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.
