Market Structures Flashcards
Spectrum of Market Structures
Highly Competitive / Low Concentration
-Perfectly Competitive Markets
- Monopolisitic Competition
- Oligopoly
- Monopoly
Low Competition / High Concentrated
Characteristics of a Perfectly Competitive Market (6)
No Barriers to Entry /Exit
Perfect Information
Infinite Number of Firms
Homogenous
Price Taker
Normal Profits
Characteristics of a Monopolisitcally Competitive Market (6)
Some product differentiation
Low barriers to entry
Good Information
Some brand loyalty
Lots of firms
Elastic PED
Characteristics of an Oligopoly (7)
High Concentration Ratio
Differentiated goods
Price Maker
High barriers to entry / exit
Interdependence
Price Rigidity / Sticky Prices
Non-Price competition
Characterisitics of a Monopoly (6)
25% + market share
Unique Good
One firm
High barriers to entry
Profit Maximisers
Price Maker
Potential Objectives of Firms (4)
Profit Maximisation
Sales Maxmisation
Revenue Maximisation
Break Even
Profit Maximisation
MC = MR
Firms produce up to the point beyond which costs would rise at a faster rate than marginal revenue, decreasing total profit.
Usually the primary objective of firms.
Revenue Maximisation
MR = 0
Firms produce up to the point beyond which no further revenue can be made.
Sales Maximisation / Break Even
AR=AC
This is the highest level of output that a firm can sustain in the long run (making normal profit).
Sales Max. - Aim to increase brand exposure
Break Even - Non-profit organisations
Divorce of Ownership from Control / Principal Agent Problem
When the ownership of firm and the management of the firm are not the same person/board.
As a result Principal (shareholder) pays for an agent (director) to act in their interests but the agent acts in their own interest, ie. Satificing
Satisficing
Doing just enough to satisfy shareholders instead of aiming to maximise profits
Allocative Effciency
AR = MC
A market equilibrium at which social welfare has been maximised.
AR is equivalent to demand and the marginal personal benefit / utility, whilst MC is equivalent to the additional costs or disutility.
Therefore, welfare and utility are maximised up to the point where AR becomes equal to MC, as beyond this, MC > AR, reducing total utility.
Productive Efficiency
AC=MC
A market equilibrium at which the existing factors of production are in their best use, the greatest possible quantity at the lowest possible price.
At this point, average costs will be at their lowest resulting in the lowest price.
Dynamic Efficiency
When a firm is able to invest into their factors of production to stimulate long-run growth.
This investment often comes from supernormal profits and involves improving the quality or quantity of FoPs.
Dynamic efficiency can also lead to new products being invented / innovated for consumers.
X-Inefficiency
A lack of effective competition in an industry means that average costs are higher than they would be if the market was more competitive/ contestable.
Wastage / Laziness etc.
Pareto Efficiency
A situation where no further improvements to society’s well being can be made through a reallocation of resources that makes at least one person better off without making someone else worse off.
Outcomes of a Perfectly Competitive Market (4)
Positive -
Allocatively Efficient - In the long-run, a perfectly competitive market will operate at an allocatively efficient level of output, where social welfare is maximised.
Productively Efficient - In the long-run, a perfectly competitive market will operate at a level of output where average (per unit) costs are minimised.
X-Efficient - As the firm is fully utilising their factors of production, the firm is x-efficient as there is no wastage within the firm.
Negative -
Dynamic Inefficieny - The lack of supernormal profits in a PC Market prevents firms from reinvesting into their FoPs, restricting LR growth.
Outcomes of a Monopoly
Negative -
Allocatively Inefficient
Productive Inefficient
DWL exists
Positive
Dynamically Efficient (could be)
Near to productive efficieny (EoS)
Role of Monopoly’s abnormal profit in the LR
Large abnormal profits provide an incentive for other firms to overcome barriers to entry.
Other firms may innovate and create new production methods to undercut the prices or quality of the incumbent monopoly.
This is called creative destruction.
Monopoly Power
The ability for a firm to determine the price and quantity of goods and services within the market, due to a dominant market share.
Determinants of Monopoly Power (3)
Barriers to Entry
Number of Competitors
Advertising and Product Differentiation
Natural Monopoly Definition
A market in which the optimal number of firms in the market is one due to large fixed costs or continuous EoS benefits.
What causes change from SR to LR in Monopolisitic Competition
The presence of supernormal profits (SR) act as a signal and an incentive for new firms to enter the market. Low barriers to entry allow them to do so with minimal start-up / sunk costs. In doing so, new firms take market share from incumbent firms and demand becomes more elastic as choice increases.
Therefore, the AR / MR curves shift downward, resulting in SNP being competed away - normal profit achieved.
Outcomes of a Monopolisitic (SR + LR)
SR - Operates as a Monopoly
LR - MC + AC curves shift downward. Profits are competed away, leading to firms achieving normal profit at AR=AC.
Allocatively inefficient
Productively inefficient
Dynamically inefficient
Despite this, it is likely that a monopolistically competitive market is more desirable than a monopoly.
Whilst not actually achieving static efficiency, the firm is able to produce near AE + PE, demonstrating some economies of scale benefits and a reasonably small welfare loss.
Explanation of Price Rigidity in Kinked Demand Oligopoly
Within an oligopoly, it is assumed that prices are rigid. This occurs due to two separate PEDs along the AR curve.
If firms increase their prices, the quantity demanded will fall significantly as other firms will continue to offer the existing price in order to increase their market share, due to the interdependent nature of firms - ie. reacting to the actions of other firms.
Price rigidity can also be evidenced when there is a change in a firm’s costs. If MC shifts from MC1 to MC2, then prices will remain at P1.
Outcomes of KD Oligopoly (3)
Price Competition may still occur in an oligopoly. Firms may try to reduce their price in order to increase their market share against their rivals, this is a price war - inefficient
Non-price Competition will likely occur. If it is assumed that prices are rigid, it makes more sense for firms to compete using non-price methods.
Temptation to collude. Due to issues that arise from prices being sticky, firms may choose to collude in order to maximise the profits throughout the market. This essentially allows firms to operate as a monopoly and fix prices.
Potential Results of Game theory (3)
Nash Equilibrium - Both firms use the low price in order to protect their prices from being undercut - LR
Collusion - Agreement to maintain high prices to maximise the market’s total profit.
Cheating - Where firms cheat on the collusive agreement in order to extend their revenue in the SR.
What can cause a competetive oligopoly (5)
A larger number of firms - a less concentrated market, making organising collusion harder.
Lower Barriers to entry - Collusion to achieve supernormal profits acts as a signal for new firms to enter the market.
If one firm has a significant cost advantage, ie EoS, organising a price to sell the product to maximise profits becomes difficult.
If goods are homogeneous - firms do not have the ability to fix prices.
If the market is saturated - lots of price competition, to gain market share, rather than attempted collusion
Factors that promote collusive oligopoly (4)
It is easier to organise collusion with a small number of firms.
Similar costs aid collusion - easier to agree on price.
High barriers - supernormal profit does not attract new firms, protect LR profit.
Ineffective competition policy - allows collusion to occurs
Factors which reduce likelyhood of cheating on a collusive agreement (2)
Brand loyalty - consumers will not change demand if you undercut their preferred firm.
Consumer inertia - consumers do not have the effort to change suppliers, barriers to switching
What is price discrimination ?
When different consumers are charged different prices for the same product.
This transfers some/all of the consumer surplus into producer surplus.
Conditions needed for price discrimination (3)
Firms must be a price maker,
Able to separate the consumers
Prevent reselling at higher prices.
First Degree Price Discrimination
Perfect Discrimination
Each individual consumer is charged the maximum price that they are willing to pay, i.e. all of the consumer surplus is converted to producer surplus.
Second Degree PD
Wholesale Discrimination
Lower prices are offered to consumers who purchase large quantities. This converts some of the consumer surplus into producer surplus.
Third Degree PD
Market Segment Discrimination
A firm charges different prices for the same product to different segments of the market.
Potential market segments include - age, times, location.
A firm is able to charge different prices by identifying differing PED between the groups, eg. rush hour travellers vs off peak travellers.
Evaluation points for Price Discrimination (3)
The use of price discrimination converts some or all of the consumer surplus into producer surplus, ie. the seller’s revenue increases at the expense of consumers.
- However, this extra revenue could be used to improve
products, investment etc.
In all cases, AR > MC, therefore price discrimination does not lead to allocative efficiency.
Consumers are not treated equally, but often the people with higher incomes are the ones charged the higher prices. This may be considered ‘fair’, especially if their higher prices allow for lower prices for others.
Contestable Market Definition
A market with low barriers to entry meaning that new firms can easily enter the market, even if actual competition is low.
Examples of Barriers to entry (9)
Licences / permits
Patents - production methods / goods
Sunk costs
Relative cost barriers / EoS
Brand Loyalty
Geographical barriers to entry
Predatory Pricing / Limit Pricing
Vertical /Horizontal Integration
Experience / Time in market
How does technological development change markets (3)
- The structure of the market - new low cost technology allows new firms to enter the market.
- Production Methods - New production methods are invented / innovated allowing for cheaper production.
- How goods + services are consumed - eg. the internet
Negative Impact of Technological Development (2)
Creative Destruction
Structural Unemployment
Positive Outcomes of a contestable market (4)
Similar outcomes to competition are achieved, even if actual competition does not exist.
As the incumbent firms move towards break even, they also become increasingly statically efficient (allocative / productive)
X-Inefficiency falls as incumbent firms aim to reduce wastage and their total costs.
Jobs may be created as quantity demanded increases, ie. labour demand is derived from consumer demand.
Disadvantages of contestable markets (4)
The lack of supernormal profits prevents dynamic efficiency occurring in the long-run.
Firms may cut costs in a dangerous way, ie. health and safety
Creative destruction that is promoted by contestable markets may cause structural job loss.
Incumbent firms may use anti competitive strategies.
Level of contestability depends upon (3)
Length of contestability - If new firms can patent their ideas or anti competitive strategies (limit pricing, excessive marketing, flooding the market), then the market will not be contestable over time.
Role of technology - New technology can be patented preventing contestability, improved information regarding consumer data - leading to Price Discrimination.
Regulation - prevent anti competitive strategy and protect product / health and safety standards.
Hit + Run tactics
Where firms enter contestable markets briefly to capitalise on SR supernoraml profits, however leave the market as these profits become competed away.
