Market Structures

Question 1

What is a Commodity?

Answer 1

A commodity is a tangible good that can be bought and sold or exchanged for products of similar value.

Question 2

Describe the assumptions in the market structure of Perfect Competition.

Answer 2

There are large numbers of buyers and sellers. This means there is neither monopoly (producer) or monopsony (buyer) power at all.

There is perfect information amongst consumers.

Products the firms make are homogenous, meaning the goods are perfect substitutes and not differentiated.

There is freedom of entry and exit in the market. No barriers to entry.

Consumer rationality is assumed (wants maximum utility).

Firm rationality is assumed (wish to maximize profit, etc.).

Question 3

Suggest the reasons to why the demand curve in a perfectly competitive firm is unit elastic (fully horizontal).

Answer 3

Consumers have perfect information given to them in the market structure of perfect competition.
This means they are completely aware of the firm with the cheapest prices.

Since consumers are given full information and are assumed to be traditional (wish to maximize utility), they will go to the cheapest producer of the good each time.

This means that if the price for petrol is on average £0.99 per liter, firms must not charge higher than that price or else they will get no sales, from the nature of elasticity.

This is supported from the fact that goods are seen as homogenous in perfect competition, so brand loyalty and etc. does not apply in the market structure.

Question 4

Suggest the reasons to why a perfectly competitive market structure stops firms from having influence to market price, and consumers from having influence to price directly.

Answer 4

Firstly, a perfectly competitive market structure assumes that there are many sellers in the market.

There are so many sellers with such a small quantity of the market share that they cannot influence market price (no monopoly power).

There are so many consumers that act traditionally (strictly) and so also have no power to influence price directly (no monopsony power).

Question 5

Explain why the average and marginal revenue curves of a perfectly competitive firm are horizontal, while those of a monopoly slope downwards.

Answer 5

Since revenue reflects the price you give to customers, the average revenue curve must be horizontal in a perfect competition market structure. This is because firms in perfect competition face perfectly elastic demand at the market determined price, and have no market power.

The reason for this is because, in a perfectly competitive market structure, consumers have perfect information within all firms, and are all assumed to be rational. As a result of this, the raise in price in one firm would force every single consumer to move to another firm selling at a cheaper price from perfect awareness (with said substitute good being homogenous, as assumed in perfect competition). This leaves the initial firm that raised it’s price with no sales.

As a result, the price of the product must be kept constant to the market set price, keeping the average revenue curve horizontal as you gain the same amount of revenue from each good, as well as the marginal revenue curve as there is no difference between the revenue you’d gain from each good.

The demand curve for an individual firm is downward sloping in monopolistic competition, in contrast to perfect competition where the firm’s individual demand curve is perfectly elastic. This is due to the fact that firms have market power: they can raise prices without losing all of their customers.

Since the firm is in monopolistic competition, it is a monopoly firm - the only producer in the industry. As a result of this, it has a very high market power and is able to set it’s own prices.
Since the demand curve in a monopoly firm is downward sloping, there is a negative relationship between revenue gained and demand. As AR increases from charging at a higher price, demand decreases following MR increasing as well, since, when AR is increasing, MR is as well.

Question 6

What is market power?

Answer 6

The ability of a firm to influence or control the terms and condition on which goods are bought and sold.

Question 7

In a perfectly competitive firm, what is the price maker:

The firm or the industry?

Explain why.

Answer 7

The industry is the price maker.

This is due to the fact that there are many competing firms and sellers in a perfectly competitive market, with every individual firm having a very small share of the market, with buyers assumed rational, as well as given perfect information among the homogenous goods offered by all firms.

Due to the pressure within the competing firms and consumer behavior, the behavior of demand becomes perfectly inelastic within firms, and therefore they are price takers - they must function specifically and directly within the industry’s set price in the market, any increase in price out of nowhere will lead to an 100% loss in demand.

Question 8

In a perfectly competitive firm, what is the price taker:

The firm or the industry?

Explain why.

Answer 8

The firm is the price taker in a perfectly competitive industry.

This is due to the fact that firms in a perfectly competitive industry are under extreme competition within the many other competing firms in the same industry, all of which have no winning share in the market.

As a result of the firms having no market power, they have no influence or control through the terms and conditions on how goods are sold.

Any attempt to manipulate prices, which means going out of the market set price set by the industry which is the price taker, would make you lose all your consumers due to the fact that they are perfectly rational, as well as perfectly informed, with each good in the industry being homogenous, making demand perfectly elastic.

Question 9

In Perfect competition, is it possible to make supernormal profits in the long run?

Answer 9

No

Question 10

In Perfect competition, is it possible to make normal profits in the long run?

Answer 10

Yes

Question 11

A firm in perfect competition makes supernormal profits in the short run.

Describe what might happen to these profits in the future.

Answer 11

Because, in perfect competition, there are said to be no barriers of entry, the supernormal profits would attract new firms to the industry.

This means that supernormal profits are ‘competed away’ in the long term - i.e. firms undercut each other until all firms make only normal profit.

Question 12

Draw the graph which illustrates a perfectly competitive industry in the short run, unaffected by the long run.

Answer 12

https://media.discordapp.net/attachments/352951793187029005/813521259991269386/unknown.png?width=637&height=563

Question 13

Draw the graph which illustrates a perfectly competitive firm in the short run, unaffected by the long run.

Describe what is seen.

Answer 13

https://media.discordapp.net/attachments/352951793187029005/813522555444396072/unknown.png?width=824&height=563

At the price of P in the firm, it will produce at Q due to the fact that (AR = MR) price is in equilibrium to MC.

Profit maximization is achieved when MR = MC, and perfectly competitive firms are seen to maximize profits.

In the short run, there are supernormal profits so P is higher than normal (P, when given normal profits, should decrease to = ATC at Q).

Question 14

Draw the graph which illustrates a perfectly competitive firm in the long run.

Describe what is seen.

Answer 14

Upon firms entering the market by finding abnormal profits, the difference between P and P1 was initially the addition onto normal profit which created supernormal profit.

When the firms entered the market since there are no barriers to entry, the increase in competition meant the supernormal profits were literally ‘competed away’ in the long term - i.e. firms undercut each other until all firms only make normal profit.

Normal profit is seen from P decreasing to P1, which lands at Q1, wherein equilibrium is reached at the lowest part of ATC. When AR = ATC, normal profits are reached, which is the lowest amount of profit needed to stay in the industry.

Question 15

Draw the graph which illustrates a perfectly competitive industry in the long run.

Answer 15

In a perfectly competitive industry in the long run, the price decreases as competition increases from the increase in competing firms, being attracted by the initial supernormal profits in the short run, constantly undercutting each other in order to get the most customers

As a result of the higher amount of firms, supply shifts to the right, reducing market price from P to P1. This moves output from Q to Q1 in an increase in the industry’s output due to the entry of more firms.

Question 16

Describe why, in a perfectly competitive market structure in the long run, reduces profits from supernormal to normal profits.

Answer 16

The reason why a perfectly competitive market structure in the long run reduces profits from supernormal to normal profits is due to the fact that the initial supernormal profits present in the short run attracted new firms into the industry following no barriers to entry.

Due to the pressure firms face in a perfectly competitive industry, the increase in competition means that firms will be constantly competing for consumers, as they undercutting each other in prices, meaning that ATC will eventually = AR - normal profits are reached, as it is the minimum amount of profit needed to stay in the industry, and they cannot undercut each other anymore as doing so will result in losses.

Question 17

What is a monopoly market?

Answer 17

A monopoly market is a market that has only one firm in it, thus it has an 100% market share.

Question 18

What is a dominant monopoly?

Answer 18

A dominant monopoly is a firm that has at least 40% market share.

Question 19

What is a working monopoly?

Answer 19

A working monopoly is a firm that has at least 25% market share.

Question 20

What is a pure monopoly?

Answer 20

A pure monopoly is a firm that has at least 100% market share.

Question 21

What is a natural monopoly?

Describe how it becomes and stays a monopoly.

Answer 21

In industries that have particularly high fixed costs or large economies of scale, natural monopolies occur due to the fact that productive efficiency on the LRAC curve, requires a large amount of output.

If a new entrant comes in with a much lower level of sales, its costs are likely to be higher and so too its prices. Therefore, the entrant will be unlikely to survive in the market.

Question 22

What is a statutory monopoly?

Answer 22

A legal monopoly, also known as a statutory monopoly, is a firm that is protected by law from competitors.

Question 23

What is a patent?

How can this cause a monopoly?

Answer 23

A parent is the legal right to be the only user or producer of a specified product or process.

This may cause a monopoly, due to the fact that certain innovations invented by firms may make the way products are made more efficient or for higher quality.

This makes the good or service being mentioned more heterogenous if a patent is secured due to the fact that firms cannot adopt the same technique in order to please consumers with a higher quality good to match the substitute - by law, they’re not allowed to.
As a result, more consumers will find the higher quality or cheaper good as a more desirable substitute to other goods in the same market, thus increasing the sales of the firm leading to a higher market share.

With certain techniques that get patented, such as a new technique that makes production for a certain good more efficient, monopolies can also occur due to the fact that they have higher productivity, which nobody is able to legally access and thus they are able to charge lower prices which can compete out firms that can’t charge as low, increasing sales and market share.

Question 24

What is a merger?

Answer 24

A merger is a combination of two previously separate firms which is achieved by forming a completely new business into which the two original firms are integrated.

The CMA may choose certain mergers from not happening.

Question 25

Give three ways firms can become a monopoly.

Answer 25

Naturally
Statutory (by law)
By patent
Merging firms

Question 26

What does the CMA stand for?

Answer 26

Competition Markets Authority

Question 27

Give an example of a real life merge scenario that got denied by the CMA.

Answer 27

Sainsburys and Asda wanted to merge, however the CMA did not allow them.

This may be because the two firms merging would give them too much of a market share and thus much more power in the industry.

Question 28

Show the long run equilibrium position for a firm in a monopoly market.

Shade in the supernormal profits.

Answer 28

https://media.discordapp.net/attachments/581202442524295179/823998725536874516/unknown.png?width=634&height=564

Question 29

Describe why, in the long run, supernormal profits may still stay in a Monopoly market.

Answer 29

The reason why, in the long run, supernormal profits may still stay is due to the fact that they are the only firm in the industry, thus they have complete market power and have the ability to set prices that influence the market.

They are able to keep the supernormal profits as they do not get competed away, as a result of the high barriers to entry - firms are not freely able to join and compete directly with the firm after doing so.

Question 30

What is a barrier to entry?

Answer 30

A barrier to entry is any potential difficulty or expense a firm might face if it wants to enter a market.

Question 31

Certain monopolies in markets that are contestable have been described by William Baumol as ‘staying on it’s toes’:

Draw a graph showing a monopoly in a contestable market.

Describe the behavior of the monopoly.

Answer 31

https://media.discordapp.net/attachments/581202442524295179/824003492787912724/unknown.png?width=620&height=564

The typical profit maximizing monopolist would operate at P1 where MR = MC and thus operate at Q1. However, in the contestable markets model the monopolist would have to adapt to protect its position from new entrants and so decreasing price at P2 to operate at Q2 is better as there will be more demand for the product and the new entry of firms will find it harder to generate sales as consumers will see the monopoly firm, temporarily functioning at P2, to be a better available substitute.

Thus, the firm operates at AR = AC under threat and is participating in better conduct.

Question 32

What are sunk costs?

Answer 32

A cost that has been committed and cannot be recovered if a firm leaves a market, i.e. rent.

Question 33

Describe the ways in which the barriers to entry can become ‘higher’ in a market.

Answer 33

An innovative new product or service can give a firm a head start over its rivals which can be difficult for a new entrant to overcome. If it is patented, then they are not even able to overcome it, thus entry into the industry competing with the more advanced firm that has legally protected innovations become harder.

Branding means that some products are very well known to consumers. The familiarity of the product often makes it a consumers first choice, and puts new entrants into the market at a disadvantage.

Monopolies in contestable markets will attempt to lower prices if they feel like they are being threatened with the entry of a new firm - they will operate at normal profits [there is a diagram you should be able to draw for this]. This is known as predatory pricing and monopolies often lower their prices to a level that a new entrant cannot match (due to economies of scale and etc.) and drive them out of business.

Question 34

Describe the ways in which the barriers to entry can become ‘higher’ in a market.

Answer 34

An innovative new product or service can give a firm a head start over its rivals which can be difficult for a new entrant to overcome. If it is patented, then they are not even able to overcome it, thus entry into the industry competing with the more advanced firm that has legally protected innovations become harder.

Branding means that some products are very well known to consumers. The familiarity of the product often makes it a consumers first choice, and puts new entrants into the market at a disadvantage.

Monopolies in contestable markets will attempt to lower prices if they feel like they are being threatened with the entry of a new firm - they will operate at normal profits [there is a diagram you should be able to draw for this]. This is known as predatory pricing and monopolies often lower their prices to a level that a new entrant cannot match (due to economies of scale and etc.) and drive them out of business, thus the barrier to entry becomes higher.

Question 35

Here is the UK grocery market share:

Tesco 27.2%
Sainsbury's 15.3% 
Asda 14.9% 
Morrisons 10.3% 
Aldi 8.1%
Other firms: 24.2%

Calculate the 5-firm concentration ratio.

Answer 35

27.2+15.3+14.9+10.3+8.1 = 75.8%

You do not calculate ‘Other’ - that measurement is made up of hundreds of firms.

Question 36

Describe and explain the assumptions of Monopolistic Competition.

Answer 36

Monopolistic Competition shares all of Perfect Competition’s assumptions, but with one difference:

-Rather than products being identical (Homogenous), they are heterogenous meaning that they are differentiated. For example, products in monopolistic competition can be uniquely advertised, branded and made a different style.

To recall other differences:

• Firms and consumers are assumed fully rational.
• Firms and consumers are perfectly informed, however, their choices will not be determined solely on price competition (like in perfect competition) as there is now differentiation between products.
• There are no barriers to entry or exit.
• There are a large number of sellers and buyers, however, compared to perfect competition, monopolistically competitive firms generally do have a degree of price-making power, due to product differentiation.

Question 37

Describe the advantages of a monopoly market..

Answer 37

Certain monopolies, such as statutory ones that are controlled by the government benefit from economies of scale and if diseconomies of scale are avoided, the firm will be able to keep its average costs low, and thus keep it’s prices lower than what would be possible in a competitive market. This benefits the consumer.

Monopolies are extremely successful firms, thus they have financial security - this means that monopolists can provide stable employment for their workers.

Another potential advantage of a monopoly is that they can use their supernormal profit to subsidize socially useful but loss-making services.

Question 38

State 1 real life example in a market where it is seen as better to run a single monopoly firm than multiple firms.

Answer 38

Electricity distribution - to distribute electricity to every home in a country, it is most efficient to have a monopoly provider. There are significant economies of scale in having a comprehensive network.
There is no point in having two electricity cables running up the same street.

Bus travel in a city - avoids duplication and enables efficient timetabling.

Question 39

Describe the disadvantages of a monopoly market.

Answer 39

There is no need for a monopoly to innovate or to respond to changing consumer preferences in order to make a profit, so the may become complacent.

Consumer choice is restricted, as there is no alternative options the consumers can pick to consume in the market if the offerings are only from one firm.

Since monopolies are lone providers, they can set any price they choose. That’s called price-fixing. They can do this regardless of demand because they know consumers have no choice and so the monopoly will often just set prices where MR = MC rather than where it is allocatively efficient.

Question 40

Draw the diagram showing the short run equilibrium position in a firm in monopolistic competition.

Shade in any supernormal profits.

Describe what is shown.

Answer 40

https://media.discordapp.net/attachments/581202442524295179/824014981812191232/unknown.png?width=594&height=564

In monopolistic competition, the product differentiation in the market gives the firms a degree of power, due to the fact that they do not compete solely on price anymore, but also on non-price competition, such as branding and innovation meaning that supernormal profits can be made, but only in the short run.

The profit maximizing level of output is where MC = MR and this position features the output leading to the profit-maximizing price at P1.
This means the firm earns supernormal profit, as C represents the average cost, the distance between C and P1 represent supernormal profit.

Due to the very low barriers to entry, the supernormal profits demonstrated by the firm signal entry of new firms into the industry.

Question 41

Draw the diagram showing the long run equilibrium position in a firm in monopolistic competition.

Include the diagram for the firm.

Answer 41

https://media.discordapp.net/attachments/581202442524295179/824034535032619078/unknown.png?width=1169&height=563

In monopolistic competition, due to no existence of barriers to entry, new firms enter the industry, thus the industry’s supply curve shifts to the right as seen from the movement at S to S1.
Due to the new entrants into the industry, the firm’s demand curve will shift to the left since the overall demand is now split between more firms and new entrants will continue to join, shifting demand to the left more over time while undercutting each other in price until only normal profit can be earned, so AC touches AR tangentially and price is set at P1.
Therefore, the firm is operating at the profit maximized level of output where MR = MC, but also at normal profit where AR = AC.

This will demotivate the entry of any new firms into the industry.

Question 42

Explain how price and output are determined for a firm in a monopolistically competitive market, in both the short run and the long run

This is a 15 marker - include diagrams.

Answer 42

Monopolistic competition is a theory that imposes artificial conditions in how a market is operated. It contains a lot of the assumptions in Perfect Competition, such as the fact that:

There are a high number of buyers and sellers in the industry. Consumers and firms are assumed rational. Consumers have symmetric information thus are perfectly informed. There are no barriers to entry or exit in the industry.

However, compared to Perfect competition, while consumers and firms are assumed rational, each firm has a small degree of power compared to firms in perfect competition, and this is because there is potential for heterogeneity between goods.

As a result of this, consumers are not influenced entirely from the price of a product, and therefore, in monopolistic competition, there is a degree of non-price competition, wherein the quality and branding of a product as well as many other factors are considered. This gives firms in monopolistic competition potential to gain a degree of power in the industry – goods between firms are not perfect substitutes. This means that supernormal profits can be earned, but only in the short run:

https://media.discordapp.net/attachments/824032924583329792/824033090741469254/unknown.png?width=638&height=564

In the short run, price and output are determined for a firm from the profit maximizing level, which is where MC = MR and this position features the output of Q1 leading to the profit-maximizing price at P1. This means the firm earns supernormal profit, as C represents the average cost, the distance between C and P1 represent supernormal profit.

Due to the very low barriers to entry, the supernormal profits demonstrated by the firm signal entry of new firms into the industry:

https://media.discordapp.net/attachments/824032924583329792/824033128083488798/unknown.png?width=1169&height=563

In the long run, due to no existence of barriers to entry, new firms enter the industry, thus the industry (diagram on the left) supply curve shifts to the right as seen from the movement at S to S1. In the firm (diagram on the right), since there is a degree of power, the demand curve is downward sloping, therefore MR is twice as steep.

Due to the new entrants into the industry, the firm’s demand curve will shift to the left since the overall demand is now split between more firms and new entrants will continue to join, shifting demand to the left more over time while undercutting each other in price until only normal profit can be earned, so AC touches AR tangentially and price is set at P1.

Therefore, the firm is operating at the profit maximized level of output where MR = MC, but also at normal profit where AR = AC.

This will demotivate the entry of any new firms into the industry.

Question 43

Describe different markets featuring monopolistic competition in real life.

Answer 43

Hairdressing salons
Bars and Nightclubs
Dry cleaners and launderettes

Question 44

What is contestability?

Answer 44

Contestability refers to how open a market is to new competitors (i.e. potential competition), even if there’s little actual competition in the market.

Question 45

Describe features of a contestable market.

Answer 45

Barriers to entry and exit are low which means that firms find access to the market easier and thus more convenient to enter.

Supernormal profits can potentially be made by new firms entering, at least in the short term.

Sunk costs are low - sunk costs are costs that cannot be recovered when a firm leaves the industry thus making the barrier to exit relatively low as well as the cost of failure, so firms are more motivated to enter the industry if they know they won’t lose much from taking a risk.

Question 46

Describe ways in which the contestability of a market can decrease.

Answer 46

Patents on key products or production methods can decrease contestability if the legally protected technique allows the incumbent firm to produce more
efficiently for lower prices, thus making it harder for smaller firms entering the market to compete as less consumers will see them as an alternative.

Pre-established brand loyalty in the industry from larger firms often make contestability lower due to the fact that people are more likely to stick to
the brand of the incumbent firm in order to wear the brand, thus decreasing the amount of people that see newer firms entering the industry as an alternative.
For example, if a new brand tried to compete with Nike, it is likely that it would not succeed - people would stick with the brand that is
currently trendy.

Sunk costs are low - sunk costs are costs that cannot be recovered when a firm leaves the industry thus making the barrier to exit higher, as well as the cost of failure and this can deter firms from taking a risk.

Question 47

Certain firms may enter an industry that is contestable in order to compete while supernormal profits are available, and leave when normal profits are reached.

What is this called?

Answer 47

A hit-and-run tactic

Question 48

What is a Hit-and-run tactic?

Answer 48

A hit-and-run tactic refers to when a firm enters a market while supernormal profits can be made, and then leaving the market once prices have been
driven down to reach normal profit.

Firms will find it worthwhile to compete in the industry for supernormal profits, even for a short time.

Question 49

What are incumbent firms?

Answer 49

Incumbent firms are businesses already established in said market or industry.

Question 50

List some things that incumbent monopoly firms would want to do in a contestable market.

Answer 50

One thing to mention is that incumbent firms are constantly under threat from new firms entering the industry, meaning that they will need to decrease
the contestability of said market. This can be done by:

Strengthening brand loyalty between your customers - This will mean that if firms were to enter the industry they are less likely to find it as an
alternative if the current brand is seen as trendy or more desirable.

Patenting - patenting new invented techniques that you find, such as techniques for better productivity means that firms are not legally allowed to use said
technique to drive down their own prices. This means that the contestability decreases as it is harder to compete with a firm that charges lower possible
prices than they do, meaning that they will likely be driven out of business as consumers will find the incumbent firm more desirable.

Question 51

What is an Oligopoly?

Answer 51

An Oligopoly is a market that’s dominated by just a few firms which together have a high concentration ratio, featuring high barriers to entry and in which firms offer differentiated products.

Question 52

What is Interdependence?

Answer 52

Interdependence refers to when a firm’s decisions are based on the actions of others.

Question 53

Describe the Prisoner’s Dilemma.

Answer 53

The Prisoner’s Dilemma is a standard example of a game analyzed in game theory that shows why two completely rational individuals might not cooperate,
even if it appears that it is in their best interests to do so, thus this explains why oligopolies are often uncertain.

You are not expected to know the context associated with the next part of this answer but this is how the scenario plays out:

Two members of a criminal gang are arrested and imprisoned. Each prisoner is in solitary confinement with no means of communicating with the other. The
prosecutors lack sufficient evidence to convict the pair on the principal charge, but they have enough to convict both on a lesser charge.

Simultaneously, the prosecutors offer each prisoner a bargain. Each prisoner is given the option to either betray the other by testifying that the
other committed the crime, or to cooperate with the other by remaining silent.

The possible outcomes are:

If A and B both betray the other, they both serve 2 years in prison as they both have admitted to the crime for the principal charge

If A betrays but B is left silent, A will be set free and B will serve three years in prison - If it wasn’t for A’s betrayal, they couldn’t have convicted the pair on the principal charge. This works the other way round too (B betrays A)

If A and B both remain silent, both of them will serve only one year in prison (on the lesser charge) as no proof has been generated for the principal charge.

Thus the payoff matrix:

https://media.discordapp.net/attachments/581202442524295179/824387585647837214/unknown.png?width=610&height=563

Question 54

What is a collusive oligopolist? Give an example of one.

Answer 54

A collusive oligopolist is when various firms cooperate with each other, particularly over what prices are charged.

An example of a collusive oligopolist is OPEC - the Organization of Petroleum Exporting Countries.

Question 55

Outline a real world example of collusive oligopolies fixing price.

Answer 55

OPEC, the Organization of Petroleum Exporting Countries, has attempted to manipulate supply to increase price.

During Covid-19, OPEC tried to cut
output by 10 million barrels a day to raise global prices. This is an example of an explicit agreement, and this was allowed by the government but
generally it is illegal.

Question 56

Draw the diagram showing the the industry and the individual firm in a collusive oligopoly when the firm is under bad conduct.

Answer 56

https://media.discordapp.net/attachments/581202442524295179/824389735447003146/unknown.png?width=1195&height=563

Question 57

What is a formal collusion?

Answer 57

A formal collusion involves an agreement between firms i.e. they form a cartel. This is usually illegal.

Question 58

Draw a payoff matrix for the following:

Both airlines price low so both £2 profit
Both airlines price high so both £4 profit
One airline (A) prices low, the other (B) high so £1 (B) and £3 (A) profit
One airline (B) prices low, the other (A) high so £1 (A) and £3 (B) profit

Describe and explain this referring to interdependence and Game Theory in your answer.

Answer 58

https://media.discordapp.net/attachments/581202442524295179/824390485715976192/unknown.png?width=676&height=564

Here, two airlines could choose to adopt a price at low or high.

If both airlines price low, they both don’t get much profit. However, if Airline A prices high and Airline B prices low, Airline B basically ‘wins out’
with better share of profits, i.e. 3:1 (B:A).
Alternatively, if A goes low and B goes high, A wins out with better share of profits, i.e. 1:3 (B:A).

If both firms could come to some agreement to fix prices, they could both gain higher profits at 4,4 - this is bad conduct and is generally illegal.
This means the CMA could be involved as the agreement between the 2 firms purposefully means that output is cut for supernormal profits and this
is not a benefit to society, as it is joint profit maximization.

However, it is possible that a firm may break the agreement or cheat on the deal (remember Prisoner’s Dilemma in Game Theory) and go low to sweep up
the market and gain a higher share of the profits, therefore oligopolies face uncertainty even in collusive markets as well as interdependence.

Question 59

List three different techniques that oligopolies do that feature their poor behavior.

Answer 59

Price Dripping
Price Anchoring
Predatory pricing

Question 60

What is Predatory Pricing?

Answer 60

Predatory pricing is the illegal act of setting prices low in an attempt to deliberately eliminate the competition.

Question 61

What is Price Anchoring?

Answer 61

Price Anchoring refers to the practice of establishing a price point which customers refer to when making decisions, taking advantage of the behavioral bias known as Anchoring - where individuals place too much emphasis on one piece of information which they use to influence their decision.

Question 62

What is Drip Pricing?

Answer 62

Drip pricing is a technique used by, for example, online retailers of goods and services whereby a headline price is advertised at the beginning of the purchase process, following which additional fees, taxes or charges, which may be unavoidable, are then incrementally disclosed or ‘dripped’.

In other words, it refers to when only part of an item’s price is advertised, with the total amount revealed at transaction.

Question 63

Cooperative Oligopolies have occurred in the past. Give an example from the real world of a Cooperative Oligopoly that is seen as desirable or good.

Answer 63

Drug companies have been working together on vaccines for coronavirus.

Question 64

Draw, describe and explain the Kinked Demand Curve.

Answer 64

https://media.discordapp.net/attachments/581202442524295179/824392890473119744/unknown.png?width=615&height=564

If the firm puts price up above the point (circle), the firm would hope that demand would be inelastic if it were to increase revenue. However, it would fear that the opposite would be the case. If the firm put the price up it would think (perceive) that its competitors would leave prices untouched, and therefore it would imagine a very elastic response to it’s price increase.

This is because individuals will find other cheaper firms as a more desirable substitute due to lower prices.

Alternatively, if the firm were to consider a price cut below the point (circle), it would hope that demand would be elastic if it were to increase revenue. However, it would fear that the opposite would be the case. If the firm puts the price down, it would think that its competitors would follow with price cuts and therefore it would imagine a very inelastic response to price reduction.

This is due to the fact that when you decrease your prices, your other competitors do in order to ensure that they do not lose consumers to you, from seeing the cheaper product or service as a substitute. As a result, all the prices of the product or service will basically decrease and this means
that the increase in demand was not related to the fact that consumers from other firms saw you as a substitute, but more that as price decreases in the market, demand generally increases.

Hence, the perceived demand curve displays a characteristic point shown at point A being elastic above and inelastic below. When the marginal revenues associated with both sections are drawn, a discontinuous section emerges.

What emerges is that the profit maximizing point can occur at several places on the discontinuous section without altering market price and output.

Once again, there is uncertainty as firms are unsure about how its rivals will react, and interdependence as they cannot set price without considering their competitors.