Market Structures & Theory of The Firm Flashcards
1
Q
Perfect Competition - Standard An (Short-Run)
A
- The short-run is where at least one factor of production is fixed in quantity.
- In a perfectly competitve market in the short-run firms are price takers, meaning that the price that a firm charges is determined by the market equilibrium, where demand is equal to supply.
- This is because, perfectly competitive firms have homogenus goods and services, good information and no barriers to entry so firms have no way to dictate price.
- Perfectly competitive firms profit maximise where MC=MR and charge price Pm and quantity Qm.
- In the short-run, perfectly competitive firms make supernormal profit as average revenue minus average costs is greater than 0. This is denoted by the area C1P1AB.
- As for efficiencies, Perfectly competitive firms are allocatively inefficient in the short-run as price does not equal marginal cost. The firm is also not productively efficient as the firm does not produce at the minimum point on the AC curve.
2
Q
Perfect Competition - Standard An (Long-Run)
A
- The long-run is where all factors of production can be altered in quantity.
- In the long-run, firms are attracted by the supernormal profits made in the short-run.
- As a result, more firms enter the market which is done easily as there are no barriers to entry, perfect information and homogenus goods. This, in turn, results in a rightwards shift in supply of x from S1-S2.
- A perfectly competitive firm, assumed to be profit maximising, will charge where MC=MR and charge the market price P2 as firms are price takers and produces at Q2.
- As a result of greater competiton the supernormal profits made in the short-run are eroded into normal profits where AR-AC=0.
- In the long-run, perfectly competive firms are statically efficient. They are productively efficient as at Q2, the firm is producing at the minimum point on the AC curve. The firm is also allocatively efficient, as price is equal to marginal cost at P2.
- However, the firm is not dynamically efficient as there are no long-run supernormal profits.
- In the long-run output and price decreases in comparison to the short-run.
3
Q
Perfect Competition - Evaluation
A
- There is no set evaluation for perfect competition, it very much largely depends upon the question.
- However, you can use efficiencies to evaluate, that is probably the best way to do so.
- Or Perhaps talk about competition - decrease LRAC - Increased innovation - link to the wider macroeconomy perhaps?
4
Q
Pure Monopoly - Standard An
A
(when you are analysing a pure monopoly you may need to adapt the links in order for it to make sense - this is what you might want to include)
* In a Pure monopoly there is only one firm in the market.
* This is because of the high barriers to entry e.g economies of scale, imperfect information and a differentiated product.
* As a result, the monopolist faces no competition in the market and therefore has a high degree of price setting power (price maker)
* The monopolist, assumed to be profit maximising, charges where MC=MR at price P1 and quantity Qpm. The firm restricts output and increases price compared to a competitve market.
* Consequently, the monopolist is able to make supernormal profits as AR-AC>0. This is denoted by the area C1P1AB.
* As for static efficiencies, the monopolist is allocatively inefficient as price does not equal marginal cost. The firm is also productively inefficient as at Qpm, the monopolist is not producing at the minimum point on the AC curve.
* However, dynamic efficiency is achieved as there are long-run supernormal profits.
5
Q
Pure Monopoly deadweight welfare loss - Evaluation
A
- However, a monopoly is bad due to the deadweight loss of welfare caused by a pure monopoly which makes society worse off.
- In a competitve market, i.e without the monopoly consumer surplus is PcAB. However, under a monopoly output is restricted and price is increased, so the new consumer surplus is PmAE, therefore consumer surplus has decreased by PcPmEB.
- Of this loss of consumer surplus, some of it is turned into producer surplus, PcPmEF.
- However, since the monopolist restricts output and increases price, there is a lost in both consumer and producer surplus due to the units that are no longer being produced under the monopoly.
- The lost consumer surplus is EFB annd the lost producer surplus is FBG.
- The total deadweight loss under a monopoly is GEB, therefore a monopoly is bad as it akes society as a whole worse off……ATQ why might that be bad etc…
6
Q
Pure Monopoly dynamic efficiency - evaluation
A
- However, perhaps a monopoly is not always bad due to the fact that monopolies achieve dynamic efficiency.
- Since the market for a pure monopoly has one firm due to high barriers to entry, imperfect information and a differentiated product, the monopolist is a price maker.
- As a result, the monopolist, assumed to be profit maximising, will charge where MC=MR at price Pm and quantity Qpm.
- Consequently, the firm is able to make supernormal profits (dynamic efficiency) as AR-AC>0. This is denoted by the area C1PmAB.
- These supernormal profits can be used to potentially benefit consumer such as increased product innovation or increased economies of scale.
- As a result, consumer quality of life and consumer surplus would increase which benefits consumers.
- However, there is no guarantee that the monopolist firm reinvests their supernormal profits back into their product or to achieve greater economies of scale, instead they may become more allocatively and productively inefficient.
7
Q
if properly reg + fixed cost MES + Profit maximise + if unregulated
Natural Monopoly - Standard An (also Evaluation for a Pure Monopoly)
gov regulate it to charge where MC=AR
A
- However, perhaps a monopoly is not bad if properly regulated into a natural monopoly. This will be particularly beneficial for industries with very high fixed costs where a duplication of resources results in a hugh real resource opportunity cost.
- In a natural monopoly e.g water, electricity, broadband etc fixed costs are so high that the minimum efficient scale of production cannot be seen.
- The Monopolist seeks to profit maximise where MC=MR at Qpm, charging price P1. Economic profit is denoted by the area C1P1AB.
- However, if this monopoly is left unregulated output is restricted and prices are too high. This is an issue because…..(Adapt to the question)
- Consequently, the government will regulate the monopoly forcing it to charge where MC=AR, meaning that the monopolist will now charge price P2 and produce at Q2. At this point the monopolist is now allocatively efficient as price is equal to marginal cost.
- However, since average costs is greater than average revenue, the monopolist would make a loss and therefore have no monetary incentive to continue to produce x. Therefore, the government provides a subsidy which is the size of the loss so that the firm makes normal profit denoted by the area P2C2CD.
8
Q
Monopolistic competition - Short-run/Long-run standard analysis
A
- The short-run is where at least one factor of production is fixed in quantity.
- In the short-run in a monopolistically competitive market, firms have some product differentiation, good information and low barriers to entry. As a result, the firm has some price setting power.
- The firm, assumed to be profit maximising, will charge where MC=MR at the price P1 and produces at Qpm.
- In the short-run, the monopolistically competitive firm makes supernormal profits as average revene is greater than average cost. Total revenue is denoted by the area OP1AQpm and total cost is Oc1BQpm, therefore the supernormal profit is denoted by the area C1P1AB.
- As for efficiencies, the monopolistically competitive firm is neither productively efficient as they do not produce at the minimum point on the AC curve at Qpm or allocatively efficient as at P1 price does not equal marginal cost.
- The long-run is where all factors of production can be altered in quantity. In the long-run, supernormal profits are not possible. This is because, firms are attracted to the supernormal profits made in the short-run and therefore enter the market and can easily do so due to low barriers to entry and good information. As a result, since the goods that these firms produce are at least partial substitutes, this would reduce demand for the their product and shift the deamnd curve for their product leftwards from AR1=D1 to AR2=D2. The MR curve would also shift downwards from MR1-MR2.
- The firm, assumed to be still profit maximising charges where MC=MR at P2 and produces at QPm2.
- Due to new entrants in the industry thus resulting in a greater availability of substitutes, the supernormal profit is eroded into normal profit where AR-AC=0.
- In the long-run effiency…..
9
Q
Competition Policy - Essay Plan
A
- This is a huge part of the spec and probably the hardest.
If there is an essay talking about competition policy in the context of regulating monopolies:
-Talk about why a monopoly needs to be regulated - i.e deadweight welfare loss to society.
How
-Competiton policy - Standard An - i.e putting restrictions on prices and the benefits of doing so - mini evaluations at the end e.g what to set the price at??
-Other Regulations - such as privatisation.
-EV: Regulatory capture - this is a huge issue
-Monopoly benefits? - dynamic efficiency - standard An
If there is an essay talking about should the government promote greater competition:
-For this it is slightly similar to the essay above, effiencies are very important here.
-talk about why greater competiton is needed e.g deadweight welfare loss under a monopoly + drawbacks of a pure monopoly - restricts prices and output leading to inefficiency and why that is good or bad?
-Why they should promote greater competition: Static efficiencies and benefits + increased consumer surplus + consider macroeconomic benefits? - increased jobs and economic growth (higher output derived demand for labour….)
-Why should they not: dynamic efficiency and product innovation + EOS (each firm produces lower output than monopoly/oligopoly firms, cannot fully exploit EOS…..)
How the government can promote greater competiton
-Privatisation + deregulation
-Competition policy - pricing controls
10
Q
where it is (2) + consumer benefits + producer benefits
Allocative Efficiency Analysis
A
- Allocative efficiency is where demand is equal to supply maximising society surplus
- This occurs when price is equal to marginal cost
- The consumer benefits from allocative effiency - resources follow consumer demand - i.e maximisng consumer utility + maximisation of CS (low prices) + increased choice and higher quality.
- Producers also benefit through increased/maintenance of market share as they can stay ahead of rivals + increased profit - more consumers come to them.
11
Q
Productive Efficiency Analysis
A
- This is the maximisation of output at the lowest possible average cost at the lowest possible EOS.
- This occurs when firms produce at the minimum of the average cost curve, better way to say this is when MC=AC.
- Productive efficiency is good for consumers - lower prices through increased EOS which increases consumer surplus.
- Productive effiency is also good for producers - higher production at lower AC EOS which can increase profit (ceteris paribus) - potentially increase market share - link to firm objectives.
12
Q
Dynamic Efficiency Analysis
A
- Dynamic efficiency is the re-investment of supernormal profits into innovation, R&D and new technology to reduce LRAS.
- The condition for dynamic effiency is supernormal profit in the long-run.
- This benefits consumers through innovation, lower prices over time and high consumer surplus.
- This benefits producers due to firm objectives - profit maximisation. Lower costs over time. Retain/increase market share and stay ahead of rivals.
13
Q
X-efficiency Analysis
A
- This is production with no waste
- This is where production is along the average cost curve.
- This is good for consumers as they can potentially get lower prices and higher consumer surplus.
- This is bad for consumers as they can potentially ge higher profit and lower prices and therefore market share.
14
Q
Deregulation - Essay Plan
A
- Deregulation is when governments reduce legal barriers to entry in given industries which incentives more firms to enter the market in order to promote competition and efficiency.
(Deregulation largely ties into the idea of promoting competition, reducing the power of monopolies/oligopolies and so can be used in any essay to argue that)
If there is a question on evaluate the view that market x needs/should deregulate
-talk about the intended effects of regulation i.e the standard An - use the privatisation diagram - show the gains in consumer surplus/static effiencies (you could make these 2 paragraphs)
-Evaluation: Some markets do need regulation for health and safety its not wise - link to negative externalities.
benefits of monopoly i.e dynamic effiency etc.
loss of natural monopoly - waste of resources and decreased allocative effiencicy
-Formation of oligopolies and local monopolies - this is a key drawback/evaluation - no guarantee of competition. For example, bus market deregulation in the UK.
15
Q
Contestable Markets - Essay Plan
A
- A contestable market is when there is a threat of competiton and not necessarily competition itself. However, this threat can effect the behaviour of firms in the market.
Pros
-Increased static effiencies - increased allocative/productive/x efficiency.
-job creation - increased competition/threat of competiton can lead to more competitive outcomes…higher output…derived demand…macro AD/AS benefits.
Cons
-Lack of dynamic efficiency - firms moving towards the limit price - lack of LR supernormal profits….However, greater competition now may mean that innovation takes place anyway which is a form of dynamic effieciency.
-cost cutting in dangerious areas - negative externaltieies. For example, health and safety, prodct safety, pollution etc not desired in society
