Market structures

Question 1

What are the main features of a perfectly competitive market?

Answer 1

Large number of buyers/sellers
Buyers/sellers have perfect knowledge
Sell/buy as much as you want at the market price (equilibrium)
No one firm can influence the market
G/S are uniform/homogeneous
No barriers to entry/exit

Question 2

What are the main characteristics of a monopoly?

Answer 2

• There are no close substitutes
• There are a range of barriers to entry and exit
• The firm is a price setter
• There is a high market share for at least one firm
• The firm has market dominance
• They are profit maximisers

Question 3

Pure monopoly

Answer 3

A single firm dominates the entire market. 100% concentration ratio.

Question 4

A working monopoly

Answer 4

A firm with more than 25% shares of a defined market

Question 5

Dominan firm

Answer 5

A firm that holds more than 40% market shares

Question 6

Monopoly efficiency

Answer 6

• Not productively efficient
• Not allocarively efficient
• Sometimes dynamically efficient (abnormal profits may be used to innovate)
• X-inefficiency is possible (Firms sometimes don’t focus on reducing costs due to their market power and lack of constestability) (common criticism of state run monopolies)

Question 7

Productive efficiency

Answer 7

Producing at the lowest cost (lowest point on AC curve)

Question 8

Allocative efficiency

Answer 8

distributing resources according to consumer preference (P=MC)

Question 9

Dynamic efficiency

Answer 9

Efficiency over time due to R&D and investment in human capital

Question 10

X-efficiency

Answer 10

A firm’s inability to fully utilize its resources, resulting in an output level that falls short of the maximum potential achievable given the resources and environment which is referred to as the efficiency frontier.

Question 11

Disadvantages of monopolies

Answer 11

• Higher prices than in competitive markets (possibly create inelastic demand)
• A decline in consumer surplus.
• Monopolies have fewer incentives to be efficient. With no competition, a monopoly can make profit without much effort, therefore it can encourage x-inefficiency.
• Possible diseconomies of scale. A big firm may become inefficient because it is harder to coordinate and communicate in a big firm.
• Monopolies often have monopsony power in paying a lower price to suppliers. A monopoly may also have the power to pay lower wages to its workers.
• Monopolies can gain political power and the ability to shape society in an undemocratic and unaccountable way – especially with big IT giants who have such an influence on society and people’s choices.

Question 12

Advantages of a monopoly

Answer 12

• Economies of scale - lower average
  costs from increased scale
• High profit can be used for research
  and development - dynamic efficiency
• The reward of getting patent (a
  monopoly power) can encourage
  investment
• Firms who become monopolies may just be very efficient, successful and innovative.
• Governments can regulate to get best of both worlds - economies of scale and fair prices.

Question 13

Evaluation of pros and cons of monopolies.

Answer 13

• It depends whether market is contestable. A contestable monopoly will face the threat of entry. This threat of entry will create an incentive to be efficient and keep prices low.
• It depends on the ownership structure. Some former nationalised monopolies had inefficiencies, e.g. British Rail was noted for poor sandwich selection and some inefficiencies in running the network. However, this may have been partly monopoly power but also the lack of incentives for a nationalised firm.
  It depends on management. Some large monopolies have successful management to avoid the inertia possible in large monopolies. For example, Amazon has grown by keeping small units of workers who feel a responsibility to compete against other units within the firm.
• It depends on the industry. In an industry like health care, there are different motivations to say banking. Doctors and nurses do not need a competitive market to offer good service, it is part of the job. If we take the banking industry, the economies of scale in offering a national banking network are limited. If it was a merger of two steel firms, which has much higher fixed costs, the economies of scale may be greater.
• It depends on government regulation. If governments threaten price regulation or regulation of service, this can reduce the excesses of some monopolies.
• Environmental factors – A monopoly which restricts output may ironically improve the environment if it lowers consumption.
• It depends on how you define the industry. A domestic monopoly in steel may still face international competition – from foreign steel companies. Eurotunnel faces a monopoly on trains between the UK and France but it faces competition from other methods of transport – e.g. planes and boats.

Question 14

prefect competition efficiency

Answer 14

• Allocatively efficient
• Productively efficient
• X-effcient due to the high levels of competition
• Dynamic efficiency is unlikely due to the lack of supernormal profits.

Question 15

Natural monopoly

Answer 15

Occurs when one large business can supply the entire market at a lower unit cost than two or more firms

Question 16

Sunk costs

Answer 16

Cost that cannot be recovered if a business decides to leave an industry

Question 17

predatory pricing

Answer 17

Deliberate (and illegal) strategy of driving competitors out of a market by selling at a price below average variable cost

Question 18

Market deregulation

Answer 18

Intervention to open up a market to competition by lowering barriers to entry

Question 19

Cooperation

Answer 19

Involves two or more companies working together for mutual benefit, without breaking any laws or engaging in anti-competitive behavior. For example, two companies might collaborate on research and development to create a new product.

Question 20

Collusion

Answer 20

Involves secret or illegal agreements between companies to engage in anti-competitive behavior, such as price fixing or market allocation. Collusion is often done in order to gain an unfair advantage over competitors or to increase profits at the expense of consumers.