Market Structures Flashcards
What are the characteristics of a monopoly?
Single dominant seller
High barriers to entry
Differentiated products -> monopoly is a price maker
Imperfect information of market conditions
Assume the firm is a profit maximiser
What are the efficiency outcomes of a monopoly?
No AE,PE,XE (meaning it is statically inefficient). Could be DE but unlikely as there is no incentive to reinvest, reduce costs and prices due to the lack of competition.
What are the monopoly outcomes?
The type of goods that a monopoly is producing could determine the effects on the economy. Monopolies can cause inequality if they occur in necessity markets. This is due to the fact that they will place high prices on necessity goods, taking up a greater percentage of income of the poor. However, if it is a luxury/normal good, the higher price may be warranted if it is matched by high quality and constant reinvestment.
In some cases, despite the productive inefficiency, the monopoly may be able to access greater economies of scale, simply due to the size. This could lead to the monopoly having lower prices and producing more than a competitive firm being allocatively efficient.
What are the regulations that can be placed on a monopoly?
- Price Regulation - Stopping monopolies from raising prices to meet inflation in order to reduce prices. The regulations could be stricter, forcing monopolies to become more efficient and reduce costs.
- Quality control/Performance targets - Although these could lead to unintended consequences and firms taking shortcuts in production.
- Profit Control - Although there is clear asymmetric information between the firm and regulator.
- Taxes on profits - Although this would incentivize tax evasion and would only worsen the effect of the high prices of monopolies.
- Merger Policy
- Privatisation
- Deregulation
- Reducing Trade Barriers
- Nationalisation
What are the key issues with monopoly regulation?
Almost all regulations on monopolies are at risk of regulatory capture; will suffer from lack of information and will incur extensive costs whilst, possibly, not resulting in benefits. Also, there are benefits of a monopoly that could be wiped out after regulation.
What are the characteristics of a natural monopoly?
- Huge fixed costs
- Enormous potential for economies of scale, to minimise AC, a high Q is required.
- Competition is undesirable - only rational for 1 firm to be in the market - Competition would result in a wasteful duplication of resources and non-exploitation of economies of scale, leading to allocative and productive inefficiency.
Natural Monopoly Explanation
Without any regulation, the natural monopoly will profit maximise, operating at Qm. This results in high prices and low quantity, which could be a problem if the natural monopoly is the supply of a necessity (such as water). Thus, regulators could force the natural monopoly to be allocatively efficient, operating at Qc. Whilst this would lower prices and increase quantity drastically, the firm would now be making a loss, with costs being greater than revenue. Thus, the government would have to impose a subsidy in order for the natural monopoly to continue to provide such goods.
What are the characteristics of oligopolies?
- Few firms dominate the market, with a high concentration ratio
- High barriers to entry/exit
- Differentiated goods
- Interdependence - Firms will not make decisions on their own, rather basing them on actions and reactions of rival firms, leading to price rigidity.
- Non-price competition
- Profit maximisation is not the sole objective.
Oligopoly Explanation
Assume the market has settled at an equilibrium. Above this price, demand is assumed to be elastic. This means raising prices will lead to firms losing quantity demanded, losing market share and falling revenue. Below equilibrium price, demand is assumed to be inelastic. If a firm were to lower their price, they would only gain a small quantity demanded. This is due to other firms following the fall in price, leading to a price war and overall a fall in revenue. Therefore, there is price rigidity as it is not beneficial for firms to raise or lower their prices.
Furthermore, if costs change within the vertical gap on the MR curve, equilibrium will remain unchanged and price will stay at the same level, as long as the firm is profit maximising (MC=MR).
Finally, there is temptation for oligopolies to collude. This collusion can be overt (directly fixing prices and quantities formally), tacit (where firms informally agree on prices or to avoid price war) or price leadership (where a dominant firm sets the tone). Firms may wish to collude in order to guarantee profits and make SNP in the long run, with them acting together as a profit maximising monopoly.
What are the characteristics of contestable markets?
- Threat of competition
- High barriers to entry/exit
- Large pool of potential entrants
- Good information
- Incumbent firms subject to hit & run competition
What has technological change (advancements) done to contestability.
Technological advancements have increased contestability. This is due to barriers to entry being broken down, an increased pool of potential entrants and improved information.
Contestable markets explanation
With a strong threat of competition, a firm will operate at AC=AR, lowering prices and limiting firm’s ability to enter a market. If a firm is making SNP, firms will have an incentive to enter the market. Losing this SNP will eliminate their incentive and lower the threat of competition. Also, it allows for a firm to prepare for an increase in competition, due to lower prices and increased quantity.
This will give benefits of the static efficiencies, due to the firm moving closer to competitive output levels. Also, the increased output will lead to a firm’s demand for labour increasing, creating more job opportunities in the market.
However, with no SNP there will be no dynamic efficiency, leading to a lack of progress over time. Also, the firm may attempt to cut in dangerous areas, such as health and safety, in order to lower costs and increase profits. Creative destruction could destroy existing firms and lead to job losses (although these workers could easily move to different firms for a similar job). Finally, the firm could use anti-competitive strategies in order to remove the threat of competition. This may lead to contestability not lasting over time.
Contestable markets eval
How long will the contestability last? - If new firms can patent their ideas, the market will not be competitive over time
Role of technology - Patents and copyrights can reduce contestability, with them raising barriers to entry
Regulation - Used to protect product standards and environmental standards from cost cutting and also used to stop firms adopting anti-competitive strategies.
Competitive markets explanation
Competition will lead to static efficiencies. AE - Increased consumer surplus, increased quantity and quality of products, lower prices. PE - Minimise AC, passing on lower costs via lower prices. XE - Minimising waste and producing on AC curve. Also, competition can lead to increased employment, due to derived demand for labour as quantity increases.
However, competition can wipe out SNP, stopping the firm from being dynamically efficient and reinvesting in order to lower costs in the long run. This is due to a lack of innovation and invention, reducing benefits to consumers. Furthermore, there may be a lack of economies of scale. This is due to smaller firms having a smaller potential of economies of scale, with monopolies having greater potential which could lead to greater benefits to consumers. Competition could lead to firms aiming to cut costs, which could be dangerous if done in a dangerous area. Finally, new firms can lead to creative destruction, leading to a fall in living standards and employment (although these workers can transfer to the new firm).
Competitive market eval
- Could still be dynamic efficiency, even if the reinvestment is small scale. Also, reinvestment may be part of the competition in the market.
- Wouldn’t want competition in a natural monopoly.
- Regulation - Stop firms taking shortcuts and cost cuts in dangerous areas.
- Static Efficiency vs Dynamic Efficiency - Which type of efficiency is desirable would depend on the market and good/service produced. For example, in the case of electronic goods, consumers would be willing to pay the higher price in order for a firm to gain the SNP and reinvest, so that the products will be of higher quality in the future.
