Module 7 - Perfect Competition And Monopoly Flashcards
Perfect Competition
A market structure in which there are many firms; where there is freedom of entry to the industry; where all firms produce an identical product; and where all firms are price takers.
Monopolistic Competition
A market structure where, like perfect competition, there are many firms and freedom of entry into the industry, but where each firm produces a differentiated product and thus has some control over its price.
Oligopoly
A market structure where there are few enough firms to enable barriers to be erected against the entry of new firms.
Monopoly
A market structure where there is only one firm in the industry.
Imperfect Competition
The collective name for monopolistic competition and oligopoly.
Factors that determine the market power of a firm
- Number of firms in the industry
- Freedom of entry into and exit from the industry
- Nature of the product
- Degree of control the firm has over the price (and the implications of this for the firm’s demand curve)
Four assumptions under perfect competition
- Firms are price takers.
- There is complete freedom of entry into the industry.
- Firms produce an identical (homogeneous) product.
- Producers and consumers have perfect knowledge of the market. (producers are fully aware of prices, costs, technology and market opportunities. consumers are fully aware of price, quality and availability of the prodict.)
Short run under perfect competition
The period during which there is too little time for new firms to enter the industry.
Long run under perfect competition
The period of time which is long enough for new firms to enter the industry.
Economic efficiency
Economic efficiency is achieved when:
- Output is produced at the minimum cost (productive efficiency)
- Consumers get maximum benefit from their income (allocative efficiency)
Productive efficiency
A situation where firms are producing the maximum output for a given amount of inputs, or producing a given output at the least cost.
Allocative efficiency
A situation where the current combination of goods produced and sold gives the maximum satisfaction for each consumer at their current levels of income.
Social optimum
The level of output at which allocative efficiency is achieved.
Discuss the extend to which perfect competition is economically efficient
Firms operating under perfect competition must be:
- efficient in order to survive
- ready to respond if competitors:
- adopt more efficient production methods
- develop new products
The consumer benefits from allocative efficiency and to some extend productive efficiency. In addition, in the long run, only normal profits are earned, so prices are reasonable and consumers are not exploited.
Describe the main features of a monopoly
In principle, a monopoly is an industry with only one firm. However whether an industry is classed as a monopoly in practice depends on the breadth of the definition of the industry. Since the definition is somewhat arbitrary, the level of monopoly power may be deemed to be more important.
Natural monopoly
A situation where long run average costs would be lower if an industry were under monopoly than if it were shared between two or more competitors.
Describe the barriers to entry that may exist
Natural barriers to entry:
- Economies of scale
- Economies of scope
- Lower costs for an established firm
Strategic barriers to entry:
- Product differentiation and brand loyalty
- Ownership or control over key inputs or outlets
- Threat or merger / takeover
- Retained profits and aggressive tactics
Legal production can be classed as natural (licence) or strategic (patent)
Explain how monopolists determine price and output
A monopolist:
- is a price maker, i.e it can choose the price it charges
- will set price and output to maximise profits (MR = MC)
Discuss how much profit may be made by a monopolist
A monopolist can make supernormal profits in both the short run and the long run because of barrier to entry.
Competition for corporate control
The competition for the control of companies through takeover.
Network economies
The benefits to consumers of having a network of other people using the same product or service.
Compare perfect competition and monopoly in terms of price and output levels
All other things being equal:
1. A monopolist will produce at a lower output and a higher price in the short run - a monopolist will produce at MR = MC, and the price will be AR; firms under perfect competition will set price equal to MC and the industry will produce where MC = AR
- A monopolist may also produce at a lower output and a higher price in the long run - firms under perfect competition will produce at the bottom of their LRAC curves; a monopolist is not forced to produce at this level.
Compare perfect competition and monopoly in terms of economic efficiency
Productive efficiency:
Firms in perfect competition produce at minimum average cost in the long run, whereas monopolist in general do not.
Monopolists have less incentive to be efficient, because they are protected by barriers to entry and will survive even if they are inefficient. However, monopolists may have greater ability to maximise efficiency.
Allocative efficiency:
Under perfect competition, firms produce at the social optimum level. Under monopoly, the firm produces less than the social optimum output level. (A state-owned monopoly may choose to produce at the social optimum)
Perfect contestable market
A market where there is free and costless entry and exit.
Describe how price and profit are affected in a perfectly contestable market
The moment the possibility of earning supernormal profits occur, new firms will enter, thus driving profits down to a normal level. Therefore this will ensure that the firm already in the market will keep its prices down, so that it just makes normal profits.
Describe how efficiency is affected in a perfectly contestable market
The firm already in the market will produce as efficiently as possible, taking advantage of any economies of scale and any new technology. If the existing firm did not do this, entry would take place and potential competition would become actual competition.
Distinguish between actual competition and potential competition
The theory of contestable markets argues that what is crucial in determining the price and output is not whether an industry is actually a monopoly or competitive, but whether there is the real threat of competition.
State the importance of costless exit in perfectly contestable markets
If the losing firm exits the industry with capital equipment that it cannot use, then it is said to have sunk costs. This may deter the firm from entering in the first place, the market is not perfectly contestable and the established firm can make supernormal profit.
Discuss the strengths/limitations of the theory of contestable markets
Simple monopoly theory merely focuses on the existing structure of the industry and makes no allowance for potential competition. The theory of contestable markets, however, goes much further and examines the size of entry barriers and exit costs.
One criticism of the theory is that it does not take sufficient account of the possible reactions of the established firm.
If a monopoly operates in a perfectly contestable market, it might bring the ‘best of both worlds’ for the consumer. Not only will it be able to achieve low costs through economies of scale, but also the potential competition will keep profits and hence prices down.
