Perfect comp, Imperfectly competitive markets and Monopoly

Question 1

Difference between Static and Dynamic efficiency

Answer 1

Static efficiency is about maximizing efficiency at a given point in time, while dynamic efficiency is about achieving efficiency over time by adapting to changing conditions.

Question 2

Conditions for productive and allocative efficiency

Answer 2

Productive - Minimising average total costs (bottom of the AC curve)
Allocative - P=MC

Question 3

Influences of Dynamic efficiency

Answer 3

Focus: Dynamic efficiency looks beyond the current moment and considers the effects of investments in innovation, research and development, human capital, and technological progress. It assesses how well an economy or firm can adapt and improve its performance over time.
Market Evolution: In dynamic efficiency, markets are viewed as evolving over time due to technological advancements, changes in consumer preferences, and shifts in the competitive landscape. It recognizes that markets are not static and that innovation and adaptation are critical for long-term prosperity.
Schumpeterian Competition: The concept of Schumpeterian competition, introduced by economist Joseph Schumpeter, is closely associated with dynamic efficiency. Schumpeterian competition emphasizes the role of innovation, creative destruction (replacing old technologies with new ones), and entrepreneurship in driving economic progress.
Examples: Evaluating the long-term economic growth of a country, assessing the effectiveness of a firm’s research and development activities, and studying the impact of innovation on an industry’s competitiveness are examples of dynamic efficiency analysis.

Question 4

Objectives of firms

Answer 4

• profit max
• satisficing
• market share (growth)
• corporate social responsibility
• quality

Question 5

Profit max rule

Answer 5

MC=MR

Question 6

Divorce between ownership and control

Answer 6

A divorce between ownership and control happens when an owner of a business does not control and does not get involved in the day-to-day decisions of the business. Instead, the decisions are made by Managers and directors. Both components are self-interested.

Question 7

The satisficing principle

Answer 7

Satisficing behaviour is an alternative business objective to maximising profits. It means a business is making enough profit to keep shareholders happy or it’s sufficient for investors to maintain confidence in the management they appoint. Satisficers may be the managers who are more concerned with increasing sales revenue or market share instead of seeking pure profit maximisation.

Question 8

In perfect competition why is the demand curve perfectly elastic?

Answer 8

Because firms receive nothing if they raise their prices.

Question 9

Efficiency of PC

Answer 9

Firms will be allocatively efficient P=MC
Firms will be productively efficient. Lowest point on AC curve.
Firms have to remain efficient otherwise they will go out of business. (X-efficiency)
Firms are unlikely to be dynamically efficient because they have no profits to invest in research and development.
If there are high fixed costs, firms will not benefit from efficiencies of scale.
see more: efficiency of perfect competition

Question 10

Examples of PC

Answer 10

Foreign exchange markets. Here currency is all homogeneous. Also, traders will have access to many different buyers and sellers. There will be good information about relative prices. When buying currency it is easy to compare prices
Agricultural markets. In some cases, there are several farmers selling identical products to the market, and many buyers. At the market, it is easy to compare prices. Therefore, agricultural markets often get close to perfect competition.
Internet related industries. The internet has made many markets closer to perfect competition because the internet has made it very easy to compare prices, quickly and efficiently (perfect information). Also, the internet has made barriers to entry lower. For example, selling a popular good on the internet through a service like e-bay is close to perfect competition. It is easy to compare the prices of books and buy from the cheapest. The internet has enabled the price of many books to fall in price so that firms selling books on the internet are only making normal profits.

Question 11

Implications of characteristics of PC

Answer 11

No firms can take competitive advantage
No way to generate any market/monopoly power
Firms are price-takers
If a firm produces more units the market won’t change

Question 12

Monopolistic comp

Answer 12

Monopolistic competition exists when many companies offer competing products or services that are similar, but not perfect, substitutes.
All same characteristics as PC but prod diff allows firms to be price-makers in their market segment.

Question 13

Diagram + efficiency of MC

Answer 13

Downward sloping D curve due to product differentiation.
A monopolistically competitive firm is not productively efficient because it does not produce at the minimum of its average cost curve. A monopolistically competitive firm is not allocatively efficient because it does not produce where P = MC, but instead produces where P > MC.

Question 14

Non-price comp

Answer 14

Non-price competition is a strategy that implies attracting customers and increasing sales by providing superior product quality, a unique selling proposition, a great location, and excellent service rather than lower prices. It helps brands stand out and win new consumers.

Question 15

Monopoly

Answer 15

A monopoly is a market structure where a single seller or producer assumes a dominant position in an industry or a sector.
- one large firm
- barriers to entry and exit
- differentiated products

Question 16

Barriers to entry

Answer 16

• Legal: e.g. patents, allow an existing firm the legal right to be the exclusive supplier of a good.
• Advertising/marketing budgets: large budgets mean larger advertisements which read a wider audience.
• Research and development budgets: supernormal profit in the LR means they can invest in research and development to innovate and be better than smaller firms.
• Limit pricing: the threat that the existing firm may undercut smaller firms.
• Sunk costs: fixed costs which are not recoverable if a firm leaves the market.

Question 17

Why might a monopoly be inefficient?

Answer 17

• social welfare loss
• overpricing
• can be dynamically inefficient but depends on motives
  A monopoly is less efficient in total gains from trade than a competitive market. Monopolies can become inefficient and less innovative over time because they do not have to compete with other producers in a marketplace.

Question 18

Benefits of monopolies

Answer 18

• gov can control some monopolies, protecting consumers from overpricing
• consistency
• standard product
• Dynamically efficient
• High profits contribute to tax rev
• natural monopoly
• economies of scale
• internationally competitive

Question 19

Monopoly model

Answer 19

Monopoly demand curve is downward sloping.

Question 20

oligopoly

Answer 20

Few large firms dominating the market. I.e. 4 firms w/ 70% market share. High barriers to entry, differentiated products, interdependency, price rigidity.

Question 21

Cartel

Answer 21

Group of firms that engage in collusion. 83% of cartels have 5 or fewer members. Behave like a monopoly = consumer exploitation.

Question 22

Price wars

Answer 22

A price war is a competitive exchange among rival companies who lower the price points on their products, in a strategic attempt to undercut one another and capture greater market share. A price war may be used to increase revenue in the short term, or it may be employed as a longer-term strategy. Gives firms a more competitive outcome = better for consumers. May also compete on non-price factors such as marketing which could result in a better quality product for the consumer.

Question 23

Tacit collusion

Answer 23

is a type of collusive behaviour where firms coordinate their actions without explicitly communicating or reaching an agreement. Instead, firms may signal their intentions through various actions, such as pricing behaviour or output levels, in order to coordinate their behaviour and achieve higher profits.

Question 24

Overt collusion

Answer 24

Illegal. Competition markets authority will try to regulate this through fines etc and way to make firms be more competitive. firms openly agree on price, output, and other decisions aimed at achieving monopoly profits. Firms that coordinate their activities through overt collusion and by forming collusive coordinating mechanisms make up a cartel. Firms form a cartel to gain monopoly power.

Question 25

Kinked demand curve

Answer 25

A kinked demand curve refers to a demand curve that is not linear but has different degrees of elasticity at different price levels. It has higher elasticity for prices above the market price and lower elasticity for prices below the market price.

Question 26

Game theory

Answer 26

Game theory is a framework for modelling scenarios in which conflicts of interest exist among the players.

Question 27

Incumbent firms

Answer 27

Incumbent firms are businesses already established in each market or industry. They may have the advantages of having built up a loyal base of customers and also achieved internal economies of scale so that their average costs are lower than those of a rival / challenger supplier or brand.

Question 28

Interdependency

Answer 28

Interdependence means that the firms in the market must take into account the likely reactions of their rivals to any change in price, output or forms of non-price competition. It is a key aspect of business competition and behaviour in an oligopoly and can be modelled by the use of game theory.

Question 29

product differentiation

Answer 29

Product differentiation is the process of distinguishing a product or service from similar offerings in the market. Companies often use product differentiation as a way to make their offering more attractive to customers and to differentiate themselves from competitors.

Question 30

n-firm concentration ratio

Answer 30

measures the combined market share of the top ‘n’ firms in the industry.

Question 31

Duopoly

Answer 31

market dominated by two rival firms.

Question 32

first mover advantage

Answer 32

when a business can develop a competitive advantage through early entry into an industry.

Question 33

Limit pricing

Answer 33

when a firm sets average revenue just low enough to discourage new entrants to the market.

Question 34

Types of monopoly

Answer 34

Working monopoly - any firm with greater than 25% of the industries’ total sales.
Dominant firm - a firm that has at least 40% market share.

Question 35

Natural monopoly

Answer 35

Occurs when a large business can supply a market at a lower price than small ones. A situation where there can’t be more than one efficient provider of a good. Minimum efficient scale is a large share of market demand.
- increasing returns to scale at all levels of output
- LRAC lowers as production expands

Question 36

First mover advantage

Answer 36

first company to offer a product to the market

Question 37

patent

Answer 37

Patents prevent firms from copying protected technology and products without the patent holder’s permission. Firms can negotiate a license fee (or royalty) for using a patent
patented technology or product.