Micro – Market Power Flashcards
What are the types of Market Structures?
1) Perfect Competition
2) Monopolistic Competition
3) Oligopoly
4) Monopoly
What is Market Power?
The extent to which each individual firm in the industry is able to control the price at which it sells its product. However, the greater the market power the greater the allocative inefficiency.
What are the Characteristics of Perfect Competition?
- Large number of firms in the industry
- Selling of homogeneous products
- No barriers to entry
What are the Characteristics of Monopoly?
- Single or dominant firm in the industry
- Selling of unique goods (no close substitutes)
- High barriers to entry
What are the Characteristics of Monopolistic Competition?
- Fairly large number of firms
- There is product differentiation
- No barriers to entry
What are the Characteristics of Oligopoly?
- Small number of large firms
- Products either differentiated or not
- High barriers to entry
What is Revenue?
Payments firms receive when they sell the goods and services they produce. There are three types: total, average and marginal revenue.
Define and Calculate Total Revenue
Amount of money obtained by the selling of goods.
TR = P x Q
Define and Calculate Average Revenue
Revenue per unit of output sold (always equal to price).
AR = TR / Q
Define and Calculate Marginal Revenue
The additional revenue for each additional output sold.
MR = Change in TR / Change in Q
What are Costs of Production?
Money payments made by a firm to buy factors of production (and anything else given up by a firm for the use of resources). There are three types: total, average and marginal cost.
Define and explain the Difference between Implicit and Explicit Costs
Explicit costs are payments made by a firm to acquire factors of production. Implicit costs is the sacrificed income arising from the use of self-owned resources.
Define Total Cost
Total cost incurred by a firm that undertakes the production of a good/service.
Define and Calculate Average Cost
Cost per unit of output produced.
AC = TC / Q
Define and Calculate Marginal Cost
Extra cost of producing each additional output.
MC = Change in TC / Change in Q
What is the Relationship between the AC and MC in the Short-run?
When MC < AC average cost is falling, when MC > AC average cost is increasing. The MC curve will always intercept the AC curve when AC is at its minimum.
What happens to Average Costs in the Long-run?
Average costs will decrease when economies of scale are achieved (first section of U shape), in the long-run however, average costs will increase as diseconomies of scale will prevail (last section of U shape).
What are Economies of Scale?
Decreases in average costs of production over the long run as a firm increases all its factors of production.
What are the factors contributing to Economies of Scale?
1) Specialization of labor
2) Specialization of management
3) Bulk buying of inputs
4) Financing economies
5) Spreading of costs over large volume of output
What are Diseconomies of Scale?
Increases in average costs of production in the long-run as a firm increases its output by increasing all its factor of production.
What are the factors contributing to Diseconomies of Scale?
1) Coordination and monitoring difficulties
2) Communication difficulties
3) Poor worker motivation
What is Profit?
Payment per unit of time to owners of entrepreneurship. Takes the form of abnormal, normal and negative (loss).
What is Profit Maximization?
Determining the level of output at which the firm will produce the highest level of profit. It can be identified by either analyzing TC and TR, or MR and MC.
How can we calculate Profit using TR and TC?
Profit = TR - TC
What are the Types of Profit according to TR and TC?
Abnormal: TR > TC
Normal: TR = TC
Loss: TR < TC
How can we identify Profit Maximization with MR and MC?
Occurs at point where MR = MC
What is Normal Profit?
The minimum amount of revenue that the firm must receive so that it will keep the business running. It is equal to zero.
What does the Revenue Curve look like in Perfect Competition?
In perfect competition, the demand curve represents marginal and average revenue. The curve is perfectly elastic at the price determined by the market. This makes the firm a price-taker.
How does a firm in Perfect Competition Maximise Profit in the Short-Run?
As the firm cannot influence the price it must make a choice on the quantity of output it should produce to maximise profit. This can be found where MC = MR.
State and describe the Levels of Profit Firms can Achieve in any Market Structure
Abnormal: AR > AC
Normal: AR = AC
Loss: AR < AC
What happens to Profit Maximization of a Perfect Competition firm in the Long-run?
The firm will earn normal profit, this is due to the low barriers of entry which allow firms to enter and exit the market so that prices fluctuate in the long-run.
When is Allocative Efficiency achieved?
When MB = MC (hence firms produce the combination of goods preferred by consumers).
Evaluate Allocative Efficiency in Perfect Competition
In the long-run, firms in perfect competition will achieve allocative efficiency (this is the only market structure in which it occurs).
What are the Advantages of Perfect Competition?
1) Achieves allocative efficiency
2) Low prices for consumers
3) Eliminates inefficient producers (due to competition)
4) Market responds to consumer tastes
What are the Disadvantages of Perfect Competition?
1) Unrealistic assumptions
2) Cannot use economies of scale (too small)
3) Lack of product variety
4) Lack of development (cannot afford to invest)
What are Natural Monopolies?
Firms that have economies of scale so large they can produce for an entire market without exhausting their economies of scale.
What are the Barriers to Entry established by a Monopoly?
1) Economies of scale (very large)
2) Natural monopolies
3) Branding
4) Legal barriers (patents/copyright/licenses/quotas)
5) Control of essential resources
6) Aggressive tactics against entrant
What does the Revenue Curve look like in Monopoly?
The curve is downward sloping as monopolies have a large ability to control prices (this makes them price-makers). The AR curve is equal to the price and represents the demand curve. MR instead, is shown on a separate downwarding curve as the firm must lower its price to produce extra units of output.
What is the Relationship between TR and MR in all Market Structures except for Perfect Competition?
TR is shown as an inverse U shape; when price increases TR will also increase until reaching its maximum price where it will decrease. MR is equal to 0 at the point where TR is at its maximum, whereas as TR decreases MR will be negative.
What happens to Profit Maximization of a Monopoly firm in the Long-run?
The firm can continue making abnormal profit in the long-run as its high barriers to entry will prevent firms to enter the industry.
What does a Natural Monopoly’s diagram look like?
The demand curve will intersect the LRAC curve at the point where AC is falling. At equilibrium the firm achieves economies of scale however producing at any quantity larger will cause a loss.
Interpret Market Demand for a Product cutting into LRAC when this is Falling
It illustrates a Natural Monopoly as it shows a single large firm can produce for the entire market at a lower average cost than two or more smaller firms.
What are the outcomes of Monopoly on the Market?
There is lower output at higher prices causing:
• Loss of consumer and producer surplus
• Welfare loss (market failure)
• Allocative inefficiency (underallocation)
What are the Disadvantages of a Monopoly?
1) Market failure (welfare loss and inefficiency)
2) Higher price and lower output
3) Loss of consumer surplus
4) Negative impacts on distribution of income
5) Lack of competition
6) Less innovative
What are the Advantages of a Monopoly?
1) Economies of scale
2) Natural monopoly
3) Technological innovation
What is Product Differentiation?
When products differ between firms, can be achieved by:
• Physical differences
• Quality differences
• Location (e.g. hotels, airports)
• Services (e.g. home delivery)
• Product image (e.g. brand, advertisement)
What does the Demand Curve look like in Monopolistic Competition?
Less elastic than in perfect competition, more elastic than monopoly.
What is Price and Non-price Competition?
Price competition occurs when a firm lowers its price to attract consumers away from rival firms. Non-price competition occurs when a firm uses product differentiation to attract consumers away from rival firms.
What type of Competition is exhibited in Monopolistic Competition?
Price and Non-price competition.
What happens to Profit Maximization of a Monopolistic Competition firm in the Long-run?
Firms will earn normal profit as barriers to entry are low and therefore firms exit and enter the market causing price fluctuations.
What are the outcomes of Monopolistic Competition on the Market?
MB > MC indicating there is market failure and underallocation of resources (hence allocative inefficiency). This is caused by product differentiation which gives up efficiency.
What are the Advantages of Monopolistic Competition?
1) Eliminates inefficient producers (due to competition)
2) Product variety (more choice to consumers)
3) Can achieve economies of scale (small level)
What are the Disadvantages of Monopolistic Competition?
1) Market failure (underallocation of resources)
What is Collusive Oligopoly?
Situation in which firms decide to collude or form an agreement between themselves to limit competition, increase market power and profit.
What is Non-collusive Oligopoly?
Oligopolistic firms which do not collude in any way.
What are the types of Collusion?
1) Cartels (formal agreement)
2) Informal collusion (implicit without a formal agreement)
3) Price leadership (dominant firm sets prices)
What are the Features of Firms inside Oligopoly?
1) Interdependence (strategic behavior)
2) Risk of Price war
3) Incentive to collude
4) Incentive to cheat (inside a collusion)
Explain Price and Non-price Competition in Oligopoly
Oligopolistic firms tend to avoid price competition as there is a high risk to result in a price war. Hence, they will usually engage in non-price competition through product development, advertising, branding, etc.
What are the Outcomes of Collusive Oligopoly on the Market?
Collusive oligopolies behave like a monopoly therefore there is underallocation of resources: higher prices for lower output. This causes market failure, welfare loss and allocative inefficiency.
What are the Outcomes of Non-collusive Oligopoly on the Market?
Non-collusive oligopolies also cause market failure as the market produces a level of output that is below the social optimum. Underallocation of resources results in market failure, welfare loss and allocative inefficiency.
What is Game Theory?
A mathematical technique which analyses the behavior of decision-makers who are dependent on each other and who display strategic behavior.
Explain the Simple Game Theory Pay-off Matrix
The Pay-off matrix shows all possible combinations of outcomes of different decisions made by the players in game theory.
Explain Game Theory in the context of the Prisoner’s Dilemma
The Prisoner’s dilemma illustrates the conflict between the pursuit of individual self-interest and the collective firm interest. The final position resulting from the game is called Nash Equilibrium.
What are Market Concentration Ratios?
Provides an indication of the percentage of output produced by the largest firms in an industry. The higher the concentration ratio the lower the degree of competition.
What are the Advantages of Oligopoly?
1) Economies of scale are achieved
2) Product development
3) Technological innovation
4) Product variety
What are the Disadvantages of Oligopoly?
1) Market failure
2) Loss of consumer surplus
3) Negative impacts on income distributions
4) Higher production costs due to lack of competition
5) Less innovative (lack of competition)
6) Collusion is illegal
What are the Advantages of Firms with Significant Market Power?
1) Economies of scale
2) Research and development
What are the Disadvantages of Firms with Significant Market Power?
- Allocative inefficiency
- Loss of consumer surplus
- Higher than necessary AC
- Less innovative
- Negative impact on distribution of income
What is Abuse of Market Power?
Situations where firms engage in activities that result in reduced competition.
What Legislation can the Government use to protect Competition?
1) Competition policy (preventing collusion)
2) Merger Policy (limits on size of combined firms)
3) Fines
What are the Limitations of Government Legislation to protect Competition?
- Difficulties in interpreting the legislation
- International differences
- Difficulty in providing evidence of collusion
- Uncertainties of which firms are allowed to merge
How can the Government solve Natural Monopoly?
1) Nationalize firm (government ownership)
2) Marginal cost pricing (to achieve all. eff.)
3) Average cost pricing (firm makes normal profit)
