Market Structures, Efficiency & Perfect Competition

Question 1

How many models of market sellers are there?

Answer 1

4

Question 2

State the 4 models of market sellers in order from most competitive to least competitive

Answer 2

1) Perfect competition
2) Monopolistic competition (imperfect competition)
3) Oligopoly (imperfect competition)
4) Monopoly (imperfect competition)

Question 3

What is the concentration ratio?

Answer 3

Market share of an industry controlled by the ‘n’ largest firms
E.g. the 4 firm concentration ratio = the market share of an industry controlled by the 4 largest firms

Question 4

What are the key 🔑 characteristics of market structures?

Answer 4

1) No. of firms/market concentration
2) Type of product sold
3) Knowledge of consumers and producers
4) Barriers to entry/exit
5) Price-setting powers

Question 5

What would the concentration ratio be for the 4 models of market sellers?

Answer 5

Perfect competition- many small firms … ⬇️ concentration
Monopolistic competition- many small firms … ⬇️ concentration BUT ⬆️ than perfect competition
Oligopoly- a few large firms dominate … fairly ⬆️ concentration
Monopoly- 1 firm has 100% concentration ratio as dominates market

Question 6

What type of product would be sold by the 4 models of market sellers?

Answer 6

Perfect competition- homogenous (exactly the same)- equal advantage
Monopolistic competition- similar
Oligopoly- some distinct characteristics e.g. Dell PC and Apple Mac
Monopoly- unique- 1 of a kind

Question 7

What would the knowledge be like in the 4 models of market sellers?

Answer 7

Perfect competition- perfect knowledge (firm has access to info about rival firms’ price and output decisions- ALSO has access to latest technology, techniques and info on who makes supernormal profits)
Monopolistic competition- imperfect knowledge
Oligopoly- imperfect knowledge
Monopoly- imperfect knowledge

Question 8

What would the barriers to entry/exit be like in the 4 models of market sellers?

Answer 8

Perfect competition- ✖️ barriers to entry/exit
Monopolistic competition- ⬇️ barriers to entry/exit
Oligopoly- ⬆️ barriers to entry/exit
Monopoly- very ⬆️ barriers to entry/exit

Question 9

How many types of efficiency are there?

Answer 9

4

Question 10

What are the types of efficiency?

Answer 10

1) Productive efficiency
2) Allocative efficiency
3) Dynamic efficiency
4) X-inefficiency

Question 11

What is productive efficiency?

Answer 11

Occurs at lowest cost per unit of output (lowest point on the average total cost curve- when MC intersects AC) … firm producing as much as possible given the inputs

Question 12

Does productive efficiency occur in long run perfect competition?

Answer 12

Yes

Question 13

What is allocative efficiency?

Answer 13

Producing at a point where price of a 🚘 is = to marginal cost of production (P=MC) … price for unit = cost of making unit … welfare maximised

Question 14

Does allocative efficiency occur in long run perfect competition?

Answer 14

Yes

Question 15

What is dynamic efficiency?

Answer 15

How changes in technology and productive techniques over time ⬆️ the productive potential of a firm (ongoing and not static unlike productive and allocative efficiency)- can be increased via investment into R and D

Question 16

Does dynamic efficiency occur in long run perfect competition?

Answer 16

No

Question 17

What is X-inefficiency?

Answer 17

When average cost is ⬆️ than lowest possible average cost (firm operates above AC/ATC curve)

Question 18

Does X-inefficiency occur in long run perfect competition?

Answer 18

No

Question 19

When is X-inefficiency more likely?

Answer 19

In highly concentrated markets e.g. monopoly or oligopoly- firms able to easily make profit as market/industry dominated because demand/AR ⬆️ AND is ⬆️ than their AC … little desire to ⬇️ AC and ⬇️ x-inefficiency

Question 20

How can you determine whether a market is an oligopoly?

Answer 20

Use the F-RULE:

If 5 or Fewer Firms have 50% market share- highly concentrated AND … likely to have characteristics of oligopoly

Question 21

Which industries approximate to the model of perfect competition?

Answer 21

1) markets for foreign currencies 💴- ⬇️ entry barriers, price takers (price of currency determined by market), many small firms, homogenous 🚘 (currencies 💴 same)
2) Agricultural goods- e.g. 🥕

Question 22

Define perfect competition

Answer 22

Market where large number of small firms co-exist selling homogeneous products. Normal profits achieved in long run as ✖️ barriers to entry to protect market share of firms who make supernormal profits in short run

Question 23

Describe the diagram of a firm and market in the short run making supernormal profit under perfect competition

Answer 23

Market- PRICE-QUANTITY AXIS- normal straight line supply and demand diagram- intersection/equilibrium price = price at which firm sells at
Firm- REVENUE/COSTS-QUANTITY AXIS- AR = MR (horizontal curve because under perfect competition) … market price taken at equilibrium (intersection of market supply and demand curve)
AC curve and MC curve- market determined price higher than average cost at same output level- when MC = MR- profits maximised … firm making supernormal profit in short run (area marked by rectangle above average cost at same output)
SEE TOP OF PAGE 27 (theme 3 book)

Question 24

Describe the diagram which shows that firms cannot continue to make supernormal profits in the long run in perfect competition

Answer 24

Market- PRICE-QUANTITY AXIS- normal straight line demand BUT with supply curve shifted ➡️ (show S1 and S2)
SHOW previous intersection point where supernormal profit made AND new intersection point where normal profit made
ALSO LABEL Q1 and Q2 on market diagram
Firm- REVENUE/COSTS-QUANTITY AXIS- LABEL previous intersection/market price as horizontal curves AR1=MR1 AND new intersection as horizontal curves AR2=MR2
SHOW reaction of firms to ⬇️ in price (P1 TO P2) by showing ⬇️ in quantity from Q1 TO Q2 on firm diagram (different to market Q1 and Q2)- REMEMBER EQUILIBRIUM WHEREVER MC=MR (where profits maximised- ALL firms assumed to be profit maximisers and max profit in perfect competition is normal profit)
… firm now producing at long run equilibrium where normal profits made (when MC=AC=AR=MR)
SEE MID PAGE 27 (theme 3 book)

Question 25

What would the price setting powers be like in the 4 models of market sellers?

Answer 25

Perfect competition- price taker (too many firms- market forces decide price)
Monopolistic competition- some degree of price setting powers in market
Oligopoly- significant price setting powers BUT interdependent on other firms in market
Monopoly- price maker (dominates market … complete control- set price to own advantage)

Question 26

Why can’t perfectly competitive firms make supernormal profits in the long run?

Answer 26

Rival firms 👀 that supernormal profits being made (due to perfect knowledge) AND enter industry (✖️ barriers to entry … easy) with intention to ALSO make supernormal profit
…-> market supply curve shifts ➡️ (⬆️ firms in industry hence ⬆️ supply) AND price ⬇️- supernormal profits competed away … firms make normal profits in long run

Question 27

How do firms respond to the right ward shift in the market supply curve?

Answer 27

Firms react to ⬇️ price (because price takers and follow market price which ⬇️ due to ➡️ward shift of market supply curve) by ⬇️ output … MAKE NORMAL PROFIT IN LONG RUN- SEE DIAGRAM FOR CLARITY

SEE DIAGRAM ON MID PAGE 27 OF THEME 3 BOOK

Question 28

What is the long run equilibrium?

Answer 28

A perfectly competitive firm in long run will always make normal profits only as supernormal profits are competed away and losses are removed by firms leaving industry (firms making loss won’t stay BUT will leave)

Long run equilibrium = MC=AC=MR=AR

SEE DIAGRAM FOR LONG RUN EQUILIBRIUM- BOTTOM OF PAGE 27- THEME 3 BOOK

Question 29

Is the shutdown point for a perfectly competitive firm the same as the shutdown point for all firms?

Answer 29

Yes all have the same shutdown point

Question 30

When is the shutdown point for a firm?

Answer 30

When the firm is not covering its average variable cost (cost of producing) and … is ✖️ making any contribution to its fixed costs (overheads e.g. rent, loans etc)
… when AVC AND MC CURVES INTERSECT

Question 31

What must you remember when drawing the diagram for a perfectly competitive firm/market?

Answer 31

Firm is price taker … price based on market price (market equilibrium- when market demand and supply curves intersect)

ALSO average revenue (demand) curve is equal to the marginal revenue curve (normally both downward sloping when MR twice as steep as AR) AND BOTH ARE THE SAME HORIZONATAL STRAIGHT LINE AT THE MARKET PRICE

Question 32

What is the supply curve of a firm in perfect competition?

Answer 32

It is the marginal cost curve above the average variable cost

DON’T WORRY IF DOESN’T MAKE COMPLETE SENSE

Question 33

What is the explanation behind the supply curve of a firm being as such?

Answer 33

Because in the long run, AVC = ATC (✖️ fixed costs) … rule holds

DON’T WORRY IF DOESN’T MAKE COMPLETE SENSE

Question 34

What do the 3 quantities represent in figure 17 at the bottom of page 28?

Answer 34

Q1 = firm making contribution to fixed costs by covering all of variable costs 
Q2 = firm making normal profits- costs = revenue- ✖️ net profit gain
Q3 = supernormal profit- typically made in short term- firms revenue more than costs ... profit

Question 35

How could you evaluate the idea of perfect competition?

Answer 35

👎- model of perfect competition is theoretical ideal based on assumptions that rarely hold in real 🌎
👍- BUT allows theoretical ideal market to be compared to alternative markets- … reference point when examining alternative models of market structure