Pack 9 - market Structures Flashcards
characteristics of monopolistic competition
- large number of buyers and sellers
- low barriers to entry and exit
- product differentiation: small amount of market power and ability to be price maker
Monopolistic competition and efficiency
- Allocative efficiency: never achieve it as set price above marginal cost
- Productive efficiency: not producing at the minimum point of their AC so not productively efficient in short or long run
- Dynamic efficiency: unable to earn supernormal profits in the long-run and so cannot fund R&D
- X-inefficiency: unlikely due to high number of firms
characteristics of oligopoly
- high concentration ratio
- high barriers to entry and exit
- product differentiation
- interdependence: actions of one firm directly affect another firm
concentration ratio
total market share that the top n-firms have
limitations of concentration ratios
- Problem defining the market
- Concentration ratios may be misleading
reasons for non-collusive behaviour
- higher profits: gain more customers = higher revenue and profits
- greater monopoly power: if firms able to gain customers at expense of their rivals, should increase market share, which hopefully can be maintained over time by increased barriers to entry due to brand loyalty, greater economies of scale
- issues with collusion: could breakdown/jail time
different types of price competition
limit pricing
predatory pricing
price wars
limit pricing
- setting price below an entrant’s average costs as to deter entry
- although this could reduce their profits, still be making a profit, as average cost likely to be lower due to economies of scale
- also increase market share due to lower price an can have long term benefits as will attract more customers and hopefully allow greater brand loyalty over time = long run profits
Evaluate:
- reduce profits in short run
- more successful if the business is dominant and has significant economies of scale
- firms may enter with a better product to justify a higher price or retained profits from another industry which enables them to sustain a loss for a short time
predatory pricing
- price below average variable cost in an attempt to force rivals out of a market
- illegal
- dominant firm able to sustain the loss for much longer than smaller firms due to having retained profits from previous years, so once other firms have left the market can increase prices again to earn supernormal profits in long-run
Evaluation:
- illegal, so face fines if caught
- short-term losses which will damage profitability at least in short run
- may not deter entry to market, as firms may observe the high level of supernormal profits made when prices rise again and enter the market to compete with dominant firm
price war
- situation where several firms repeatedly lower prices to outcompete other firms, such as to defend market share
Reasons: - to protect market share: maintain market share even if profits are falling
- to use some products as loss leaders: whilst product that is experiencing a price war is making a loss, it may attract other customers to use their business/purchase other products
- to eliminate competition:example of predatory pricing
Evaluation:
- damage to short-run profits and losses incurred
- can be illegal if price drops below AVC
other pricing strategies
- cost plus pricing: firms place a mark-up on average cost (size depends on level of competition)
- premium pricing: pricing high to signal high quality
- penetration pricing: initially pricing low in order to introduce a product
- price skimming: pricing a product and then gradually reducing price over time
- loss leaders: pricing a product low in order to attract customers to the store in order to buy other higher priced products
- price leadership: price leader with sufficient market power decided to change price in hope all other firms will follow to increase overall industry profits
types of non-price competition
-
advertising: activity of attracting public attention
- impact on firm’s costs, so revenue gained must outweigh this and must be effective -
sales promotion:
- loyalty card scheme, competitions etc to boost sales and gain higher market share
- EV: may only boost short-term sales/side-effects of promotions if consumers confused -
Product Launch:
- offering new/improved brand could boost sales, profits and market share
- loyalty = strong barrier to entry
- EV: cost of redesigning product/research costs, also success depends on customer needs -
Place (or distribution decisions):
- e.g setting up online -
customer service:
- repeat purchasers who are brand loyal so boost sales and profits
EV: incur costs, such as better provision of staff training
what is collusion
- collective agreements between firms not to compete with each other in attempt to increase industry profits/restrict competition
factors that make collusion easier
- high concentration: only few firms easier
- similar firms: consumers have no reason to go to one firm over another
- competition policy is ineffective:
- less likely to be fined
reasons for collusive behaviour
- higher prices and profits: should be able to increase price as customers will have no option but to purchase as the higher price
- reduced competition and cost of competing:
- Reduced uncertainty: not competing with one another, instead working together
- failure of competition authorities
overt collusion
- firms agree to restrict competition using a formal agreement
- formal collusive agreement is called a cartel
benefits:
- each firm explicitly knows what to do with prices and when: less confusion and easier to manage
however: easier for competition authorities to prove collusion
tacit collusion
- firms agree to restrict competition without a formal agreement
- one way it can occur is through price leadership, price leader changes their price and other firms in the market match the price change
- so price leaders can without communicating with other firms formally engineer a situation where prices of all firms have risen
Benefits:
- help conceal firms behaviour as without hard evidence harder for authorities to prosecute
however: harder to manage without formal agreement and is still illegal
Evaluating game theory
-
information gaps:
- relies on all agents in the game to know the outcomes and have perfect information, however may not be true if information gaps -
assumptions used in game theory:
- many simplifications, e.g only two firms in the market so never completely accurate model
- another key assumption is rational economic behaviour, but if this not the case
- e.g habitual behaviour or herding behaviour
- alternative business objectives
oligopoly and efficiency
allocative efficiency:
- not achieve it
- because they are price makers
- significant deadweight loss in collusive oligopoly
- higher consumer welfare/associated allocative efficiency in non-collusive oligopoly
Productive efficiency:
- no as do not minimise average costs
Dynamic efficiency:
- able to earn supernormal profits due to high barriers to entry/exit
- so yes
X-inefficiency:
- due to market power yes
what is monopsony power
few dominant/powerful buyers
pure monopsony = single buyer
factors reducing monopsony power
- more buyers set-up: more chance for suppliers to negotiate a better deal, as can sell to other firms if given unfair price
- suppliers become more powerful: if suppliers gain more market share = more negotiation power
impact on firm with monopsony power
Benefits:
- lower cost of supplies
- higher profits: if keep price same, earn a higher profit margin
However:
- issue with quality/reliability: if supplier forced to cut costs to survive
- reduce choice of suppliers in future: if put suppliers out of business
- damage to brand image and fines: if exploiting suppliers
Impact of monopsony on suppliers
Costs:
- lower prices: must offer competitive price to gain a deal as do not have much negotiating power
- lower profits and chance of survival
However:
- some suppliers are less affected
- increased chance of sales: if signing large, long term contract with big supplier e.g Tesco
Impact of monopsony on employees
- employment prospects and job security: higher profits for monopsony so business less likely to shut down
- however: workforce of suppliers may lose jobs if they are forced to cut costs
- wages and living standards: higher if high profits for monopsony but could be opposite if work for supplier
