perfect competition and monopoly Flashcards
Define consumer surplus
the difference between what consumers were willing to pay, and what they actually pay
Define producer surplus
the difference between what producers are willing and able to supply a good for and the price they actually receive
When does dynamic efficiency occur?
in the long-run
What is dynamic efficiency linked to?
the pace of innovation and investment, leads to the improvements in the performance and quality of the product
What is needed for dynamic efficiency to occur?
supernormal/abnormal profits
Give 4 characteristics of perfect competition
large number of small buyers and seller (theoretically infinite)
no barriers to entry or exit
perfect knowledge/information
goods are homogenous
price takers
no abnormal profits made in the long-run
why is the market price and marginal revenue flat in perfect competition?
as no matter how much is sold the firm can sell at the same market price
Explain why a firm in perfect competition cannot make abnormal profits in the long-run
due to no barriers to entry, any abnormal profits will attract new entrants into the industry
this increases the market’s supply, reducing the price until all abnormal have been competed away
Explain why a firm in perfect competition will not make a loss in the long-run
due to no barriers to entry, if firms are making a loss, some will choose to leave the market
this will decrease supply, pushing up price until no losses are being made
What profit is made in the long-run in perfect competition?
normal profit
What efficiencies does a perfect competition firm operate at in the long-run?
productively efficient
allocatively efficient
erfect competition will only result in allocative efficiency if…
… there are no externalities (positive or negative) in the market
short run equilibrium of firm in perfect competition
In a competitive market, the firm is a price taker and MR = P
why is the long run supply curve less steep than the short run?
Each firm can fully adjust all factors
The number of firms in the industry can vary
In the extreme case where all potential and existing firms have identical costs, the long-run industry supply curve is horizontal at the price corresponding to the lowest point on each firm’s LAC curve.
Profit is always zero.
In a perfectly competitive
market do Firms cover their cost of capital?
yes
Over the last 30 years UK
markets have become more
competitive yes or no?
no
which market structure has the lowest price?
perfect competition
give 3 conclusions that can be made about perfect competition
In a perfectly competitive market firms’ profits are always zero in the long run.
Competitive markets maximize surplus or welfare.
An important benchmark for other market structures.
what are 4 characteristics of monoploys
25%+ of market share
price makers
profit maximising
abnormal profits
high barriers to entry
At what point will a monopoly operate at?
at the point of profit maximisation, where MR = MC
How could a monopoly be deemed as disadvantageous to the consumer?
operating below the point of allocative efficiency
thus there is a deadweight loss to society
What is deadweight loss?
the reduction in economic surplus resulting from a market not being in competitive equilibrium
How could a monopoly be deemed as advantageous to the consumer?
make supernormal profit, so can be dynamically efficient
this could be used for investment, innovation, research and development, which could reduce costs in the long-run
this could then be passed onto the consumer in terms of lower prices
Give 3 determinants of monopoly power
high barriers to entry
low number of competitors
advertising and product differentiation
Give 2 types of legal barriers to entry
licences
patents
Explain what is meant by absolute cost barriers
the large amount of capital required to set up a firm in some markets
Explain what is meant by relative cost barriers
AC of new firms is higher than AC of incumbent firms
incumbent firms enjoy economies of scale and the benefits of R + D
Explain how high barriers to entry is a cause of monopoly power
decreases the number of potential competitors
means that one firm can dominate the market
When does a natural monopoly occur?
occurs when the benefits of economies of scale in an industry are so large that it is uneconomic for more than one firm to supply in that industry
An industry is a natural monopoly when a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms.
Explain how high relative cost barriers is a cause of monopoly power
AC of new firms would be higher than the incumbent monopoly
because the monopoly has dynamic efficiency, economies of scale, R + D, etc
discourages new firms from entering the monopoly, reducing competition, causing/increasing the monopoly power
name 5 sources of monopolys
Superior product offer
Government license
Barriers to entry
Minimum efficient scale (natural monopoly)
Illegal practices (abuse of market power)
what is the welfare cost of a monopoly?
due to operating above marginal costs there is less quantity sold and this in turn leads to them falling short of social optimum
The monopolist produces less than the socially efficient quantity of output.
why would a government grant monoploy?
To facilitate innovation (e.g. patents)
To cover fixed costs (e.g. rail)
To generate revenue (license auctions)
how do you minimise deadweight loss from a monoploy?
The monopolist can set different prices for different (groups of) customers
Differential pricing increases the monopolist’s profit and reduces the deadweight loss.
Discrimination is more likely to be successful for goods that cannot be easily re-sold.
I.e. personalised items; medical treatments
(discriminating monopoly)
Give 5 characteristics of monopolistic competition
large number of small buyers and sellers
few and low barriers to entry
good knowledge/information
goods are non-homogenous / goods are slightly differentiated
has some market power
Explain what happens if a firm is making abnormal profit in a monopolistic competition market
low barriers to entry allow new competitors to enter the market
this has the effect of reducing the % of overall market share each individual firm enjoys, and make the demand for each product more PED elastic (due to an increased number of substitutes)
this shifts the AR and MR curves downward, competing away abnormal profits away
For a firm is monopolistic competition, when can abnormal profits be made?
in the short-run
Explain what happens if a firm is making abnormal profit in a monopolistic competition market
Short-run economic losses encourage firms to exit the market.
Decreasing the number of products offered.
Increasing demand faced by incumbent firms.
Demand for the incumbent firms’ products increases, and their profits increase too.
Give 2 reasons why firms in monopolistic competition are not forced to be productively or allocatively efficient
differentiated products
lack of rigorous competition
Compare the PEDs for a monolpoly and a firm in monopolistic competition
PED is more elastic for the firm in monopolistic competition
Compare the PEDs for a firm in perfect competition, and a firm in monopolistic competition
PED is more elastic for the firm in perfect competition
Explain how monopolistic competition can improve consumer choice of products
low barriers to entry mean that there is intense competition between firms
provides an incentive to compete for market share and profit
leading to more choice of product for consumers
Explain why the increased product choice for consumers, as a result of monopolistic competition may not always be beneficial
consumers have bounded rationality and may not make optimal decisions if there is a bewildering choice
Referring to MC and price, give a potential benefit of monopolistic competition
in monopolistic competition, prices are kept closer to marginal cost, leading to improved allocative efficiency
Explain why monopolistic competition may not be beneficial to the firms, in terms of productive efficiency
although competition keeps prices low, the saturation of products may lead to firms not exploiting economies of scale
this leads to a loss of productive efficiency
explain welfare and monopolistic competition
There is the normal deadweight loss of monopoly pricing in monopolistic competition caused by the markup of price over marginal cost.
summary of monopolistic competition
A monopolistically competitive market is characterised by three attributes: many firms, differentiated products, and free entry.
The equilibrium in a monopolistically competitive market differs from perfect competition in that each firm has excess capacity and each firm charges a price above marginal cost.
Monopolistic competition does not have all of the desirable properties of perfect competition.
There is a standard deadweight loss of monopoly caused by the markup of price over marginal cost.
Give 4 characteristics of a oligopoly
few firms control majority of the market share
high barriers to entry and exit
sticky or rigid prices
firms are interdependent
non-price competition
some product differentiation
Why are firms in an oligopoly able to make long-run abnormal profit?
due to high barriers to entry
Why are firms in an oligopoly likely to be dynamically efficient?
as they face stiff competition so they are likely to use supernormal profits in order for future gain and to keep up with competition
How do firms in an oligopoly prefer to compete?
using non-price competition
Give 3 examples of non-price competition
advertising
marketing campaigns
loyalty programs
As firms in an oligopoly choose not to compete on price, what does this result in?
sticky/rigid prices
Why is there an incentive for firms in an oligopoly to collude and fix prices? (2 reasons)
it would maximise their joint profits
it would increase their producer surplus
What law would it break if firms in an oligopoly decided to collude?
EU competition law
If firms in an oligopoly do collude, what market structure would they effectively be operating as?
a monopoly
What would the 2 main costs to consumers from firms in an oligopoly colluding?
higher prices
lost consumer surplus
What is meant by a non-collusive oligopoly?
where firms in the market act independently when setting prices
What is meant by a collusive oligopoly?
where firms collude to fix prices or overall market supply
Why doesn’t it make sense for a firm in an oligopoly to raise its price?
if it raises its price, other firms will not follow, so you lose a lot of quantity demanded
Why doesn’t it make sense for a firm in an oligopoly to lower its price?
if it lowers its price, other firms will follow, so the quantity demanded wouldn’t massively increase
Is a competitive oligopoly good for consumers and/or firms?
good for consumers
bad for firms
Is a collusive oligopoly good for consumers and/or firms?
good for firms
bad for consumers
what is the key feature of an oligopoly?
Because of the few sellers, the key feature of oligopoly is strategic interaction.
name the 2 forms of collusion
Implicit (tacit) agreement between existing firms to avoid or limit competition with one another.
Explicit formal agreements between firms (cartel). Mostly illegal
what is game theory?
Game: A situation in which decisions are necessarily interdependent normal form or extensive form
cooperative or non-cooperative
Strategy: A game plan describing how the player will act or move in every conceivable situation
Dominant strategy: A player’s best strategy is independent of those chosen by others
Nash Equilibrium: mutual best-response strategies
name an oligopoly
OPEC
It is more difficult to collude if…
Market conditions are changing rapidly
There are no barriers to entry
The product is not standardised
There are too many firms in the industry to cooperate
Firms have surplus capacity
name more olipoly models
Bertrand competition
Similar to Cournot except that firms focus on price rather than output
Stackelberg leadership
The leader firm (Market Leader) moves first and then the follower firms move sequentially
what are characteristics of contestable markets
Characterised by
Free entry and free exit
No sunk costs
Allows hit-and-run entry
May constrain incumbent firms from exploiting their market power
Why is the number of firms that exist in a contestable market irrelevant?
due to the constant threat of new competition
What is the point of allocative efficiency?
MC = AR
What is the point of productive efficiency?
MC = AC
Explain why the point MC = AR is allocatively efficient
as the value that consumers place on a good or service (reflected in the price they are willing and able to pay) equals the marginal cost of the scarce factor resources used up in production
