Market Structures Flashcards
Distinguish between a PLC and Ltd company.
PLC:
- Shares available on the stock market
- Divorce of ownership of control
Ltd:
- Shares only available privately
- Access to additional capital restricted.
List some of the main objectives of firms.
- Profit maximisation
- Survival
- Quality
- Output maximisation
- Satisficing
- Social welfare maximisation
What are the determinants of the objective of a firm?
- Ownership and control
- Size of the firm
- Short vs long run
- Level of competition
- Stage of economic cycle
State the traditional theory of the firm.
Firms wish to maximise profits (maximise total revenue, minimise total costs).
State the profit maximising rule.
MR = MC
State the managerial theory of the firm.
Managers concentrate on sales, growth, market share and even their own career prospects.
State the organisational/ behavioural theories of the firm.
The firm aims to maximise the objectives of different stakeholders. Much will depend on the power each stakeholder holds or believes it holds, potentially leading to short term conflicts.
What is the difference between shareholders and stakeholders?
- Shareholders own shares of a company’s stock, representing ownership.
- Stakeholders are anyone affected by the firm’s operations.
State the satisficing principle of the firm.
Firms try to achieve a satisfactory outcome, rather than the best possible outcome, which helps resolve some of the conflict that may exist.
State the theory of natural selection.
- In the real world, forces of competition are not strong enough to force inefficient firms out of the market.
- However, large ones can be dealt by the capital or financial market
- These firms will follow the profit maximising path.
Outline the principal-agent problem.
- Divergence of interest between the principal (owner/ shareholder) and agent
- Agent entrusted with responsibility to make decisions and take actions that will benefit principal
- Incentives may not perfectly align with those of the principal, leading to conflicts of interest
List some of the consequences of the principal-agent problem.
- Market failure due to asymmetric information
- Firms may be inefficient
- Firms may not survive or grow
- Firms may not maximise profits in long run
- Share price can fall when it comes to light managers have not acted in interest of shareholders
List 3 solutions to the principal-agent problem.
- Employee share ownership schemes
- Performance related pay for senior management
- Long term employment contracts for senior management
Define production.
A measure of the volume/ value of output in a given time period.
Define productivity.
Measures the efficiency of factors of production in a given time period (e.g. output per person per hour).
Differentiate between the short, long and very long run.
- Short run: at least one factor of production is fixed (capital).
- Long run: all factors of production are variable.
- Very long run: state of technology can change.
Define the law of diminishing returns.
As more and more units of a variable input are added to a fixed input, after a certain point the marginal product and then the average product will begin to decrease.
What is the relationship between marginal and average product?
- When marginal is lower than average, the average must be falling.
- When the marginal is higher than the average, the average must be rising.
Hoe does diminishing returns affect cost?
- As diminishing returns set in, the marginal cost of supply will increase.
- Variable input becomes less productive as more of it is added.
Define returns to scale.
- An increase in the scale of all factors of production causes an increase in output.
- Increasing: more than proportionate
- Constant: proportionate
- Decreasing: less than proportionate
State the difference between returns to scale and economies of scale.
- Returns to scale: technical relationship between inputs and outputs measured in physical units (production theory).
- Economies of scale: long run cost theory.
Where is the minimum efficient scale?
Lowest point on the average cost curve.
Why are small firms common in industry supplying services (e.g. hairdressers)?
Markets services are provided in typically possess economies of small-scale production. Diseconomies of scale set in early, resulting in an MES at a relatively low level of output.
List the 6 types of internal economies of scale.
- Purchasing
- Technical
- Financial
- Managerial
- Marketing
- Risk bearing
List some types of external economies of scale.
- Better transport infrastructure
- Component suppliers move closer
- R&D firms move closer
- Better quality labour
List the 4 types of internal diseconomies of scale.
- Technical
- Communication
- Coordination
- Motivation
List some types of external diseconomies of scale.
- Traffic congestion
- Competition for labour/ raw materials pushing up prices.
List some of the characteristics of a market which determines the behaviour of firms.
- Number of incumbent firms in a market and their relative size
- Contestability
- Barriers to entry and exit
- Extent to which the goods sold are similar or branded
- Extent to which all firms in the market share the same knowledge
- Extent to which actions of one firm will affect another firm
Can an individual firm make supernormal profits in perfectly competitive markets?
They can in the short run, but it will attract new entrants to the market which will shift the industry supply curve and remove these profits.
Why is revenue both lost and gain at the same time if a monopoly decides to sell an extra unit of output?
In order to sell one more unit of output, the price of all units has to be reduced.
Can monopoly’s make supernormal profits?
No distinction between short and long run to entry due to barriers to entry preventing another firm from entering the market, so the monopoly enjoys long term abnormal profit.
Define consumer sovereignty.
The ability and freedom of consumers to choose from a range of different goods and services. Consumers ultimately decide how scarce resources are allocated.
Define producer sovereignty.
Firms have the power and ability to influence consumer decisions (e.g. a monopoly setting the price of a good).
Define sunk costs.
Costs that have already been incurred and cannot be recovered.
Distinguish between limit prices and predatory pricing.
- Limit prices: prices set low enough to make it unprofitable for new firms to enter the market.
- Predatory pricing: prices set below average cost/ cheaply with the aim of forcing rival firms out of business.
List some barriers to entry.
- Patents
- Brand loyalty and reputation
- Licenses and permits
- Highly specialist machinery
- Access to technology
- Economies of scale
List some barriers to exit.
- Redundancy costs for the workforce
- Exit fees from rental agreements
- Reduced value of owned equipment sold at rock-bottom prices in a fire-sale
Distinguish between a working monopoly and a dominant firm.
- Working monopoly: any firm with greater than 25% of the industries’ total sales.
- Dominant firm: a firm that has at least 40% market share.
How can a firm build and then keep monopoly power?
Build
- R&D leading to invention and innovation
- Product differentiation
- Mergers/ acquisitions
- Patents
Keep
- Barriers to entry
- Product differentiation
At which point on a diagram are firms allocatively efficient?
P = MC
At which point on a diagram is a firm productively efficient?
Lowest point of the (LR)AC curve
How can a firm become more dynamically efficient?
Invest in R&D leading to long run improvements in technical and productive skills and efficiency.
At which point on a diagram are firms X efficient?
Any point on the AC curve.
List some cases against monopolies.
- Prices are higher than under competitive conditions
- Leads to a loss of allocative efficiency
- Absence of genuine market competition may lead to production inefficiencies.
- X-inefficiencies such as wasteful production and advertising spending
- Higher prices can limit the final output in a market and lead to fewer economies of scale being exploited
List some benefits of monopolies.
- Can reinvest supernormal profits in R&D, leading to dynamic efficiency.
- Benefit from massive economies of scale due to their size.
- Monopoly’s marginal cost curve is lower than a perfectly competitive firm, so a profit maximising monopoly produces greater output while charging a lower price than an allocative efficient perfectly competitive firm (see diagram).
How is an economic cost calculated?
Money cost (accounting cost) + imputed cost (opportunity cost)
Where is normal profit made on a diagram?
AR = AC
Why is profit important in a free market economy?
- Rewards risk takers such as entrepreneurs.
- Provides stimulus to innovate to introduce new products and new production techniques.
- Provides a source of funds for investment in R&D.
- Sends signals to potential investors and entrepreneurs.
How can profits be regulated?
- RPI-X regulation (permitted price increases determined by RPI, minus expected efficiency improvements)
- Rate of return regulation (government taxes 100% of profits made above ‘normal’ rate)
- Windfall (one-off) tax
- Price regulation
What kind of profits are made in the short and long run in monopolistically competitive markets?
- Short run: abnormal profits
- Long run: normal profits (AR curve will shift to touch AC curve)
Why might monopolistic competition be seen as undesirable?
Allocatively and productively inefficient
Why might monopolistic competition be seen as desirable?
- Product differentiation increases the range of choice available, increasing economic welfare
- Some incentive to innovate
List some characteristics of a monopoly.
- A few big firms dominate the market
- Firms possess monopoly power
- Producer sovereignty
- High degree of market concentration
- Interdependence l
- High barriers to entry
- Non-price competition
List some of the barriers to entry present in an oligopoly.
- Economies of scale (cost asymmetry)
- Vertical integration
- Brand loyalty
- Control of important platforms
- Expertise, goodwill and reputation
- Patent protection
What two factors determine the behaviour of firms in an oligopoly?
- Firms are interdependent: actions of one firm affect most others
- Uncertainty: firms suffer from imperfect information and do not know how other firms will behave
