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9708 Economics A2 > Market Structures > Flashcards

Market Structures Flashcards

1
Q

define market structure

A

the characteristics of a market that can be used to explain the behaviour of firms within it

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2
Q

characteristics of perfect competition

6 main

A
  1. infinite number of buyers and sellers and concentration ratio of 0
  2. homogeneous products
  3. 2 makes firms price takers
  4. no barriers to entry or exit
  5. perfect info of market conditions for P and C
  6. objective: profit maximise
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3
Q

characteristics of monopoly

6 main factors

A
  1. one dominant firm
  2. differentiated products
  3. 2 gives firms price making power
  4. high barriers to entry and exit
  5. imperfect info for P and C
  6. firms are profit maximisers
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4
Q

characteristics of oligopoly

6 + 2 unique factor (inter… and price/non-price)

A
  1. few large firms dominate market, concentration ratio approx. 70%
  2. product differentiation
    1. makes firms price makers
  4. high barrier to entry and exit
  5. strategic interdependence
  6. non-price competition and price rigidity
  7. objective varies depending on best way to increase market share under current market conditions
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5
Q

characteristics of monopolistic competition

A
  1. large no. of buyers and sellers
  2. low barriers to entry and exit
  3. slight product differentiation
    1. makes firms price makers
  5. non-price competition to increase market share as cannot increase prices significantly
  6. objective: profit max

examples: fast food industry!

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6
Q

why can SNP exist in the SR but not in the LR for monopolistic competition?

A

in the SR, firm can exploit the price making power they have due to producing a unique good or service to charge a price higher than AC, making SNP

in the LR, there are low BTE, meaning that any firm that is incentivised to enter the market due to the existence of high SNP can do so, this reducing the incumbent’s demand (shift left) until AC is tangent to AR. This is because the same no. of customers are shared among more firms now. This results in normal profits

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7
Q

steps to draw LR monopolistic diagram

A
  1. AR and MR
  2. MC
  3. profit max price and output
  4. draw AC such that it is tangent to the AR curve at the profit max price BUT the MC curve still intersects AC at its lowest point
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8
Q

implication of monopolistic competition being ‘slightly differentiated’?

A

firms have price making power leading to a downward sloping demand curve, but not as much as a monopoly

due to much greater competition, cannot increase prices by too much or will lose market share so demand curve is price elastic

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9
Q

define contestable market

A

market where entry is free and exit is costless, meaning the threat of new entrants is faced by all current firms

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10
Q

define concentration ratio

A

measure of the combined market share of the biggest 3, 4 or 5 firms in an industry. For example, (now use a simple worked example)

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11
Q

what are some barriers to entry?

A
  1. legal barriers - patents, copyrights
  2. access to key inputs
  3. brand name, loyalty and advertising
  4. high capital set up costs
  5. high EOS exploited by existing firms
  6. sunk costs
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12
Q

what are some barriers to exit?

A

sunk costs - losing capital investment if some costs like R&D cannot be recovered and capital assets cannot be transfered

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13
Q

define predatory pricing

A

firm sells goods below AVC to force competitors out of the market

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14
Q

define limit pricing

A

firms temporarily abandon profit max objective to stop new firms from entering a market by pricing low enough to discourage entrants with higher costs, while still pricing high enough to still be profitable for the incumbent firm

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15
Q

explain the SR and LR equilbrium of PC firms

A
  • two paned analysis to show that ruling market price is accepted by price taking firms
  • to profit max where MR=MC can choose the Q they produce
  • at this quantity, P > AC so SNP is made
  • two paned analysis to show outward shift of market S
  • in the LR, existence of SNP signals and incentivises new entrants
  • no BTE so can enter
  • market supply shifts right, leading to new lower market price.
  • This is equal to supply curve for individual firm, which shifts down until tangential to AC
  • now only normal profit is made
  • SNP not sustainable so firms always return to this LR eq
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16
Q

explain the SR shut down rule

A
  • draw diagram showing ATC above price and AVC below price at a quantity Q
  • firms can continue producing at a loss in the SR, i.e. if P<AC, as long as P<AVC
  • at
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17
Q

PC performance pros

A
  1. AE in the LR - explain readjustment of price to equal ATC, making P=MC
  2. PE in the LR - EOS fully exploited

  1. firms with high unit costs cannot afford to remain in the market in the LR as price falls, so the only firms remaining are operating at or close to their MES
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18
Q

PC performance cons

A
  1. no DE in LR - no SNP; homogeneous products
  2. product homogeneity doesn’t benefit consumers who want choice
  3. cut quality of output to cut costs
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19
Q

when is a situation pareto efficient?

A

when you cannot make someone better off without making someone else worse off

if you CAN do this, situation is pareto inefficient

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20
Q

challenge assumptions of PC

A
  1. all firms have some degree of price setting power as products are differentiated ITO variations, branding - even in highly competitive markets
  2. increasing product complexity increases info asymmetries
  3. ignores existence of patents/copyrights - BTE
  4. exit will never be costless!
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21
Q

evaluate outcomes of PC

A
  1. consumers may be prepared to trade off some static efficiency for dynamic efficiency
  2. in reality, firms in highly competitive markets will reinvest even normal profits n hopes of gaining competitive advantages
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22
Q

describe LR and SR monopoly behaviour

A
23
Q

3 conditions for price discrimination

A
  1. firm has some degree of monopoly power
  2. firm is able to segment market based on varying values of PED
  3. firm can prevent arbitrage
24
Q

define price discrimination

A

charging different groups of consumers different prices for the same good or service for reasons unrelated to costs

25
Q

explain first degree PD

A

each consumer is charged the maximum price they are willing to pay for a good or service

all consumer surplus is extracted and turned into producer surplus, i.e. SNP

26
Q

explain second degree PD

A

is also known as excess capacity pricing, where empty seats/space in a hotel or stadium for e.g. are sold at a lower price to contribute to FC

in a hotel, rooms can be filled for the same MC until they reach capacity

a profit maximising hotel will produce where MR=MC, but at this point there are excess rooms

the hotel could contribute to its FC if it can sell these rooms for more than MC, by claiming ‘last minute deals’

hence hotel can contribute to FC and these consumers will benefit from extra CS by paying less

27
Q

explain third degree PD

A

firm is able to segment the market based on varying PED. Dividing into two submarkets - elastic and inelastic demand due to differences in age, location, time

e.g. for train travel - peak time travellers and leisure travellers

at a single price charged to the whole market, a lower profit of ____ is made

assume the MC and AC of supply to both markets is the same as in the whole market

profit maximising firm will produce at point where MR=MC. The profit max price will be higher in the peak and lower in the off-peak market

a higher total profit of ____ is made by price discriminating

28
Q

define natural monopoly and its characteristics

4 main

A

type of monopoly where one large firm can supply the entire market at a lower LRAC than if multiple smaller firms supplied the market AS LONG AS THEY’RE REGULATED

  1. this is due to having an overwhelming cost advantage - the industry having very high FC (capital infra) and low MC, meaning that AC are minimised at high level of output
  2. this means there are significant EOS to exploit as the firm’s LRAC curve is downward sloping over a much larger range of output
  3. competition is undesirable
  4. tend to operate in public interest and be publically owned

tend to operate in public interest and be state owned

29
Q

characteristics of perfectly contestable markets

4

A
  1. no barriers to entry or exit, particularly sunk costs
  2. large pool of potential entrants create threat of entry
  3. perfect info on costs and tech for firms
  4. incumbents subject to hit and run competition
30
Q

why is competition undesirable in a NM?

A
  1. more firms means each exploits lower EOS (PE)
  2. wasteful duplication of capital resources if firms leave market (AE)
  3. no incentive for new entrants to compete with incumbent natural monopolist as EOS differential can be used to predatory price and force out
31
Q

how has technology increased contestability?

A
  1. lower barriers to entry and exit and sunk costs - can operate online; easier advertising to overcome brand loyalty
  2. innovation - easier to disrupt markets e.g. Uber and Airbnb, but also lower costs to compete with
  3. better info - knowing costs, tech make level playing field
32
Q

describe firm behaviour in NM

A
  • profit maximising NM will produce where MR=MC
  • makes X SNP
  • this is a socially undesirable outcome since the service is essential to society, e.g. water distribution/rail**
  • P>MC , and Q is below Q , leads to price exclusion and shortages
  • regulators intervene and frce monopolist to produce at social optimum
  • increases quantity and lowers price and increases social welfare
  • however, monpolist suffers a loss of X at this price since it is below AC
  • regulators must offer unit subsidy equvalent to the unit loss to incentivise firm to produce
  • socially optimal output is restored

** many natural monopolies operate services in the public interest

33
Q

explain why monopolies are allocatively inefficient and create a DWL

A
  1. monopoly has market power so can set price above MC at the profit max output where MR=MC
  2. this is consumer surplus that has been extracted to turn into SNP, X
  3. this higher price leads to DWL of consumer welfare since the price is higher and quantity lower than the social optimum PQ
  4. this is the loss of net efficiency from the loss of socially desirable trades
34
Q

monopoly performance pros

A
  1. SNP made in LR - promote DE
  2. despite productive inefficiency, may be large enough to exploit higher EOS than smaller competitive firms - lower prices
  3. can cross-subsidise loss-making socially desirable goods with SNP
35
Q

monopoly performance cons

A
  1. Allo. inefficient
  2. productively inefficient - to profit max must produce at below MES
  3. regressive effects on poorer households - relative poverty and income inequality
36
Q

monopoly performance evaluation

A
  1. inefficiency depends on quality of regulation - surrogate for competition
  2. natural monopoly is good provided regulation
  3. depends on CONTESTABILITY of market - threat of competition may force a monopolist to charge less and improve quality
  4. depends on objectives of firm - not all are profit maximisers, differing price, output and investment decisions
37
Q

explain what the kinked demand curve shows

A

explains price rigidity in oligopoly - 1) there is no incentive to change prices and 2) there is no need to change prices

38
Q

explain how game theory can be applied to oligopoly

A

models strategic interdependence
- explain dominant strategy
- this is determined by each firm anticipating their rivals’ reaction before choosing
- no way to unilaterally improve outcome so this is also NE
- explain NE
- this is a LR equilibrium since both firms would perefer to keep prices low instead of being undercut
- not most profitable outcome but explains why price rigidity exists

39
Q

what causes price wars?

A
  1. collapse of cartel price fixing agreement
  2. incentive to win market share
  3. entry of new firms threatening incumbent market position
  4. managerial motives - reduce price to increase revenue and hence bonus
  5. response to recesssion to generate cash and survive
40
Q

define collusion

A

rival firms cooperate with the aim of maximising joint profits, reducing the costs of competition and reducing market uncertainty.

They behave anti-competitively by price fixing, restricting supply or market sharing

41
Q

describe price collusion in oligopoly

A
  • competitive market equlibrium occurs when MC=AR
  • however cartel has enough market power to control supply and behave as a profit maximising monopolist, producing at MR=MC and pricing above MC
  • each individual cartel member becomes a price taker, selling at the cartel price
  • to control market supply, cartel will set each member a production quota
  • individual members make a profit of X, but there is potential to make more by producing slightly more at a lower price than the cartel
  • this is the incentive to cheat on the collusive agreement due to self-interest, explaining why cartels eventually lose power and break down as members depress the cartel price
42
Q

conditions for effective collusion

A
  1. industry regulators are weak
  2. penalties for collusion are low compared to potential revenues from colluding
  3. group of firms have a high percentage of total sales and control over market supply
  4. firms can communicate well and have similar stratrgic objectives
  5. products are standardised and output is easily measurable (quotas)
  6. brands are strong and have consumer loyalty - less of an incentive to cheat if consumers won’t switch
43
Q

why do cartels break down

A
  1. enforcement problems (quota, prices) - cheating and price wars
  2. falling demand - recession (Cash) or tastes change
  3. non-cartel firms join market successfully
  4. legal barriers or whistle-blowing members
  5. some members have higher costs than others - lower profits at agreed prices
  6. strategic objectives change/trust breaks down
44
Q

costs of collusion

A
  1. AE and PE
  2. artificial BTE erected that reduces contestability in the LR
45
Q

pros of collusion

A
  1. some collusive acts are socially beneficial - product quality, innovation
  2. SNP can promote DE (linked to 1)
46
Q

evaluate impact of collusion on consumer welfare

A
47
Q

oligopoly performance pros/cons

A

if competitive oligopoly - PC pros/cons

if collusive oligopoly - monopoly pros/cons

48
Q

oligopoly performance eval

A
  1. quality of regulation - surrogate for competition
  2. depends on contestability
  3. depends on objectives of firm - influence price, output and investment decisions
49
Q

referencing economic welfare, what are the pros of price discrimination

A
  1. some consumers benefit from lower prices and higher CS - price becomes closer to MC
  2. potential for cross-subsidisation of loss-making socially desirable G/S
  3. higher SNP may promote DE
50
Q

referencing economic welfare, what are the cons of price discrimination?

A
  1. consumer exploitation and loss of AE - worsened relative poverty and income inequality
  2. used as limit pricing strategy to erect BTE and limit competition in LR - higher prices, lower output and quality
51
Q

price discrimination eval

A
52
Q

describe the LR market readjustment for monopolistic competition

A
53
Q

why do natural monopolies need to be regulated?

A

unregulated, natural monopolies will operate at the profit max price and output where P exceeds MC and quantity is lower than AE outcome

natural monopolies tend to be firms providing essential goods and services like water and electricity. At a lower quantity, people will have to go without and significant welfare loss will occur

9708 Economics A2 (25 decks)

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