monopolistic competition?
A market structure that contains elements of a perfectly competitive market and a monopoly.
Monopolistic competition market structure characteristics
- Many buyers and sellers
- Perfect competition
- No barriers to entry or exit
- Slightly differentiated products
How does supernormal profits and economic losses in the SR effect a monopolistic market?
Supernormal profits in SR:
- Attracts new firms to enter
- Shrinks size of market available to each firm
- Shifts revenue curves to the left
Economic losses in the SR:
- Encourages firms to leave market
- Increases size of market for remaining firms
- Shifts revenue curves to the right.
What questions do you need to think about when answering a question on monopolistic markets?
Efficiency effects:
- Productive efficiency?
- Allocative efficiency?
- Dynamic efficiency?
Impacts:
- Impacts on consumers?
- Impact on producers?
- Impact on other stakeholders?
Why might monopoly’s develop?
Barriers to entry
Differentiated products
Government Design
Economies of scale
How does government design lead to monopoly markets?
Governments may legislate to create monopolies or operate monopolies directly
e.g
NHS
What is economies of scale?
Decreasing average costs due to an increase in the size and scale of a firm
What is monopoly power v
The ability of a single firm to influence an entire market.
What is barriers to entry?
Barriers to entry are obstacles which hinder firms from entering a market.
Examples of barriers to entry?
Patents
Predatory Pricing
Sunk Costs
What are patents?
Patents allow an existing firm the legal right to be the exclusive supplier of a good.
What is predatory pricing?
Predatory pricing is the the threat that existing firm may undercut the entrant to force them out of the market.
What are sunk costs?
Sunk costs are fixed costs that are not recoverable if the firm decides to leave the market
Where do monopolists produce?
Monopolists produce where MR=MC.
Monopolist is a profit-maximising firm.
What happens in the short run and long run for monopoly markets?
Supernormal profits likely and barriers to entry allow supernormal profits in LR.
What is productive efficiency?
Productive efficiency is when a firm produces at the lowest possible average cost.
What is allocative efficiency?
Allocative efficiency occurs when there is an optimal allocation of resources.
P=MC
What is dynamic efficiency?
Dynamic efficiency is making the best possible improvement to productive efficiency over time.
What is an oligopoly
An oligopoly is a market with a small number of dominant firms.
Examples of oligopolies
Video game platforms
Credit card processing
Mobile phone networks
What is a pure oligopoly?
Small number of large firms control the entire market
What is a realistic oligopoly?
Several large firms dominating a market
What is a duopoly?
Two firms that dominate and control the market
Characteristics of an oligopoly market?
- concentrated market
- high barriers to entry (allowing firms to continue earning supernormal profits)
- Firm interdependency
- Product differentiation
- Collusion possibilities
- Price wars avoidance (race to the bottom).
What does firm interdependency mean?
Firm interdependency means that market outcomes for firms depend not only on their own decisions but also upon other firms’ decisions.
What is meant by collusion?
Firms may attempt to work together to protect profit positions.
What is meant by price wars?
Price wars is an intense form of competition where firms compete with each other to charge lower prices and thereby forcing the market price down.
Limit pricing?
Undercut new entrants whilst still making a profit due to purchasing economies of scale.
What is game theory?
Game theory is mathematical models that attempt to study and explain strategic interactions between rational decision-makers.
Basic elements of game theory and the 2 crucial assumptions.
- Players
- Rules
- Outcomes
- Payoffs
Assumptions:
- Rationality:
all players in the game act rationally and in accordance with the maximisation principle.
- Common knowledge:
all players have equal knowledge of the rules of the game and the players involved
What is the payoff matrix?
The payoff matrix is a table that represents the final outcomes of any game theoretic situation.
What is Nash equilibrium?
Nash equilibrium is the solution to a game theoretic situation where all players are selecting their best response to all the other players expected actions.
What is meant be collusion in oligopoly?
Firms in the oligopoly market work together for their own mutual benefit.
Why would rival firms want to collude with each other?
Collusion may benefit all firms by enabling them to earn supernormal profits.
- Maximise profits
- Avoid price wars
- Drive out competitors
What forms of collusion are there?
- Overt collusion
- Tactit collusion
- Price cartels
What is tactit collusion?
Firms follow a mutually beneficial, co-operative strategy without explicitly agreeing to do so.
- Hidden from the public eye
- Price leadership
- All other firms follow the leader
- Done to avoid detection
What is overt collusion?
Overt collusion is formal and explicit co-operation and agreement between rival firms.
- Leaves a paper trail
- Health + safety standards
- Improves public welfare
- Often done through cartels
What factors need to present to increase chances of a cartel succeeding?
- Perfect information between each member
- Barriers to entry
- Low demand changes
Why are cartels illegal?
Results in anti-competitive effects on the wider market:
- higher prices
- reduces competition
- restricts innovation
- damages efficiency
How can cartels be stopped?
Competitions and market authority (CMA)
The UK body responsible for strengthening competition and reducing anti-competitive practices in markets.
Impose fines of up to 10% of a company’s global turnover.
What is price leadership and why do firms do it?
Firms have an incentive to go under the radar to avoid detection from regulators and so they do this via price leadership.
- One firm assumes the role of the ‘leader’ and sets the price
- Other firms tacitly copy the ‘leader’ (no explicit deal)
- ‘Leader’ sets artificially high market price (profits for all).
Why is tacit collusion hard to prove?
Tacit collusion is illegal but very hard to prove due to:
- no explicit agreements made between firms
- no paper trail for regulators to cling on to
- colluding firms can just deny any accusations
Is collusion always bad?
- Higher prices and profits = bad collusion (restricts output)
- Efficiency improvements = good collusion (lowers prices)
What is consumer surplus?
The difference between what a consumer is willing and able to pay for a good and what they actually pay for it.
What is price discrimination?
The act of selling the same product to different people (or in different circumstances) for different prices.
What is 1st degree price discrimination?
Each consumer is charged a different price, equal to exactly their valuation.
Considered perfect price discrimination.
Why is 1st degree price discrimination not common?
- Requires firms to have perfect information about every consumers valuation.
Why is 1st degree price discrimination considered perfect price discrimination?
The firm transforms all consumer surplus into producer surplus.
What is 2nd degree price discrimination?
Different prices are charged depending on the volume bought.
What is 3rd degree price discrimination?
Consumers are split into groups with each group being charged a different price.
Barriers to entry definition.
Factors which make it difficult for firms to successfully enter an existing industry.
What are some natural barriers to entry?
- Ownership of key resources
- Large initial capital costs
- Network effects
Some products are only useful because other people use them.
What are some artificial barriers to entry?
- Patents
- Branding and advertising
Consumers may develop brand loyalty - Switching costs
Switching firms may incur cost and effort to the consumer
Barriers to exit definition
Factors which make it difficult or costly for firms to successfully leave an industry.
What are sunk costs?
Sunk costs are costs which cannot be recovered if the firm decides to leave the market.
Examples of sunk costs?
- Depreciation on capital assets
- Marketing expenditure
- Niche capital assets
What makes a market contestable?
- Firms are profit maximisers
- There is perfect information
- There are no barriers to entry or exit
Why do firms only make normal profits in the LR, in a contestable market?
- Supernormal profit
- Hit-and-run competition enters the market
- Normal profits
- If prices go up again then hit and run competition will return
- So potential for new competition keeps prices low
What is productive efficiency?
Producing at the lowest possible average cost
What is a monopsony market?
A market with one dominant buyer and many sellers I.e a single buyer of labour.
What is monopsony power?
The ability of a large buyer to influence the market outcome
Examples of monopsony example?
Government:
- Police services
- NHS
- Civil Servants
Market power in setting wages and choosing how many workers to employ.
What are the problems of monopsony market power?
- Depresses wages below MRP
- Allows firms to mark larger profits
- Poor working conditions
- Few options for workers
What is a trade union?
An organisation to members who are usually workers or employees, which protects the rights and pay of workers through collective bargaining.
What are the objectives of trade unions?
- Protect and improve real incomes
- Appeal for better working conditions
- Protect against unfair dismissal
- Provide job security
- Collective bargaining
- Industrial action
Arguments for trade unions?
- Employment levels protected or increased
- Efficient wage theory
- Keynesian theory
Arguments against trade unions?
- Real wage unemployment
- Profits and employment reduced
- Prevent flexibility in labour market
- Encourage cost-push inflation
