micro 34 - 40 theory of the firm Flashcards
1
Q
define perfect competition?
A
A market that is highly competitive, where firms have no price making power.
2
Q
what are the assumptions made about the model of “perfect competition”?
A
- Many buyers and seller - no price making power.
- No barriers to entry/exit - as they please.
- Perfect knowledge - know what consumers want and know competitors prices.
- Homogenous goods - no branding.
- SR profit maximisers - MC=MR.
3
Q
What is the shape of the AR curve for perfectly competitive firms?
(demand curve)
A
perfectly elastic - this is because firms are price takers.
AR=MR
4
Q
How are supernormal profits shown on a diagram in a perfectly competitive industry
A
5
Q
how is a loss shown on a diagram in a perfectly competitive industry?
A
6
Q
What profits are made in the long run in a perfectly competitive industry?
A
normal profits.
7
Q
how can you show the change in the long run in perfectly competitive industry on a diagram when the industries are making supernormal profits?
A
Shift supply to the right as profits signals to producers to join the market.
8
Q
how can you show the change in the long run in perfectly competitive industry on a diagram when the industries are making a loss?
A
shift supply to the left as producers will leave the market.
9
Q
what equilibrium does the competitive pressure ensure in the long?
A
10
Q
what happens when a firm has a unique factor, such as a brilliant manager, which allows it to produce at a lower cost?
A
The manager will demand a salary that will match the supernormal profits.
11
Q
Are perfectly competitive firms productively efficient?
A
NO (In the SR).
MC does not equal AC.
However, in the LR, they are going to be as the industry becomes competitive.
12
Q
Are perfectly competitive firms allocatively efficient?
A
YES.
MC=AR.
No shortages or surpluses.
13
Q
Are perfectly competitive firms dynamically efficient?
A
NO.
No incentives or patents that protect you from other firms copying your product.
Also, there are no supernormal profits to reinvest.
14
Q
Are perfectly competitive firms X-efficient?
A
YES.
Because costs need to be lowest possible. If not, they will lose their competitiveness as goods are homogenous.
15
Q
define monopoly?
A
An industry supplied by one seller.
16
Q
What assumptions does the “Monopoly” model follow?
A
- One seller - price makers.
- No substitutes - Inelastic demand.
- High barriers to entry/exit - EOS, info, loyalty, predatory pricing.
- SR profit maximisers.
17
Q
What does the CMA define monopoly as?
A
A firm with 25% or more of the market share.
18
Q
What are the three main causes of monopoly power?
A
- External growth - takeovers and mergers.
- Legal causes - govt might grant a license to a firm led by a monopoly. Eg: royal mail.
- Control of physical resources - when a firm that sells the final product controls the input.
19
Q
because monopolies are SR profit maximisers, where will output take place on a diagram? And what will the price be?
A
Output is the point where MC=MR.
Price is found by going up to the AR curve from the point of MC=MR.
20
Q
how does the monopoly diagram look?
A
21
Q
Does the monopoly firm make a profit or a loss?
A
they make supernormal profits.
22
Q
Why is the monopoly model considered market failure?
A
The signals/incentives fail due to barriers of entry/exit.
Shown by deadweight welfare loss.
The units are not produced at all.
23
Q
define limit pricing?
A
the pricing strategy used by monopolies to discourage new entrants.
24
Q
what are the reasons why limit pricing can be overcome by the market?
A
- New firm might be a conglomerate that can achieve EOS and overcome the limit pricing.
- Depends on industry - govt might subsidise new entrants.
25
what is the difference between limit pricing and predatory pricing?
limit pricing is price place above AC, but predatory pricing is when price is placed below AVC
26
finish chapter on limit pricing
27
define natural monopoly?
An industry where the EOS are soo substantial that only one firm can operate in the market.
28
what are some features of natural monopolies?
1. Ratio of fixed to variable cost is very high.
2. Minimum efficient scale happens at very large levels of output.
3. LRAC curve continues to fall over a large range of output.
29
why is it beneficial to not introduce competition to natural monopolies?
assuming the total costs in the industry is 200 million , and there are 10 million households, then average costs would be 20. If the regulator introduces competition, The output per firm falls to 2 million households and so AC will increase to 100 pounds, from 20 pounds.
30
what type of system is the network rail?
(govt owned)
Franchise system - govt has given parts of the infrastructure to different owners.
This is harmful as the different owners will not have enough finance (competition led to loss) to keep the rail operating, leading to them needing finance from the government.
31
Why does natural monopolies being allocatively efficient lead to them making a loss?
Because AC>AR
32
what are the efficiencies of natural monopolies?
finish
33
what are 3 advantages of natural monopolies?
1. Dynamic efficiency - supernormal profits leads to reinvestment (eval: no comp).
2. EOS - lower AC (eval: not pass them on).
3. Beneficial to society as competition will increase prices.
34
what are 4 disadvantages of natural monopolies?
1. High prices - price making power (eval: regulators can change this).
2. Less choice - no competition.
3. Allocative inefficiency - shortage (regulators can fix this by maximum price).
4. Monopsony power.
35
are all monopolies bad?
NO - natural monopolies are needed.
36
define price discrimination?
firms charge different prices to different consumers for the same good or service.
37
define 3rd degree price discrimination?
And give an example.
Involves charging different prices to different consumers for the same product in different segments.
Eg: Rail travel - peak and off peak.
38
What are the 3 conditions for price discrimination?
1. Market power - firm needs to be a monopoly.
2. Elasticities - the submarket must have different elasticities.
3. Have to be able to prevent resale - because when someone buys the good in market A, will resale the good in market B at a lower price.
39
show the diagram for the 2 submarkets that have different elasticities?
Keep cost curves elastic as they remain constant for both.
40
What are 4 advantages of price discrimination?
1. Allows unprofitable firms prevent bankruptcy and continue offering the service.
2. Some groups benefit from lower prices.
3. Avoids congestion which is a negative externality.
4. Dynamic efficiency.
41
What are 4 disadvantages of price discrimination?
1. Some groups pay higher prices.
2. Fall in consumer surplus and some people are rationed out of the market.
3. Potentially unfair - people who work at rush hour times.
4. Exploit the power.
42
define monopolistic competition?
Imperfect market structure where firms compete on the basis of product differentiation.
43
what are the 4 assumptions of the model of "monopolistic competition"?
1. Differentiated products - Non homogenous goods and so brand loyalty is important.
2. No barriers to entry/exit - Normal profits in the long run.
3. Large number of buyers and sellers.
4. SR profit maximisers.
44
are monopolistically competitive firms price takers?
NO - Price makers because of brand loyalty.
45
what does the PED for monopolistic competitive firms looks like
Inelastic for big firms due to loyalty.
46
what will happen if a firm increases price in a monopolistically competitive industry?
Face an elastic response as consumers can switch to alternatives (only if price change is significant because element of brand loyalty).
47
what does the diagram look like for a monopolistic competitive firm in the short run?
same as monopoly diagram.
48
what happens to monopolistically competitive firms in the long run.
In the short run, the firm is making supernormal profits. In the long run, new firms will join the market. This leads to more competition and so supply shifts right. Each firm will have less of the market share. This means that the AR curve will shift inwards until it is tangential to the AC curve.
49
how does a diagram of a monopolistically competitive firm look like in the long run?
They make normal profits in the long run because AC=AR. And they are at profit maximising level of output because MC=MR
50
Are monopolistically competitive firms productively efficient?
NO - Not operating at lowest point of the AC curve. Because they are SR profit maximisers and restrict output.
51
Are monopolistically competitive firms allocatively efficient?
NO - MC does not equal MR.
They restrict output. which leads to shortages.
However, in the long run, supernormal profits will signal to producers to join the market and so shortage will end.
52
Are monopolistically competitive firms dynamically efficient?
YES.
They make supernormal profits which can be reinvested.
53
Are monopolistically competitive firms X-efficient?
NO.
Organisational slack may develop in the short run.
In the long run, pressure from competitors may lead to efficiency.
54
what are some disadvantages of the monopolistic competition model?
1. New firms will not be seen as a close substitute.
2. If a firm has strong brand loyalty and product differentiation – this itself becomes a barrier to entry.
55
what are some advantages of the monopolistic competition model?
1. Reduces shortages in the long run.
2. More choice.
3. Lower prices - pressure to cut costs.
56
What is the market structure oligopoly?
This is where a small number of firms dominate the market - most common market structure.,
57
define market concentration ratio?
Measures the extent to which the market is dominated by a few number of firms (market share).
58
What does a high market concentration ratio mean?
There is less competitive pressure in the industry and the large firms have more market power.
59
What are the assumptions that make up an oligopoly?
1. 3-5 firms concentration ratio.
2. Firms are interdependent - have to consider other firms reaction when making a decision.
3. High barriers to entry and exit.
4. product differentiation.
5. Short run profit maximisers.
60
Is an oligopoly a market structure or a market conduct?
BOTH.
Market conduct refers to price and quantity.
61
What is the kinked demand curve theory?
Assumes that the way firms respond to another firm changing price depends on whether the price is increased or decreased.
62
How will other firms react when a firm reduces their price?
They will lower price too as they will lose market share if they don't.
This tells us that the firm that initially reduced its price below p1 has inelastic demand for their goods.
63
How will other firms react when a firm increases their price.
Other firms will keep the price the same.
This tells us that the firm that initially increased the price will have elastic demand for their goods.
64
so what does the kinked demand theory therefore tell us?
That the demand curve facing a firm is more elastic for a price increase than for a price fall.
65
Given that the AR curve is kinked, what will the MR curve be?
Discontinuous - there is a significant jump in revenue when a firm changes its price.
66
what does the kinked demand curve look like? (oligopoly)
67
What is the game theory?
Feature of oligopolies which explains the conduct of firms - The interdependence ad actions of firms.
68
draw the game theory grid for the situation of the 2 robbers with the info below.
69
What assumptions does the game theory make?
- Only 2 companies.
- Perfect information.
- Assumes the other company will respond.
- Assumes collusion/defect will lead to the same prices.
70
What is the first key feature of the an oligopolistic market?
PRICE WARS.
When 2 firms engage in extreme lowering of prices in retaliation. Leads to consumers winning and firms losing.
Common in markets of airlines, supermarkets and newspapers.
71
What is the second key feature of an oligopolistic market?
COLLUSION.
This is an agreement between 2 firms to fix prices and output (also limit innovation).
72
Why would firms in an oligopolistic market collude?
- To increase profits.
- Inelastic demand.
- Create a barrier to entry.
73
What are 2 types of collusion and define them?
1. Cartel - formal agreement (coming soon)
2. Tacit collusion - Informal agreement where dominant firm price leadership occurs because of their price making power.
74
What is the third feature of an oligopolistic market?
PRICE RIGIDITY.
Because the case of price wars, prices tend to be stable.
Another reason prices are stable is the impact of rising costs - evident from the kinked demand curve where a shift in costs will not have an impact on price (change has to be significant).
75
What happens when there is a small change in costs in oligopolistic markets?
Because of the discontinuous portion of the MR curve, costs will be absorbed by the firm in the form of reduces supernormal profits.
76
What is the fourth feature of an oligopolistic market?
NON-PRICE COMPETITION.
Non-price competition have particular importance.
These could include: Quality, Customer service, Branding, Opening hours, Convenience and more.
77
Define cartel?
A formal agreement between 2 firms to fix price and output.
(COLLUSIVE AGREEMENT)
78
What is the most famous example of a cartel in operation?
OPEC - Produce oil.
79
Are cartels legal?
Cartels are illegal in most countries but some firms do it anyways and take the risk because they make profits.
80
What diagram can be drawn for cartels?
A simple monopoly diagram.
81
What will be the impact of government intervention to tackle the abuse of power by a cartel?
Shortage will be solved - price will fall and output will increase
82
Draw a diagram of a firm cheating?
83
why is there a temptation to cheat for firm 2 in the cartel?
Because it has a smaller market share.
Profits are maximised at MC=P, so it will add more revenue than it will costs.
84
What will happen as either one of the firms in the cartel increase output?
The market price will fall and the cartel will break.
85
When are cartels most successful?
- When there is no incentive to cheat, meaning they have the same cost structures.
- When they are able to monitor output.
86
Why might the government not be able to intervene when there is collusion?
It's not easy to detect, especially if its tacit collusion. A firm will set a high price and the other firm will follow.
87
When can collusion benefit society?
- In the market of demerit goods, as some people will be rationed out.
- Farmers, to get more money.
88
are oligopolies productively efficient?
NO. AC does not equal MC.
There is an incentive to collude.
Low competitive pressure so no incentive to reduce costs.
High barriers to entry.
EVAL: Competition in supermarket industries, they have to utilise EOS.
89
Are oligopolies allocatively efficient?
NO. MC does not equal AR.
Price making power because of differentiation. They can restrict output because of high barriers to entry.
EVAL:
- Small profit margins so no point of restricting output.
- Price wars in short run so may not restrict output.
90
Are oligopolies dynamically efficient?
YES.
They make supernormal profits which can be reinvested. They also compete on the basis of differentiation.
EVAL:
- Might pay dividends.
91
Are oligopolies X-efficient?
NO.
Organisational slack may occur due to high barriers to entry and exit.
A change in costs will not change price.
EVAL:
- High costs will be punished as there will be less innovation and the firm will be left behind.
92
What are the main features of a contestable market?
No barriers to entry/exit.
No sunk costs.
93
Why is the theory of contestability important?
The theory predicts that actual competition is not important but potential competition is. Firms should worry if there is room for competition. The CMA shouldn't worry about a monopoly if the market is contestable.
94
Are contestable markets productively efficient?
YES.
Threat of competition, threat of hit and run. The monopoly firm will now make normal profits because of the threats.
95
define hit and run?
When a firm temporarily enters a market and then leaves when supernormal profits are exhausted.
96
Are contestable markets allocatively efficient?
YES - MC = MR.
97
What are the implication for long term and short term supply/price/profits?
PROFITS:
ST- supernormal.
LT- normal.
PRICES:
ST- allocatively inefficient.
LT- Allocatively efficient.
SUPPLY:
ST- Restricted.
LT- Higher supply.
98
Draw the diagram for a contestable market?
MC=AC.
AC=AR.
MC=AR
99
What has led to markets becoming more contestable?
Technology - as they have low barriers and no sunk costs.
100
What does "contestability is a dynamic concept" mean?
An industry that is uncontestable, can become contestable.
101
Is the theory of contestability realistic?
There's no such thing as perfect contestability as it's a matter of extent. There may always be sunk costs and barriers.
102
How do regulators make a market more contestable.
Reduce barriers to entry by deregulation.
103
Define regulation?
Rules designed to improve the welfare of customers and stop abuse of a dominant position.
104
What is regulation designed to influence?
- Barriers to entry/exit.
- Product standards.
- Efficiency.
- Price.
105
What are the main objectives of the CMA.
1. Investigate when competition is weak.
2. Encourage competition.
3. Take action against firms, individuals and cartels.
106
What creates the case for government intervention?
The welfare loss on a monopoly diagram that shows output is restricted.
107
finish chapter on controlling monopolies.
108
define privatisation?
The transfer of assets from the public sector to the private sector.
109
define deregulation?
The removal of legal barriers from a market.
110
What are 4 arguments for privatisation?
1. Discipline of the free market - lead to business efficiency and therefore achieve economic welfare.
2. Efficiency - Lowering prices and more choice because of increased contestability.
3. Macro impacts - more growth.
4. Increased productivity - Share ownership for employees leads to more contribution, thus increasing productivity.
111
What are 4 arguments against privatisation?
1. Monopoly argument - Often creates a monopoly.
2. Safety and cutting costs - safety cuts and higher unemployment due to firing.
3. Poorer quality of service after privatisation.
4. Externalities - Energy intensive industries means firms don't pay attention to social costs.
112
What are some examples of why privatisation has not worked?
· High rail prices (fares are cheaper in other countries such as Germany)
· Under-investment by firms
· Delays and companies going into administration due to low profits.
113
When is privatisation likely to be most successful?
· If it is deregulated
· Regulation to prevent abuse.
114
Are there any industries which are unlikely to be privatised?
Any of national importance.
115
What are 4 argument for nationalisation?
1. Eliminates monopoly abuse.
2. Government has objective of environment so will pay attention to social costs from energy intensive industries.
3. Lower chances of delays and poor service. Can't go into administration.
4. No profit incentive, so no incentive to cut costs for shareholders. Will increase jobs and safety.
116
What are 3 argument against nationalisation?
1. The state doesn’t have the discipline of the free market. There will be X-inefficiency - higher prices.
2. Spending cuts mean government is unlikely to invest in modernisation.
3. Lack of dynamic efficiency unlike private firms.
117
What are some example of privatisation in the UK?
British airways.
British gas.
British telecom.
Royal mail.
