Market Structures

Question 1

At what point does allocative efficiency occur?

Answer 1

Allocative efficiency occurs when the price equals the cost of producing an additional unit of the product, P=MC. This means that consumers are paying the exact amount that it costs producers to produce the last unit.

Question 2

At what point does productive efficiency occur?

Answer 2

Productive efficiency exists when production is achieved at lowest cost.

Question 3

What is dynamic efficiency?

Answer 3

Dynamic efficiency is a measure of how efficiently a firm allocates resources over a period of time.

Question 4

What is x-inefficiency?

Answer 4

X inefficiency is a specific type of productive inefficiency which can occur due to a lack of competition. It occurs when a firm is not producing at its lowest possible cost for a given level of output

Question 5

What are the characteristics of perfect competition? (4)

Answer 5

1) There are many buyers and sellers in the market, none of whom are large enough to influence price.
2) Barriers to entry and exit are low.
3) Buyers and seller possess perfect knowledge of prices.
4) All firms produce homogenous goods, there is no branding of products, they are all homogenous.

Question 6

What are the characteristics of monopolistically competitive markets? (4)

Answer 6

1) Slightly differentiated products giving firms some price-setting power.
2) There are many buyers and sellers, firms are price makers and face a downward sloping demand curve.
3) There are low barriers to entry and exit.
4) All firms aim to maximise profits, MC=MR.

Question 7

What are the characteristics of an oligopoly? (5)

Answer 7

1) A few firms dominate the market (the market ratios are high).
2) There are high barriers to entry and exit.
3) Firms aim for profit maximisation, MR=MC.
4) The firm faces a downward sloping demand curve.
5) Firms are interdependent, meaning that the actions of one firm are influenced by the actions of another.

Question 8

What is the n-firm concentration ratio?

Answer 8

The n-firm concentration ratio measures the proportion of the market dominated by the largest n firms.

Question 9

What is game theory?

Answer 9

Game theory is used to analyse and evaluate the actions of firms in oligopoly. Game theory is a set of ideas which looks at strategies firms use to make decisions, for example on price levels or levels of advertising.

Question 10

Name pricing strategies used in oligopoly. (5)

Answer 10

1) Price wars
2) Predatory pricing
3) Limit pricing
4) Price leadership
5) Non-price competition

Question 11

What are price wars?

Answer 11

Price wars occur when price cutting leads to retaliation and other firms cut prices, meaning the original firms want to cut prices to increase their sales.

Question 12

What is predatory pricing?

Answer 12

Predatory pricing involves cutting prices below the average cost of production, this can also mean that prices are below the average variable costs. It is used in the short-term only, once other firms have been forced out of the market the firm raises prices back up again. This is almost always illegal.

Question 13

What is limit pricing?

Answer 13

Limit pricing involves cutting the price to the point where new possible entrants or newly entered higher-cost firms cannot compete. The incumbent firm can sustain this position in the long term because it has lower costs.

Question 14

What is price leadership?

Answer 14

Price leadership is where in some markets, the dominant firm will act to change prices and others will follow. This is because if other firms try to make price changes, this could set off a price war or other sorts of retaliation.

Question 15

What is non-price competition?

Answer 15

Non-price competition is where firms take action to compete without changing the price of their products. This might be through loyalty cards, advertising or similar strategies.

Question 16

What is overt collusion?

Answer 16

This is where firms work together through formal or written agreement, it is illegal and easier to detect than tacit collusion.

Question 17

What is tacit collusion?

Answer 17

This is where firms work together, or collude without some kind of formal or written agreement. It is illegal, but incredibly difficult for the competition authorities to detect.

Question 18

What is a pure monopoly?

Answer 18

A pure monopoly exists when only one firm is supplying a good or service.

Question 19

What is the legal definition of a monopoly?

Answer 19

The legal definition of a monopoly is that a firm supplies at least 25% of the market.

Question 20

What are the characteristics of a monopoly? (4)

Answer 20

1) Firms are price makers
2) Firms aim to profit maximise
3) Only one supplier or the firm owns at least 25% of the market.
4) High barriers to entry and exit.
5) Firms face a downward sloping demand curve

Question 21

What are the benefits of a monopoly for consumers? (3)

Answer 21

1) Innovation - monopolies may be able to take the risk of trying new ideas to innovate and cut costs.
2) Research and development - monopolies generally make supernormal profits which can therefore be reinvested into research and development.
3) Investment - large scale firms can and will afford to invest because they are confident that they will reap the rewards.

Question 22

What are the benefits of a monopoly for governments? (2)

Answer 22

1) Large firms pay higher rates of corporation tax. The more profit the monopoly makes the more the firm will pay in tax.
2) Monopolies might have many competitors outside the country. Monopoly power helps to keep jobs within the country and may improve the balance of payments.

Question 23

What are the benefits of a monopoly for workers? (2)

Answer 23

1) Monopolies might offer better job security.

2) Higher profits for the firm might mean higher bonuses or perks for the workers.

Question 24

What are the benefits of a monopoly for other firms such as suppliers? (2)

Answer 24

1) A monopoly can offer a secure outlet for suppliers. If your country makes car tyres then a monopoly car producer could keep the orders rolling in.
2) Firms which buy from monopolies are more likely to have consistent quality. It is not worth a monopoly taking any risks with the quality of a well known brand, as there is too much to lose.

Question 25

What are the costs of a monopoly for consumers? (3)

Answer 25

1) Less choice - large firms keep to the brands that make the most profit.
2) Higher prices - monopolists can increase price to maximise their profits.
3) Lower quality - with no competition firms do not have much incentive to become more efficient or to improve the quality of their good or service.

Question 26

What are the costs of a monopoly to the government? (2)

Answer 26

1) Monopolies often find various ways to avoid paying tax.

2) Inequality tends to increase as the rich get richer.

Question 27

What are the costs of a monopoly for workers? (2)

Answer 27

1) it is hard for workers to move jobs if they are trained in industry where there is a monopoly.
2) Monopoly profits may be invested in machinery which threatens the jobs of human workers.

Question 28

What are the costs of a monopoly for other firms? (2)

Answer 28

1) Firms which bur from monopolies can be exploited.

2) Other firms can be forced out of the market by a monopolist.

Question 29

What is a pure monopsony?

Answer 29

A pure monopsony is a firm which is the sole buyer of resources or supplies. Many firms have some degree of monopsony power, which means firms have some control over their suppliers.

Question 30

What are the benefits of monopsony to firms and consumers? (3)

Answer 30

1) Power in buying means the firm can make more profits as suppliers cannot overcharge.
2) Lower buying costs might be passed onto the consumer in retail prices.
3) Higher profits of monopsony can be used to invest and innovate.

Question 31

What are the costs of a monopsony to firms and consumers? (4)

Answer 31

1) Suppliers can be squeezed out of business.
2) Choice for consumers could be limited, as monopsony acts as a barrier to entry for new firms.
3) Higher profits of monopsony can mean inequality.
4) Firms might be investigated by the competition authorities.

Question 32

What are barriers to exit?

Give examples. (4)

Answer 32

Barriers to exit are barriers which prevent a firm from leaving the market.
Examples include:
1) The cost and time of making employees redundant.
2) Cost and time of selling premises and stock.
3) Cost and time of notifying customers and suppliers.
4) If a firm is locked into a contract to supply another firm or has agreed to buy products from a firm.

Question 33

What are barriers to entry?

Give examples.

Answer 33

Barriers to entry are barriers which prevent potential competitors form entering a market.
Examples:
1) Capital costs
2) Sunk costs
3) Economies of scale
4) Marketing barriers
5) Limit pricing

Question 34

What is price discrimination?

What are the conditions for price discrimination? (3)

Answer 34

Price discrimination occurs when a firm with some degree of market power charges more than one price for the same good or service.

There are three conditions for price discrimination:

1. There are different submarkets with different price elasticities of demand.
2. Consumers cannot move between submarkets.
3. The cost of keeping the markets separate is less than the increased profits from doing so.