Market Structure

Question 1

competitive markets features (6)

Answer 1

1) no dominant firm
2) plenty of choice of good/service
3) low prices
4) few barriers to entry
5) low profit
6) several firms in the market

Question 2

perfect competition features (6)

Answer 2

1) no barriers to entry
2) perfect information
3) many firms
4) freedom of entry/exit (low sunk costs)
5) homogeneous product
6) firms are price takers: firm’s D curve is perfectly elastic

Question 3

changes in equilibrium with perfect competition

Answer 3

• if increase in D, there’ll be an increase in price. Therefore, AR increases causing temporary supernormal profits
• this attracts new firms into the market, causing prices to fall back to Pe
• if firms are making a loss, some firms will close down, causing price to ruse
• in the long run, firms will make normal profits (AR=AC)

Question 4

efficiency of perfect competition (4)

Answer 4

1) allocative achieved as long run equilibrium occurs where P=MC
2) productive achieved as firms produce at the lowest possible point on SRAC
3) X achieved as competition between firms will act as a spur to increase efficiency and make sure firms use the best combination of inputs
4) resources aren’t wasted on advertising as product are homogeneous

Question 5

disadvantages of perfect competition (5)

Answer 5

1) no scope for economies of scale; many firms producing small quantities
2) undifferentiated product give little choice to consumers
3) lack of supernormal profit make research in R+D unlikely
4) perfect knowledge- no incentive to develop new technology as it would be shared with other companies
5) if there are externalities in production/consumption there is likely to be market failure without gov’t intervention

Question 6

features of oligopoly (4)

Answer 6

1) dominated by a few firms. UK definition= 5 firm mkt concentration ratio of more than 50%
2) interdependence of firms
3) barriers to entry (but, less than a monopoly)
4) differentiated product. Advertising is important

Question 7

determinants of oligopolists’ behaviour

Answer 7

• objectives of firms: profit or sales max?
• degree of contestability: level of barriers to entry?
• government regulation: preventing collusion?

Question 8

efficiency of oligopoly depends on the way firms compete and behave: (4)

Answer 8

1) if industry is collusive: allo. inef. P>MC; prod. inef. as output is not at lowest point on SRAC; X inef. as less incentive to cut costs
2) few large firms meaning they can benefit from economies of scale; lower average costs
3) if low barriers to entry, will be contestable but often oligopolies have significant barriers to entry: bad
4) depends on objectives of the firms. If they seek to increase market share, there’ll be price competition and greater allocative efficiency

Question 9

features of a monopoly (4)

Answer 9

1) pure monopoly = only one firm in the industry
2) natural monopoly= when most efficient number of firms in the industry is 1 (e.g. railway network)
3) monopoly power occurs if a firm has more than 25% of market share
4) dominant monopoly = 40+% mkt share

Question 10

monopsony (2)

Answer 10

• when a firm has market power in employing workers or purchasing raw materials
• often a firm with monopoly power in selling goods also has a degree of monopsony power

Question 11

barriers to entry definition

Answer 11

factors that make it difficult for new firms to enter the market

Question 12

types of barriers to entry (7)

Answer 12

1) high fixed costs (incumbent firm has eco’s of scale, the higher AC of a new firm would be uncompetitive)
2) vertical integration; when a firm has control over different stages of production and retail
3) legal monopoly; patent on an invention
4) advertising; may be very strong brand loyalty
5) predatory pricing
6) being the first firm in the industry (Google)
7) geographical barriers

Question 13

monopoly diagram

Answer 13

• maximises profit where MR=MC
• therefore sets price = Pm and quantity = Qm
• firm makes supernormal profit = (AR-AC)Q

Question 14

disadvantages of a monopoly (7)

Answer 14

1) allocative inefficiency as P>MC
2) productive inefficiency as Qm isn’t lowest point on AC
3) X inefficient as no incentive to cut costs (AC curve high)
4) less choice for consumers
5) higher prices lead to lower consumer surplus
6) poor product quality as no incentive to develop
7) may also have monopsony power meaning they can pay low wages

Question 15

advantages of a monopoly (4)

Answer 15

1) economies of scale- if industry has high FC, monopolist can benefit from lower AC due to economies of scale
2) research and development = affordable from supernormal profits
3) international competition enabled via domestic monopoly (Sky)
4) may be efficient; e.g. Google

Question 16

Contestable market definition

Answer 16

A market in which there are no barriers to entry/exit and the costs facing new and incumbent firms are equal

Question 17

Features of a contestable market (3)

Answer 17

Absence of sunk costs (no barriers to entry and no potential barriers to entry)
Perfect information
Freedom to advertise and legal right to enter the market

Question 18

Hit and Run Competition

Answer 18

Firms quickly entering the market when there are supernormal profits and leaving it when the supernormal profits disappear

Question 19

Benefits of contestable markets (4):

(similar to benefits of a competitive market

Answer 19

• Lower prices (allocative efficiency)
• Increased incentives for firms to cut costs (x efficiency)
• Increased incentives for firms to respond to consumer preferences
• could be significant economies of scale as contestable market theory doesn’t require there to be that many firm

Question 20

Methods to increase contestability of markets

Answer 20

• Remove legal barriers to entry
• Force firms to allow competitors to remove its network
• Legislation against predatory pricing
• Office of Fair Trading can legislate against abuse of monopoly power

Question 21

Monopolistic competition definiton

Answer 21

A market structure in which there is a large number of small firms selling a similar product and where there are few barriers to entry and exit

Question 22

Features of a monopolistic competition (3)

Answer 22

• Many Firms
• Freedom of entry and exit
• Brand Differentiation
• In the Long Run, only normal profit is made
• inelastic demand curve as produce differentiated products

Question 23

Limitations of Monopolistic competition model (2)

Answer 23

• Some firms better at brand differentiation and therefore new firms not seen as close substitute so will be able to make supernormal profit
• Likely to be some barriers to entry