Markets and the Competitive Environment

Question 1

What are the four market types?

Answer 1

Perfect competition
Monopolistic competition
Oligopoly
Monopoly

Question 2

What is perfect competition?

Answer 2

• Arises when there are many firms
• Each selling an identical product
• Many buyers
• No restrictions on the entry of new firms into the industry
• Perfect information
  E.g wheat, corn, rice and other grain crops

Question 3

What is monopolistic competition?

Answer 3

• Large number of firms compete by making similar but slightly different products
• Making product slightly different from the product of a competing firm = product differentiation
• An element of market power
• The firm is the sole producer of that particular good in question

Question 4

What is oligopoly?

Answer 4

• Market structure in which a small number of firms compete
• E.g Computer software, airplane manufacture and international air transportation
• Oligopolies might produce identical products

Question 5

What is monopoly?

Answer 5

Arises when there is just one firm which produces a good or service that has no close substitutes and in which the firm is protected by a barrier preventing the entry of new firms

Question 6

What is the four firm concentration ratio?

Answer 6

• The % of the value of sales accounted for by the 4 largest firms in the industry
• The range of the concentration ratio is from zero for perfect competition to 100 for a monopoly

Question 7

What does a low concentration ratio indicate compared to a high cr?

Answer 7

A low concentration ratio (60%

Question 8

What is the Herfindahl-Hirschman Index?

Answer 8

The square of the % market share of each firm summed over the largest 50 firms (or summed over all the firms if fewer than 50)

Question 9

How does HHI vary according to market structure?

Answer 9

• In perfect competition the HHI is small
• In a monopoly, the HHI is 10,000
• A market with a HHI of less than 1000 is competitive
• 1000-1800 is moderately competitive

Question 10

How does the geographical scope of the market limit the value of the concentration measure?

Answer 10

Concentration measures take a national view of the market but some goods are sold regionally and globally as well

Question 11

How do barriers to entry and firm turnover limit the value of the concentration measure?

Answer 11

• Some markets are highly concentrated but entry is easy and the turnover of firms is large
• Markets with only a few firms might be competitive because of potential entry

Question 12

How does market and industry correspondence limit the value of the concentration measure?

Answer 12

Concentration ratios are calculated through classifying firms into particular industries. Markets do not always correspond closely to industries. Markets are often narrower than industries. Firms make several products so they operate in separate markets

Question 13

What is the difference between firm coordination and market coordination?

Answer 13

Firms hire labour, capital, land and use command systems and incentive systems to coordinate their production activities. Markets coordinate production by adjusting prices and making the decisions of buyers and sellers of factors of production and components consistent .

Question 14

When should firms outsource i.e let the market coordinate production?

Answer 14

If markets can perform a task for a lower cost than a firm, markets will do the job. Any attempt to set up a firm to replace such market activities will result in failure.

Question 15

Why are firms often more efficient than markets at coordinating production?

Answer 15

• Lower transaction costs
• Economies of scale
• Economies of scope
• Economies of team production

Question 16

What are transaction costs?

Answer 16

Costs that arise from deciding with whom to do business, of reaching an agreement about the price and other aspects of the exchange and ensuring that the terms of the agreement are fulfilled e.g need for lawyers

Question 17

What are economies of scale?

Answer 17

When the cost of producing a unit of a good falls as its output rate increases, economies of scale exist - arise from specialisation and division of labour

Question 18

What are economies of scope?

Answer 18

A firm experiences economies of scope when it uses specialised resources to produce a range of goods and services

Question 19

What are economies of team production?

Answer 19

A production process in which the individuals in a group specialise in mutually supportive tasks is team production