Perfect Competition, Imperfectly Competitive Markets and Monopoly 1 Flashcards
What are the features of oligopoly?
What are the market features of imperfect competition?
A few very large sellers
low freedom of entry
Differentiated products but doesn’t really matter
more imperfect information
Less independent-pay more attention to other producers.
What determines the typical behaviour of firms in a particular industry?
Market structures
Market structures classify industries as either imperfectly competitive or perfectly competitive.
What are the two main categories of market structure?
Imperfectly competitive and perfectly competitive
Examples of imperfectly competitive structures include monopoly and oligopoly.
List the key characteristics that define market structure.
- Number of buyers and sellers
- Freedom of entry and exit
- Product differentiation
- Degree of perfect knowledge
- Degree of interdependence among firms
What is a barrier to entry in market structure?
Factors that deter new firms from entering a market
Barriers can include capital costs, sunk costs, scale economies, and more.
What are capital costs?
High expenses required to set up a business
An example is the cost of establishing a new mobile phone network.
Define sunk costs.
Costs that cannot be recovered if a firm exits the market
Examples include marketing and website setup costs.
What are economies of scale?
Cost advantages that arise as production scales up
Industries with large economies of scale may lead to natural monopolies.
What are natural cost advantages?
Competitive advantages arising from factors like superior location
Example: A petrol station in the best town location attracting more customers.
What are legal barriers to entry?
Laws that restrict new firms from entering a market
Examples include patents and copyrights.
What are marketing barriers?
Challenges posed by existing firms with substantial marketing budgets
Heavy advertising can create brand loyalty that new entrants cannot match.
What are anti-competitive practices?
Actions taken by firms to hinder new market entrants
Examples include refusing to supply retailers that sell rival products.
What is perfect competition?
A market structure where many firms sell identical products and have free entry and exit
Characteristics include perfect knowledge and no significant barriers to entry.
What is an oligopoly?
A market structure characterized by a few firms that dominate the market
Firms in an oligopoly are interdependent, meaning the actions of one affect others.
What defines a monopoly?
A market structure where a single firm controls the entire market supply
Monopolies can arise from high barriers to entry and significant market power.
What is the rule for profit maximisation?
Set marginal revenue (MR) equal to marginal cost (MC)
This means firms produce until the last unit produced has revenue equal to its cost.
What assumptions are made in models of perfect competition and monopoly regarding firm objectives?
Profit maximisation is assumed
This is the primary objective of firms in these models.
What are some informational difficulties firms face in achieving profit maximisation?
Firms may face:
* Using accounting costs instead of opportunity costs
* Difficulty estimating the demand curve
* Anticipating competitor reactions
* Uncertainty over the time period for maximisation
What is the satisficing principle in the context of firm objectives?
Decision makers aim for a target level of profit rather than the absolute maximum
Firms may have multiple aims, with profit maximisation being just one.
How does the satisficing principle influence firm behavior?
Firms may set minimum targets rather than maximum and can be less innovative
This occurs as managers seek to satisfy various stakeholders.
What is the neo-Keynesian theory regarding profit maximisation?
Firms maximise profits in the long run rather than the short run
This theory suggests firms use a cost-plus pricing strategy.
What is the difference between sales maximisation and revenue maximisation?
Sales is measured as volume, while revenue is measured as value
Managers may be judged based on sales or revenue performance.
What are some reasons firms might aim for growth maximisation?
Managers gain utility from being in large firms and achieving economies of scale
Large firms may offer greater salaries and power.
What is the principle-agent problem?
A situation where the shareholder (principal) employs a manager (agent) to act on their behalf
It can lead to inefficiencies due to asymmetric information.
What are potential solutions to the principle-agent problem?
Solutions include:
* Increased monitoring of managers
* Linking managers’ salaries to firm profitability
What influences the severity of the principle-agent problem?
The problem may be less severe in competitive markets
Managers align their goals with shareholders to ensure survival.
Fill in the blank: Firms may have multiple aims, and these often lead to ______ behavior.
satisficing
True or False: All firms aim to maximise profit as their primary objective.
False
Firms may pursue other objectives based on stakeholder interests.
What can result from a firm focusing on survival?
Cautious and risk-averse behavior
This is particularly common for small businesses during downturns.
What is a common pricing strategy used by neo-Keynesian firms?
Cost-plus pricing strategy
Firms calculate long run average costs and add a markup for profit.
What are the two types of efficiency in economics?
Static and Dynamic efficiency
What does static efficiency measure?
Efficiency at a point in time
What are the two main measures of static efficiency?
- Productive efficiency
- Allocative efficiency
What is productive efficiency?
Achieved when production takes place at the level of output associated with the lowest possible average cost
At what output level does productive efficiency occur?
At the lowest point on the AC curve.
What is X-inefficiency?
When a firm fails to minimise its costs of production
What is the difference between productive efficiency and X-efficiency?
Any point on the AC curve is X-efficient, while any point above the AC curve is X-inefficient
What defines allocative efficiency?
Resources are used to produce goods and services that consumers want to buy
What is the economic definition of allocative efficiency?
A situation where no consumer can be made better off without making another consumer worse off
What is the criteria for allocative efficiency in economic theory?
P = MC
What does dynamic efficiency measure?
Whether resources are allocated efficiently over a period of time
How is dynamic efficiency linked to allocative and productive efficiency?
Investment leads to new/better products or processes that consumers wish to buy or new/better process that allowed the production process to become more efficient.
Give an example of dynamic efficiency.
The development of digital streaming to replace physical CDs/DVDs
Why is dynamic efficiency used as an argument for monopoly power?
Monopolies may charge higher prices but invest supernormal profits into research and development
What industry is given as an example of high prices justifying research into new medicines?
The pharmaceutical drug industry
What does perfect competition describe?
A market structure whose assumptions are extremely strong and highly unlikely to exist in most real-time and real-world markets
Why is perfect competition still studied?
the theoretical model of perfect competition achieves a high level of economic efficiency. It is used as a benchmark against which to judge other forms of market structure
Why have economists become more interested in perfect competition recently?
the rapid growth of ecommerce as a means of buying and selling goods and services
What are the basic assumptions for perfect competition to exist?
- Many small firms - each of whom produces an insignificant percentage of total market output and thus exercises no control over the ruling market price.
- Many individual buyers - none of whom has any control over the market price – i.e. there is no monopsony power.
- Perfect freedom of entry and exit from the industry - this assumption ensures all firms make normal profits in the long run.
- Homogeneous (identical) products - products are perfect substitutes for each other. This leads to firms being price takers and facing a perfectly elastic demand curve for their product.
- Perfect knowledge – buyers and sellers have perfect market information and can access this at zero cost which means no party has any power or control over the market due to imperfect information.
Why is it true that the real world is imperfectly competitive?
Monopoly power, monopsony power, barriers to entry/exit, differentiated products, imperfect information (e.g. information gaps), influence of persuasive marketing and advertising. Asymmetric information, negative and positive externalities- divergence between private and social costs and benefits. There may be imperfect competition in related markets such as the market for essential raw materials, labour or capital goods.
What must be the case to achieve the level of efficiency that the theory of perfect competition predicts?
That perfect competition exists in every market in the economy
Describe allocative efficiency in perfect competition in the SR & SR
In both the short and long run, price is equal to marginal cost (P=MC) and allocative efficiency is achieved. At the ruling market price, consumer and producer surplus are maximised. No one can be made better off without making some other agent at least as worse off. In other words, the conditions are in place for a Pareto optimum allocation of resources.
Why is productive efficiency not achieved in the SR but always in the LR?
Because profit maximising output only occurs at the lowest point of the average cost curve if normal profit is being made. In the short run in perfect competition, there can be firms making supernormal and subnormal profit as well. However in the long run, all firms in a perfectly competitive market will be productively efficient as all firms make normal profit.
Why is innovation designed to make products differentiated from each other in order to gain a competitive advantage restricted in perfect competition?
Homogenous products and perfect information. A cost-reducing innovation from one producer will also, be immediately and without cost transferred to all of the other suppliers.
What is argued to be the optimum market structure and why?
A competitive market rather than a perfectly competitive market. A competitive (contestable) market is argued to provide the discipline on firms necessary to keep their costs under control (productive/x efficiency) and refrain from exploiting the consumer by setting high prices and enjoying high profit margins (allocative efficiency) whilst at the same time providing the incentive to innovate to gain competitive advantage (dynamic efficiency). this can stimulate improvements in both static and dynamic efficiency in the long run.
What are the assumptions of the model of pure monopoly?
There is only 1 firm in the industry.
Complete barriers to entry prevent any new firms from entering the market.
What is monopoly power?
When a firm is said to have monopoly power when it controls 25% or more of a market.
What two sources generally lead to monopoly power?
Barriers to entry
Growth
What can growth be and what can it allow?
Growth can be either internal (organic) or external <integration> (by merger/acquisition). Integration will also potentially increase monopoly power by reducing the number of firms in the industry.
Growth allows a firm to gain monopoly power over a market by increasing its market share.</integration>
How does a monopoly make supernormal profits in the SR & LR?
Pure monopoly faces a downward sloping demand curve because the firm is the industry.(a price maker)
Assuming that the monopolist is a profit maximising firm – equilibrium output is where MR = MC, giving output Qm sold at price Pm.
AR > AC therefore supernormal (abnormal) profits are being made by the monopolist.
In competitive markets, this level of profits acts as a signal for new firms to enter the industry in the long run.
But a monopolist is usually able to prevent the entry of new firms by using barriers to entry, thereby allowing them to continue to make supernormal profits in the long run.
What static efficiencies will a monopoly achieve?
None, a monopolist will be neither allocatively nor productively efficient at long run equilibrium.
At profit maximising output, P>MC (not allocatively efficient) and profit maximising output is not at the lowest point on the AC curve (not productively efficient).
Why do firms seek to grow? (motives)
- The profit motive
- The cost motive: economies of scale help to raise profit margins
- The market power motive: increase their market dominance giving them increasing pricing power in the markets
- The risk motive: desire to diversify production so that falling sales in one market might be compensated by stronger demand in another market.
- Managerial motives: business expansion may be accelerated by the decisions of managers whose aims and objectives might be different from those who are major shareholders. (growth max)
What is organic growth? (internal growth)
Happens when a business expands its own operations.
How might organic growth occur?
- Expansion of existing production capacity through investment in new capital and technology (e.g. increasing number of classrooms)
- Developing & launch of new products (e.g. offering BTECs or other qualifications)
- Growing a customer base through marketing
What is external growth?
The fastest route for growth which comes in the form of mergers and aquisitions (intergration)
When does horizontal integration occur?
When two businesses in the same industry at the same stage of production become one.
What are some examples of horizontal integration?
Disney buys Fox 2019
Facebook buys Instagram 2012
What are the advantages of horizontal integration?
- It increases the size of the business and allows for more internal economies of scale- lower LRAC- improved competitiveness and profits.
- One large firms may need fewer workers, managers and premises than two- rationalisation to cost save
- Creates a wider range of products (dversifcation)
- Reduces competition by removing rivals- increases market share and pricing power (CMA may investigate)
What is vertical integration?
When a business aquires another business in the same indsutry but at different stages of the supply chain (production).
What are some examples of vertical integration?
Brewers owning and operating pubs
Ikea owning forests
What are the advantages of vertical integration?
- Greater control of the supply chain- helping tor reduced costs and improve quality of inputs
- Improved access to important raw material used in manufacturing
- Better control over retail distribution channels e.g. pubs can make sure their products are sold in busy pubs and clubs.
What does lateral integration involve?
Companies joining together that produce similar but related products e.g. Google and YouTube, Coke and Costa Coffee.
What is conglomerate integration (diversification)?
Where the businesses joining together are in unrelated industries e.g. Amazon merger with Whole Foods, Unilever and Diageo.
When do joint venture occur?
When two or more businesses work together to pursue a common project or goal. e.g. Google and NASA for Google Earth.
What are some evaluative points on integration?
May integrations fail to achieve their aims.
Huge financial costs of funding takeover
many mergers fail because of clash of corporate cultures and failure to find lower LRAC.
Competition policy concerns come into play, especially when there is risk of monopoly.
Sizeable job losses with important socio-economic consequences in the area
How do smaller businesses survive?
- Act as a supplier/ sub-contractor to larger enterprises ( e.g. construction industry)
- Can taker advantage of low PED and high YED for demand for specialist ‘niche’ goods and services
- Smaller businesses are often innovative, flexible and can avoid diseconomies of scale.
When do demergers happen?
When a business spins off one or more of the businesses that it owns into a separate company. The ai is to improve shareholder value by giving management to focus on reducing debt and costs.
Demergers can also result from government intervention- CMA could want a monopoly to be broken up
Examples include: Walmart selling Asda 2021, PayPal splitting from eBay 2014
Why is competition generally seen as good?
Because of:
1. Lower prices
as a result of the large number of competing firms already in the industry and
low barriers to entry meaning the potential and actual entry of new firms to provide extra competition and ensure prices are kept low.
2. Economic efficiency
Firms attempt to minimize their costs and move towards productive efficiency.
Price will be closer to the MC of production leading to greater allocative efficiency.
Faster rate of technological progress – e.g. dynamic efficiency - to maintain competitiveness.
Why is monopoly generally seen as bad?
- Monopolists earn extra profits at the expense of economic efficiency by setting prices above those that would exist in competitive markets (P>MC).
- Monopolists will not be producing at the lowest possible average cost of production (productive inefficiency) at their profit maximising level of output.
- Monopolists may suffer from X-inefficiency as the lack of competition means they fail to minimise costs of production.
What are the potential benefits of monopoly?
- Economies of scale and investment
Monopoly suppliers might be better placed to exploit economies of scale – which means that consumers may benefit from lower prices. - Research/Development and Innovation
Higher profits from monopoly may lead to a faster rate of technological development that reduces costs and produces better products for consumers.
Creating monopoly power, in the form of patents and copyright (legal barriers to entry) which give a time limited monopoly on new products/processes/ideas, may also be required in some circumstances to persuade firms to invest in R&D and to innovate. - International Competitiveness
In some markets, the economy needs large companies operating on a scale big enough to compete effectively in global markets – e.g. the global car market
When do natural monoploies exist?
When there is great scope for economies of scale.
It is associated with industries where there is a high ratio of fixed to variable costs.
For example, the fixed costs of establishing a national distribution network for a product might be enormous, but the cost of supplying extra units of output may be very small.
With a pure natural monopoly, there is only room for one firm to be able to exploit the available economies of scale fully.
