Market competition

Question 1

What are the two extreme types of market competition?

Answer 1

Monopoly and perfect competition

Question 2

What is the definition of perfect competition?

Answer 2

In a perfectly competitive market, both the buyers and the sellers believe their own actions have no effect on the market price.

Question 3

What is the definition of a monopoly?

Answer 3

The only seller or potential seller in the industry sets the price.

Question 4

What are the characteristics of perfect competition?

Answer 4

. 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

Question 5

What is a perfectly competitive firms MR =to and why?

Answer 5

MR=P because selling extra output doesn’t bid the price down.

Question 6

How does a perfectly competitive firm choose its output?

Answer 6

SMC=MR=P

Question 7

Explain the short run supply curve in perfect competition

Answer 7

. 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>

Question 8

What is the long run equilibrium of perfect competition?

Answer 8

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.

Question 9

Explain what happens when there is a rightward shift in demand in a perfect market effect on SrSS and LRSS.

Answer 9

. 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

Question 10

What are the characteristics of a monopoly?

Answer 10

. 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.

Question 11

Explain profit maximisation by a monopolist?

Answer 11

. Profits are maximized where MC = MR
. AR is greater than AC so the firm makes monopoly profits
.

Question 12

monopoly compared with perfect competition implies:

Answer 12

. higher price

. lower output

Question 13

What happens to LAC in a natural monopoly?

Answer 13

LAC declines right up to market demand

Question 14

Explain what a discriminating monopoly is?

Answer 14

. 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

Question 15

Explain an imperfectly competitive firm

Answer 15

Faces a downward-sloping demand curve. Its output price reflects the number of goods it makes and sells

Question 16

What is an oligopoly?

Answer 16

An industry with few producers, each recognising that its own price depends both on its own actions and those of its rivals

Question 17

What is monopolistic competition?

Answer 17

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

Question 18

How can LRAC have an impact on the market structure?

Answer 18

. 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

Question 19

What are the characteristics of monopolistic competition?

Answer 19

. 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…

Question 20

Explain the price and quantity level in relation to monopolistic competition

Answer 20

. 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

Question 21

What may an oligopoly be characterised by?

Answer 21

collusion or by non-co-operation

Question 22

What is collusion?

Answer 22

an explicit or implicit agreement between existing firms to avoid or limit competition with one another and means they can gain monopoly profits

Question 23

What is a cartel?

Answer 23

is a situation in which formal agreements between firms are legally permitted.
e.g. OPEC

Question 24

Collusion is difficult if…

Answer 24

. 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

Question 25

What is the kinked demand curve?

Answer 25

Deman curve under oligopoly which helps explain firms output and price decision

Question 26

Explain the kinked demand curve

Answer 26

. 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

Question 27

What is a game?

Answer 27

a situation in which intelligent decisions are necessarily interdependent

Question 28

What is strategy?

Answer 28

a game plan describing how the player will act or move in every conceivable situation

Question 29

What is the dominant strategy?

Answer 29

where a player’s best strategy is independent of those chosen by others

Question 30

Give an example of the prisoners dilemma?

Answer 30

. 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

Question 31

How is the probability of cheating in an oligopoly reduced?

Answer 31

. 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

Question 32

What is the reaction function of a firm in a duopoly?

Answer 32

. 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.

Question 33

What is the nash equilibrium?

Answer 33

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

Question 34

What are contestable markets?

Answer 34

. 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

Question 35

What is strategic entry deterrence?

Answer 35

. 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