Market types Flashcards
Assumptions of perfect competition
Sellers and buyers are price takers
There is free entry in the long run
When are the perfect competition assumptions likely to hold?
- there are many buyers and sellers
- firms produce homogeneous products
- consumers have full information
- transaction costs are negligible
- there are no market barriers
Ad valorem tax
When the tax is a % of the value of the good being taxed (e.g VAT)
Specific or unit tax
Tax is a specified amount in £ collected per unit of output
Statutory incidence
Who is legally responsible for paying the tax?
Economic incidence
What is the actual change in the distribution of income brought about by the tax
What does the economic incidence depend on?
The price elasticity of supply and demand
When is the economic incidence entirely on the consumer?
When supply is perfectly elastic
Causes of monopoly
Cost advantages
•superior technology or organisation
•exclusive control over an important production input
•natural monopoly where average cost curve is always downwards sloping
Government intervention
•where government is sole provider of good or service
•patents create temporary monopoly to encourage innovation
When will a monopoly shut down?
If revenue < variable cost
At what output do monopolies produce at?
Where MC=MR
Marginal revenue for monopoly
MR= dR(Q)/dQ= dp(Q)/dQ xQ + p(Q)
How can marginal revenue for a monopoly be written as a function of price elasticity of demand and what does this imply
MR= p(Q) x (1+ 1/Ed)
That the firm will never operate on the inelastic part of the demand curve
What are methods of preventing or regulating monopolies?
Structural remedies: alter an industry’s structure to make it more competitive. Could block mergers, force companies to restructure and even break up companies
Conduct remedies: restrict a monopolists behaviour without changing the underlying market structure
Problems with price regulation
- regulator only has limited information about demand and marginal cost curves, so it is hard to set a price
- the monopolist must be allowed to mags at least zero profits, for a natural monopoly if p=MC the firm will shut down
- regulatory capture: monopolist have better info about curves so must be involved in regulation. This leads to regulator becoming too closely alliance with the firm
Price discrimination
When a firm charges consumers different prices for the same good for reasons not associated to cost
First degree price discrimination
Perfect price discrimination where each unit is sold for the customers reservation price
Second degree price discrimination
Price varies with the quantity purchased, but all customers who buy a given quantity pay the same price
Third degree price discrimination
Firms charge different groups of customers different prices
What are the necessary conditions to be able to price discriminate?
- The firm must have market power
- The firm must be able to identify which customers are willing to pay more
- The firm must be able to prevent resale between customers
Is 1st degree price discrimination efficient?
Yes since the profit maximising output is the same as in perfect competition but this time there is no consumer surplus since it is all taken by the producer
What does price discrimination do to welfare, consumer surplus and producer surplus when compared to a normal monopoly?
Welfare increased
Consumer surplus decreased
Producer surplus increased
In 3rd degree price discrimination which group is charged the higher price?
The group that is less elastic
Assumptions of monopolistic competition
- Firms are price makers
- Buyers are price takers
- There is free entry in the long run
Assumptions that sellers have market power is more likely if one or more of the following hold
- there are few firms in the market
- firms produce heterogeneous products
- imperfect information and transaction costs may be present
How do firms in monopolistic competition behave in SR and LR?
In SR, firms behave like monopolists
In LR, entry shifts demand curve inwards until AC=p and so each firm faces zero economic profits
Is monopolistic competition efficient?
- firms produce where MC=MR<p>MC which isn’t efficient
- firms produce where AC is not minimised, this is called excess capacity problem
- excess capacity problem ignores that consumers value variety and there is greater variety with more firms </p>
What does the number of LR firms in monopolistic competition depend on?
Fixed costs. If fixed costs are high there will be fewer firms
How does the entry of a third firm effect welfare, consumer surplus and producer surplus?
Increases consumer surplus
Decreases producer surplus
Welfare depends on the case
Game theory
A set of tools to analyse strategic decision making of rational individuals
Payoff function
Specifies each players payoff as a function of the actions chosen by all players
Dominant strategy
A strategy that produces a higher payoff than any other strategy the player can use for every possible combination of their rivals outcome. A rational player must play a dominant strategy if they have one
Nash equilibrium
A set of strategies such that, when all players use these strategies no player can obtain a higher payoff by choosing a different strategy
When does a Nash equilibrium occur?
When both firms are using a best response
Assumptions of models about oligopolies
- sellers have market power and behave strategically
- buyers are price takers
- there are significant barriers to entry even in the long run
Why do oligopolies have an incentive to form a cartel?
Forming cartels allows the firms to behave like a monopoly and increase profits
Detecting and punishing cheating firms is easier if
- you have access to firms cost and revenue functions
- it is easier to monitor rivals’ output levels and prices
- there are fewer firms
- product differentiation means lower profit from cheating, punishment is less effective, more complex agreements are needed
Cournot model
Explains how oligopolies behave if they don’t collude
Residual demand curve
Market demand not met by other seller at any given price
Where is the cournot equilibrium
Where the firms beat response functions intersect. No firm has an incentive to deviate from this quantity
Bertrand model
Oligopoly model where firms choose rices rather than quantity
Nash Bertrand equilibrium
Where all firms in the market price at p=mc giving the same outcome as perfect competition
Why doesn’t the Nash Bertrand equilibrium occur in real life?
- firms actually set quantity not price in homogeneous markets
- in most markets products are differentiated so dropping price doesn’t mean every customer will buy your goods
Key features of demand functions for differentiated products
- demand decreases with own price, increases with competitors price
- firms don’t lose all sales if price is slightly higher than competitor’s
- demand changes smoothly with price
- products are imperfect substitutes
What is the difference in cournot best response functions and betrand best response functions
Cournot’s are downward sloping
Bertrand’s are upward sloping
How efficient is the Bertrand model when products are differentiated?
P>MC so not perfect competition outcome
Which of the following statements about a profit maximising, perfectly competitive firm is false?
A) the firm will expand output until MC=P
B) the firm will expand output until MC=MR
C) the firm will shut down if p
D) the firm will operate where ac are minimised
