Perfect Competition, Imperfectly Competitive Markets and Monopoly Flashcards
The Spectrum of Competition
- Perfect competition
- Monopolistic competition
- Oligopoly
- Monopoly
How to distinguish between different market structure
- Number of farms in the market (competitiveness)
- The degree of product differentiation. (The more differentiated the products,
the less competitive the market) - Ease of entry into the market
- The degree to which perfect knowledge exists in the market
- The degree to which the actions of firms are independent of each other or interdependent
Profit Maximisation
MR=MC
Reasons for the consequences of a divorce of ownership from control
- The principle-agent problem
- When an owner of a firm sells shares, they lose some of the control they had over
the firm - When a manager sells their shares, shareholders gain more control over the
decisions of the firm. This could give rise to ‘shareholder activism’
Other possible objectives of a firm
- Survival (e.g. 2008 financial crisis)
- Growth
- Increasing their market shares
- Quality
- Maximise sale revenue (MR=0)
The Satisficing Principle
a decision-making process in which an individual or organization settles for a satisfactory solution rather than striving for the optimal solution. e.g. enough profit to keep shareholders happy
Perfect competition profit in short/ long run
In the short run, firms can make supernormal profits. In the long run where profits are competed away, only normal profits are made.
Implications for firms and the industry of perfect competition
Large numbers of producers
Identical products
Freedom of entry and exit
Perfect knowledge
Price takers
Firms operating in perfect competition are price…
takers
Efficiency’s Golden Child (Perfect Competition)
Productive Efficiency: Firms operate at the minimum efficient scale, minimizing production costs and ensuring output at lowest per-unit cost.
Allocative Efficiency: The market price equals the marginal cost of production, meaning consumers pay exactly what it costs to produce the last unit, reflecting true social value.
No Deadweight Loss: Efficient allocation minimizes societal waste and maximizes consumer surplus (the difference between what consumers are willing to pay and what they actually pay).
Characteristics of monopolistically competitive markets
Many firms, but not as many as in perfect competition.
Products are similar, but not identical - they have some differentiation, like branding or slight differences in features.
Firms have some control over price, but not as much as in a pure monopoly.
Entry and exit are somewhat easier than in monopolies, but not as easy as in perfect competition.
Monopolistically competitive markets will be subject to…
Non-price competition
Main characteristics of an oligopoly
- Few Dominant Firms
- Interdependent
- Significant barriers to entry
- Non-price competition
Concentration ratio
The concentration ratio of a market is the combined market share of the top few
firms in a market
Collusive oligopoly (cartel)
where firms enter into agreements with each other (collude) in order to reduce the uncertainty that comes from interdependence. The market ends up acting like a pure monopoly (restricting output, raising prices/profits and restricting choice) but without the potential benefits of monopoly such as greater economies of scale or the incentive to be more dynamically efficient.
Non-collusive oligopoly
where firms do not enter into agreements with each other (do not collude)
Difference between cooperation and collusion
Cooperation is allowed in the market, whilst collusion is not. Collusion is usually with
poor intentions, whilst cooperation will be beneficial
A Cartel
is a group of two or more firms which have agreed to control prices, limit
output, or prevent the entrance of new firms into the market. A famous example of
a cartel is OPEC, which fixed their output of oil. This was possible since they
controlled over 70% of the supply of oil in the world.
Price Leadership
when one firm changes their prices, and other firms follow.
This firm is usually the dominant firm in the market. Other firms are often forced
into changing their prices too, otherwise they risk losing their market share.
Price Wars
When firms constantly cutting their prices below that of its competitors
Barrier to Entry
Firms might try to drive competitors out of the industry in order to
increase their own market share. Barriers to entry are designed to prevent new firms
entering the market profitably. This increases producer surplus.
Game theory
(used to illustrate interdependent decision making in oligopolistic markets and the uncertainty that arises from it, the incentive to collude and the incentive to cheat on collusive agreements)
Prisoners Dilemma
a model based around two
prisoners, who have the choice to either confess or deny a crime. The consequences
of the choice depend on what the other prisoner chooses.
The dominant strategy is the option which is best, regardless of what the other
person chooses. This is for both prisoners to confess, since this gives the minimum
number of years that they have to spend in prison. It is the most likely outcome.
This is still higher than if both prisoners deny the crime, however. If collusion is
allowed in this dilemma, then both prisoners would deny. This is the Nash
equilibrium.
Nash equilibrium
a concept in game theory which describes the optimal strategy
for all players, whilst taking into account what opponents have chosen. They cannot
improve their position given the choice of the other.