Perfect Competition, Imperfectly Competitive Markets & Monopoly Flashcards
Traditional theory of the firm thinks the main objective of firms are?
To maximise profits
Profit is the difference between?
Total revenue & total cost
Where does profit maximisation occur?
Where marginal cost (MC) = marginal revenue (MR)
Reasons why firms choose to profit maximise?
It provides greater wages & dividends for entrepreneurs.
Retained profits are a cheap source of finance, which saves paying high interest rates on loans.
Some firms might profit maximise in the long run since consumers dont like rapid price changes, so this will provide a stable price & output.
Explain divorce ownership of control
When an owner of a firm sells shares, they loose some control. Shareholders & managers then have different objectives which might conflict.
Other possible objectives of a firm:
- Survival: new firms in the short run
- Growth: increase size of firm to take advantage of economies of scale
- Increasing their market share: can be achieved by maximising sales
- Quality: increase competitiveness by improving quality
- Maximising their sales revenue: this occurs when MR = 0
- Sales maximisation: firms aims to sell as much of their goods & services as possible without making a loss
- Environment
- Worker welfare
Explain the satisficing principle:
A firm is profit satisficing when it’s earning just enough profits to keep its shareholders happy.
Characteristics of a perfectly competitive market:
- Many buyers & sellers
- Sellers are price takers
- Free entry & exit from the market
- Perfect knowldge
- Homogenous goods
- Firms are short run profit maximisers
- Factors of production are perfectly mobile
Perfect competition profit maximising equilibrium in short run with diagram & explanation
The short run equilibrium for a perfectly competitive market. The firm is a price taker & accepts the industry price of P1 & produces an output Q1. The shaded rectangle shows the area of supernormal profits earned in the short run. It is assumed that firms are short run profit maximisers.
Perfect competition profit maximising equilibrium in long run with diagram & explanation
Supernormal profits made by existing firms means that new firms have an incentive to enter the industry. Since there are no barriers to entry, new firms are able to enter. This causes supply in the market to increase, as shown in shift in supply curve. The price level in the market consequently falls. As firms a price takers, they must accept new, lower price. Supernormal profits are competed away, so firms only make normal profits in the long run. The new equilibrium at P=MC means firms produce at the new output of Q2.
Advantages of perfectly competitive market.
- In the long run, there is a lower price. Price = MC, so there’s allocative efficiency.
- Since firms produce at the bottom of their AC curve, there is productive efficiency.
- The supernormal profits produced in the short run might increase dynamic efficiency through investment.
Disadvantages of perfectly competitive market
- In the long run, dynamic efficiency might be limited due to the lack of supernormal profits.
- Since firms are small, there are few or no economies of scale.
- The assumptions of the model really applying in real life.
Characteristics of monopolistic competitive market
- Imperfect competition
- Short run profit maximisers
- Sell non-homogenous goods due to product differentiation
- Close substitutes
- Compete using non-price competition
- No barriers to entry or exit
- Imperfect knowledge
Monopolistic profit maximising equilibrium in the short run:
In the short run, profits maximise at the point MC = MR. The area P1C1AB represents supernormal profits in the short run.
Monopolistic profit maximising equilibrium in the long run
In the long run, new firms enter the market since they’re attracted by the profits that existing firms are making. This makes the demand for the existing firms products more price elastic which shifts the AR curve to the left. So, only normal profits can be made in the long run. The long run equilibrium point is P1Q1.
Advantages of monopolistic competitive markets:
- Consumers get a wide variety of choice
- It’s more realistic than model of perfect competition
- Supernormal profits produced in the short run might increase dynamic efficiency through investment
Disadvantages of monopolistic competitive markets:
- Firms are allocatively inefficient in short & long run (P > MC)
- Since firms don’t fully exploit their factors, there’s excess capacity & they don’t produce at bottom of AC curve. This makes firms productively inefficient in short & long run.
- In long run, dynamic efficient might be limited due to lack of supernormal profits
- Firms aren’t as efficient as those in perfectly competitive market.
Characteristics of an oligopoly:
- High barriers to entry & exit
- High concentration ratio
- Interdependence of firms
- Product differentiation
- Few firms in market
What is concentration ratio of a market?
It’s the combined market share of the top few firms in a market.
Collusive oligopoly is?
Collusive behaviour occurs if firms agree to work together on something. They might choose to set a price of fix the quantity of output. Collusion leads to a lower consumer surplus, higher prices & greater profits. Can allow them to act like monopolists.
Non-collusive behaviour?
Occurs when the firms are competing. It establishes a competitive oligopoly.
Explain the kinked demand curve model - how it shows price stickiness in oligopolies
If a firm was to rise its price, other firms wouldn’t follow as they wish to gain market share. Firm looses significant amount of demand, meaning demand is price elastic, & revenue falls. Meaning raising price is illogical. If a firm was to lower its price, the others would too, and demand rises by a small amount. This means demand is price inelastic, & when price falls when it’s inelastic, revenue falls too. So it’s illogical to lower prices.
A cartel is, what does it do & what can it lead to?
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. It can lead to higher prices for consumers & restricted outputs.
What is price leadership?
It occurs when one firm changes their price, & other firms follow. The firm is usually dominant in the market. Other firms are forced to change their prices to avoid loosing market share.
