Market structure Flashcards
1
Q
Characteristics of perfect competition
A
- infinite number of suppliers and consumers - 1) No firm has market power 2) Each firm is ‘price taker’
- consumers have perfect info
- producers have perfect info
- products are homogenous (perfect substitutes)
- firms are profit maximisers - firms produce where MC=MR
2
Q
Perfect Competition - Allocative efficiency and externalities
A
- allocative efficiency occurs when P=MSC
- perfect competition results in long run equilibrium where P=MPC
- if there are negative externalities then MPC there’s allocative efficiency -> overconsumption and overproduction
3
Q
Perfect Competition - No Supernormal profits
A
- no firm will make supernormal profits in the long run -> any short term SN profits attract new firms to market -> SN profits competed away in long term
4
Q
Perfect Competition - Productive Efficiency
A
- comes from all firms trying to max. profits
- only achieved if no economies of scale - infinite number of firms -> each firm is very small -> can’t take advantage of the economies of scale
5
Q
Perfect Competition - Dynamic Efficiency
A
- in perfect competition no reward for taking risks as only normal profits made therefore no dynamic efficiency. Can achieve degree of dynamic efficiency without becoming too allocatively and productively inefficient
6
Q
Perfect Competition - Static Efficiency
A
- if allocative and production efficiently achieved at any point - static efficiency. Can’t last forever as consumer taste changes
7
Q
Government policies to move economies closer to perfect competition
A
- encourage new enterprises with advice and subsidies
- increase consumer knowledge by ensuring that comparison information available
- introduce more consumer choice in public area -> might involve internal markets such as health and schooling
- privatise and deregulate monopolistic nationalised industries
- discourage mergers and takeovers (lower number of firms)
- encourage more international competition e.g. EU
8
Q
Barriers to entry due to incumbent firms’ actions
A
- innovative new product/service can give firm head start and make it difficult for new entrant to overcome. If new tech is patented - legally protected.
- strong branding makes products well known to consumers and as first choice - difficulty for new entrants
- genuinely better products or effective advertising mean the barrier to entry is the expense in attracting consumers away from market leaders
- predatory pricing - new entrants can’t match lower prices of large firms (EOS) therefore driven out of market
- the threat of ‘price war’ can defer new firms
9
Q
Barriers to entry due to nature of an industry
A
- some industries require huge amounts of capital investment before any revenue is made (e.g. steel production) -> large cost means new entrants cant break through
- barriers to exit - sunk costs, including investment, can’t be recovered when a firm leaves an industry -> new entrants deterred from entering market
10
Q
Barriers to entry due to government regulations
A
- if an activity requires a licence, restricts number and speed entry of rims. Also, in a regulated industry (e.g. banking), firms need to approved by a regulator before they can carry out certain activities
- new factories may need planning permission before being built
- regulations regarding health and safety and working conditions that firms need to keep to
11
Q
Advantages of new entrants
A
- not all new entrants to market are small firms -> larger firms can diversify into new markets as they have larger financial resources
12
Q
Monopolies - How they come about
A
- barriers to entry preventing new entrants to markets
- advertising and product differentiation - firm may act as price maker if consumers see products as more desirable than other firms’
- few competitors in market - more price-making power and easier to differentiate products
13
Q
How a firm behaves in a monopoly market
A
- assuming firm is profit maximiser, level of output is where MC=MR
- difference between AC and P is supernormal profit per unit
- barriers to entry are total therefore profits aren’t competed away
- this is long run equilibrium position for monopolist
14
Q
Drawbacks of how a firm behaves in a monopoly market
A
- at long run equilibrium position MC isn’t equal to AC therefore not productively efficient
- P>MC therefore not allocatively efficient
- due to restricted supply, product underconsumed
- no need to increase efficiency therefore X-inefficiency will remain high
- restricted consumer choice
- monopsonist power may be used to exploit suppliers
15
Q
Natural monopolies
A
- industries with high fixed costs and for large EOS lead to natural monopolies
- if more than one firm in industry, then they would all have same high fixed costs -> higher costs per customer than could be obtained by single firm
- monopoly might be more efficient than having lots of time competing
- will have continuous EOS (MC always < AC). A profit max monopoly will restrict output to MC=MR
- government reluctant to break up NMs as might reduce efficiency. However may provide subsidies to natural monopoly to increase output to point where AR=MC -> will reduce price
16
Q
Benefits of monopolies
A
- monopsonists large size means can take advantage from EOS -> can keep AC low (if DEOS avoided)
- security and SN profits mean firm can invest in innovating new products -> dynamic efficiency
- financial security means firm can provide stable employment
- intellectual property rights allow form of limited monopoly in consumers interest (better products) - e.g. copyright and patents allow firm exclusive use of innovative ideas -> SN profits may be made -> without IPR, firms no incentive to innovate as better products will be copied and take profits away
17
Q
Monopsony
A
- single buyer dominates market
- monopsonist can act as price maker and drive down prices - e.g. supermarkets may exploit their suppliers by forcing low prices but this may be in consumer interest if low prices passed on
- if firm is single buyer of labour, may lower wages of its employees
18
Q
Price discrimination
A
- when a seller charges different prices to different customers for exactly same products
- attempts to turn consumer surplus into additional revenue
19
Q
Conditions needed for firm to use price discrimination
A
- seller must have some price making power
- firms must be able to distinguish separate groups of customers who have different PEDs
- must be able to prevent seepage (customers reselling product at higher price)
20
Q
First degree price discrimination
A
- each individual customer charged max they’re willing to pay
- would turn all consumer surplus into extra revenue
- cost of gathering required info to do this and difficulty in preventing seepage makes this method unlikely to be used
21
Q
Second degree price discrimination
A
- often used in wholesale markets, where lower prices are charged to people who purchase large quantities
- turns some of consumer surplus into revenue and encourages large orders
22
Q
Third degree price discrimination
A
- when a firm charges different prices for same product to different segments of market. E.g. different ages, customers who buy at different times, customers in different places, customers with different incomes (student discounts)
23
Q
Evaluation of price discrimination
A
- although seller increases revenue at expense of consumer, extra revenue could be used to improve products, or invested in more efficient production methods which may lead to lower prices
- AC>MC therefore price discrimination doesn’t lead to allocative efficiency
- people with higher income often end up paying more but can afford it therefore might be seen as fair especially if the greater profits made from some customer used to subsidise lower prices paid by others
24
Q
Oligopoly - in terms of market structure
A
- a market dominated by just a few firms
- has high barriers to entry
- firms offer differentiated products
25
Oligopoly - in terms of the conduct of firms
- firms are independant
| - firms use collusive or competitive strategies to make interdependence work to their advantage
26
Competitive behaviour
- when firms don't cooperate but compete instead
- more likely when: one firm has lower costs than others, relatively large number of big firms in market, firms produced very similar products, low barriers to entry
27
Collusive behaviour
- when firms cooperate, especially over what prices are charged
- formal collusion - involves agreement between the firms i.e. they form a cartel. Usually illegal
- Informal collusion - happens without any kind of agreement. Happens when each firm knows its not in they best interest to not compete
- some firms might still be able to act as price leaders
- more likely when - firms have similar costs, there are relatively few firms in market, brand loyalty, high barriers to entry
28
Results of collusive oligopolies
- similar results to monopolies
- higher prices and restricted output (and under consumption), allocative and productive inefficiency
- firms have resources for more efficient production methods and achieve dynamic efficiency, but not always incentive to do so therefore can lead to market failure
- make SN profits at expense of customers
- firms may still compete through marketing policies - for example firm may try to differentiate product, use sales promotions, try to find new export markets
29
Why oligopolies aren't so bad
- some economists argue formal collusion unlikely as its illegal and any informal collusion likely to be temporary as one firm will decide to 'cheat' and lower its prices to gain advantage (first mover advantage) -> likely to trigger price war
- if firms aren't competing on price, then non price competition might be stranger -> dynamic efficiency -> innovational and improvements good for consumers
- firms unlikely to raise prices to very high levels -> would provide strong incentive for new entrants to join market
- competitive oligopolies can achieve high levels of efficiency
30
Kinked demand curve
- shows only one type of interdependence
- two assumptions:
- if one firm raises its prices, then the other firms won't raise theirs. When price is increased, demand is price elastic. The fall in demand will more than cancel out gains from charging higher price.
- if one lowers its prices, then the other firms will lower theirs. When price is decreased, demand is price inelastic. Any time that reduces prices will lose out - they won't gain market share but average price for products will have fallen
- outcome - firms have no incentive to change prices as they would lose out
31
Conditions for monopolistic competition
- some product differentiation - either due to advertising or real differences in products
- > seller has some price making power -> demand cure slopes downwards -> smaller the differences, the more price elastic the demand for each product will be
- lower or no barriers to entry
32
Short run monopolistic competition
- SN profits only made in SR therefore SR position like a monopoly
- SN profits made due to barriers to entry and/or product differentiation
33
Long run monopolistic competition
- like perfect competition
- low barriers to entry -> new entrants -> demand curve shifts to left
- new entrants will continue to join until only normal profit can be earned (P=AR=AC) ; AC curve and AR curve touch tangentially where MC=MR
- Not productively or allocatively efficient but will still achieve greater efficiency levels
34
Prices being higher in monopolistic competition than perfect competition
- the time taken from looking like a monopoly to a perfect competition will affect the prices set: if it takes long time, market will resemble monopoly -> firms willing to spend lots of money to try to differentiate their product. The longer the firm can retain its price making power
- firm isn't producing at lowest point of AC curve -> prices higher than perfect competition as firms need to spend money on differentiating their product and create brand loyalty
- firms chosen to restrict output to max profit therefore can't take advantage of EOS
35
Monopolistic competition - Dynamic efficiency
- lack of barriers of entry means firms unlikely to invest huge amounts to innovate -> less dynamic efficiency
- absence of SN profits -> not much money for investment
36
Contestable market
- low barriers to entry and exit. If SN profits made, new firms will enter
- SN profits can potentially be made by new firms
37
Conditions for high barriers to entry
- patents on products or production methods - give firm legal protection
- advertising by incumbent firms creates brand loyalty
- threat of predatory pricing by incumbent firms
- trade restrictions present - don't follow foreign entrants to compete in domestic markets on equal terms
- incumbent firms are vertically integrated -> access to supply of raw materials distribution networks difficult for new firms
- sunk costs are high
38
Hit and run tactics
- entering market while SN profits are made and leaving once driven down to normal-profit levels
39
Effects of contestability on behaviour of incumbent firms
- sacrifice short term profits and set lower prices to avoid attracting new entrants -> best way to max. profits in LR
- interest in creating high barriers to entry e.g. heavy spending on advertising, preparing to engage in predatory pricing
- in LR firms move to productive and allocative efficiency - must settle for normal profits
40
Technological change can have an impact on
- barriers to entry and exit
- structure of a market
- production methods
- consumption of goods and services
41
Invention and innovation can lead to
- improvements in capital equipment -> improvements in quality of goods produced
- change in barriers to entry/exit
- a level of monopoly power for first firm which utilises new invention and innovation
- improvements in labour productivity and efficiency
- larger EOS
42
Creative destruction
- the idea that markets are constantly changing due to innovation and invention of new products and production methods. Can lead to destination of old markets and creation of new ones. Can cause job losses and firms to go out of business but new jobs created and society benefits from better goods and services. Threat of it means firms have incentive to keep inventing and innovating
43
Game theory
- to do with analysing situations where two or more ‘players’ are each trying to work out what to do to further their own interests
- the fate of each of the players depends on their own decisions of everyone else. All players are interdependent. This is why it’s often used to analyse situations in economics
