Market structure Flashcards
Define market structure
The market environment within which firms operate
Define perfect competition
A form of market structure that produces allocative and productive efficiency in the long-run equilibrium
What is a price taker
A firm that must accept whatever price is set in the market as a whole
Allocative efficiency
achieved when consumer satisfaction is maximised. P=MC
Productive efficiency
Attained when a firm operates at minimum ATC, choosing an appropriate combination of inputs and producing the maximum output possible from those inputs. (Producing at bottom of AC)
Features of perfect competition
Profit maximisation is an objective, many buyers and sellers, homogenous product, no barriers to entry or exit, perfect knowledge, price takers
What is a homogenous product
products are seen as identical by consumers, there is no brand loyalty so all products are perfect substitutes
What is perfect knowledge
Buyers and firms know prices charged by other firms, and no firm has a superior production technique
Examples of perfect competition
agriculture, commodities, foreign currency market
What is perfect competition demand curve like
perfectly elastic. because the quantity the firm sells is small compared to the size of the market, so doesn’t influence (AR=MR)
Analysis for perfect competition diagram
The firm cannot sell above P0 because buyers have full knowledge of the market and will buy elsewhere. The firm can not sell below P0 and profit maximise (P0 is where MR=MC so firm charges at P0). To profit maximise the firm produces at Q0 because MC=MR.
Perfect competition in the short run
The firm is making SNP which attract competitors and firms enter the market with no barriers to entry. Shifts supply right, and lowers market clearing price
Perfect competition in the long run
SNP lowers to 0. If profits fell below normal profits, some firms would leave the market (no barriers to exit). Supply shifts left and market clearing price increases. This increases SNP to a level they are at 0.
Perfect competition efficiency in the short run
Allocatively efficient. Not productively efficient
Perfect competition efficiency long run
Both allocatively (P=MC) and productively efficient (Producing at minimum AC)
How can the government change the nature of perfect competition to make it more competitive
force profit maximisation as the primary objective, increase number of buyers/sellers (encourage new enterprise, subsidies/tax breaks, discourage mergers, international comp), homogenous product (enforce safety standard), no barriers to entry (access to same technology), perfect knowledge (increase consumer knowledge by providing comparison info)
Define monoply
Form of market structure in which there is only one seller of a good or service
What is perfect/first-degree price discrimination
A situation arising in a market whereby a monopoly firm is able to charge each consumer a different price
What is arbitrage
A process by which prices in two market segments will be equalised as a result of purchase and resale by market participants
What is third degree price discrimination
Firm charges different price for the same product to different market segments
What are assumptions in the monopoly model
firms aim to profit maximise, single seller of a good, no substitutes for the good (heterogenous product), has barriers to entry, imperfect knowledge (monopolist may have patent/unique knowledge so is price maker)
Examples of monoploy
Google (search), facebook, microsoft windows (operating system)
Monopoly in the short run and long run
Monopoly profit maximises (MC=MR). Q0x(P0-AC0) is total SNP. Barriers to entry are very high, new firms unable to enter so SNP is made in the long-run. Production not at bottom of AC curve not productively efficient. Not allocatively efficient as P does not equal MC
Advantages of monopoly
Can be dynamically efficient (invest SNP into R&D keeping barriers to entry high), Benefits from economies of scale (achieve lower AC than a competitive firm)
Disadvantages of monopoly
economically inefficient (allocative inefficiency means that quantity supplied to consumers is restricted, higher price and lower utility), could be x inefficient (lack of competition so less incentive can lead to lower dynamic efficiency), dynamically inefficient/lack of consumer choice (no incentive to reinvest profits)
What is x inefficiency
actual AC is above the AC curve due to lack of competitive pressure
Why a monopoly could be better than a more competitive market
Depends on objectives - state owned monopoly may seek allocative efficiency, social costs and benefits.
If a monopoly is threatened with competition it can be forced to become dynamically efficient and stll benefit from economies of scale
Why can a monopoly be worse than a more competitive market
Lack of competition can cause a monopoly be x inefficient, little innovation, charge high prices. Consumers have reduced choice and high price without benefiting frim high quality product
What conditions does price discrimination need to be under
seller is a price maker, seller can identify different groups of customers with different PED, consumer must not be able to easily resell the product to a different market segment for a higher prices
Analysis of a monopolist of first degree price discrimination
All consumer surplus becomes extra SNP because the consumers are paying the maximum that they are willing to, assumes the monopolist has perfect knowledge of the consumer’s preferences and this knowledge costs less to acquire than the extra SNP
Examples of price discrimination
houses, insurance, cinema tickets, national trust
Analysis of a monopolist with third degree price discrimination
Monopolist charges lower prices to a market segment like children/students. A high price is charged to customers like adults. This leads to consumer surplus taken from adults becoming extra SNP.
Advantages of monopolistic price discriminating
Low prices for some consumers. Increases viability of good/service (a single price may not lead to SNP and can cause the good not being provided at all)
Disadvantages of monopolistic price discrimination
High prices for some consumers - may have less to spend on other goods and have lower utility than if the market were competitive
What does price discrimination depend on
Its benefit depends on the nature of the good/service; a product with positive externalities and price discrimination means more people can afford it
What is a natural monopoly
Monopoly that arises in an industry in which there are such substantial economies of scale that only one firm is viable
What is nationalisation
Where a privately owned firm or industry is taken into public ownership
Define privatisation
Where an enterprise in public ownership is returned to private ownership
Examples of natural monopoly
royal mail, network rail, water, london underground
How does a natural monopoly take advantage of economies of scale
Industries that need to build a network have very high fixed costs that lead to large economies of scale. (causes downward sloping LRAC as economies of scale can never fully be exploited). The single firm has low costs so can charge lower price. Productively efficient
Analysis of profit maximising natural monopoly
declining LRAC. LRMC below LRAC. Available economies of scale can not be exhausted by a single firm. AC decline, high fixed costs spread. . Single firm low AC. More productively efficient. Avoids duplication of networks
Analysis of an allocatively efficient natural monopoly
Natural monopoly has a subsidy of (AC0-P0)xQ0. Increases quantity produced. P0=MC so allocatively efficient
Advantages of natural monopoly
Greater economic efficiency (productive as can better exploit economies of scale. Allocative if subsidised by government). Can be dynamically efficient (invest SNP into R&D, improve tech and training keeping barriers to entry high)
Disadvantages of natural monopoly
low competition may lead to higher prices. Can be x inefficient (lack of incentive to reduce excessive stock levels leads to high prices, overstaffing, lower utility), can be dynamically inefficient/lack of consumer choice (no pressure to reinvest consumers have to buy them anyway)
What does the desirability of a natural monopoly depend on
Depends on objectives. e.g. state owned firm with social utility maximization as an objective can be more allocatively efficient and productively with a subsidy. However a profit maximising firm may lead to higher prices
What is monopolistic competition
a market that shares some characteristics of monopoly and some of perfect competition
What is production differentation
A strategy firms adopt that marks their product as being different from their competitors
What are the characteristics of monopolistic competition
large number of firms, no dominant firm, no/low barriers to entry (first 3 like perfect competition), product differentiation (unique to monopolistic competition), downward sloping demand curve (like monopoly)
Examples of monopolistic competition
Restaurants, hotels, pubs, coffee shops, hair dressing
Analysis of monopolistic competition in the short-run
Firms profit maximise so produce at MC=MR. Q0x(P0-AC0) is total SNP. Low barriers to entry so SNP attracts new firms which will produce differentiated products; so SNP can only be earned in short run.
Analysis of monopolistic competition in the long run
Firms attracted by SNP due to low barriers of entry. Cause established firms demand curve to shift left, as market demand is split between more firms. Incumbent firms increase spending on advertising, raising AC. Competition competes away SNP leaving normal profit and no further incentive for firms to enter the market
Advantages of monopolistic competition
competition lowers price and increases consumer choice (increase utility as can buy product best reflecting preferences), lower x-inefficiency, advertising informs consumers
Disadvantages of monopolistic competition
no economic efficiency (in both short/long run), advertising spending is wasteful (could be better spent on R&D which would increase utility), can not fully exploit economies of scale (causes higher prices)
Judging monopolistic competition
assumptions may be unrealistic and not represent conditions in the real world. The extent to which it benefits depends on characteristics of the product as it determines the extent to which economies of scale are foregone
What is the n firm concentration ratio
A measure of the market share of the largest n firms in an industry
What is an oligopoly
A market with a few dominant sellers in which each frim must take account of the behavior and likely behavior of rival firms in the industry
What is non-price competition
A strategy whereby firms compete by advertising to encourage brand loyalty, or by quality or design, rather than on price
What is a cartel
An agreement between firms on price and/or output with the intention of maximising their joint profits
What is a tacit collusion
A situation occurring when firms refrain from competing on price but without communication or formal agreement between them
Examples of oligopoly
entertainment industry, mobile phone networks, car manufacturers, supermarkets
How can market share be calculated
% of total sales, % of total sales revenue, % of profits, % of employees
Characteristics of an oligopoly
few large firms, high barriers to entry, non-price competition, price makers, interdependent decision making (takes strategic decisions based on rivals)
What do oligopoly’s that engage in non-price competition compete with
innovation, customer service, free upgrades, loyalty schemes, branding, breadth of product range, convenient location
Why do firms engage in non price competition
keeps revenues/profits high, as firms do not want to be forced onto inelastic part of the demand curve. Oligopolys can do this as few firms make tacit collusions possiblr
Why do oligopoly have a kinked demand curve
There are few competitors so firms either compete or cooperate with them. Oligopolies assume that if one firm raises prices they will lose customers, causing elastic demand when price rises. If one firm lowers price the others will too, demand is price inelastic when prices fall. Firms have no incentive to change price so it stays the same
Analysis of the kinked demand curve
Kinked demand curve models behavior of its rivals to its actions. Elastic - price rise lowers TR as competitors will not increase prices and consumers buy substitutes. Inelastic- price cut lowers TR as others copy causing discontinuous MR curve.Laeds to price stability and non-price competition.
When does price competition occurs
When oligopolistic conditions are weaker
When do collusions occur
When firms cooperate on price or output against the interests of consumers
What is strategic alliance
Where firms cooperate in a legal way, are often about reducing costs, such as contributing to open source software, ISO standards, bulk buying
What is price leadership
where a dominant firm sets a price to see if others follow without the nerd for overt discussion. Trying out a price rise, with the intention of cutting again if others do not follow, is barometric price leadership.
When does collusive behaviour occur
when oligopolistic conditions are stronger
Analysis of collusion
tacit collusion takes place with a small number of firms, easier to predict responses. Firms face similar cost conditions. High barriers to entry makes price competitions more difficult.
Advantages of oligopoly
dynamically efficient (SNP to R&D), benefits from economies of scale (lower AC, lower price than competitive), competitive oligopoly’s raise efficiencies (allocative and lower x inefficiency)
Disadvantages of oligopoly
x inefficient (lack of incentive to reduce overstaffing/excessive stock levels), dynamically inefficient (lack of pressure), collusive oligopolys raise prices and output - economically inefficient (qs restricted, reducing utility)
Which advantages of oligopoly are like monopoly
dynamically efficient, benefits from economies of scale
Which advantages of oligopoly are like monopolistic competition
competitive oligopolies raise efficiencies
Which disadvantages of oligopoly are like monopoly
could be x-inefficient
Oligopoly compared to monopoly
better than monopoly due to increase in consumer choice, and if competitive, lower prices. Worse than monopoly because less opportunity to benefit from dynamic efficiency and economies of scale
Oligopoly compared to monopolistic competition
better than monopolistic competition because more chance of benefiting from economies of scale and achieve dynamic efficiency in the long run. Worse if a collusive oligopoly because prices are higher and output is restricted leading to fewer consumers benefiting and loss of consumer surplus
Define contestable markets
a market in which the existing firm makes only normal profits, as it cannot set a price higher than average cost without attracting entry, owing to the absence of barriers to entry and sunk costs.
What are sunk costs
costs incurred by a firm entering the market that cannot be recovered if the firm ceases trading
What is hut and run entry
where a firm enters the market to take short-run SNP knowing it can exit without incurring costs
What is predatory pricing
Anticompetitive strategy in which a firm sets price below average variable cost in an attempt to force a rival or rivals out of the market and achieve market dominance
What are the characteristics to a perfectly contestable market
no barriers to entry and exit, no sunk costs, no threat of predatory pricing, equal access to technology, no competitive disadvantage compared with the incumbent firm, productively and allocatively efficient
What impact does the threat of increased competition have on contestable markets
firs are forced to set prices equal to average costs if they are to avoid hit and run entry, perfectly contestable markets can deliver the benefits of perfect competition without the need for a large number of firms
Examples of contestable markets
fast food, private education, parcel delivery, bookselling
Analysis of contestable market diagram
if the monopoly profit maximizes and produces at Q0 =MC=MR and charges price P0, then in a contestable market the firm is vulnerable to hit and run entry. The only way the monopoly can avoid this is produce where price = AC, so there is no SNP to act as an incentive. Monopoly produce at AC=AR with P1 and Q1 and change objective to sales volume maximization.
Analysis of perfectly contestable market diagram
Firms are forced to produce at sales volume maximization and make 0 SNP, to defend against hit and run entry. This is due to the nature of the market, 0 barriers to entry and exit, no economies of scale, equal access to technology and no sunk costs firms enter compete away SNP and leave without cost. Lead to productively efficient level of output a Q1 is at MC=AC and allocative efficient as P1 is at P=MC
What are the advantages of a perfectly contestable market
leads to static efficiency (achieves both productive and allocative efficiencies, furthermore firms are forces to be x efficient)
What are the disadvantages to a perfectly contestable market
equal access to technology reduces dynamic efficiency (less incentive to R&D), lack of SNP reduces dynamic efficiency (less scope to invest into R&D)
Why is a contestable market more useful than other market structures
more realistic than perfect competition (doesn’t rely on a large number of firms), the characteristics of a perfectly contestable market gives actionable advice to the government on how to improve the functioning of the market to the benefit of consumers with increased output and lower prices
Why is a contestable market less useful than other market structures
assumption are almost as unrealistic as perfect competition
