Market Structure/Competition

Question 1

Describe consumer surplus

Answer 1

• Consumer surplus refers to the difference in the price consumers are willing to pay and the free market price, the price they actually pay.
• Increased consumer surplus may suggest increased disposable income therefore more money entering the economy (Potential AD rise).
• The more inelastic a market is the greater the CS.

Question 2

Describe producer surplus

Answer 2

-Producer surplus refers to the difference in the price a firm is willing to produce/supply at and the price they actually sell at (free market equilibrium).

Question 3

Describe productive efficiency

Answer 3

• Productive efficiency refers to firms acting at the lowest point on the AC cost curve, suggesting the firm is fully taking advantage of EOS as well as utilising resources efficiently.
• Occurs at the lowest point on the AC curve.

Question 4

Describe allocative efficiency

Answer 4

• Allocative efficiency refers to an output level that is aligned with consumer preferences. A firm that is allocatively efficient is producing at an output level that is optimum for societies interests/preferences, ‘what society wants’.
• Occurs when AR = MC / P = MC

Question 5

Describe dynamic efficiency

Answer 5

• Dynamic effiency occurs in the long run and refers to potential improvements to methods of production, the improved quality of goods/services and the overall efficient of a business and market.
• Supernormal profits earned by businesses can be reinvested to aim to achieve long run dynamic efficiency.
• Related to the future rate of innovation being at an optimum level which will cause increased efficiency/better quality goods/services etc.

Question 6

Describe a pure monopoly

Answer 6

• A pure monopoly is defined as a firm in a market which holds 100% of market share and the market only contains one seller.
• In a monopoly price/output is determined by the firm not the market, therefore price makers.

Question 7

Describe a working monopoly (monopoly power)

Answer 7

• The UK Competition and Markets Authority (CMA) describes a working monopoly as a firm in which holds at least 25% of the market share.
• EG) Google is responsible for around 85% of market share in the search engine industry.
• In a monopoly price/output is determined by the firm not the market, therefore price makers.

Question 8

Describe potential disadvantages of monopoly power

Answer 8

• Monopoly firms are allocatively inefficient therefore producing at an output not desirable for society, this is a form of market failure/ welfare loss to society.
• Restricted consumer choice in the market
• Deadweight loss of social welfare
• Potential price discrimination/exploitation, may have a larger proportionally effect on poorer income individuals (price exploiation may have regressive effect)
• Potential internal diseconomies of scale, monopolies have no incentive to become more productive/lower unit costs/prices as they are not threatened by competition (‘may become lazy’).
• Due to lack of competition there may be no incentive to re-invest supernormal profits to attempt to achieve dynamic efficiency and develop/innovate new technology/capital, this may have an effect on the economies overall productive capacity/trade competitiveness (less productive).
• Productively inefficient, firm is not utilising resources in the most efficient way possible.

Question 9

Describe potential advantages of monopoly power

Answer 9

• The supernormal profits made by a monopoly firm can be used to reinvest into the business (RnD) leading to future developments in capital/technology –> long run increase in productivity –> lower prices for consumers as well as better quality goods/services.
• As a monopoly firms grows their able to take advantage of EOS potentially leading to lower production costs and potentially lower prices for consumers (unlikely). Can be shown on the LRAC curve.
• Monopoly firm may provide a large amount of secure and stable jobs with potential high worker benefits due to supernormal profits.
• Government taxation revenue from corporation tax on supernormal profits, can be redistributed throughout the economy.
• Cross subsidisation, a monopoly firm may use supernormal profits to subsidise/reduce the [price of another good/service they produce which may be desirable for society as Allocative effiency may be achieved.

Question 10

Describe typical characteristics of a monopoly

Answer 10

• Firms profit maximise at MC = MR
• Firms in monopoly power earn supernormal profits in both short run and long run due to a range of factors.
• Monopoly firms are price makers.
• High barriers to entry
• Potential price exploitation and restricted supply.
• Differentiated products

Question 11

Describe factors to why monopolies are able to achieve both short run and long run supernormal profits and remain in monopoly power.

Answer 11

• As monopoly firms grow in size they can take advantage of many different EOS leading to potentially lower costs therefore have a cost advantage (if needed to be utilised) against potential entry firms.
• Owning of a resource/patenting allows monopoly firms to get ahead of competition through the use of developed capital/technology. Eg) Monopoly may own the rights to use an algorithm which more accurately predicts consumer behaviour than competitors solutions.
• High barriers to entry/start up costs restrict potential competition by making entry into a market very costly/risky and difficult. Eg) Capital, land, large workforce.
• High sunk costs, if sunk costs are high within a market firms will be deterred from entry. Eg) High advertisement costs.
• Brand loyalty/high advertising cost makes it more difficult for other firms to gain sales/marketshare.

Question 12

Describe factors which may lead to reduced monopoly power

Answer 12

• Falling barriers to entry and sunk costs leading to increase competitiveness.
• Technological change may lead to smaller firms developing tech products/methods of production which may challenge current monopoly power.
• Increase in regulation/ breaking up of a monopoly market by the government.

Question 13

Describe first degree price discrimination

Answer 13

-First degree price discrimination occurs when consumers are charged the maximum they are willing to pay therefore removing all consumer surplus from the economic transaction.

Question 14

Describe second degree price discrimination

Answer 14

• Second degree price discrimination occurs when a firm charges reduced prices for entities which purchase a large quantity of a good/service whilst charging higher prices for entities purchasing less of a good.
• By price discriminating of the second degree firms can take advantage of additional revenue.
• EG) Wholesale industries

Question 15

Describe third degree price discrimination

Answer 15

• Third degree price discrimination occurs when a firm charges different prices to different sections of the market, based on PED.
• Allowing firms to make additional revenue compared to if the same price was charged for everyone.

Question 16

Benefits and costs of price discrimination for producers

Answer 16

Benefits:

• Higher profits –> reward shareholders, reinvestment, attract more investors/easier to raise capital.
• Higher profits can be used to reinvest into research and development to achieve long run dynamic effiency, develop more efficient technology and improve the quality of a good/service.

Costs:

• May be detrimental/ineffective to a business if not all conditions to price discriminate are met, potential creation of other markets.
• Firms may breach regulation and be investigated by Competition and Markets Authority.

Question 17

Costs and benefits of price discrimination for consumers

Answer 17

Benefits:

• Cross subsides through the use of additional profit made, EG) subsiding another good a firm makes to make it more accessible to some consumers/market/lower price.
• Potential higher taxation revenue which can be passed down to consumers through government spending.
• If higher income individuals are targeted with higher prices this may be seen as fair and potentially lead to a reduction in income/wealth inequality as additional profit may be used for cross subsidies.

Costs:

• Consumer surplus is removed/taken from producers and replaced by profits.
• May be seen as unethical/unfair on certain groups/consumers who are targeted based on specific characteristics.
• Potential price exploitation

Question 18

Costs and benefits of price discrimination for consumers

Answer 18

Benefits:

• Cross subsides through the use of additional profit made, EG) subsiding another good a firm makes to make it more accessible to some consumers/market/lower price.
• Potential higher taxation revenue which can be passed down to consumers through government spending.
• If higher income individuals are targeted with higher prices this may be seen as fair and potentially lead to a reduction in income/wealth inequality as additional profit may be used for cross subsidies/improve services.

Costs:

• Consumer surplus is removed/taken from producers and replaced by profits.
• May be seen as unethical/unfair on certain groups/consumers who are targeted based on specific characteristics.
• Potential price exploitation and the strengthening of monopoly power in the long term, long term higher prices/restricted choice.

Question 19

Describe a contestable market + characteristics

Answer 19

• A contestable market is a market which faces competition, has relatively low BTE, a large pool of potential entrants, good level of information, entrants willing to ‘ hit and run’ and firms currently existing in the market.
• Contestabilty refers to how open a market is to potential competition.

Question 20

Advantages and disadvantages of monopolistic competitive markets

Answer 20

Advantages:

• Wide range of choice for consumers
• Firms have less price making ability due to increased competition therefore potentially reduced price discrimination/exploitation.
• Firms can potentially be dynamically efficient in both short and long run (SR RN profits and LR non-price incentives to re-invest/innovate)
• More realistic model of competition in an economy compared to perfect comp.

Disadvantages:

• LR dynamic efficiency may be difficult due to lack of SN profit.
• Both allocatively and productively inefficient in the LR, factors of production not being utilised most effectively.

Question 21

Describe the short and long run position for a firm in a monopolistic market.

Answer 21

• In the short run firms profit maximise, sell differentiated products and earn supernormal profits whilst acting as a monopoly. Firms can earn supernormal profits due to current barriers to entry (even if they’re low) and brand loyalty.
• In the long run, due to the fact BTE are low as well as the fact the market sells differentiated products, new firms enter the market. This continuous entering of the market due to SN profit incentive –> fall of in the existing firms demand/AR curve (demand being split up into a higher num of firms) leading to normal profit being made in the long run.
• In the long run firms are neither allocatively or productively efficient however may become more allocatively efficient than in a monopoly market –> reduced social welfare loss. Firms may also find it difficult to be dynamically efficient in the LR due to low SN profits, however due to high competition firms are incentivised to non-price compete and innovate their product to gain competitive advantage.

Question 22

Describe the short and long run position for a firm in a monopolistic market. + long run position in terms of effiency

Answer 22

• In the short run firms profit maximise, sell differentiated products and earn supernormal profits whilst acting as a monopoly. Firms can earn supernormal profits due to current barriers to entry (even if they’re low) and brand loyalty.
• In the long run, due to the fact BTE are low as well as the fact the market sells differentiated products, new firms enter the market. This continuous entering of the market due to SN profit incentive –> fall of in the existing firms demand/AR curve/becomes more elastic (demand being split up into a higher num of firms) leading to normal profit being made in the long run.
• In the long run firms are neither allocatively or productively efficient however may become more allocatively efficient than in a monopoly market –> reduced social welfare loss. Firms may also find it difficult to be dynamically efficient in the LR due to low SN profits, however due to high competition firms are incentivised to non-price compete and innovate their product to gain competitive advantage.

Question 23

Describe an oligopoly + charactersitics

Answer 23

-An oligopoly is a market which is dominated by a number of firms (high concentration ratio), has high barriers to entry, products sold within the market are differentiated and firms are interdependent (changes to behaviour of one firm leads to a potential change in behaviour of another.)

Question 24

Describe the concentration ratio

Answer 24

• The concentration ratio of a market measures the combined market share of a few dominant firms within a market.
• Eg) The concentration ratio of the supermarket industry for the top 4 firms (Tesco, Asda, Sainsbury’s and Morrisons) ≈ 75%.
• higher the concentration ratio the more concentrated a market is/less competitive.

Question 25

Describe collusive oligopoly + outcome of a collusive oligopoly

Answer 25

• A collusive oligopoly is an oligopoly where firms agree to come together to maximise their producer surplus/SN profits.
• Collusive oligopolies can be tacit (informal), a form of collusion which doesn’t require an agreement as firms know it is in their best interests to not compete. Example of informal collusion is price leadership, where multiple firms follow the pricing behaviour of perhaps the largest firm to keep prices at a similar level/raise p’s and SN profits.
• Collusive oligopolies can be formal due to the creation of a cartel, when a group of firms come together to fix prices, restrict output and generally maximise PS and SN profits.
• Outcome of a collusive oligopoly is the oligopoly acting as a monopoly structure, therefore the same outcomes as a monopoly //Compare to the outcomes of a competitive market/oligopoly (efficiencies, competitiveness, incentives to invest, welfare etc
• Firms within a collusive oligopoly may be incentivised to cheat the ‘price foxing’ as well by increasing output and potentially reducing price/may increase output and market share by competing on non price factors. Most oligopolies break up due to firms putting their own interests in front of the cartels, leading to a more competitive market.

Question 26

Describe non-collusive/competitive oligopolies + most likely to occur in

Answer 26

• A competitive oligopoly is an oligopoly that do not collude and instead compete on factors such as non-price competition (brand loyalty/good quality) and price competition (reduced costs/lower prices for consumers.)
• A competitive oligopoly usually occurs in an oligopoly with a fairly large amount of large firms within the market, little product differentiation and BTE are relatively low.
• Eg) Airline industry

Question 27

Describe how the kinked demand curve can be used to explain price stability/’stick prices’

Answer 27

The kinked demand curve is a model that can be used to illustrate why prices within an oligopoly remain stable in the long run.
In the event a firm raises their prices, this will lead to a reduction in demand for this firms good/service (consumers switch to cheaper alternative) and this leads to the higher prices being canceled out by the fall in demand therefore raising prices has lead to a net loss of revenue for this firm. (Demand curve is elastic at this point)
In the event a firm reduces prices, all other firms will follow to prevent the firm who has lowered the price to gain a competitive advantage, as all firms have lowered prices this has led to a loss in overall revenue therefore have not gained any market share but have lost out on revenue. (Demand curve is inelastic at this point)
Therefore as both scenarios lead to a net revenue/producer surplus loss for firms within an oligopoly therefore firms are incentivised to keep prices stable and remain in the output level that is most profitable as possible.

Question 28

Describe the advantages and disadvantages of collusive oligopolies

Answer 28

Advantages:

• Higher supernormal profits for firms
• Higher profits may be used to reinvest into capital/technology (LR dynamic efficiency) leading to a potential consumer welfare gain (quality of good).
• May be used to prevent the collapse of businesses within an industry during recession/low profitability by increasing SN profits.
• Higher SN profits can be taxed (corp tax) and redistributed within the economy, however firms incentivised to tax evade.

Disadvantages:

• As the collusive oligopoly operates as a monopoly in the LR experiences same negative effects as a monopoly market.
• Potentially Illegal, firms not incentivised to stop breaking the law as the punishment is fractional to SN profits potentially.

Question 29

Describe examples of formal collusion within an oligopoly (cartel behaviour)

Answer 29

• Price exploitation by agreeing and fixing prices within a market.
• Collusion to prevent the entry of new firms and potential competition which could reduce the industry profit levels, therefore increasing BTE.
• Suppliers may be forced to reduce prices/sell cheaper resources/supplies to collusive firms within an oligopoly as the supplier has no other alternative but to sell to the oligopoly which is demanding cheaper supply prices.

Question 30

Describe potential policies to reduce monopoly power

Answer 30

• Subsidising medium sized or firms willing to compete and enter the market, low prod costs –> develop capital to gain competitive advantage and rival monopoly.
• Price cap/max price to incentivise firms to use resources in a more efficient way (PE AE), may reduce profits, increases output/lowers price reduces exploitation.
• Breaking up of monopolies to make the market more contestable
• Government Free trade policies may open up competition due to foreign markets (labour and supplies) being accessable.