perfect competition, imperfectly competitive markets and monopoly Flashcards
profit maximisation
MC=MR
why do firms aim to profit maximise
greater dividends for shareholders
allows for lower costs
reward entrepreneurship
why might firms not want to aim for maximising profit
principle-agent problem link to asymmetric info
conflicting objectives between shareholders
shareholder activism
competitor suspicion
profit satisficing
sacrificing profits to satisfy as many stakeholders as possible
stakeholder
anybody interested or involved with how well a firm is performing
survival
short term objective for a hypercompetitive market
revenue maximisation on the graph
MR=0
revenue maximisation
each extra unit sold generates no extra revenue
why might a firm maximise revenue
economies of scale
predatory price - drives out new firms entering the market and drive out competition through low pricing
principle-agent problem - divorce between ownership and control
sales maximisation
AC=AR
why might a firm maximise sales
economies of scale
-limit pricing- takes away incentive of new firms enetering the market, limiting competition
-flood the market- enticing customers, gain loyalty then later change objective
greater market share
other objectives/responsibilities
-environmental
-social (corporate social responsibility)
-ethical and sustainable e.g Body shop
What are market structures characterised by
Number of firms in their market
The degree of product differentiation (homogenous)
Barriers to entry/exit
Examples of barriers to entry
Economies of scale
Control of technology
Brand loyalty (in elastic demand)
Reputation
Characteristics of perfect competition
Many buyers and sellers
Perfect knowledge
Free entry and exit
Short run profit max
Perfectly mobile factors of production
How is the price determined in perfect competitive markets
The interaction of demand and supply
Why are profits lower in perfectly competitive markets than oligopoly/ monopoly markets
Very small market shares
Market power is small
Making profit attracts new firms
Drives down average e costs from increased supply
Existing firms profit competed away
What profits can be made in short run (perfectly competitive markets)
Supernormal profits
What profits are made in the long run (perfectly competitive markets)
Normal profits (as they are competed away)
Advantages of perfect competition
In the long run their is lower price
P=MC allocative efficiency
Produce at bottom of ac curve
Productive efficiency
Supernormal profits
Invest for dynamic efficiency
Disadvantages of perfect competition
Long run dynamic effiency limited through loss of supernormal profits
Few/no economies of scale
Advantages of monopolistic markets
Allocatovely efficient short run
Variety of choice
More realistic theory
define market structure
The organisational and other characteristics of a market
Important features of a market structure
Number of firms in market
Market share
Costs incurred by firms
Nature of sales revenue
Barriers to entry and exit
Product differentiation
Price setting procedures
Characteristics of perfectly competitive markets
Lots of buyers and sellers
Perfect market information
Price takers
No barriers in the long run
Example of imperfect competitive market
Oligopoly
Define oligopoly
A market containing a few firms with high market shares
Why is their entry barriers in monopoly’s
To stop new firms entering the market and taking away profits
What is a natural barrier
Barriers that result from inhertent features of the industry
E.g. economies of scale or high r&d costs
What are artificial barriers to entry
Erected by the firms themselves
E.g. product differentiation and expenditure on advertising/marketing
Why might incumbent firms in a market set low prices
To deter new firms entering the market by making it unprofitable
What are predatory prices and what do they do
Prices set below AC, which remove recent entrants to the market
Define product differentiation and example
Marketing of generally similar products with minor variations
E.g. Apple and Samsung are rivals. Samsung differentiates but launches new phones more frequently and with wider options
Equation for total profit
Total revenue - total costs
Explain what MR = MC means
Firms profits are greatest when
Addition to sales from the last unit sold (MR)
Is equal to
Addition to total cost incurred from the production of last unit of output (MC)
What does the divorce of ownership from control mean
Owners of firms and those who manage firms are different groups with different objectives
(Principle/agent problem)
2 reasons why principle/ agent problem happens
- cost of the principle punishing the agent is too high
-information asymmetry (agent may know more what’s happening in business than principle)
Draw a diagram to show MR=MC
Other business objectives
Maximising management power
Maximising sales revenue
Satisficing
Environmental targets
Social corporate responsibility
How is price set in perfectly competitive markets
Accepts ruling market price of interaction between supply and demand and this becomes the AR=MR curve
Draw the diagram for short run profit max in perfect competition
(Pg. 64 of textbook)
What profit do perfectly competitive markets make in short run
Abnormal profits
What does the price signal do in long run (perfectly competitive)
Signals to firms outside market that abnormal profits can be made and incentivises them to enter the market
Draw the diagram for long run profit max in perfectly competitive markets
See page 65 in textbook
5 step analysis of long run pc
Too many firms enter market shifting supply S 1-S2
This lowers the market ruling price from p1-p2 firms make subnormal profits. (Loss )
Firms begin to leave the market shifting supply left from. S2 to S3
This increases market price again p 2 to p3 where surviving firms make normal profits
They are producing on lowest point of AC curve which is most efficient (constant returns)
Draw the short run diagram for monopoly
Pg 67
2 disadvantages of monopoly
Market failure and resource misallocation
Firms increase its price to profit max on the AR curve
Output falls and price rises
Draw a diagram showing how monopoly rises price and restricts output
Pg 67
2 advantages of monopoly
Economies of scale producing at bottom of LRAC curve
Dynamic efficiency (result of technology and R&D advanacements)
Argument that monopoly reduce promotion of innovation and efficiency
Likely profit satisfices not profit max
Define productive efficiency
The level of output at which average costs are minimised
Define allocative efficiency
Where is it possible to improve economic well-being
Price must be equal to marginal cost (P=MC)
Why are profits lower in a competitive market
They are competed out by new firms entering the market attracted by the profit
The invisible hand acts as a mechanism for eliminating high profits
Desirable properties of competitive markets
Economic efficiency
Welfare maximisation
Consumer sovereignty
First degree price discrimination
This involves charging consumers the maximum price they are willing to pay for it
There will be no consumer surplus
What is consumer surplusn
When the price is less than they are willing to pay
Second degree price discrimination
This involves charging different prices depending upon the choices of the consumer
E.g. quantity,time,coupons
Third degree price discrimination
This involves charging different prices to different groups of people
E.g. student discount
Production versioning
Example of practicing discrimination of price offering different product options
E.g. priority tickets
Indirect segmentation
Offering different products for different prices, separating consumers who are willing to pay higher prices
Conditions necessary for price discrimination
Firm is a price maker
Separate markets
Different elasticities of demand
Low admin costs
Advantages of price discrimination
Firms will increase revenue
Increased investment
Lower prices for some groups
Manages demand
Disadvantages of price discrimination
Decline in consumer surplus
Higher prices for some groups
Administration costs
Predatory pricing
Marginal cost in price discrimination
If MC is low for every extra passenger is low, the firm is incentivised to use price discrimination to sell them all, to try sell all the tickets
2 main benefits of monopolies
Economies of scale
Innovation and invention
What falls when monopolies have economies of scale
Long run average costs fall
collusion
when rival firms agree to work together
what does collusion do
lead to higher proifts and reduce competition
negatives of cartels
illegal
anti competitive
against public interest
positives of cartels
joint production development
cooperation to ensure product and labour standards are maintained
example of tacit collusion
2008- retailers and cigarette companies colluded on price to increase profits illegally
what does the kinked demand curve theory show
how a competitive oligopoly may be affected by a rivals reaction to its price and ouput decisions
it explains price rigidity and the absence of price wars in oligopolys
why might the best policy for oligopoly be to keep prices unchanged
any price above p1 at the kink is demand elastic
any price below p1 at kink is inelastic
any change in price will reduce total revenue
fears an increase or a cut will likely reduce total profit
MR curve on kinked demand curve
creates discontinuity
any change in MC on vertical gap wont alter profit max output
if MC was increased or cut out of vertical gap, oligopolist would have to set different price to max profits, given that accurate AR (imperfect info)
criticisms of kinked demand curve theory
-no expantion of why p1,q1 on the kink in first place
-more realistic that firms test the market (increasing or decreasing price to see how rivals react)
-oligopoly prices tend to be sticky
-lower prices quickly/significantly if costs of production or demand increases
price leadership
setting prices in the market by a dominant firm which is followed by other firms in a market
price agreement
made between firms and their suppliers, and firms and customers regarding price of a good or a service
price wars
take place in monopolistic and oligopoly, deliberalety or accidnetaly
when rival firms continuously lower prices to undercut eachother
benefits of price wars?
consumers will benefit in the short run
if firms are driven out and monopoly power of surviving firms increases will lead to detriment of consumers
consumer surplus
the difference between the maximum price a consumer is prepared to pay and the actual price they have to pay
market price falling = increase in consumer surplus/welfare
producer surplus
the difference beyween the minimum price a firm has to charge for a good and the actual price charged
conditions necessary for price discrimination
- must be possible to identify diferent groups- when customers differ knowledge of the market
2.the different customer groups have different elasticites of demand - profit max by charging higher price when demand is inelastic
3.markets seperated to prevent seepage
seepage
when customers buying at the lower price in one sub market resell it iin another submarket at a price undercutting oligopolists own market selling price
benefits of price discrimination
lower prices for some
spreads out demand
increased investment with extra profit
costs of price discrimination
higher prices for some
decline in consumer surplus
administration costs
company profit takes higher share of GDP
contestable markets
a market in which the potential exists for new firms to enter the market
perfectly contestable market
no entry or exit barriers
no sunk costs
no barriers to technology
sunk costs
costs incurred when entering a market that are irrecoverable
policies suggested by the theory of contestable markets
removal of licensing regimes e.g tv
removal of controls over ownership
removal of price controls
hit and run competition
a new entrant hits the market, makes profts then runs given that there are no barriers to entry or exit
contestable pricing in monopoly
moves from AC curve to AC=AR to prevent market being contested
consumer and producer surplus whe perfect competition is replaced by monopoly
monopoly raises price
monopoly gains some of the consumer surplus which wouldve existed under pc
produce surplus incraeses
there s a net los of economic welfare
amount bought and sold Q2 falls
loss of consumer and producer surplus
form of non price competition
advertising/branding
brand loyalty
new productions/innovation
dynamic efficiency in the long run (perfect competition)
loss of dynamic efficiency as profits are competed away by an influx of new firms into the market, and so firms cannot invest into capital, technology therefor productive potential of one firm may fall
2 reasons perfectly competitive firms may not be efficient
no scope for EOS - many small firms producing relatively small amount of goods
cannot be dynamically efficient in the long run when supernormal profits get competed away
how are perfectly competitive firms allocatively efficient
goods are produced as a direct respond to consumer demand (price set by market forces)
P= MC
the pressure to innovate and invest (dynamic overtime)
markets will reduce supply if more firms enter the market ensuring not to waste resources
how are perfectly competitive firms productively efficient
they produce on the lowest point of the AC curve
the equilibrium profit max output is at the min AC
features of monopolistic competition market structure
product differentiation (high XED of goods)
larger number of buyers and sellers that are small and act independently
no/low barrier to entry
imperfectt info
evaluate downward sloping demand curve of monopolistic competition
they can raise their prices without losing customers because they have a degree of price setting power
profit maximisation equilibrium in the short run (monopolisitic competition)
q1 hits mc=mr and up to AR
p1 to c1 = supernormal profits
profit maximisation equilibrium in the long run (monopolistic competition)
new firms enter market incentivised by snp
demand for existing firms goods more price elastic shifts AR curve to left
only NPs made
how might monopolistic competition firms stay in the short run to avoid losing supernormal profits
product differentiating and innovating
advantages of monopolistic competition
allocative efficiency in short and long run (P>mc)
firms do not fully exploit factors leaving spare capacity in the market (productively inefficient)
consumer choice
more realistic than PC
sSNP in short run may contribute to dynamic efficiency
