Imperfect markets Flashcards
Explain Monopolies
A monopoly exists when there is one seller of a good or service for which there is no close substitute.
Characteristics of monopolies
- There is only one seller of the product
- There are barriers to entry (caused by patents, property rights, control over resources, government regulations and decreasing costs.)
- The monopolist is regarded as a price maker (able to influence the market price through changing the quantity it supplies to the market.)
- The are no close substitutes. The product cannot be easily replaced.
- Consumers have no choice in price and quality of the product.
- There is no competition. (One business in the market will control the supply of goods and services.)
- Products are differentiated and unique. (Monopolies manufacture a variety of products which are difficult for other companies to copy).
- Large amounts of starting capital are required.
- Monopolies have legal considerations. (New inventions are protected by patent rights.)
- Services, like the Post Office are protected by law and other businesses are prohibited from entering the market.
- It is also possible for the monopolist to make an economic profit in the long run. (This is because it faces no competition from new entrants as a result of the barriers to entry.)
Name the two main groups (due to barriers that exist) the monopolies can be classified as.
- Natural monopolies: High development costs prevent others from entering the market and therefore the government supplies the product.
E.g. Electricity in South Africa is provided by the government enterprise, Eskom. It costs billions of rands to build and maintain power stations and therefore there are no other suppliers.
- Artificial monopolies: Here the barriers to entry are not economic in nature. An example of a barrier is a patent. A patent is a legal and exclusive right to manufacture a product,
e.g. Denel Land Systems manufacturing Casspirs.
Explain The demand curve of the monopolist
- Under perfect competition the individual producer faces a horizontal demand curve since it is a price taker.
- By contrast, the monopolist faces a normal market demand curve which slopes downwards from left to right.
- It is also the industry’s demand curve, since the monopolist is responsible for the entire output of the market.
Explain The marginal revenue curve of a monopolist
- The demand curve for a monopolist, which is downward sloping, implies that, if it wishes to increase its sales by an additional unit, it must decrease the price of the product. (The lower price applies to all its customers.)
- Its marginal revenue will therefore be less than the price.
- The marginal revenue curve and the demand curve are therefore not the same curve.
- The Marginal revenue curve will be lower than the demand curve.
Explain the difference between a monopoly and a perfect market
Monopoly:
* Price setter (maker)
* Individual business is the industry
* Consumer buys less if the selling price is high (and vice versa)
* Monopolist produces a lower output at higher prices thus at sub-efficient quantities.
* Producer and consumer surpluses are smaller
* Product is unique with no close substitutes
* Long-term: can make economic profit
Perfect market:
* Price-taker
* Individual businesses add up to make the industry
* Business can’t choose its price and if it sells at a different price it loses out
* Larger output and lower prices.
* Economically efficient quantities produced.
* Producer and consumer surpluses bigger
* Product are homogenous
* Long-term: only normal profit
Explain Oligopolies
- An oligopoly exists when a small number of large companies are able to influence the supply of a product or service to a market.
- By controlling the supply they aim to keep its prices and profits high.
- Oil companies are one of the best examples of an oligopoly. A special type of this market form is a duopoly – an industry with only two producers.
What are the Characteristics of oligopolies?
- There is limited competition. Only a few suppliers manufacture the same product.
- Products may be identitcal or slightly differentiated.
- This market is characterised by mutual dependence. The decision of one company will influence and will be influenced by the decisions of the other companies.
- Oligopolies can frequently change their prices in order to increase their market share. However this can result in a price war.
- Extensive use is made non-price measures to increase market share e.g. advertising, efficient service or product differentiation.
- Producers have considerable control over the price of their products although not as much as in a monopoly.
- If oligopolies operate as a cartel, firms have an absolute cost advantage over the rest of the competitors in the industry. Abnormal high profits may be a result of joint decisions in an oligopoly.
- Entry is not easy in an oligopolistic market. This is due to brand loyalty and it also requires a large capital outlay.
Explain what is meant by Kinked demand curve for the oligopolist
- An oligopolist faces a kinked demand curve. This demand curve consists of two sections:
- The top section: the section that relates to high prices is a very elastic slope (i.e. demand is very sensitive to a price change.)
- The bottom section: the section that relates to lower prices is very inelastic (i.e. demand is not sensitive to a price change).
- The oligopolist is therefore faced with a difficult decision because in both instances it will not benefit.
- Increasing the price of goods (or reducing the price) to increase sales will not lead to more revenue.
- (This is one theory devised by an American economist, Paul Sweezy, used to determine the oligopolist’s demand curve.)
Discuss, in detail, Non-price competition in oligopolies.
- Oligopoly firms are reluctant to change prices because a price war will drive prices down and profits will be eliminated.
- They make use of non-price measures to attract customers and increase their market share.
- An important aspect of non-price competition is to build brand loyalty, product recognition and product differentiation.
- This is done by means of advertising and marketing. As a result, oligopoly firms tend to spend a substantial amount of money on this.
Name other forms of non-price competition
- extended shopping and business hours
- doing business over the internet
- after-sales services
- offering additional services
- loyalty rewards for customers
- door-to-door deliveries
What is meant by Collusion in Oligopolies?
- Collusion takes place when rival firms cooperate by raising prices and restricting production to maximise profits.
- A formal agreement between firms to collude it is called a cartel
Discuss, in detail, the concept of a cartel
- A cartel is a group of producers who form a collective monopoly in order to fix prices, limit supply and competition.
- Although there is an incentive to collude there is also an incentive to compete. This has caused many cartels to be unsuccessful in the long term.
- In general, cartels are economically unstable because there is a great incentive for members not to stick to the agreement, to cheat by cutting prices illegally and to sell more than the quotas set by the cartel.
- Some well known cartels are the Organisation of Petroleum Exporting Countries(OPEC) and De Beers diamonds in South Africa.
- Overt/Formal collusion e.g. cartels are generally forbidden by law in most countries. However, they continue to exist nationally and internationally.
What is referred to price leadership and is an example of a tacit collusion?
Sometimes in an oligopoly market, a dominant firm will increase the price of a product in the hope that its rivals will see this as a signal to do the same
Characteristics of monopolistic competition
- The products are differentiated. Products are similar but not identical.
- The are similar in that they satisfy the same need of the consumer.
- There may be differences in packaging but the product is the same. e.g. sugar or salt.
- Differentiated products create opportunities for non-price competition e.g. advertising.
- Monopolistic competition displays a hybrid structure. It is a combination of competition and a monopoly.
- There are many sellers.This indicates the element of competition.
- Entry into the market is easy.
- Businesses have little control over the price of the product. Each business sells at its own price since a single price cannot be determined for the differentiated product because a range of prices could apply.
- Information for buyers and sellers is incomplete.
- Collusion is not possible under monopolistic competition.
- Restaurants, plumbers, lawyers, insurance brokers, hairdressers, funeral parlours and estate agents are all examples of monopolistic competitors.
