monopolist markets Flashcards
Allocative efficiency
When resources are distributed to the goods and services that consumers want. This maximises utility. Where P = MC, which means that consumers pay for the value of the marginal utility they derive from consuming the good or service. Free markets are considered to be allocatively efficient.
Productive efficiency definition and draw a diagram
This is when firms produce at the lowest point on the short run or long run average cost curve. Since the MC curve cuts the AC curve at the lowest point, MC = AC is a point of productive efficiency. All points on the PPF curve are productively efficient.
Dynamic efficiency
When all resources are allocated efficiently over time, and the rate of innovation is at the optimum level, which leads to falling in long run average costs. The market is dynamically efficient if consumers need and wants are met as time goes on. Related to the rate of innovation, which might lead to lower costs of production in the future, or the creation of new products.
What is dynamic efficiency affected by?
Short run factors such as demand, interest rates and past profitability.
X-inefficiency and show on a graph
When costs are higher than they would be with competition in the market.
What causes X-inefficiency?
Organisational slack, waste in the production process, poor management, or simply laziness. Often monopolies suffer from X-inefficiencies.
What are the characteristics of a perfectly competitive market?
Many buyers and sellers
Sellers are price takers
Free entry to and exit from the market
Perfect knowledge
Homogeneous goods
Firms are short run profit maximisers
Factors of production are perfectly mobile
Draw the short run equilibrium for a perfectly competitive market and explain it
The firm is a price taker, and it accepts the industry price of P1. In the short run, the firm produces an output of Q1. The yellow shaded rectangle shows the area of supernormal profits earned in the short run. It is assumed that firms are short run profit maximisers.
Draw and explain a diagram showing the long run equilibrium for a perfectly competitive market.
The supernormal profits made by an existing firm means that new firms have an incentive to enter the industry. As there are no barriers to entry in a perfectly competitive market, new firms are able to enter the industry.
This causes the supply in the market to increase, as shown by the shift in the supply curve from S to S1. The price level in the market falls as a consequence. Since firms are price takers they must accept this new, lower price.
Firms can only make normal profits in the long run.
Advantages on a perfectly competitive market
In the long run there is a lower price, P=MC, so there is allocative efficiency.
Since firms produce at the bottom of the AC curve, there is productive efficiency.
]
The supernormal profits produced in the short run might increase dynamic efficiency through investment.
Disadvantages of a perfectly competitive market.
In the long run, dynamic efficiency might be limited due to the lack of supernormal profits.
Since firms are small there are few or no economies of scale.
The assumptions of the model rarely apply in real life. In reality, branding, product differentiation, adverts and positive and negative externalities, mean that competition is imperfect.
Draw and explain a profit maximising firm in the short run
In the short run, firms profit maximise at the point MC = MR. The area P1C1AB represents the supernormal profits that firms in a monopolistically competitive market earn in the short run.
Draw and explain a profit maximising firm in the long run
In the long run new firms enter the market as they are attracted by the profits that existing firms are making. This makes the demand for the existing firms products more price elastic which shifts the AR curve (demand curve) to the left. Consequently, only normal profits can be made in the short run.
Disadvantages of monopolistically competitive markets
Firms are allocatively inefficient in the short and long run (P>MC)
Since firms do not fully exploit their factors, t
there is excess capacity in the market. This makes firms productively inefficient.
Dynamic efficiency might be limited due to the lack of supernormal profits in the market.
Firms are not as efficient as those in a perfectly competitive market. As they have little incentive to minimise their costs.
Advantages of monopolistically competitive markets
Consumers get a wide variety of choice.
The model of monopolistic competition is more realistic than perfect competition.
The supernormal profits produced in the short run might increase dynamic efficiency through investment.
