economics 2- market structures Flashcards
describe these markets structures
What are some characteristics of a perfect competition
-all firms sell same products= the goods firms produce are perfect substitutes for each other. Also means firms can’t compete in price as all the same good
-suppliers/ customers perfectly informed about price/profits
-free entry and exit only in long run/ in short run number firms is fixed none can enter and exit
Oat, wheat and milk markets would be examples of perfect comp/ monopolistic/ oligopoly/monopoly
perfect comp- are all selling the same product (homogenous products in perfect comp)
In perfect comp, firms are price takers; what does this mean
cannot influence the price/ takes price from market
What markert structure do these demand curves represent; perfect comp/ monopolistic/ oligopoly/monopoly
perfect comp. The flat line is price the market set
What is a maximum profit
where difference between total revenue and total cost is the biggest
When a firms MC=MR
What are 2 options to do if you are making a loss in the short run
- cannot leave market in SR
-cease production- you make a loss of your fixed costs every day
-contine is loss minimising if making some contribution towards fixed costs and therefore optimal strategy
What happens if businesses are making abnormal profit in the short run
encourages buisneses to enter market in the long run
What is q*
profit maximising level of production
Where is the firm making abnormal profit
What is the point where the MC curve crosses the demand curve
making no economic profit, but making accounting profit; at this point average rev= av cost. So the firm is making normal profit
What is abnormal profit
this area is the difference between average revenue and average costs, multiplied by units sold
Dave is making a loss. What should he do in the in the short run
Stay open- he is covering his variable costs and making some contribution towards his fixed costs. If he closed, he would have a loss of £2000 per week. if revenue falls below £4000 per week it is not worth staying open
Abnormal profit can be competed away. In this diagram a firm is making abnormal profit, which encourages other firms to join in the long term. How does this effect the diagram and where do we draw a new supply curve
- Initial equilibrium at P1 and Q1; firm is price taker so takes market price as its own
- New entering businesses increase industry supply; shifts supply curve to right
- surplus of the good
- price starts to fall to P2, which increases demand (lower price goods have higher demand) and so new equil at P2,Q2
- firms now make normal profit
You can tell how much abnormal profit the firms were making before by comparing it to the profit firms make now after more businesses enter. Where is the abnormal profit area
On the second diagram where are firms making normal profits
-When demand curve touches bottom of ATC
-this point is minimum amount firm needs to be making to prevent them from deciding they need to leave the industry in long term
Why is there no AVC curve on long run graphs (average variable costs)
in long run don’t distinguish between variable costs and fixed costs because all costs are now variable [no fixed factors]
define productive efficiency
production occurs at bottom of AC curve. Goods are produced in less costly way (first produce when average cost is at minimum)
define allocative efficiency
Price= MC. Resources are allocated to produce the goods society wants; supply=demand
What are characteristics of a monopoly
are monopolies price makers/takers
price makers
What are some examples of monopolies
public utilities/ microsoft/ some airway companies
What is tacit collusion
collusion between competitors, which do not explicitly exchange information and achieving an agreement about coordination of conduct.
what is overt collusion
formal and explicit co-operation and agreements take place between rival firms
What is Concoius parallism
dominant firm sets prices and other firms follow
When goods have substitutes will their demand curve be elastic or inelastic
elastic, changes in price will effect quantitiy demanded as consumers will buy substitute
Why are monopoly curves inelastic
monopolies have no close substitutes; customers have no alternative
What is a natural monopoly
monopoly in an industry where it is most efficient for production to be done by a single firm (free-market competition would be economically inefficient)
Why does a monopoly have a downwards sloping AC curve
the entire scale of production has economies of scale at all levels out output. As the quantities supplied gets bigger, the average costs decrease. For context, AC is usually U shaped because of DMR
Between a and b, what is the relationship between average costs and average revenue
AR is bigger than AC, so a single firm is making abnormal profit
Why does D1 (lowest demand curve) not ever make a profit
AC>AR at all levels of output; average cost is always bigger than average revenue being brought in
Why is there no long run and short run in a monopoly
difference between LR and SR is entry+exit. There is only 1 firm in a monopoly and barriers to stop entry and exit
true/false; In a monopoly the firms demand curve also equals the industries demand curve
true- as only 1 firm in the market
Why is a monopoly not allocatively efficient or productively efficient
Because abnormal profit cannot be competed away
What would a monopolies MR (marginal revenue) curve look like if this was its demand curve (revenue gained by producing one additional unit of a product or service)
MR curve is a straight line that falls at twice the rate of the demand curve
This graph compares perfect competition to a monopoly. The MR line only applies to monopoly. Why is the perfect comp equilibrium P and Q where it is
perfect comp equilibrium when supply=demand
This graph compares perfect competition to a monopoly. The MR line only applies to monopoly. Why is the monopoly not allocatively efficient
price is set above MC. allocative efficiency is price=MC.
Why are monopolies not productively efficient
1.productive efficiency= production occurs at bottom of AC curve. No competition means monopolies have no incentive to produce at the bottom of their AC curve
2. leads to excess capacity- if not producing at bottom AC curve- the firms could have produced more of the good and sold it in the markert
What is a consumer surplus
diff between total amount consumers are willing to pay vs what they actually pay
What is producer surplus
diff between what producers are able to produce/supply vs the price they actually receive
What is total welfare
sum of consumer surplus and producer surplus (maximised in perfect comp)
What is predatory pricing
trying to become a monopoly- one firm dramatically reduces prices intending to drive competitors out of the market
What are some barriers to going into a monopoly industry
large barriers such as enormous fixed costs (water supply)
Equation for average cost
TC/Q
Why is adding another company to a monopoly allocatively inefficient (context of water supplier)
each water company will not share resources and each will have to build their own infastructure/pipes so massive fixed costs, while also average cost doubling TC/Q because customers are shared/ halved so Q decreases
Why can consumer welfare be limited in a monopoly
Consumers have to pay more and buy less of the product. Monopolies will charge higher price and restrict output in comparison to perfect comp
Why would governments want to regulate monopolies
1.promote overall customer welfare
2. To avoid deadweight loss
3. Monopolies are allocatively inefficient
Which part of the curve is consumer surplus (diff between total amount consumers are willing to pay vs what they actually pay)
A+B+ triangle above (amount you were willing to pay but you get a lower price for)
Which part of the diagram is producer surplus (diff between what producers are able to produce/supply vs the price they actually receive)
Reasons against monopolies/ how are monopolies not allocative efficient or productive efficient
- not allocative efficient (don’t produce at bottom of ATC curve)
- can set market prices higher than in a competitive market- so costumers are losing out.
- productive inefficiency- excess capacity exists/ do not produce at bottom of AC curves so firms could have produced more of the good and sold it in the market
What is a benefit to a monopoly
could reinvest abnormal profits into infrastructure/ into innovation
-innovation could widen consumer choice and aid economic growth
-innovation in new production processes could lead to lower average costs of production
Why might businesses collude
They are all able to set higher prices to make more profits/ In game theory the collusive outcome is the best outcome (if no cheating then no hash equilibrium)
What sanctions would you give businesses that have colluded
- a fine that was bigger than the profits made otherwise that would just encourage them to collude again
- governments strictly monitor the markets
What type of economy could encourage collusion
declining economy/ More and more industries are oligopoly structures- companies are encouraged to cooperate in economic downturn so they can stay afloat
What is the most likely outcome of a one shot of prisoners dilemma
cheat
What are the characteristics of an oligopoly
a few firms that share a large portion of
a perfect competition operates at supply=demand, which is also
MC= price
How do governments promote competition and try to reduce the power or monopolies
- active bodies that seek out abuses of monopoly power
- look for collusion/ preditory pricing
- fines
What is monopolistic competition
everything same as perfect comp, except firms produce different products not the same
What is an oligopoly
few firms share large proportion of the market
What is a duopoly
2 firms control the whole market (eg. airbus and Boeing)
What is the idea of mutual interdependence
the actions of a firm has significant effect on its rivals (if apple launches a massive advertising campaign, Samsung could loose out)
Oligopolists can either compete or collude. What are these two things
compete- to gain larger market share of industry profits
collude (act like monopoly) to jointly maximise industry profits
What does the kinked demand curve show about an oligopoly
Above P, will loose significant customers because other firms will not have followed suit
Below P- competitors match low price and so company will not gain significant amount of customers
Why does the MR curve look this way
MR falls at twice the rate of a demand curve. So takes the gradient of each line and makes it fall twice as fast
What is true of the product price between A and B
price is constant
What are the problems with kinked demand (go against the theory)
-price stability may be due to other factors
-lacks empirical observation
-does not explain how P* came to the market price
-explains only price stability due to economic downturn
What does cournot oligopoly assume (2)
- 2 firms selling homogenous products
- equal marginal costs of production
Why is MC=0
MC=the cost added by producing one additional unit of a product or service.
If the guy is just there filling up bottles it costs nothing to fill up an extra bottle
If a second person discovers another stream and starts doing the same, how does the second person know how much to produce
depends upon how much he thinks seller 1 will produce/ assuming seller 1 will not change its output
What is the cournot conjecture and a residual demand curve (subject=oligopoly)
Describe the customers preferences on the residual demand stretch
customers who are not willing to pay P1A, and are available for seller 2 to use
(spring water trail example) This is seller 1 in a monopoly; How should seller 2 decide the level of output to sell
Should produce Q2 units of output because Profit is at maximum when MC=MR
-new MR curve drawn which falls at twice the rate of the demand curve
(spring water example) There are 2 sellers of spring water on the mountain trail. What does seller 1s reaction function line represent
tells us firm 1’s optimal (profit maximising) level of production for every level out output of its rival firm
What does seller 1 and seller 2’s reaction functions mean and what does the cournot equilibrium represent
cournot equilibrium- neither firm has incentive to adjust their prices/ both their best response
seller 1 reaction function- their optimal level of production for every level of seller 2 production + visa versa
What do the arrows A–>E represent
A- seller 2 enters market
- in response seller 1 sells at B
- seller 2 increases output to C
- D is response by seller 1 and continues
What do the arrows A–>E represent
A- seller 2 enters market
- in response seller 1 sells at B
- seller 2 increases output to C
- D is response by seller 1 and continues
Is the cournot equilibrium model limited to representing just two firms
no
What is the Nash equilibrium in game theory
definition- where competitor is pursuing best possible strategy given the likely strategy of the other competitors in the game
bottom right corner- point where no incentive for either competitor to move
Which box is the collusive outcome and which is the Nash equillibrium
Why does backward induction state that collusion is not feasible
each player will cheat in every round
In the prisoners dilemma, repetition of games gives scope for previous cheaters to be punished in later rounds. What is the grim trigger
rival cheats and you never co-operate with them again, game will repeat at Nash equilibrium forever
What are some ways of collusion in practice
- price matching- “if you find a lower price for this product we will match it”- warning other firms not to lower price because both firms will loose out
- information via trade/ journals
What does a concentration ratio do
measure of seller concentration in the market
What is the concentration ratio (Cn)
% of the value of sales accounted for by the N largest firms in the market
What does a high/low Concentration ratio (Cn) value mean
high %- high levels concentration
low %- Low levels concentration
C4 ratio= concentration ratio using the top 4 firms
What does the concentration ratio not take into account
the size distribution of firms
What is the HH index (Herfindahl-Hirschman)
index which takes into account all the firms in a market and is the sum of all of their squares of the markert shares in each firm. Usually a value between 0-10,000
In a HH index on the scale 0-10,000; what does 0 represent and what does 10,000
0= perfect comp
5,000= duopoly
10,000= pure monopoly
What would be the HH index for this
This still suggests an oligopoly, but the measure has a fairer comparison across market structures than Cn index
How do higher quality goods signal their true worth in the product market/financial market/ labour market
How could a university degree loose its value of signalling a higher productivity
pooling equillibrium- if they become too easy to obtain
Why might this be the case
Because HP people may be smarter and see it as less of a struggle/cost to obtain a degree because they wouldnt have to put in as much effort as a LP person to obtain the same degree. A LP person may see obtaining a degree as too much work and therefore too high a cost (relative to rewards)
For a degree to maintain its worth, what must be the cost of obtaining one for a LP worker and a HP one
The red line is the return from education (represented as wage). When should the LP worker stop higher education and when should the HP
LP should not do higher education; difference between return and schooling is at max
HP- stop at e, as max return between school and return
What happens to the amount of education LP and HP should get for max return, when the value of a degree falls/ cost of acquiring a degree falls
less productive workers now have C’ instead of C. Their greatest return is now at e, because B-E is bigger than A-0 at the start.
This leads to labour market pooling because HP workers also have greatest benefit at e
Why should a HP workers not go for e’ levels of education and should stay at e*
more education will give less and less return because B stays at a constant place. They will loose out
What how is advertising intensity (AI) related to degree of competition (market comp MC) in the market
Inverted U shaped relationship
-Low market conc (comp market) AI is low. Firms more likely to use price to compete than advertising
-Higher MC (oligolisitic) AI is high and firms will want to avoid price competition (kinked demand curve)
What markets are represented on the line past CR*
higher concentration markets (oligopoly/monopoly right at the end)
monopoly is right at the end of the curve. Why does it still have a level of advertising (curve is not at 0)
Monopolies still need to let customers know their website is out there/ advertising is not used to increase market share
Why can brand proliferation increase advertising costs
This is a firms demand curve and it is selling a product at P*. How does the demand curve change in the firm starts advertising the product
D1 is before advertising and D2 is after advertising. What area shows the revenue gained through advertising
This is an inelastic demand curve changing due to advertising (D1 and D2). The second diagram is an elastic firm. Draw their second demand curve if the firm does the same amount of advertising as the other
Advertising has a greater impact the more elastic the demand curve/ the greater advertising elasticity of demand.
If something has a greater advertising elasticity of demand then the Demand curve shifts more to the right
D1 is before advertising and D2 is after advertising. What area shows the revenue gained through advertising
If advertising increases a bands loyalty, how will their demand curve change
Hope is to shift to right as well as make it more inelastic.
-demand curve becomes steeper as the brand can charge higher prices and will not change the amount of customers that much
A brand has advertised and brand loyalty has increased so curve is more inelastic. The brand will now charge a higher price above P*. Show how by doing this their loss in customers doesn’t outweigh their gain in revenue from charging a higher price
How would you work out the numerical revenue gained at P* for D1
P* x Q1
Total sales revenue= price x quantity sold
This shows relationship between market conc (perfect comp or monopoly) and the set up costs to enter the market. Why in low advertising industries do set up costs decrease as the market size gets bigger
If the market size is bigger, there are more brands and therefore less established brands (monopolies) to compete with
For a search good, what type of advertising will these goods generally have
Informational/ key features/ try to convince you to test out
What type of advertising will these goods generally have
What type of advertising will these goods generally have
What is price discrimination
All consumers have different utility functions/willingness to pay for a service or good
Under uniform pricing, using the diagram what quantity will a firm produce and at what price
will sell where where marginal revenue= marginal cost
MR=MC
so Q* and P* (price taken from demand curve)
What area is the consumer surplus under uniform pricing (when the price consumers pay for a product or service is less than the price they’re willing to pay)
ABP* triangle (top small one)
Under uniform pricing (normal from beginning of course) What area is the firms profits equal to
rectangle P*BDE
Now look at this graph for a company who is using price discrimination. The demand curve= MR (ignore pink line). At first they will charge the first person a high price at A, then the second person a slightly lower price and so on. Will charge prices all along the demand curve until it gets to C. Why will it not charge a price below C
The demand curve= MR curve.
At C MR=MC (green line). Beyond C, marginal costs will be greater than marginal revenue
-profits are maximised when MR=MC
If the price discriminating firm now charges the price E, what area on the graph is its profits
Will the uniform pricing system (sells at point E), or price discriminating system (sells at P*) sell to more customers
price discriminating system; sells at E which has higher Q than at P*.
What is the second degree of price discrimination (bulk-buying)
- different prices charged for different quantities of the same good
firm selling at different prices depending on how much for the good the customer buys
-getting unlimited data for £20 and using lots of data is cheaper per GB than getting limited data and using less
The firm charges Pu and Qu. What does the yellow shaded area show
firms profits
In a uniform price setting a firm will sell at p2 and q2 which must mean MC=MR here. Their profits is the yellow shaded area. If bulk buying is introduced; person 1 buys quantity 0-Q1 and pays P1, to person 3 who buys Q2-Q3 will pay P3. Explain how this bulk-buying method brings in more profit than just uniform pricing
blue shaded areas are additional profits from second degree price discrimination, added to the yellow area which is profit under uniform pricing
What is third degree price discrimination (seperation)
-identifying groups of consumers with different sensitivities to variations in price
separates consumers into different groups based on their relative price elasticity of demand and charges them accordingly
This firm sells the same product in an elastic market and an inelastic one. What price would they sell at in the elastic market sell vs the inelastic market sell and what are their combined profits
Both sell where MR=MC (green line hits blue line)
elastic market-P2
inelastic- P1
combined profits= blue area
What is arbitrage
e.g buying in an elastic market and selling in an inelastic market
Say these individual markets collapsed (due to arbitrage) and become combined. What would the combined demand curve look like
- initially same as inelastic
- At point when elasticity starts to set in the demand curve becomes elastic ( second pink line)
In the combined market the firm will charge P*. How does this show that markets under third degree price discrimination are better than a combined market
under third degree price discrimination (charging different prices depending on how elastic audience is), more profits are made; blue area is bigger than yellow
Compare total welfare, firm welfare and consumer welfare under price discrimination markets and monopoly pricing markets
-total welfare and firm welfare better under price discrimination but
-customer welfare isn’t (eg. is it fair that interactional students pay higher than home?)
How can firms use product differentiation to segment the market
cater for different consumer types/ offer different versions of their products e.g different types of razor blades
Here we have 3 packages for seats at a football game. If prices are at a-c-b, the consumers affordable set it bound along a-c-b and the same for C. Say the prices of packages A and B stay the same (a, b on lines stay same place), but prices of package C change to c. Has package C price gone up or down
gone up, less space alone a-c*-b than a-c-b, so customer has less affordable set/budget constraint
Here we have 3 packages for seats at a football game. If prices are at a-c-b, the consumers affordable set it bound along a-c-b and the same for C. Say the prices of packages A and B stay the same (a, b on lines stay same place), but prices of package C change to c. Has package C price gone up or down
gone up, less space alone a-c*-b than a-c-b, so customer has less affordable set/budget constraint
Why might this indifference curve set up mean firms might want to introduce a new package of football stadium seating
Suzzy is indifferent to points a and b along her I2 indifference curve, but she would prefer to be on I3 (where dotted line meets I3)
Why would the club need a relatively large group of ‘suzies’ in order to actually create a third package
potentially large fixed cost to introduce new packages (might need to build new seats our pay chefs) so revenue earned must outbalance new fixed costs
What is an example of (1) not being created but (2) happening
Tesla are already a legal entity in the electricity vehicle market, but if they invest into a Berlin factory they are just bringing extra capacity to the European electrical vehicle market
What is an example of (2) not being created
but (1) happening
takeover or merging/ ASDA sold from Walmart to TDR brings no new capacity to the market just transfers it from one legal entity to the other
How can new entires in a market lead to all other firms making less profits
New enters shift supply curve to S2 which means firms have to take a lower price
How can new entires in a market lead to all other firms making less profits (firms make normal profits only)
New enters shift supply curve to S2 which means firms have to take a lower price
What is the contestable market theory
What are 4 main barriers of entry to a market
Why are ‘absolute cost advantages’ that incumbent firms have, a barrier for new entries
-big supermarkets have already established product chains
How is product differentiation of established brands a barrier to new entry
adverting can enhance brand loyalty which can make products price inelastic
What are 4 barriers to exit
How are ‘fixed costs of exit’ a barrier to entering a market and exiting
if the firm closes down, it will have to pay all these fees
-compensation for breaking any long term contracts
What are ‘strategic considerations’ and why would they be a barrier for exit
-by becoming a smaller organisation (after pulling out of one market) firm may loose bargaining power, bulk buying
- could also loose shared facilities or not be able to meet customers needs
What are government barriers of exit
What are innocent vs strategic entry deterance
types of entry deterrence; What is joint cost raising
- raises the rivals costs to make their business unprofitable (also raises the cost of the firm doing it)
- can be done through:
-dirty tricks-convincing customers rivals products are unsafe
-raising switching costs-introduce consumer reward schemes(clubcard)
-prodcut improvement- pharmaceutical companies lobby for tighter restrictions/standards
What is increasing input costs
types of entry deterrence; what is investment in excess capacity
in response to new entry, an incumbent firm will increase its production, which will reduce price and hit industry profits. (costly to incumbent firm but is a signal of aggression)
How is customer welfare effected with predatory pricing
What is the difference between corporate strategy and business unit strategy
corporate strategy- influence all buisness units (apple headquarters California)
business strategy- apple (Europe) will tailor its strategy such as pricing for the European market
What are the 5 factors that effect a firms profitability in a given market (porters 5 forces)
How does threat of substituted products effect a firms profitability
example 2- channel tunnel would hit profitability of cross-channel ferries
How does the bargaining power of suppliers effect a firms profitability
How does the bargaining power of buyers effect a firms profitability
How does intensity and industry rivalry effect a firms profitability
when rivalry is high- market is less profitable
if firms collude/ less rivalry the market becomes more profitable
What are two strategies to gain a long term competitive advantage in a market
How does the differentiation strategy help a firm to gain a long term competitive advantage in a market
making their product differ from rivals. Usually involves providing extra benefits or product features such as:
How does the low cost strategy help a firm to gain a long term competitive advantage in a market
tries to improve profitability by reducing costs to the minimum. Typically offer a basic product
For goods and services, demand peaks at particular times/ roads and public transport during commuter rush hours, for electricity during late afternoon and so on. What is true about the MC of an extra house of electricity/ commuter on highway
MC=high during peak periods because of capacity constraints. Prices should be higher during peak periods.
(D1 is peak period) The firm sets MC = MR for each period.
-It is also efficient; the sum of producer and consumer’s surplus is greater because prices are closer to MC
