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Economics > Firms and Decisions Pt II > Flashcards

Firms and Decisions Pt II Flashcards

1
Q

What are the 4 characteristics that determine market structure?

A
  1. Number of sellers relative to market size
  2. Extent of barriers to entry
  3. Nature of product
  4. Knowledge of product/market
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2
Q

What are the characteristic of a perfectly competitive market?

A

Large number of buyers and sellers, fulfilled when each firm has no significant share of the market due to the absence of entry barriers.
No barriers to entry and exit.
Homogenous products, all products are perfect substitutes.
Perfect knowledge. Sellers know the prices and production costs of rivals, costs, available technology etc. Buyers know all the prices, quality and availability of products

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3
Q

Why are firms in a PC market price-takers?

A

Due to the large number of buyers and sellers, homogeneity of products, and perfect knowledge, PC firms have no control over prices but has to follow the market price determined by forces of demand and supply. It has to sell at the prevailing price as Qdd will fall to 0 should it increase its price, and it has no incentive to reduce its price.

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4
Q

When is a PC firm in equilibrium?

A

By the traditional theory of the firm, when it is producing at the level where total profit is maximised, where MR=MC and MC is rising.

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5
Q

Why must MR=MC for a PC firm to be in equilibrium?

A

In order to maximise profits, a firm should produce at the level where addition to the total revenue from the sale of the last unit of output equals to the addition to total cost in producing it, ie MC=MR.

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6
Q

Why should MC be rising when a PC firm is in equilibrium?

A

When MC is falling, additional output will add more to the total revenue than total cost, thus MC≠MR and it should still increase outputs to maximise profits.

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7
Q

What is the short run shut down condition?

A

Whether its total revenue can cover its variable costs. It should keep producing if total revenue is more than variable costs as the surplus generated can be used to offset part of its fixed costs. If revenue earned is less than variable costs, the firms should shut down so that its losses are limited to only the fixed costs instead of making losses on both fixed and variable costs.

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8
Q

What are the implications of a shut down in the short run?

A

It will still retain its capital assets but will not leave the industry or avoid paying for its fixed factors of production. If market conditions improve, a firm can resume production. If it does not, the firm cannot keep incurring losses indefinitely, so it will exit the market.

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9
Q

Why do PC firms only make a maximum of normal profits in the long run?

A

Firms that earn supernormal profits attract new firms to enter the market, causing Qss to increase at every price, increasing market supply, leading to a surplus and hence equilibrium price to fall. PC firms are price-takers and hence have to sell at this lower price. Supernormal profits get eroded.
Some firms that earn subnormal profits may exit the market since there are no exit barriers, number of firms thus decreases, quantity supplied decreases at every price and market supply falls. There is a shortage and market price increases. Losses made thus reduce and firms earn normal profits.

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10
Q

What is a monopoly?

A

A market structure whereby the firm is the only seller of a good or service that has no close substitutes, complete barriers to entry and exit and imperfect information.

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11
Q

What are the characteristics of a monopoly?

A
  1. Single producer
  2. Complete barriers to entry and exit
  3. Unique product
  4. Imperfect knowledge
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12
Q

What does a monopoly being a single producer result in?

A

The monopoly faces no competition, and able to exert control over how much it charges for its product and is a price setter. However, it is still constrained by market demand, meaning it can only change price or output.

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13
Q

What are the barriers to entry and exit in a monopoly?

A
  1. Artificial barriers to entry
  2. Natural barriers to entry
  3. Sunk costs
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14
Q

What are the two artificial barriers to entry?

A
  1. Strategic barriers
  2. Statutory barriers
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15
Q

What are strategic barriers to entry in a monopoly?

A

Any move by the incumbent firm to keep potential firms out of the market. Examples include intensive advertising, gaining control of supplies of essential raw materials, hostile takeover and acquisitions, research and development.

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16
Q

How does intensive advertising raise barriers to entry?

A

It boosts demand and persuades consumers that there are no substitutes, inducing customer loyalty, making it more difficult for them to break into the market. Demand is also less price elastic.

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17
Q

How does gaining control of supplies of essential raw materials raise barriers to entry?

A

New entrants find it difficult to access resources, thus production and potential for profits are limited. This deters them from entering the market.

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18
Q

How do hostile takeover and acquisitions raise barriers to entry?

A

When the dominant company buys up a rival firm, new firms are less able to compete with an even bigger firm, thus they are deterred from entering.

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19
Q

How does research and development raise barriers to entry?

A

By coming up new products, improving quality, increasing product range and lowering costs, new firms are less likely to be able to compete and thus are deterred from entering.

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20
Q

How do statutory barriers raise barriers to entry?

A

They prevent potential firms from entering by legal means, if potential firms are caught flouting, heavy penalty is given. This deters them from entering, keeping demand high and less price elastic.

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21
Q

What are statutory barriers?

A

Barriers to entry given by force of law.

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22
Q

How do natural barriers raise barriers to entry?

A

Capacity expansions lower unit cost of production, thus allowing the incumbent firm to be more cost effective and thus more price competitive. They can thus lower prices to retain consumers and make a credible threat to potential entrants.

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23
Q

What are natural barriers?

A

Barriers that arise from differences in production and costs between incumbent and potential firms.

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24
Q

How do sunk costs raise barriers to exit?

A

It increases risk of making huge losses if firms decide to leave the market because once these costs are committed, they cannot be recovered.

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25
Q

What does the firm having a unique product result in?

A

Greater price-setting ability and less price elastic demand.

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26
Q

What does imperfect knowledge result in?

A

Greater price setting ability of firm.

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27
Q

What is MR equal to for a monopoly?

A

The price the firm receives from the last sale minus the loss of revenue from the sale of all other units at a lower price.

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28
Q

Why is MR always lower than AR in a monopoly?

A

It has to lower price on all units in order to sell an extra unit since it charges a uniform price for every unit of product.

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29
Q

When is a monopoly in equilibrium?

A

When it is producing at the point where MR=MC.

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30
Q

When will a monopoly shut down in the short run?

A

When total revenue is unable to cover variable costs.

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31
Q

What is a natural monopoly?

A

A market in which the market demand is large enough to support only one large firm operating at or near its minimum efficient scale of production.

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32
Q

What is a monopolistic competition?

A

A market structure whereby a relatively large number of small firms sell similar but differentiated products and barriers to entry and exit are low and information is imperfect.

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33
Q

What are the characteristics of a monopolistic competitive market structure?

A
  1. Large number of small buyers and sellers relative to market size
  2. Low barriers to entry and exit
  3. Differentiated products
  4. Imperfect knowledge
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34
Q

What does a large number of small firms result in?

A

Each firm has a small share of the total market. Ability to set price above its marginal cost is limited. Each firm acts independently of the other. Gain in sales revenue is spread thinly over many rivals thus the extent to which each rival firm suffers is negligible.

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35
Q

What do low barriers to entry and exit result in?

A

Firms only being able to earn normal profits in the long run.

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36
Q

What are the 3 forms that product differentiation can take?

A
  1. Real physical differences: goods differ in some minor ways
  2. Imaginary differences: design, packaging, branding, method of promotion can be differentiated through non-price competitive techniques which make demand less price elastic.
  3. Differences in conditions of sale: location of shop and service quality.
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37
Q

When will an MPC firm shut down in the short run?

A

When its total revenue is unable to cover its variable costs.

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38
Q

Why do MPC firms earn a maximum of normal profits in the long run?

A

Firms that earn supernormal profits attract new firms to enter the market, causing Qss to increase at every price, increasing market supply, leading to a surplus and hence equilibrium price to fall. Firms keep entering until supernormal profits get eroded.
Some firms that earn subnormal profits may exit the market since there are no exit barriers, number of firms thus decreases, quantity supplied decreases at every price and market supply falls. There is a shortage and market price increases. Losses made thus reduce and firms earn normal profits.

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39
Q

What is an oligopoly?

A

A market dominated by a few large firms where market concentration is high, hence firms are mutually dependent, with high barriers to entry and exit and imperfect knowledge, selling both homogeneous and differentiated products.

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40
Q

What are the characteristics of an oligopoly?

A
  1. Few dominant firms
  2. High barriers to entry and exit
  3. Both homogeneous and differentiated products
  4. Imperfect knowledge
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41
Q

What does a few dominant firms in an oligopoly result in?

A

Large proportion of the market share commanded by the firms, thus they have high market power and thus are price setters.
A high degree of interdependence and rival consciousness exists, every action taken by a dominant firm will affect sales of all other firms dramatically.

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42
Q

How is degree of development of oligopoly power measured?

A

Market concentration ratio.

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43
Q

What are the barriers to entry and exit in an oligopoly?

A
  1. Artificial barriers
  2. Natural barriers
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44
Q

What are the types of artificial barriers in an oligopoly?

A
  1. Strategic barriers
  2. Statutory barriers
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45
Q

What are the strategic barriers to entry in an oligopoly?

A

Limit and predatory pricing, advertising and branding.

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46
Q

What is limit and predatory pricing?

A

Limit pricing involves charging a price that is lower than profit maximising price.
Predatory pricing involves lowering prices below costs to drive out existing competitors and scare off potential entrants.

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47
Q

How do limit and predatory pricing raise barriers to entry?

A

Cause rivals who typically operate on a smaller scale to incur higher long run unit costs of production.

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48
Q

How do natural barriers raise barriers to entry in an oligopoly?

A

The few dominant firms enjoy substantial IEOS, thus their LRAC falls over a large output. Due to lack of consumer base, new firms cannot match the scale of production of incumbent firms. Thus AC is likely to be higher, making it harder for them to compete.

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49
Q

What do high barriers to entry and exit in an oligopoly result in?

A

Firms able to retain supernormal profits.

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50
Q

What is the oligopoly known as when products are homogenous?

A

Perfect.

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51
Q

What is the oligopoly known as when products are differentiated?

A

Imperfect.

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52
Q

Why does product differentiation occur on a bigger scale in an oligopoly?

A

Oligopolies can retain supernormal profits, and are thus incentivised to use these non pricing strategies to maintain their grip of the market share.

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53
Q

What is a collusive oligopoly?

A

When firms work together to reduce uncertainty in the market and increase the predictability of their rival’s reactions to their pricing decisions and maximise profits. through engaging in formal or informal agreements among themselves to reduce competition.

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54
Q

What are the main conditions for a collusion to be effective?

A
  1. Market dominated by few large firms to allow for coordination and ease of monitoring to prevent cheating
  2. Similar products sold, perfectly substitutable or closely related.
  3. No government efforts to curb collusion.
  4. Firms have similar cost structures.
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55
Q

What are the types of collusion?

A
  1. Cartels
  2. Price leadership model
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56
Q

Explain the formation of a cartel:

A

To reduce uncertainty from mutual interdependence, sellers may collude to maximise joint profits and market share. Demand curve is horizontal if products are homogenous, if not demand curve is downward sloping, cartel’s marginal cost curve is the horizontal sum of all the individual cost curves. Their profit maximising decision is the same as that of a monopolist. They produce less at a higher price. Each firm is given a production quota.

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57
Q

What factors limit the effectiveness of cartels?

A
  1. Cartel being illegal
  2. Risks and uncertainty from cartel
  3. Number of sellers
  4. Homogeneity of products
  5. Market demand
  6. Barriers to entry
58
Q

How do cartels being illegal lead to their ineffectiveness?

A

Laws might be made to break their collusion.

59
Q

How do risks and uncertainty lead to cartels’ ineffectiveness?

A

There is incentive to cheat to increase individual profits since firms are not producing at profit maximising output. When this happens, the other members will follow suit , increasing supply and driving down prices, causing the cartel to break down and earn less than joint profits.

60
Q

How do a large number of sellers lead to cartels’ ineffectiveness?

A

Difficult to monitor and detect cheating and to formulate policies that meets the need of every member.

61
Q

How do differentiated products lead to cartels’ ineffectiveness?

A

Difficult to reach agreements on price and production quotas.

62
Q

How does a variable market demand lead to cartels’ ineffectiveness?

A

Falling market demand creates excess capacity and pressures firms to discount prices to maintain revenue. It is also difficult to make agreements due to difficulties in predicting and due to the need to make frequent amendments to agreements.

63
Q

How do low barriers to entry lead to cartels’ ineffectiveness?

A

There is greater fear of disruption of new firms as firms might be incentivised by the high profits and steal consumers away from members.

64
Q

Explain the price leadership model:

A

Barometric: The firms more adept at identifying changes in market conditions and has the ability to respond more efficiently will be the price leader.
Dominant: When one firm controls the vast majority of market share and enjoys the lowest average cost. When dominant firm adjusts price, smaller firms must follow to maintain market share.

65
Q

Explain the kinked demand curve theory:

A

Prices are generally stable in an oligopoly for fear of competitors’ reactions because of the high degree of mutual interdependency amongst the few large firms. Firms face elastic demand at high prices as consumers are more likely to switch to lower priced products, causing quantity demanded to fall more than proportionately, decreasing revenue. Firms face inelastic demand a low prices as competitors will follow suit. Quantity demanded increases less than proportionately, decreasing revenue. Oligopolies will thus be reluctant to change prices as price wars are unsustainable and suboptimal.

66
Q

Explain price wars:

A

When there is considerable excess capacity in the industry, firms with largest MES may initiate price wars. Rivals operating on a smaller scale have higher unit cost of production and might thus have to shut down. In the long run, if they are unable to cover total cost, rivals will exit the industry, and the winner gains market share, which they can use to charge higher prices and earn more profit.

67
Q

What are pricing strategies?

A

The firm’s plan for setting the price of its product given the market conditions it faces and its desire to achieve a specific aim. It has to accept the quantity demanded which corresponds to the price.

68
Q

What is price discrimination?

A

The selling of the same good at different prices whereby the price difference does not reflect the differences in the cost of supplying the customer, to capture consumer surplus and earn higher revenue and hence profits.

69
Q

What are the 3 conditions necessary for price discrimination?

A
  1. The seller must have market power so it can choose price.
  2. The firm must be able to identify and segment the market based on differences in PED. Charge groups with lower PED with higher price.
  3. The firm must be able to prevent resale and arbitrage for price discrimination to work.
70
Q

What is third degree price discrimination?

A

A pricing strategy whereby the firm charges a different price to different groups of customers buying the same product by segmenting the market based on identifiable characteristic of these groups and the PED is different between these groups. Customers can be identified by their characteristics like age, location or past purchase behaviour.

71
Q

Benefits of price discrimination:

A
  • Enjoy lower average cost of production through exploiting IEOS when sales volume increases from customers encouraged to enter market from the difference in price.
  • Allows firms to produce in cases where cost cannot be covered by revenue when charging a single price by cross subsidisation.
  • Allows firms to clear unsold inventories and make better use of their shops and plan and hire staff accordingly to manage customer flow.
72
Q

Limitations of price discrimination:

A
  • Only effective if firms are successful in segmenting the market and preventing resale. If costs of preventing resale are significant, thus reducing profit.
  • Technological advances allow consumers to have greater access to information that reduces the effectiveness of price discrimination.
73
Q

What is predatory pricing?

A

The deliberate strategy of driving competitors out of the market and scaring off potential entrants by selling below its AVC in the short run, resulting in significant losses for the predator and victims. It gives them higher market power and profitability due to reduced competition and improves reputation, and makes them be seen as a credible threat, deterring rivals from taking any aggressive actions against them.

74
Q

Limitations of predatory pricing:

A
  • Firm must have sufficient past supernormal profits or cross subsidisation option to cover the losses in the present time
  • Predatory pricing is unsustainable in the long run as it may trigger a price war.
  • Low prices may cause customers to think that the product is cheap and of poor quality.
75
Q

What are price wars:

A

A situation where suppliers attempt to undercut one another’s prices in an attempt to achieve a greater share of the market. Rivals are expected to reduce prices as well. The goal is not to cede consumers to rivals.

76
Q

Limitations of price wars:

A
  • Harmful and unsustainable in the long run as firms may be forced to charge a price below average cost of production and earn subnormal profits and thus exit the industry.
  • Price cuts do not necessarily lead to higher revenues.
77
Q

What is limit pricing?

A

Setting a price below the profit maximising price but above the competitive level to deter entry of new firms. Entrant’s unit cost of production may be higher than limit price as it operates on a small scale and is unable to exploit IEOS, and thus might make a large loss and have no resources to sustain the loss until they reach a competitive level.

78
Q

Limitations of limit pricing:

A

Large and established firms may be willing to enter the market for diversification even if it is unprofitable in the short run, as it can cross subsidise and rely on past supernormal profits. Limit pricing thus more effective in industries with high sunk cost.

79
Q

What are the non-price strategies?

A
  1. Marketing
  2. Product differentiation
  3. Research and development that lead to product innovation
  4. Cost reducing strategies
80
Q

What are the types of marketing strategies?

A

Advertisement and promotions

81
Q

Explain advertising:

A

Informative advertising reduces search cost by bringing customers all the information necessary. Persuasive advertising change consumers’ behaviour by acting as a nudge and tapping on their cognitive biases, thus increasing demand and reducing PED. Advertisements tap on the saliency bias. They also increase cost of switching to rivals’ products by creating loyalty.

82
Q

Explain promotions:

A

Promotions target consumers’ aversion to loss. Consumers are more motivated by the prospects of losses than the promise of gains and will hence take decisions to avoid losses of any kind which are valued more than gains

83
Q

Limitations of advertising:

A
  • It is costly and may result in wastage of resources
  • Time is needed to change consumers’ taste and preferences
  • Excessive advertising may backfire and generate negative feedback
  • Firms may continue to spend heavily on advertising since they have already committed to launching the product, even if there is no material gain, due to the sunk cost fallacy.
84
Q

What is the saliency bias?

A

The tendency of people to focus on items or information that are more noteworthy while ignoring those that do not grab their attention, even if the objective difference between them is irrelevant.

85
Q

What is loss aversion?

A

People are more willing to take risks to avoid a loss than to make a gain.

86
Q

What is the sunk cost fallacy?

A

Continuing a behaviour or endeavour as a result of previously invested resources.

87
Q

Explain product differentiation:

A

Product differentiation can take the form of real differentiation, when physical changes are made, imaginary differentiation which can take the form of repackaging and branding, and service differentiation. Product differentiation targets the saliency bias of customers. It increases opportunity cost of switching by lowering degree of substitutability, deepening degree of brand loyalty, and strengthening relationships with customers. Loyalty programs target consumers’ loss aversion and sunk cost fallacy, increasing switching barriers,

88
Q

Limitations of product differentiation:

A

Other manufacturers can include similar features in their products, thus uniqueness of product is only in the short run, thus differentiation has to occur constantly, which is expensive.

89
Q

Explain R&D:

A

R&D includes activities that companies undertake to innovate and introduce new products and services. Product innovation involves researching the needs of customers and developing new, improved products and services.

90
Q

LImitation of R&D:

A
  • Expensive
  • Firms are susceptible to the sunk cost fallacy, leading to greater costs incurred
  • Resources invested in R&D are irrecoverable and results of R&D are uncertain and revenue takes a long time to be generated
91
Q

What are the cost reducing strategies?

A
  • Source for cheaper inputs to reduce TVC
  • Exploit IEOS by increasing scale of production and banding together with other firms
  • Automate certain production processes, reducing office space used, reducing AC and MC
  • Offshoring (relocation of a business to a foreign country)/outsourcing (hiring outside supplies to provide specific goods instead of producing them in house) various stages of production to countries that can produce that stage for the lowest cost, lowering AC
92
Q

Limitations of cost-reducing strategies:

A
  • Automation is costly and hurts demand that thrives on buyer-seller relationship
  • AI requires regular updates, failure of AI is costly
  • Offshoring may result in difficulties controlling quality
  • Communication barriers
  • Increase risk associated with data sensitivity and loss of confidentiality to external parties
93
Q

What are the growth strategies?

A
  1. Merger and acquisitions
  2. Franchising
94
Q

What is a merger?

A

A merger occurs when a firm combines with one or more existing firms to form an entirely new enterprise or by buying over another firm.

95
Q

What are the 3 types of merger and acquisitions?

A
  1. Horizontal integration
  2. Vertical integration
  3. Conglomeration
96
Q

What is horizontal integration?

A

It occurs when a firm combines with or takes over a similar form at the same stage of production to form a single entity.

97
Q

What is the objective of horizontal integration?

A

To lower long run unit cost of production as it expands its scale of production towards its MES and fully exploits IEOS, or to have greater market share dominance and less price elastic demand, so it can have higher revenue and higher profits.

98
Q

What is vertical integration?

A

It occurs when a firm combines with or takes over another firm at a different stage of production but in the same industry. It includes forward and backward integration.

99
Q

What is the objective of vertical integration?

A
  • Diversifying away from the traditional product space and venturing into new markets to offset some of the loss in revenue from traditional product space by creating new revenue streams.
  • Lowering cost by reducing or removing them in a forward integration.
100
Q

What is forward integration?

A

A firm moving into succeeding stages of production and gaining ownership over other companies that were once customers.

101
Q

What is the objective of forward integration?

A
  • Lower uncertainty with regard to access to markets, improving supply chain coordination
  • More control over presentation and distribution and price of product
  • Lower costs in cases where distributors charge significant cost
102
Q

What is backward integration?

A

One firm merging with another firm involved in the previous/earlier stage of production.

103
Q

What is the objective of backward integration?

A
  • Lower uncertainty with regard to securing FoP, improving supply chain coordination
  • Greater control over quantity and quality of scarce FoPs, thus being able to determine final products quality
  • Entry deterrence by restricting availability of supplies of critical FoPs, preventing demand from falling
  • Lowered cost since suppliers used to sell products to retailers at profit maximising price
104
Q

Limitations of vertical integration:

A
  • Diseconomies of scale
  • More complex and time inconsistent management decisions, making firm less responsive to changes in market conditions
  • More difficult to monitor workers and coordinate activities in a larger firm, increasing monitoring cost
105
Q

What is a conglomerate?

A

One very large firm consisting of many smaller firms formed through mergers or acquisitions. Parent company sells a variety of goods and services that are not directly related to one another through its subsidiaries. Subsidiaries run independently but report to the parent company.

106
Q

What is the objective of conglomeration?

A

Diversification, which reduces uncertainty and risks.

107
Q

Limitations of conglomeration:

A
  • Rising average cost due to the added layers of management and corporate culture issues
  • Parent company may not have skills and expertise to support newly acquired subsidiaries
  • Conglomerate may continue to hold on to poor performing subsidiaries for the purpose of diversification which hurt the performance of the more profitable subsidiaries
108
Q

What is franchising?

A

The practice of selling the right to use a firm’s successful business model and brand for a prescribed period of time.

109
Q

What is the objective of franchising?

A
  • To quickly expand while avoiding the risk of investing significant amounts of capital.
  • Build brand presence, reducing search cost for consumers
  • Increase revenue by collecting fees from franchisees
  • Reap marketing economies
110
Q

Limitations of franchising:

A
  • Negative impact on reputation if franchisee does not maintain the standard of quality and service
  • Costly communication with franchisees
  • High cost of training
  • Franchisees lack freedom to operate independently
  • Franchisees may not be profitable due to high payment of royalties
111
Q

What is mark-up pricing?

A

Retailers wanting to know with some certainty what the gross profit margin of each sale will be, allowing it to know that all its costs are being covered.

112
Q

What is disruptive technology?

A

An innovation that considerably changes the way buyers and sellers communicate, conduct transactions and firms operate, replacing well established systems, products and even habits due to its far superior attributes.

113
Q

What are the impacts of technological disruption on profitability?

A
  • Spurs new demand and encourages creation of new products
  • Ease of browsing for goods and services increases demand and hence revenue and profits
  • Allows firms to differentiate their goods, reducing degree of substitutability, increasing market power and limiting competition
  • Digitalising operations can cut costs
  • E-commerce can improve the efficiency of supply chains
  • Supply chains can be tightened to avoid accumulating inventories and minimise losses
114
Q

What are the risks to adopting disruptive technologies?

A
  • Reliance on labour declines, reducing demand for goods
  • Barriers to digital connectivity may slow the adoption of disruptive technologies
  • Increased exposure to cyberattacks increases cybersecurity risks
115
Q

What are the impacts of disruptive technologies on competition and contestability?

A
  • Smaller firms with fewer resources to enter and target segments of the market are allowed to compete
  • Reduce exit costs by reducing set up costs
  • Reduce barriers to entry and exit weakens the position of established players and gives new firms space to grow
  • Firms slow to respond to disruptive technologies or leverage on it are likely to be phased out over time
116
Q

What are the criteria for assessing performance/desirability?

A
  1. Allocative efficiency
  2. Productive efficiency
  3. Dynamic efficiency
  4. Equity
  5. Consumer choice
117
Q

What is allocative efficiency?

A

The situation in which the society produces and consumes a combination of goods and services that maximises its welfare, when goods and services wanted by the economy are produced in the right quantities.

118
Q

What is the condition for allocative efficiency?

A

Price = Marginal cost of production, ie society values the last unit of good as much as the opportunity cost of producing it.

119
Q

Does a PC firm achieve allocative efficiency?

A

Yes. Price=AR=MR, when MR=MC, price=MC.

120
Q

What is productive efficiency?

A

All resources fully and efficiently utilised.
Macro-economic perspective: Resources used to maximum capacity.
Society’s POV: When firm is operating at MES and all IEOS have been exploited
Firm’s POV: All points along the LRAC are productively efficient

121
Q

Does a PC firm achieve productive efficiency?

A

Yes. Since PC firm is a price taker, it has to be cost efficient to maximise profits. If it does not operate on LRAC, it will earn subnormal profits and will have to shut down.

122
Q

What is dynamic efficiency?

A

A situation where firms are technologically progressive in order to reduce the average cost of production and/or meet the changing wants and needs of consumers over time.

123
Q

Does a PC firm achieve dynamic equilibrium?

A

No. There is no incentive or ability for research and development due to assumption of perfect information (innovations will be quickly replicated by competitors), long run normal profits (R&D expenditure is high), and assumption of homogenous products.

124
Q

What is equity?

A

Fairness in distribution in wealth, income, opportunities and profits.

125
Q

Does a PC firm achieve equity?

A

Yes. Due to no barriers to entry, profits are spread amongst many small firms. Consumer surplus is also maximised as P=MC.

126
Q

What is consumer choice?

A

Freedom to choose from a variety of goods and services, as well as purchase goods from different producers.

127
Q

Does a PC firm achieve consumer choice?

A

No. Goods are homogenous, no variety.

128
Q

How does degree of market power affect degree of allocative inefficiency?

A

Greater market power, greater price-setting ability, steeper the AR curve, extent to which price exceeds MC is greater, greater the degree of allocative inefficiency.

129
Q

Do MPC firms achieve productive efficiency?

A

From the firm’s POV, yes, because due to long run normal profits, they have to operate on the LRAC, if not they will have to shut down.
From society’s POV, no, because MPC firms have small market share, and thus demand is not large enough to support producing at MES thus the firm has yet to exploit all IEOS.

130
Q

Do oligopolies and monopolies achieve productive efficiency?

A

From a firm’s POV, they can afford to be cost-inefficient and not operate on the LRAC since they are able to retain their supernormal profits, allowing them to exist in the industry without minimising costs.
From society’s POV, output of oligopolies and monopolies are large enough for them to reap IEOS and is able to produce closer to the MES, thus it can be productively efficient.

131
Q

What affects a firm’s ability to attain dynamic efficiency?

A

Their willingness and ability to innovate, which depends on the level of competition between firms within the market.

132
Q

Do MPC firms achieve dynamic efficiency?

A

MPC firms are willing to differentiate their products, however their long run normal profits limit their ability to innovate through huge investments in R&D. Thus, MPC firms only emphasise superficial product differentiation.

133
Q

Do oligopolies and monopolies achieve dynamic efficiency?

A

They are able to retain long run supernormal profits, thus have the ability to engage in R&D. High barriers to entry allow them to retain profits from innovation, thus making them willing to do so. For oligopolies, existing competition induces them to engage in R&D to differentiate their product from their rivals’, Monopolists might not achieve dynamic efficiency if they become complacent.

134
Q

Do MPC firms achieve equity?

A

Only normal profits are made since new firms can easily enter and compete, thus MPC firms tend to spread opportunities and wealth across the society, hence achieving equity.

135
Q

Do oligopolies and monopolies achieve equity?

A

They exacerbate inequity as their profits are concentrated at the hands of few dominant firms who are able to block new entrants, and there is sustained redistribution of income from households to firms due to presence of supernormal profits. Collusion and price discrimination reduce consumer surplus.

136
Q

Which market structure achieves consumer choice?

A

MPC and oligopolies as there is product differentiation. For monopolies, consumers do not have a choice as to which variant of the product to purchase as products of monopolists are unique.

137
Q

What is the theory of contestable markets?

A

What is crucial in determining price and output is whether there is a real threat of competition.

138
Q

What are the key conditions for a perfectly contestable market?

A
  1. Entry into and exit from the market are costless.
  2. No exit costs, encouraging firms to enter an industry because if they are unsuccessful, they can transfer their capital equipments elsewhere.
  3. Perfect information and ability to make use of the best available production technology in the market.
  4. Low consumer loyalty which reduces the risk of entering the market.
139
Q

What is hit and run competition?

A

Firms entering a market for a short period of time when profits are high then quickly withdraw.

140
Q

What are the benefits of price discrimination?

A
  1. Greater equity for consumers as consumers from lower income groups can benefit from relatively lower prices
  2. Higher profits for firms as firm can extract consumer surplus and add to revenue, increasing profits, which can be reinvested into research and development which leads to product improvement and cost reductions
141
Q

What are the costs of price discrimination?

A
  1. Less equity, producers benefit at the expense of consumers, which worsens the sustained redistribution of income from consumers to producers.
  2. Unfair strategy to keep potential entrants out as strategic barriers are set up to keep out potential entrants.

Economics (6 decks)

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