Lec 3 - Competition Flashcards
What are the differences between competitive and non-competitive markets?
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Price taking Entry and absence of barriers Information Externalities
When there is an effect that is not internalised, what does that mean?
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Cigarette smoke example
> Buying a bigger car, I am protected in it, in case of accident more likely to injure the one in the smaller car
How is a Perfect Competition Market characterised by?
Large number of buyers and sellers
=Everybody is a price taker (no firm large enough to influence price)
Homogeneous and perfectly divisible product
= Consumers view products of different firms as perfect substitutes (price is the only decision factor)
Free entry / exit
= No transaction costs to participate in the market (costs are linked to only inputs)
Perfect Information and equal access
No Externalities!
What are Transaction costs?
Cost needed for an exchange to occur, but not needed for the good itself
1. Search and Information Costs
=Farmer finding the best price for fertilizer
2. Bargaining and Negotiation Costs
=Time spent on agreeing rather than producing
3. Enforcement Costs
=Deviations from a contract & need for a lawyer
What is Perfect Information?
Every agent can costlessly and immediately collect the information that is needed (quality, prices etc.)
What are Externalities?
What are its 2 types?
Effects of one’s actions on all third parties, that are not planned or compensated for. When they are not considered in the production decision, then it can cause to market failures.
Negative Externality: Social costs exceed private costs
=Pollution
Positive Externality: Social benefits exceed private benefits
=Flu vaccine, education
What are some tools for correcting negative externalities so they dont cause market failures?
Taxes and Subsidies
=Gasoline tax to reduce CO2 Emissions
=R&D Subsidies could increase R&D activity
What is welfare and welfare implications of Perfect Competition?
Welfare is the benefit that society as a whole derives from exchange of a good between producers and consumers
To analyse welfare, we consider a situation of “Market Equilibrium”
What are the 2 principles that the framework for analysing behaviour of human beings and firms in economics is based on?
- Optimization Principle
a) Firms decide how much to produce based on the cost of production and the price for which they can sell their good
b) Based on the same price consumers decide how much of the good they want to buy, maximising their utility - Equilibrium Principle
=Prices adjust until Demand = Supply
What is the price that emerges in a competitive market?
Visualise for p<=>Q
Where on a price to Quantity plane the supply curve S(p) and the demand curve D(p) crosses, which gives the equilibrium price p* and the equilibrium price Q*
What does WTP mean?
Willingness to Pay means the maximum price for which the consumer is still considering to buy the product
What is the Consumer Surplus?
Visualise for p<=>Q
It is the difference between WTP and the actual price paid
The area below the Demand Curve D(p) and above the equilibrium price p*
at p* it is 0
What is the Producer Surplus?
Visualise for p<=>Q
It is the difference between production costs and the actual price the product is sold for
The area above the Supply Curve S(p) (a marginal cost curve) and below the equilibrium price p*
at Q* it is 0, costs are exactly p*
What is Welfare?
How does Competitve EQ affect it?
Concept in economics to measure how well an industry performs
= Consumer Surplus + Producer Surplus
Competitive EQ maximises Welfare!
What is Deadweight Loss (DWL)?
When does it occur?
Visualize both losses of Consumer and Producer for p<=>Q!
When the conditions for a competitive EQ are violated by setting the price too high or producing too mmuch, there is a loss to the total welfare, which is called DWL.
What are the 3 characteristics of Short-Run?
New firms cannot enter
Quantity of (at least one) input is fixed
Fixed costs might be sunk
What are the 3 characteristics of Long-Run?
Firms can enter and exit
Quantity of inputs can be varied
Fixed costs can be avoidable (if there are factors that do not vary continuosly with quantity)
What are the 2 Equilibrium Conditions in the Short-Run?
- MC(q) = p (firms choose profit max q level)
2. nq* = D(p*) (market clears: supply=demand)
What are the conditions that determine the n* number of firms in the long-run?
New firms will enter if positive profit exists or can be made!
Firms can exit if profits are negative!
Firms produce at their “Minimum Efficient Scale”, where AC are minimised!
What is the mathematical formular difference between long-run and short-run?
What does this difference mean in terms of EQ Conditions?
In the Long-Run Equilibrium, in addition to p* and Q, which are also in the Short-Run Equilibrium, there is n.
This means that we have 3 unknowns and need 3 conditions to solve for them!
What are the 3 Equilibrium Conditions in the Long-Run?
- MC(q) = p (firms choose profit max q level)
- MC(q) = AC(q) (Free Entry Condition: AC minimising q*)
- nq* = D(p*) (market clears: supply=demand)
What is the new condition of Long-run and what does it mean?
- MC(q) = AC(q) (Free Entry Condition: AC minimising q*)
MC are set equal to AC, so that at that point the AC are minimised!
At this point producer will make exactly 0 profit, so there is no incentive for entry or exit and it is an EQ
What are the objectives of Competition Policy?
Protection of Smaller Firms Promotion of Internal Market Fariness and Equity Social Reasons Protectionist Goals
= Main goal is to implement these objectives without reducing welfare
What does a deviation from the Perfectly Competitive EQ Quantity lead to?
It leads to a loss of welfare!
What is the main foal of Competition Policy?
Increase Welfare!
What is an EQ Price?
A price that clears the market: Supply = Demand
What are the conditions for a SR?
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What are the conditions for a LR?
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Will firms make profits in a Competitive EQ in the:
1) SR?
2) LR?
1) Firms can make a profit in the SR
2) If all firms are identical, firms make zero profit in the LR. If some firms produce more EFFICIENTLY than others, they can make a positive profit in the LR
What is the effect of a Unit Tax on CS, PS and TS?
The tax drives a wedge between the p for consumers and producers. It increases the p consumers have to pay and decreases the p producers receive. The consumers will therefore demand less and producers will supply less relative to the Competitive EQ without the tax.
Consuming a lower q at a higher p reduces CS, and selling less at a lower p reduces PS. =Both reduced
The loss of CS and PS for each unit exchanged is Tax Revenue (which contributes to Total Welfare).
The loss of CS and PS from the units that are no longer exchanged is DWL and it is lost to society. DWL means a decrease in TS.
