Market competition Flashcards
What are the two extreme types of market competition?
Monopoly and perfect competition
What is the definition of perfect competition?
In a perfectly competitive market, both the buyers and the sellers believe their own actions have no effect on the market price.
What is the definition of a monopoly?
The only seller or potential seller in the industry sets the price.
What are the characteristics of perfect competition?
. many buyers and sellers
- so no individual believes that their own action can affect market price (price takers)
. firms take price as given
- so face a horizontal demand curve (industry demand curve is downwars but a firm is only a small partr
. the product is homogeneous (no niche)
. perfect customer information
. free entry and exit of firms
What is a perfectly competitive firms MR =to and why?
MR=P because selling extra output doesn’t bid the price down.
How does a perfectly competitive firm choose its output?
SMC=MR=P
Explain the short run supply curve in perfect competition
. Above the point where P=SMC=SATC firm makes supernormal profits but only in short run as other firms will undercut
. where P=SMC=SATC, firm makes normal profits.
. where SAVC <p></p>
What is the long run equilibrium of perfect competition?
The market settles in long-run equilibrium when the typical firm just makes normal profit by setting LMC=MR=P at the minimum point of LAC. Long-run industry supply is horizontal.
Explain what happens when there is a rightward shift in demand in a perfect market effect on SrSS and LRSS.
. Markert demand shifts rightward
. in the short run the equilibrium is where SRSS and D’ intersect
. in the long run firms can adjust inputs as well as new firms attracted to the supernormal profit and so the equilibrium falls to the intersection with the LRSS
What are the characteristics of a monopoly?
. is the sole supplier of an industry’s product and the only potential supplier
. is protected by some form of barrier to entry e.g tech, patent
. faces the market demand curve directly.
. Unlike under perfect competition, MR is always below AR.
Explain profit maximisation by a monopolist?
. Profits are maximized where MC = MR
. AR is greater than AC so the firm makes monopoly profits
.
monopoly compared with perfect competition implies:
. higher price
. lower output
What happens to LAC in a natural monopoly?
LAC declines right up to market demand
Explain what a discriminating monopoly is?
. Suppose a monopolist supplies two separate groups of customers
. with differing elasticities of demand
. e.g. business travellers may be less sensitive to air fare levels than tourists.
. The monopolist may increase profits by charging higher prices to the businessmen than to tourists.
. Discrimination is more likely to be possible for goods that cannot be resold e.g stadium tickets
Explain an imperfectly competitive firm
Faces a downward-sloping demand curve. Its output price reflects the number of goods it makes and sells
What is an oligopoly?
An industry with few producers, each recognising that its own price depends both on its own actions and those of its rivals
What is monopolistic competition?
There are many sellers producing products that are close substitutes (differentiated products)for one another with each firm having only limited ability to influence its output price. e.g. cars
How can LRAC have an impact on the market structure?
. The size of the MES relative to market demand has a strong influence on market structure.
. Pure monopoly will have larger economies of scale and therefore an output level large relative to demand which means that less firms or only one firm may be able to get to the MES and drive the others out of the industry.
. the perfectly competitive firm will have the opposite and imperfect competition in between
What are the characteristics of monopolistic competition?
. many firms
. no barriers to entry
. product differentiation
- so the firm faces a downward-sloping demand curve
. The absence of entry barriers means that profits are competed away…
Explain the price and quantity level in relation to monopolistic competition
. Firms end up in TANGENCY EQUILIBRIUM, making normal profits.
. MR=MC
. P is where demand touches the LAC curve because if the demand curve was higher new firms would come in and push demand down
. Firms do not operate at minimum LAC because D is downward sloping
What may an oligopoly be characterised by?
collusion or by non-co-operation
What is collusion?
an explicit or implicit agreement between existing firms to avoid or limit competition with one another and means they can gain monopoly profits
What is a cartel?
is a situation in which formal agreements between firms are legally permitted.
e.g. OPEC
Collusion is difficult if…
. There are many firms in the industry
. The product is not standardised
. Demand and cost conditions are changing rapidly -so harder to see if someone is cheating
. There are no barriers to entry- new firms can enter and reduce their power
. Firms have surplus capacity- stronger incentive to use and brake agreement
What is the kinked demand curve?
Deman curve under oligopoly which helps explain firms output and price decision
Explain the kinked demand curve
. demand in response to a price reduction is likely to be relatively inelastic because any frim who drops price will be matched by the others e.g. supermarket price match
. but for a price increase, rivals are less likely to react so demand may be relatively elastic above market price so a loss in market share
. Since the MR curve has a discontinuous vertical segment at Q0, it remains optimal to leave price unchanged
. Price will tend to be stable, even in the face of changes in marginal cost as long as it stays in the range of the discontinuity
What is a game?
a situation in which intelligent decisions are necessarily interdependent
What is strategy?
a game plan describing how the player will act or move in every conceivable situation
What is the dominant strategy?
where a player’s best strategy is independent of those chosen by others
Give an example of the prisoners dilemma?
. Two firms face an output decision in a payoff matrix
. if both produce high then they both have a small profit of 1
. if both produce low they both have a profit of 2 (collusion)
. if one produces high and the other low, the one producing high gets 3 and the one low gets 0 and vice versa.
. dominant strategy is to produce high
How is the probability of cheating in an oligopoly reduced?
. Pre-commitment
an arrangement, entered voluntarily, restricting future options with a payback agreement
. Credible threat
a threat which, after the fact, is optimal to carry out
What is the reaction function of a firm in a duopoly?
. A firm’s reaction function shows how its optimal output varies with each possible action of its rival.
. the larger the output firm B is expected to sell the smaller is the optimal output of A.
What is the nash equilibrium?
Where two firms reaction functions intersect. At this point each firm’s guess about its rival’s output is correct and neither will wish to change its behaviour
What are contestable markets?
. A contestable market is characterized by free entry and free exit.
. no sunk costs
. allows hit-and-run entry
. Contestability may constrain incumbent firms from exploiting their market power
What is strategic entry deterrence?
. Some entry barriers are deliberately erected by incumbent firms:
- threat of predatory pricing
- spare capacity
- advertising and R&D
- product proliferation e.g soup powder
. Actions that enforce sunk costs on potential entrants
