Pack 8 - Market structures part 1 Flashcards
What are the different kinds of economic efficiency?
allocative efficiency: meeting consumer needs and price = Marginal cost - more likely in competitive market
Productive efficiency: minimising production costs - minimum AC - likely in competitive as lower AC needed to reduce prices
X-inefficiency: rising average costs due to lack of competitive pressure - pure-monopoly (less competition and AC may rise)
Dynamic Efficiency: economic efficiency over time e.g innovation and R&D - pure monopoly (have profits to reinvest)
What is perfect competition and its characteristics?
- large number of buyers/sellers
- freedom of entry/exit
- homogeneous products: identical so no branding present to differentiate between firms
- perfect knowledge: so if one firm were to charge higher, all customers go to competitors so firms must accept market price
- firms are price takers
What type of profits to firms in perfect competition make in the long run?
- only make normal profits in the long run: if firm earn supernormal profits, new firms can enter market due to low barriers of entry/perfect information. Lead to increase in supply/lower prices until only normal profits made
- similarly if firms make a loss then firms will exit market due to low barriers to exit/perfect information and so reduce supply and increase price until normal profits made again
How does a firm know whether to shut down in the short-run/long run in perfect competition?
Shutting down in the short-run:
- if price is below AVC: will make a negative contribution to paying back fixed costs and therefore increasing their losses by remaining in business
Shutting down in the short-run:
and so increasing losses by remaining in business
- if price is above AVC: can make a positive contribution to aging back field costs and therefore minimising their losses by remaining in business
to stay in business in short-run firms must cover variable costs
Shutting down in long run:
- if price below AC: business is making a loss and so will shut down in long run
- if price above AC: making supernormal profits and will continue to operate in the long run
to stay in business in the long-run firms must cover all costs
What are the shut down points in perfect competition?
- short run: price must exceed AVC, shut down point: price=AVC
- long run: all costs must be covered to remain in business, shut down point - price=AC
What happens in the long run perfect competition when firms make supernormal profits?
- perfect information/low barriers to entry more firms enter = higher supply = lower price
- continue until all firms are making normal profits
- due to lower price/increased competition each firm will produce less
- however, industry produce more as more individual firms producing
What happens in long run perfect competition when firms are making losses?
- firms will exit market without cost due to low barriers to exit
- reduce industry supply/raise industry price
- continue until firms are making normal profits
- due to higher price/decreased competition each firm will produce more
- industry as a whole produce less
Perfect competition and Economic efficiency
Allocative : always as they are price-takers, so always set Price = marginal cost and so social welfare maximized
Productive efficiency: not in short run as not minimising AC, are in long run
Dynamic efficiency: unlikely as normal profits in long run so little money available to invest
X-inefficiency: no as highly competitive
Monopoly characteristics
- set marginal cost = Marginal revenue and so maximize profits
- one single firm in the market (pure monopoly)
- high barriers to entry - branding, patents, start up costs
- price makers
What are the main sources of monopoly power for a firm?
- strong barriers to entry and exit
- high degree of product differentiation -gain a higher market share
What is a natural monopoly?
- when due to EOS an industry s best served by a single supplier
- occurs where LRAC falls over wider range of output levels so there may only be room for one supplier to fully exploit all the economies of scale
Shifts on monopoly diagram:
Changes in demand
Changes in fixed costs
Changes in Variable costs
Demand: shift AR and MR
Fixed costs: shit AC not MC
Variable cost: shift both AC and MC
Monopoly and economic efficiency
Allocative efficiency:
- not be as have to price above MC to increase supernormal profit = deadweight loss (reduction in social welfare)
Productive efficiency:
- not as not minimising AC
Dynamic efficiency:
- potential due to high levels of supernormal profits which could be re-invested
- however, may not have incentive to innovate, as an already dominant firm
X-inefficiency:
- more likely
- not much competition means AC being higher than competitive level due to inefficient workers/fringe benefits
Cost and benefits of monopolies for firms
Benefits:
- should be able to set higher pries and earn supernormal profits:
- should benefit owners (higher return on investment = higher income)
- used by firm to invest
- can offset short-term losses
- gain economies of scale as dominate market = higher profit margin due to lower LRAC
- able to compete internationally
Costs:
- face greater regulation and scrutiny
- may experience rising costs: diseconomies of scale/X-inefficiency
- may not innovate and could suffer from creative destruction: e.g growth of online streaming disrupting film industry
Costs and benefits of monopolies for consumers
Benefits:
- benefit from innovation and R&D: better products
- gain lower prices from economies of scale
- benefit from cross-subsidization: where a firm decides to fund loss from one product by raising the price of another = widening range of products = more choice e.g universities charging higher fees for foreign students to partly fund cheaper places for domestic students
Costs:
- suffer from higher prices
- lack of choice of quality products
Costs and benefits of monopolies for Suppliers
Benefits:
- benefit from higher sales and profits e.g if food manufacturer can get produce into major supermarket, much higher potential for sales/profits as more potential customers
- benefit from a long term relationship with monopoly: can plan to work with monopoly over several year without fear of going out of business - security
Costs:
- may be exploited:
- monopsony power - if monopolist one of the only firms who buys their product, may suffer from lower prices
Costs and benefits of monopolies for employees
Benefits:
- high levels of employment and job security: profits to remain in business in long run even if losses in the short run
- may gain higher wages and bonuses as should be able to reward employees
Costs:
- may have fewer employment opportunities: due to lower output level of the monopolist as they will restrict output in order to raise price/maximise profit and so lower derived demand for Labour
- may be exploited by employer as could drive wages down if one of major employers int he area
Conditions for price discrimination
- two distinguishable markets with different PED
- market power - price (so consumers don’t switch to rivals)
- no arbitrage (reselling)
What is price discrimination/how does it work?
- where a firm sells the same product, at a different price in different markets
- in effect, companies are appropriating consumer surplus to increase TR as charging consumers nearer to their willingness and ability to pay
- increase price in market with price inelastic demand: increase TR as increase in price only lead to less than proportionate change in demand
- Decrease price in market with price elastic demand:
- increase total revenue as decrease in price lead to more than proportionate change in demand
Costs and benefits of price discrimination on producers
Benefits:
- increased TR and profits:
Knock on benefits:
- supernormal profits benefit owners
- supernormal profits used by firms to invest into areas
- supernormal profits can offset short-term losses
- can use price discrimination to prevent entry into the market by lowering price in one market so other entrants cannot compete
- lower prices can boost consumer loyalty - higher inelastic demand
Costs:
- could face higher costs, outweighing increase in TR: need to put in measures to stop arbitrage, can be cheap e.g student cinema tickets checked but may be expensive e.g preventing medicine being smuggled and resold from LEDCS to MEDCs
- could lead to greater chance of investigation by competition authorities
Costs and benefits of price discrimination of consumers
Benefits:
- some consumers gain lower prices than before: e.g student cinema goers
- consumers benefit if producers use monopoly profits to invest in innovation and R&D: improved quality
- more choice open to consumers: loss making product subsidised by other highly-profitable markets
Costs:
- some consumers pay higher prices
- higher profits may be used to strengthen barriers to entry and increase inefficiency: less incentive to be efficient/innovate if dominant firm already
different business objectives
profit maximisation - firm sets marginal revenue equal to marginal cost in order to maximise the difference between total revenue and total cost.
revenue maximisation - sets marginal revenue equal to zero in order to maximise total revenue gained.
sales maximisation - firm sets TR = TC (or AC = AR) in order to maximise sales without making a loss.
satisficing: aims for a satisfactory or adequate result, rather than the optimal solution
reasons for revenue maximisation
- marginal revenue equal to zero.
- benefits to managers: if judged by sales revenue, increase rewards also if want to grown firm
- higher market share: monopoly power, ability to increase prices in future, also EOS
reasons for sales maximisation
- Entry deterrence and long-run profit maximisation: new entrants may not be able to compete with low price
- lowering its price hoped firm will gain brand loyalty
- long term monopolist will hope to be able to raise its price
- social or ethical reasons: could be because the good or service provides benefits to the local community or society in general, such as life-saving medicines or a local youth centre in a local town.
