Market structures Flashcards
Perfect competition
Market structure where is there are many firms; where there is freedom of entry into the industry; where all firms produce an identical product; and where all firms are price takers.
Monopoly
A market structure where is only one firm in the industry
Monopolistic competition
A market structure where, like perfect competition, there are many firms and freedom of entry into the industry, but where each firm produces a differentiated product and thus has some control over its price
Oligopoly
A market structure where there are few enough firms to enable barriers to be erected against the entry of new firms
The are four alternative market structure under which firms operate. In ascending order to firms’ marker power, they are:
Perfect competition, monopolistic competition, oligopoly and monopoly
The market structure under which a firm
operates affects its conduct, which in turn affects its performance
Imperfect competition
the collective name for monopolistic competition and oligopoly
Short run under perfect competition
the period during which there is too little time for new firms to enter the industry
The long run under perfect competition
The period of time that is long enough for new firms to enter the industry
Allocative efficiency
a situation where the current combination of goods produced and sold gives the maximum satisfaction for each consumer at their current levels of income
The assumptions of perfect competition are:
a very large number of firms, complete freedom of entry, a homogeneous product, and perfect knowledge of the good and its market by both producers and consumers
In the short run, there is not time for new firms to
enter the market, and thus supernormal profits can persist. In the long run, however, any supernormal profits will be competed away by the entry of new firms.
The short-run equilibrium for the firm is:
where the price, as determined by demand and supply in the market, is equal to marginal cost. At this output the firm will be maximising profit.
The long-run equilibrium is where
the market price is just equal to firms’ long-run, average cost
There can be no substantial economies of scale to be gained in a
perfectly competitive industry. If there were, the industry would cease to be perfectly competitive as the large, low-cost firms drove the small, high-cost once out of business.
Productive efficiency
A situation where firms are producing the maximum output for a given amount of inputs, or producing a given output at the least cost.
Natural monopoly
A situation where long-run average costs would be lower if an industry were under monopoly than if it were shared between two or more competitors.
Network economies
The benefits to consumers of having a network of other people using the same product or service.
Competition for corporate control
The competition for the control of companies through takeovers.
Perfectly contestable market
A market where there is free and costless entry and exit.
Sunk costs
Costs that cannot be recouped (e.g. by transferring assets to other uses).
A monopoly is where
there is only one firm in an industry. In practice, it is difficult to determine where a monopoly exists because it depends on how narrowly an industry is defined.
Barriers to the entry of new firms will normally be necessary to
protect a monopoly from competition. Such barriers include economies of scale (making the firm a natural monopoly or at least giving it a cost advantage over new (small) competitors), control over supplies of inputs or over outlets, patents or copyright, and tactics to eliminate competition (such as takeovers or aggressive advertising).
Profits for the monopolist will be maximised (as for other firms) where
MC = MR.
If demand and cost curves are the same in a monopoly and a perfectly competitive industry
the monopoly will produce a lower output and at a higher price than the perfectly competitive industry.
On the other hand, any economies of scale will, in part, be passed on to
consumers in lower prices, and the monopolist’s high profits may be used for research and development and investment, which in turn may lead to better products at possibly lower prices.
Potential competition may be as important as
actual competition in determining a firm’s price and output strategy.
The threat of this competition is greater, the lower are the
entry and exit costs to and from the industry. If the entry and exit costs are zero, the market is said to be perfectly contestable. Under such circumstances an existing monopolist will be forced to keep its profits down to the normal level if it is to resist entry of new firms. Exit costs will be lower, the lower are the sunk costs of the firm.
Independence (of firms in a market)
Where the decisions of one firm in a market will not have any significant effect on the demand curves of its rivals.
Product differentiation
Where one firm’s product is sufficiently different from its rivals’ to allow it to raise the price of the product without customers all switching to the rivals’ products. A situation where a firm faces a downward-sloping demand curve
Non-price competition
Competition in terms of product promotion (advertising, packaging, etc.) or product development.
Monopolistic competition occurs where there is
free entry to the industry and quite a large number of firms operating independently of each other, but where each firm has some market power as a result of producing differentiated products or services.
In the short run, firms can make
supernormal profits. In the long run, however, freedom of entry will drive profits down to the normal level. The long-run equilibrium of the firm is where the (downward-sloping) demand curve just touches the long-run average cost curve.
The long-run equilibrium is one of
excess capacity. Given that the demand curve is downward sloping, the point where it just touches the LRAC curve will not be at the bottom of the LRAC curve. Increased production would thus be possible at lower average cost.
Firms under monopolistic competition may
engage in non-price competition, in the forms of product development and advertising, in order to maintain an advantage over their rivals.
Monopolistically competitive firms, because of excess capacity, may have
higher costs, and thus higher prices, than perfectly competitive firms, but consumers may gain from a greater diversity of products.
Monopolistically competitive firms may have fewer
economies of scale than monopolies and conduct less research and devel-opment, but the competition may keep prices lower than under monopoly. Whether there will be more or less choice for the consumer is debatable.
Excess capacity (under monopolistic competition)
In the long run firms under monopolistic competition will produce at an output below their minimum-cost point.
Interdependence (under oligopoly)
One of the two key features of oligopoly. Each firm will be affected by its rivals’ decisions. Likewise its decisions will affect its rivals. Firms recognise this interdependence. This recognition will affect their decisions.
Collusive oligopoly
Where oligopolists agree (formally or informally) to limit competition between themselves. They may set output quotas, fix prices, limit product promotion or development, or agree not to ‘poach’ each other’s markets.
Non-collusive oligopoly
Where oligopolists have no agreement between themselves, formal, informal or tacit.
Cartel
A formal collusive agreement.
Quota (set by a cartel)
The output that a given member of a cartel is allowed to produce (production quota) or sell (sales quota).
Tacit collusion
Where oligopolists take care not to engage in price cutting, excessive advertising or other forms of competition. There may be unwritten ‘rules’ of collusive behaviour, such as price leadership.
Dominant firm price leadership
Where firms (the followers) choose the same price as that set by a dominant firm in the industry (the leader).
Barometric firm price leadership
Where the price leader is the one whose prices are believed to reflect market conditions in the most satisfactory way.
Nash equilibrium
The position resulting from everyone making their optimal decision based on their assumptions about their rivals’ decisions. Without collusion, there is no incentive for any firm to move from this position.
Takeover bid
Where one firm attempts to purchase another by offering to buy the shares of that company from its shareholders.
Kinked demand theory
The theory that oligopolists face a demand curve that is kinked at the current price, demand being significantly more elastic above the current price than below. The effect of this is to create a situation of price stability.
Vertical integration
A business growth strategy that involves expanding within an existing market, but at a different stage of production. Vertical integration can be ‘forward’, such as moving into distribution or retail, or ‘backward’, such as expanding into extracting raw materials or producing components.
Horizontal integration
A business growth strategy that involves expanding within an existing market at the same stage of production by moving into allied products. An example would be an electricity supplier moving into gas supply or a car manufacturer moving into the production of coaches or heavy goods vehicles.
Countervailing power
Where the power of a monopolistic/oligopolistic seller is offset by powerful buyers which can prevent the price from being pushed up.
An oligopoly is where there are just a few
firms in the industry with barriers to the entry of new firms. Firms recognise their mutual dependence.
Oligopolists want to maximise their
joint profits. This tends to make them collude to keep prices high. On the other hand, they want the biggest share of industry profits for themselves. This tends to make them compete.
They are more likely to collude if there are
few of them; if they are open with each other; if they have similar products and cost structures; if there is a dominant firm; if there are significant entry barriers; if the market is stable; and if there is no government legislation to prevent collusion.
Collusion can be
open or tacit.
A formal collusive agreement is called a
‘cartel. A cartel aims to act as a monopoly. It can set price and leave the members to compete for market share, or it can assign quotas. There is always a temptation for cartel members to ‘cheat’ by undercutting the cartel price if they think they can get away with it and not trigger a price war.
Tacit collusion can take the form of
price leadership. This is where firms follow the price set by either a dominant firm in the industry or one seen as a reliable ‘barometer’ of market conditions. Alternatively, tacit collusion can simply involve following various rules of thumb such as average cost pricing and benchmark pricing.
Even when firms do not collude they will still have to
take into account their rivals’ behaviour.
In the Cournot model firms assume that
their rivals’ output is given and then choose the profit-maximising price and output in the light of this assumption. The resulting price and profit are lower than under monopoly, but still higher than under perfect competition.
In the Bertrand model firms assume that
their rivals’ price is given. This will result in prices being competed down until only normal profits remain.
In the kinked demand-curve model, firms are likely to
keep their prices stable unless there is a large shift in costs or demand.
Whether consumers benefit from oligopoly depends on
the particular oligopoly and how competitive it is; whether there is any countervailing power; whether the firms engage in extensive advertising and of what type; whether product differentiation results in a wide range of choice for the consumer; and how much of the profits are ploughed back into research and development.
Game theory (or the theory of games)
The study of alternative strategies that oligopolists may choose to adopt, depending on their assumptions about their rivals’ behaviour.
Dominant strategy game
Where the same policy is suggested by different strategies.
Prisoners’ dilemma
Where two or more firms (or peo-ple), by attempting independently to choose the best strategy for whatever the others) are likely to do, end up in a worse position than if they had co-operated in the first place.
Credible threat (or promise)
One that is believable to rivals because it is in the threatener’s interests to carry it out.
Decision tree (or game tree)
A diagram showing the sequence of possible decisions by competitor firms and the outcome of each combination of decisions.
Game theory is a way of
modelling behaviour in strategic situations where the outcome for an individual or firm depends on the choices made by others. It enables us to examine various strategies that firms can adopt when the outcome of each is not certain.
The simplest type of ‘game’ is a
single-move or single-period game. Many single-period games have predictable outcomes, no matter what assumptions each firm makes about its rivals’ behaviour. Such games are known dominant strategy games.
Non-collusive oligopolists will have to work
out a price strategy. By making the best decisions based on assumptions about their rivals’ behaviour we can arrive at a Nash equilibrium. However, a ‘Nash’ equilibrium may not always be the best strategy for the firms collectively. It is possible that both could do better by co-operating or colluding.
In multiple-move games, play is passed from
one ‘player’ to the other sequentially. Firms will respond not only to what firms do, but also to what they say they will do. To this end, a firm’s threats or promises must be credible if they are to influence rivals’ decisions.
A firm may gain a strategic advantage over its rivals by being
the first one to take action (e.g. launch a new product). A decision tree can be constructed to show the possible sequence of moves in a multiple-move game.
First-mover advantage
When a firm gains from being the first to take action.
Price discrimination
Where a firm sells the same or similar product at different prices and the difference in price cannot be fully accounted for by any differences in the costs of supply.
Third-degree price discrimination
Where a firm divides consumers into different groups based on some characteristic that is relatively easy to observe and acceptable to the consumer. The firm then charges a different price to consumers in different groups, but the same price to all the consumers within a group.
Second-degree price discrimination
Where a firm charges customers different prices for the same (or similar) product depending on the amount or time purchased.
First-degree price discrimination
Where a firm charges each consumer for each unit the maximum price they are willing to pay for that unit.
Predatory pricing
Selling at a price below average variable cost in order to drive competitors from the market.
First-degree price discrimination is where is consumer is
is charged the maximum he or she is prepared to pay. Second-degree price discrimination is where the same consumer is charged different prices according to the amount, timing or other features of the purchase. Third-degree price discrimination is where consumers are divided into groups and the groups with the lower price elasticity of demand are charged the higher prices.
Price discrimination allows the firm to
earn a higher revenue from a given level of sales.
Some people will
gain from price discrimination; others will lose. It is likely to be particularly harmful when it is used as a means of driving competitors from the market (predatory pricing).
Average cost pricing
where a firm sest its price by adding a certain percentage for (average) profit on top of average cost
Price benchmark
A price that is typically used. Firms, when raising a price, will usually raise eat from one benchmark to another.
Cornout model
Model of duopoly where each firm makes its price and output decisions on the assumption that its rival will produce a particular quantity
Duopoly
On oligopoly where there are just two firms in the market
