Firms and Decisions Flashcards
Define market structure.
Market structure is defined as the way in which a market or industry is organised.
Define barriers to entry.
Barriers to entry are anything that prevents or impedes the entry of firms into an industry and thereby impacts the profits firms can make in the long run.
What is the characteristics of a perfectly competitive industry?
There are no barriers to entry, and hence, there are a large number of sellers, who are in no position to influence the market price; every seller is a price taker. The product in a perfectly competitive market is exactly the same, and any producer’s product is a perfect substitute.
What is a monopoly?
A monopoly refers to a market with a single dominant seller
What are the characteristics of monopolistically competitive markets?
Barriers to entry are relatively low and firms can enter and exit easily as start-up costs are relatively low. There are many firms in the market and each firm is relatively small and there is no dominant firm. Products are slightly differentiated. Due to the vastness in the availability of product offerings by many firms, customers and firms don’t have all available knowledge and there is imperfect information.
What are the characteristics of a monopoly?
There are high barriers to entry to prevent competitors from entering the industry so the monopoly retains its position. It also requires a huge amount of startup infrastructure and R&D costs before production. There is only one firm being the dominant producer. There are no existing products that can satisfactorily substitute the goods from the monopoly and hence the monopoly is a price setter. There is imperfect information as all knowledge resides within the monopolist.
What is an oligopoly?
An oligopoly is a market with a few large firms dominating the market. Oligopolistic firms are mutually interdependent and one firm’s behaviour greatly affects its rivals.
What are the characteristics of an oligopoly?
Barriers to entry are very high oligopolistic firms have no freedom of entry and exit. Only a small number of firms have a large majority of market share. The goods could be either differentiated or homogenous. Oligopolistic firms do not have perfect knowledge.
How does price competition increase profits for a firm?
A monopoly in theory would set prices where MC = MR to maximise profits. If costs or demand falls, the monopolist will lower its prices so that it can move to its new profit-maximisation position. The monopolist may also lower its prices to earn more revenue if it perceives the demand for its products as relatively price elastic. Lowering prices will bring about a more than proportionate rise in quantity demanded if PED>1, hence increasing revenue.
What is a limitation of price compeition?
Other firms may start to reduce prices as well, resulting in a price war and total revenue may fall instead.
What is price rigidity?
A competitive oligopolistic market adopts price rigidity which is where the prices of goods and services are often observed to remain relatively unchanged and seldom practices price competition. Any attempt to reduce prices will be matched by rivals resulting in a loss of total revenue. Hence since a rational competitive oligopolistic firm will not increase or decrease price, it will choose to keep price unchanged.
How does limit pricing increase the profits of a firm?
Limit pricing refers to the practice of charging a price below its profit maximising price to deter new entrants especially if the market is highly contestable. Prices need to be reduced to the point a new entrant will not be able to make any profit upon entering the market usually below its AC. This will cause potential competitors to not be able to make at least normal profits, and hence not enter the industry. This allows oligopolies to maintain its market share and market power and also make their demand more price inelastic so they can increase their prices to increase total revenue in the long run.
How does predatory pricing increase the profits of firms?
Predatory pricing is practised through pricing a good below its AC. This is so that existing smaller competitors will be driven out so the demand for the bigger firms will be increased. By driving out existing competitors the firm can increase its demand for their own products and reduce PED.
What is the limitations of limit pricing and predatory pricing?
The firm will likely earn less revenue because of the lower price set than at the profit-maximising price level. This results in lower profits and in extreme cases the firm might earn subnormal profits in the short run and the firm would need to tap into its past profits to sustain its existence.
Define price discrimination.
Price discrimination means the charging of different prices to different customers or for different units of the same product when there are no differences in costs.
How does price discrimination increase the profits of firms?
A firm raises its price in the sub-market where demand is price-inelastic and lowers its price in the sub-market where demand is price-elastic. This enables the firm to enjoy higher revenue and assuming costs remain the same, higher profits will be earned as compared to charging a single price to both sub-markets. (explain the PED thingy)
What are the limitations of price discrimination?
Ability to raise revenue depends on the firm’s ability to segment the markets appropriately.
How does growth increases profit for a firm?
Growth is measured in terms of growth in sales revenue. It can be achieved by internal expansion, by increasing the firm size via promoting extensively or by opening more stores in other locations. It can also be achieved by merger which is the combination of two firms to create a bigger firm or acquisition which is the takeover of one firm by another. This allows the firm to capture more market share as the firm can tap on the ready base of existing consumers of the other firm and increasing the firm’s demand.
What are some limitations of growth?
Excessive growth may result in poorer quality products which may reduce the firm’s demand and the strategy could be expensive and unprofitable.
How does diversification increases the profits of a firm?
Diversification enables a firm to achieve new sources of revenue by extending a more diverse range of products and also spreads its risks of losses incurred for one product as it can be offset by profits earned by other products. With diversification, a firm can take advantage of the sunk cost fallacy of upselling. Once consumers pay a large sum for a product, they are more easily persuaded to pay a little more for related products and services.
What are some limitations of diversification?
Diversification into a new market is risky and costly as consumers may have reservations about buying unproven products.
How does innovation and research and development increase profits for firms?
Usually only works for monopolies and oligopolies as they have the incentive and financial ability to invest.
(i) Process innovation: new or improved production to reduce COP
(ii) Product innovation: Improving packaging of product to increase demand for product.
What are some limitations for innovation and R&D?
It is expensive and a long-drawn process, revenue may not rise and cost may not fall in the short run.
How does product differentiation and advertising increase profits for a firm?
The aim is to produce a product different from rivals and will sell well. Hence, differentiating products makes their product better or at least different from that of the rivals. Advertisation aims to inform consumers about the product’s existence and availability. This helps increase demand and revenue makes the demand less price elastic and also reduces the degree of substitutability of other products from the firm’s product.
