In Depth Market Structures Knowledge Flashcards
What are the characteristics of Contestable markets?
-No barriers to entry or exit
-Must have good information (e.g on costs & technology)
-The supernormal profits make the incumbent firms subject to the threat of competition (hit & runners who are looking to eat away these profits and then quickly exit)
How has technology increased contestability?
-Firms don’t have to be as physical anymore thanks to technology, therefore reducing labour and startup / sunk costs
-Technical economies of scale are easier to achieve
-Advertisement is easier to achieve, overcoming the barrier of brand loyalty
-It’s encouraged innovation (e.g Uber, AirBnB, Microsoft, Apple, etc.)
-It’s increased information to new entrants thanks to the internet and also better communications
What is the behaviour of a firm in a Contestable market?
-If there’s a strong threat of contestability, a monopolist would move to where AC=AR to earn normal profits:
this would deter/detract hit & runners as it’d take away the incentive for new firms to enter the market
What are the benefits of contestability?
-There’s a movement towards allocative efficiency (lower prices, higher quality/choice, higher consumer surplus)
-There’s a movement towards productive efficiency (exploitation of the economies of scale, leading to lower prices for consumers) & X efficiency (minimal wastage lowers costs & prices)
(These static efficiencies occur as firms have to be prepared for competition)
-With there being more quantity and labour being a derived demand, there’ll be more job creation
What are the disadvantages of contestability?
-Lack of dynamic efficiency due to lower profit margins ; Eval: (However new firms with innovative ideas may bring the benefits of dynamic efficiency, such as increased R&D)
-Cost cutting may include neglecting health & safety, product safety, environmental standards and wages: these changes are not socially desirable
-Creative destruction may occur where innovators destroy incumbent firms, causing job losses; Eval: (However those who lost their jobs can still work in the new large firms, therefore staying in the same industry)
-Anti competitive strategies may be used in the long run (such as mergers, flooding the market with excessive advertisement)
Evaluation of contestability
1.) Markets won’t be Contestable over time if:
-New firms can patent their ideas
-Firms are using anti-competitive strategies
2.) Technology may reduce contestability because of patents and copyrights
3.) There may be regulation to prevent anti-competitive strategies (such as the presence of the CMA)
What are the characteristics of perfectly competitive markets?
-Many Buyers & Sellers
-Perfect information: Consumers know everything about the prices and quality of goods; producers know everything about the costs, technologies & market segments of their consumers
-No barriers to entry or exit
-Homogenous goods & services : therefore they are price takers
-Firms are profit maximisers (producing where MC=MR)
Why are supernormal profits only a short run equilibrium in perfect competition?
Because they attract new firms into the market:
With firms being able to enter easily because of their perfect information and No barriers to entry or exit, supernormal profits won’t last in the long run.
Graphically, the industry supply increases to the right, decreasing the price and therefore the average revenue (AR) for the individual firm, causing supernormal profits to disappear and normal profits being earned where AR shifts down from AR1 to AR2 where AR=AC
Why are losses/subnormal profits only a short run equilibrium in perfect competition?
Because firms are inclined to leave the market and pursue producing their opportunity cost if they’re making losses (again they can do so freely as there’s no barriers to exit as it’s costless to do so)
Graphically, if firms are leaving the market, then the industry supply will decrease to the left, causing an increase of prices, therefore causing an upward shift of the firms average revenue to the point where the losses are eradicated and normal profits are being earned where AR=AC
Why do firms have to be statically efficient in perfectly competitive markets?
Because if they deviate away from the three static efficiencies (allocative, productive & cross/X) then they won’t survive because of the nature of competition
What is the downside to perfect competition?
There’s no dynamic efficiency as firms can’t make supernormal profits in the long run, meaning they can’t reinvest into their companies, meaning:
1.) Consumers may not see brand new innovative products over time
2.) Producers may not be able to lower their costs as they won’t have new technologies
-Also there are homogenous goods, meaning there’s no product differentiation
What are the characteristics of Monopolistic competition?
- Many buyers & sellers : Therefore a price elastic demand
- Slightly differentiated goods: firms have slight price making ability because there are other firms with good substitutes (meaning firms can’t exploit their price-setting power) — Like a monopoly but limited due to competition
-Low barriers to entry/exit
-Good information of market conditions
-Non price competition (as firms can’t exploit their price making ability) : competition based on branding, advertising, product quality & customer service
-Firms are profit maximising (producing where MR=MC)
Examples of monopolistically competitive markets
-Clothing markets
-Restaurants/Fast food sector
-Taxis
-Hairdressers & Salons
-Bars & Nightclubs
Why do firms make supernormal profits in monopolistic competition in the short run?
Because there’s less competition, meaning their goods are more unique, allowing them to exploit their price-setting abilities without any repercussions/consequences on consumer demand
Why do supernormal profits disappear in the long run in monopolistic competition?
More firms will enter the market as they’re attracted to the supernormal profits (they can enter easily due to low barriers to entry & there’s good information)
Normal profits are made instead where AR=AC
Why does monopolistic competition seem bad?
Because there’s:
1.) Allocative inefficiency (consumers are being exploited as prices are greater than marginal costs and choice/output is being restricted)
2.) Productive inefficiency: Not producing at the lowest point of AC curve, and foregoing economies of scale
3.) Lack of dynamic efficiency as there’s normal profits being made and not enough supernormal profits that can be reinvested into research & development
How can we compare allocative efficiencies between different market structures to make monopolistic competition seem the best one?
-Well to start, the price exploitation isn’t going to be as bad as in monopoly
-In perfect competition, there are homogenous goods — this isn’t desired amongst consumers as we’d rather desire product differentiation;
therefore we’d be willing to pay more & erode our consumer surplus for these differentiated goods, therefore some allocative inefficiency may be good in fact.
How can we compare productive efficiencies between different market structures to make monopolistic competition seem the best one?
-Compared to monopoly, the productive inefficiency isn’t nearly as bad because in monopolistic competition there are good substitutes, meaning firms can’t afford to forego economies of scale (otherwise they’d fall out of the competition)
-In comparison to perfect competition, there may be productive inefficiency because of the consumer demand for differentiated goods, making it harder to exploit economies of scale as opposed to if it were just one homogenous good (like in perfect comp)
How can we compare dynamic efficiencies between different market structures to make monopolistic competition seem the best one?
-Firms are more likely to be dynamically efficient in monopolistic comp than in monopoly, because in monopoly firms tend to be more greedy in distributing the supernormal profits amongst themselves / shareholders instead of reinvesting
-In the long run, the normal profits being made can still be reinvested (even if the extent is small), e.g in the clothing sector where firms have to be innovative in coming up with new fashion designs so they don’t lack behind in competition
-The supernormal profits that were made in the short run may be sufficient enough to be reinvested in the long run
