Market Structures Flashcards
What models are required for theme 3
The characteristics of 4 models of market sellers are required, as well as one of market buyers (monopsony)
Tell me the competition spectrum (most to least competitive models of market sellers)
Most competitive (thus most sellers) to least competitive
Perfect competition
Monopolistic competition
Oligopoly
Monopoly
^ all apart from perfect competition are imperfect competition
What are the prices and output of firms largely determined by
Firms operate in a market structure and the prices and output they set are determined largely by the nature of competition in the market.
What’s one useful thing to look at when observing market structure
When considering market structure, it is always useful to consider how many firms dominate the market. In highly concentrated markets few firms dominate - for example, the mobile phone industry or the UK banking sector.
What’s the concentration ratio
The concentration ratio can be defined as the market share controlled by the n largest firms. For example, the four firm concentration ratio is the market share controlled by the four largest firms in an industry. An oligopoly would be highly concentrated and a monopolistically competitive market would have a low concentration ratio.
Tell me a useful rule to decide whether a market is an oligopoly
The handy f-rule: if Five or Fewer Firms have 50% market share, the market is highly concentrated and likely to have the characteristics of an oligopoly.
List me the four market models of market sellers
Perfect competition
Monopolistic competition
Oligopoly
Monopoly
What are the number of firms/ market concentration like in: perfect competition
Many small firms/low concentration
What are the number of firms/ market concentration like in: monopolistic competition
Many small firms/low concentration (same as perfect competition)
What are the number of firms/ market concentration like in: oligopoly
A few large firms dominate/high concentration
What are the number of firms/ market concentration like in: monopoly
One firm has 100% concentration ratio
What are the type of product like in: perfect competition
Homogenous
What are the type of product like in: monopolistic competition
Similar
What are the type of product like in: oligopoly
Some distinct characteristics, such as PC and MAC
What are the type of product like in: monopoly
Unique
What’s the knowledge like in: perfect competition
Perfect
What’s the knowledge like in: monopolistic competition
Imperfect
What’s the knowledge like in: oligopoly
Imperfect
What’s the knowledge like in: monopoly
Imperfect
What are the barriers to entry/exit like in: perfect competition
None
What are the barriers to entry/exit like in: monopolistic competition
Low
What are the barriers to entry/exit like in: oligopoly
High
What are the barriers to entry/exit like in: monopoly
High
What are the price setting powers like in: perfect competition
Price taker
What are the price setting powers like in: monopolistic competition
Some degree of price setting power in local market
What are the price setting powers like in: oligopoly
Significant price setting powers, but interdependent
What are the price setting powers like in: monopoly
Price maker
Tell me the characteristics of a price competition market structure
Many small firms/low concentration
Products are homogenous
Perfect knowledge
No barriers to entry/exit
Price taker
Tell me the characteristics of a monopolistic competition market structure
Many small firms/low concentration
Similar products
Imperfect knowledge
Low barriers to entry/exit
Some degree of price setting power in local market
Tell me the characteristics of oligopoly market structure
A few large firms dominate/high concentration
Products have some distinct characteristics, such as PC and Mac
Imperfect knowledge
High barriers to entry and exit
Significant price setting powers, but interdependent
Tell me the characteristics of a monopoly market structure
One firm has 100% concentration ratio
Unique product
Imperfect knowledge
High barriers to entry and exit
Price maker
Tell me the four types of efficiency
Productive efficiency
Allocative efficiency
Dynamic efficiency
X-inefficiency
What is productive efficiency
Occurs at the lowest cost per unit of output, of the lowest point of the average cost curve. The firm is producing as much as possible relative to inputs. It is where the marginal cost intersects the average cost.
What’s allocative efficiency
Occurs when the cost of production and the demands of consumers are taken into account to maximise welfare. Firms will charge a price equal to the marginal cost (P = MC) of manufacturing the good. It is where the price charged for the last unit (the amount people are prepared to pay) is equal to the cost of making the last unit, so net welfare falls if any more united are produced. It is also called welfare maximisation.
Define productive efficiency
Occurs at the lowest point on the average cost curve. This is where average cost is at its lowest.
Define allocative efficiency
Producing at a point where the price of a good is equal to the marginal cost of production
What’s dynamic efficiency
Looks at how changes in technology and productive techniques over time will increase the productive potential of a firm. This is very distinct from productive and allocative efficiencies which are assumed to be static.
What’s x-inefficiency
Occurs when the average cost is higher than the lowest possible average cost: in other words, the firm operates above its AC curve. This can happen in highly concentrated markets, such as monopoly and oligopoly, wheee firms are able to make supernormal profits and have an AR that is greater than their AC, thus reducing the need or desire to lower AC and decrease x inefficiency.
What are the characteristics of perfect competition
Many small firms
Homogeneous products (exactly the same)
Perfect knowledge - this doesn’t mean the firm knows everything about rival firms price and output decisions. Rather, it means the firm has access to this information, including the latest technology and techniques and information on who makes supernormal profits.
No barriers to entry or exit
No price setting powers - perfectly competitive firms take the price set by the market. They are known as price takers.
Define perfect competition
A market where a large number of small firms co exist selling homogenous products. Normal profits are achieved in the long run because there are no barriers to entry to protect the market share of those firms that make supernormal profits in the short run.
Tell me examples of perfect competition in real life
The characteristics required for perfect competition suggest that there are few industries that approximate to the model of perfect competition. These include the market for foreign currency, where there are low barriers to entry, price takers (the price of currency sold is determined by the market), many small firms and homogenous goods (currencies are the same whoever sells them), and the market for agricultural goods such as carrots.
Tell me about the profit maximising equilibrium in the short run in perfect competition
The firm is taking the industry or market determine price, P. This is above the firms average cost at the profit maximising output of MC = MR. Therefore, the firm is making supernormal profits.
AR = MR = D is a horizontal line as price takers.
Why can’t perfectly competitive firms maintain supernormal profited in the long run
Because rival firms will see that these supernormal profits are being made (because of perfect knowledge) and enter the industry (no barriers to entry). The market supply curve will shift to the right and thus AR = MR curve will shift downwards and the price will fall, until all the supernormal profits are competed away and the firms make normal profits in the long run.
What’s long run equilibrium for perfect competition
In the long run, a perfectly competitive firm will always make normal profits only, any supernormal profits having been competed away and the losses removed by firms leaving the industry. This is known as the long run equilibrium.
The horizontal AR = MR curve equals MC equals AC.
What’s the shutdown point for a perfectly competitive firm (and all firms for that matter)
Occurs when the firm is not covering average variable costs. It may be feasible for a firm to make a loss in the short run, as long as it covers the variable cost of making the good and therefore makes a contribution to the fixed costs. A firm will shut down if it cannot cover average variable cost.
Tell me about monopolistic competition and some examples
These firms have many of the characteristics of firms operating under conditions of perfect competition except they are are able to set price to a limited extent because the products they produce are not exactly the same, customers have some loyalty in the market, and the demand curve is not perfectly price elastic.
Examples include restaurants, hairdressers and nail bars. The firms are easy to set up, have some local loyalty from returning customers, but do not enjoy supernormal profits in the long run. They are closed down quickly if demand falls.
What’s the supply curve of a perfectly competitive firm
It’s the marginal cost curve above the average variable cost. In the long run, the average variable cost is the same as average total costs (there are no fixed costs) so the rule still holds.
Tell me the characteristics of monopolistic competition
Many small firms
Similar goods, slightly differentiated possibly though, among other things, quality, branding or advertising.
Imperfect knowledge about rival firms price and output decisions but firms will be able to identify when supernormal profits are being made.
Low barriers to entry and exit
Firms can set price to an extent because they are producing goods that are slightly different from those of rival firms.
Define monopolistic competition
A market with many small firms, which supply goods that are slightly differentiated, allowing them some price setting powers.
What’s the short run profit maximising equilibrium like for monopolistic competition
In the short run, a monopolistically competitive firm can make supernormal profits. As with all market structures apart from perfect competition, a monopolistically competitive firm need not operate at the productively efficient (ie lowest point On the average cost curve) or allocatively efficient (ie where p = MC) levels of output.
AR and MR curves are separate with MR being steeper and closer to y axis. Supernormal profit area is where MC =MR drawn up to the AR curve and so including though the AC curve. The area is between the AR and AC curve.
What’s the long run profit maximising equilibrium like for monopolistic competition
As with perfect competition, a monopolistically competitive firm cannot maintain supernormal profits in the long run due to the near perfect knowledge that allows firms to identify the profits to be made, and the low barriers to entry that allow firms to enter the market and compete profits away. It is for these reasons that the long run position for a monopolistically competitive firm is described below:
Check page 30 please. AC is above AR and MR and touches the AR curve at one point, directly below this, MR intercepts MC. Normal profits being made.
What’s monopolistic competition also referred to as
Imperfect competition
Why do monopolistically competitive firms not make losses in the long run
Because, as in perfect competition, there are very low barriers to exit, which means that should firms be making losses they will leave the industry rather than try to persevere in the long run. They are unlikely to have sufficient cash reserves to be able to justify the pursuit of long run profits as a motive.
Where do oligopolies exist and what does interdependent mean
Oligopoly exists where a few, interdependent firms dominate the market. Interdependence means that the actions of one firm in the industry will impact on the other firms in the industry: for example, if one firm were to lower its prices, this could force other firms to react in the same way, otherwise they would lose market share. This sort of market structure typically plays host to collusive behaviour among the main firms. Examples of oligopolies include the brewing industry, pharmaceuticals, food and confectionary manufacturers and petrol retailers.
Define oligopoly
A market dominated by a few large firms - often associated with interdependence and collusion
Tell me the characteristics of oligopoly
A few large firms dominate
Goods with some similar characteristics but brand loyalty tends to be strong
Imperfect knowledge about rival firms price and output decisions
High barriers to entry and exit
Oligopolies can set price but may decide to agree price fixing deals with rivals to avoid price competition
What is competition in oligopolies characterised by
With only a few firms dominating an industry (I.e a high concentration ratio), firms will tend to avoid price competition. This happens because if one firm were to lower prices, others would follow, and although they might gain some additional sales, this would be at the cost of lost revenue from the price war that would ensue. Therefore an oligopoly is also characterised by non price competition.
How are price wars triggered
Price wars are triggered when one firm in an oligopoly cuts price. Others tend to follow to avoid losing market share. This can lead to further price cuts.
Why do firms engage in collusion
Collusion can be defined as an agreement between two or more firms to limit competition and therefore divide the market, set prices or output, and increase the welfare gains of the firms concerned to the detriment of other firms and consumers. Most collusion is illegal due to its restrictive nature and its impact on firms and consumers.
Define collusion
Firms, often operating under oligopoly conditions, working together to fix prices and avoid price wars.
What are the two types of collusion that take place
Overt collusion
Tacit collusion
What is overt collusion
Where firms openly fix prices, output, marketing or the sharing out of customers. An extreme form of overt collusion is forming a cartel, which is a formal agreement between firms to act together, as in the case of the sugar cartel that operated in the USA between 1934 and 1974, but cartels are illegal in the EU And many other countries.
What is tacit collusion
This is quiet or ‘behind the scenes’. This may be implicit co operation and involve no spoken agreement. The result of tacit collusion is the same as with overt collusion - the firms do not compete with each other or prices are higher than they would otherwise be: that is, there is price fixing. Tacit collusion may take the form of a collection of firms avoiding competition and following the actions of a market leader, known as a price leader. This type of collusion is also illegal in most countries and can result in firms being fined or executives being jailed for their actions.
Define price fixing
Firms coming together to ensure that prices remain stable and therefore price competition is avoided.
What’s the different between overt and tacit collusion
Overt collusion is open - it is an agreement between firms to collaborate in some way to restrict competition. Tacit collusion Is quiet, unspoken or unwritten. It may be implied, or involve firms operating according to some pattern that has never been agreed but has come into effect.
Why is there temptation to break a collusive agreement
These is always a temptation to break an agreement either to maximise a firms sales by lowering prices and catching a rival unaware or to gain immunity from prosecution by acting as a whistle blower and informing the competition authorities about any collusion agreement.
Tell me about game theory
Let us assume that there are two firms, called Adrian and Juju, in an industry. It is clear that if Adrian and Juju collude, they will be able to make profits of £100 million each by setting prices at a high level. This collusion will result in the two firms collaborating to maximise their combined profits. However, they each know that they can increase their individual profits by lowering prices and breaking any collusive agreement, so obtaining £120 million while the other firm keeps higher prices as agreed and ends up with profits of only £50 million. This is known as the maximax strategy because it seeks to maximise the firms maximum payoff.
As a result of neither firm trusting each other, they will therefore both adopt the low price strategy, trying to do so before the other does, and they will end up with £80 million, which is a worse outcome than if they had colluded and set a high price, but better than if they had continued to pursue a high price strategy while the other firm lowered its prices. This suggests that due to a lack of trust between firms, any collusive agreement is likely to be broken. This is referred to as the maximin strategy because it maximises the firms minimum pay off.
Tell me an example of game theory
Include the prisoners dilemma, which can be used to explain the reaction of two prisoners lacking trust and pursuing their own self interest in the same way as we consider the reaction of two firms.
Game theory can be used to illustrate the behaviour of oligopolies.
What can the kinked demand curve be used for - what is it
You don’t need to know the analysis but may be helpful.
It can illustrate the behaviour of oligopolies. It shows the price rigidity that exists in many markets and the asymmetric reaction by other firms when one firm raises or lowers its price. It also suggests that firms will not break any collusive agreement as they can see that the outcome will be a price war that is of no benefit to either party.
What does the kinked demand curve look like
Please check diagram, basically it’s like a line bent so the left half has a low gradient and at a point it switches to a steeper gradient. Please just check diagram idrk
Explain the kinked demand curve
It illustrates why firms will tend to fix prices at a certain level. If a firm raises prices on more horizontal part of line, it will be operating on the price elastic part of the demand curve. This is because other firms will not respond and consumers will switch away from the firm raising its price.
However, if the firm decided to lower the price from the break point to the more vertical part of the curve, other firms in the market would follow suit and a price war would ensue, meaning that none of the firms would gain a significant increase in their market share. Therefore the demand for the good is relatively price inelastic in relation to a price fall.
This suggests that the firm is best keeping its prices at the break point, because either raising or lowering prices leads to a fall in revenue. This can be used to explain sticky prices - the observation that many shops charge the same amount for some things as their competitors and prices do not change much over time. It might look like collusion, but here is a reason to argue that it is not.
Can evaluation can the kinked demand curve be used for
Use the kinked demand curve to show that what might look like collusion or a cartel is instead of ‘sticky price’. It is useful evaluation for showing that something that looks like tacit collusion is in fact legal, rational behaviour by interdependent firms.
What is a monopoly
A monopoly is the sole supplier of a good or service. The firm is able to set prices and output and to maximise profits. It is known as a price maker.
Define monopoly
Single seller, with high barriers to entry
Tell me the characteristics of monopoly
One firm
Unique product
Imperfect knowledge, potential rival firms will not know the incumbent firms pricing and output strategy
High barriers to entry and exit
Price maker
What’s the profit maximising equilibrium in a monopoly market structure
As a result of high barriers to entry, monopolists can set high prices to maximise profits without fear that another firm could enter the industry. It is for this reason that many governments will intervene to prevent the development of monopolies and ensure that competition is maintained in some form. Monopolies are also often accused of being x-inefficient. This refers to their tendency to allow costs to rise when there is no threat of a more efficient firm undercutting prices, and their being less inclined to innovate and develop new products because they have no need to maintain an edge over competitors. They may make supernormal profits at the expense of consumer surplus and are neither productively nor allocatively efficient.
The diagram is just that of supernormal profit.
Compare monopoly with perfect competition about the following characteristic: profit maximisers
Both yes
Compare monopoly with perfect competition about the following characteristic: allocatively efficient
Monopoly no
Perfect comp yes
Compare monopoly with perfect competition about the following characteristic: productively efficient
Monopoly: no
Perfect comp: yes
Compare monopoly with perfect competition about the following characteristic: price
Monopoly: prices are higher under monopoly compared with perfect competition
Perfect comp: prices are lower under perfect competition compared with monopoly
Compare monopoly with perfect competition about the following characteristic: quantity
Quantity is lower under monopoly compared with perfect competition
Quality is higher under perfect competition compared with monopoly
Tell me the disadvantages of monopoly power: supernormal profits
Less incentive to be efficient and to develop new products
The existence of resources to protect market dominance by raising barriers to entry and preventing new competition- this will allow the monopolist to exploit its position by allowing it to exert pressure on any suppliers that might rely on it.
Tell me the advantages of monopoly associated with supernormal profits
Supernormal profit means: finance for investment to maintain competitive edge
Firms can create reserves to overcome short term difficulties, giving stability to employment
Funds for research and development
Tell me the disadvantages of monopoly power
Higher prices and lower output for domestic consumers
Monopolies may waste resources by undertaking cross-subsidisation, using profits from one sector to finance losses in another sector and employing more labour.
Monopolists may undertake price discrimination to raise producer surplus and reduce consumer surplus.
Monopolists do not produce at the most productively efficient point of output (ie at the lowest point of the average cost curve)
Monopolists can be complacent and develop inefficiencies
Monopolies may lead to a misallocation of resources by setting prices above marginal cost, so that price is above the opportunity cost of providing the good, ie price is not equal to marginal cost.
Tell me the advantages of monopoly power
Firms will have the financial power to match large overseas competitors
Cross-subsidisation may lead to an increased range of goods or services available to the consumer: for example, the provision of services that are loss making but provide an external benefit, eg rural bus services.
Price discrimination may raise the firms total revenue to a point that allows the survival of a product or service.
Monopolists may be able to take advantage of economies of scale, which means that average costs may be lower than those of a competitive firm at its most efficient position. This is especially the case when there is a natural monopoly.
There are a few permanent monopolies and the supernormal profit opportunities act as an incentive for rival firms to break down the monopoly through a process of creative destruction, I.e breaking the monopoly by product development and innovation and therefore bypassing any barriers to entry.
Monopolists can avoid undesirable duplication of services.
When does price discrimination occur
Occurs when a firm sells the same product in different markets with differing elasticities at different prices. This is used by a firm with monopoly power to increase profits and to reduce consumer surplus and is possible because of high barriers to entry and exit.
Define price discrimination
The sale of the same good to two different markets at different prices. To do this a firm must be a monopolist able to identify two different groups and keep them separate.
What are the three conditions are needed for price discrimination to be successful
There are high barriers to entry and a degree of monopoly power
There are at least two separate markets with differing price elasticities of demand
The markets can be kept separate at a cost that is lower than the gain in profits. This is to prevent resale (arbitrage) between the markets.
What’s the model we are required to use associated with price discrimination
In practice you are unlikely to see perfect price discrimination and the model you will be required to use is third degree price discrimination.
Tell me about third degree price discrimination and some examples
Here firms can use different prices based on regional, consumer age or time of use differences. Examples of this type of price discrimination include the sale of child and adult railway tickets and the sale of peak and off peak telephone, electricity and gas services. Lunchtime menus, airline tickets and retail outlets often demonstrate this.
Tell me about the diagram of third degree price discrimination
The firm splits the market into relatively elastic and relatively inelastic demand, selling the output at different prices to the markets and keeping these separate. In this example we assume that the firm faces constant average and marginal costs and has managed to identify two separate markets with differing elasticities. When the firm maximises profit in each market, it is able to make more supernormal profits than if the markets remained as one. Check the diagrams please
Why do many textbooks show third degree price discrimination as having three parts rather than 2
This is also correct and can be used to show either the total additional profit by adding together the elastic and inelastic markets, or the position before the market was split, allowing the student to show where the horizontal average and marginal costs have come from.
Where does a natural monopoly exist
A natural monopoly exists when an industry can only support one firm. This is typical of an industry that has high sunk costs and requires large levels of output to exploit economies of scale.
Define sunk costs
Costs that a firm cannot recover on exit, such as advertising.
Why do natural monopolies exist
The introduction of competition, perhaps by some government agency, will not be possible in the long run, as neither of the competing firms would be able to obtain sufficient market share to ensure that it was able to exploit economies of scale. Any new firm would experience both significant start up costs, establishing the necessary infrastructure, and long run losses as it tried to compete with the existing suppliers.
Tell me examples of where natural monopolies exist
Natural monopolies exist in the supply of water, gas, the rail income and electricity, where there are high start up and infrastructure costs. The costs of establishing a competing firm will outweigh any economic or social benefit that might materialise. Should the market be opened to competition and both firms take an equal share of the market, they will each make a loss. If one of the firms gained a greater market share then it might be able to survive, but this would be at the expense of the other firm, which would eventually fail, returning the industry to a monopoly situation.
Define monopsony
Where there is a sole buyer of a good. For example, the government is the sole buyer of defence equipment in the UK. Government can use this power to extract the best price for itself, often by reducing the producer surplus the selling firm receives. Firms can use these powers to exploit their suppliers and drive down prices.
Where does monopsony power exist - examples
Monopsony power exists when sellers face powerful buyers. For example, if an individual wishes to work in emergency healthcare in the uk, then the sole buyer of such employees is the national health service. A number of firms could act together (collude) to increase buying power. In the supermarket industry, for example, the major retailers may join together to exploit their suppliers and ensure that the supermarkets are able to get the best possible price for their goods. A farmer faced with the choice of selling everything produced to the supermarket, or selling goods in the open market, usually opts to sell to the supermarket even if it is at a heavily discounted rate.
How can monopsonys exploit their suppliers
This sort of power may allow a firm to exploit its suppliers in the knowledge that the supplier has few options beyond selling to the sole buyer. This can mean that cheaper prices are passed on to the consumer, but only at the expense of the supplier of goods.
Monopsony refers to what power
Buying power, not selling power.
Tell me some advantages of monopsony
Lower prices are passed on to consumers, and quality might be better than if there was perfect competition in buying resources. Monopsony power might balance out monopoly power. For example, some ‘DOC’ wine producing regions use their monopoly power to charge a high price, but supermarkets (monopsonists) can force them to supply at lower prices in order to make a high volume of sales.
