Perfect Competition, Imperfectly Competitive Markets and Monopoly Flashcards
different market structures
LOWER BARRIERS TO ENTRY, MORE CONTESTABLE
perfect competition
monopolistic competition
MORE MARKET POWER, LESS EFFICIENCY
oligopoly
monopoly
Each market structure is characterised by:
The number of firms in the market.
The more firms there are, the more competitive the market is.
The degree of product differentiation.
The more differentiated the products, he less competitive the market. In a perfectly competitive market, products are homogenous. Products can be differentiated using price, branding and quality. This affects cross price elasticity of demand.
Ease of entry into the market.
This is the number and degree of the barriers to entry. Barriers to entry are designed to prevent new firms entering the
market profitably
examples of high barriers to entry
Economies of scale.
Brand loyalty, which makes demand more inelastic. It is hard for new
firms to gain consumer loyalty, when one firm’s brand name is already
strong.
Controlling the important technologies in the market.
Having a strong reputation.
Backwards vertical integration, which controls supply, means firms
can control the price they pay their suppliers. This makes it hard for
new firms to compete on price, which is a barrier to entry.
Barriers to entry can be structural, where they arise due to
differences in production costs, strategic, where firms use different
pricing policies, such as undercutting another firm’s price, or
statutory, where patents protect a franchise. An example of this is a
television broadcasting licence.
Break even
Firms break even when TR = TC
profit increases
when MR > MC. Profits decrease when MC > MR
Some firms choose to profit maximise because:
o It provides greater wages and dividends for entrepreneurs
o Retained profits are a cheap source of finance, which saves paying high
interest rates on loans
o In the short run, the interests of the owners or shareholders are most
important, since they aim to maximise their gain from the company.
o Some firms might profit maximise in the long run since consumers do not like
rapid price changes in the short run, so this will provide a stable price and
output.
characteristics of perfect competition
A perfectly competitive market has the following characteristics:
o Many buyers and sellers
o Sellers are price takers
o Free entry to and exit from the market
o Perfect knowledge
o Homogeneous goods
o Firms are short run profit maximisers
o Factors of production are perfectly mobile
what are profits likely to be like in a competitive market
profits are likely to be lower than a market with only a few
large firms. This is because each firm in a competitive market has a very small market
share. Therefore, their market power is very small.
what effect does new firms joining have
. The new firms will increase supply in the market, which lowers the
average price. This means that the existing firms’ profits will be competed away
profit maximisation in the short run
firms can make supernormal profit
profit maximisation in the long run
profits are competed away and only normal profit are made
adv of perfectly competitive markets
In the long run, there is a lower price.
P =MC, so there is allocative
efficiency.
Since firms produce at the bottom of
the AC curve, there is productive
efficiency.
The supernormal profits produced in
the short run might increase dynamic
efficiency through investment.
disadv of perfectly competitive markets
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 rarely
apply in real life. In reality, branding,
product differentiation, adverts and
positive and negative externalities,
mean that competition is imperfect.
characteristics
A monopolistically competitive market has imperfect competition. Firms are short
run profit maximisers.
Firms sell non-homogeneous products due to branding (there is product
differentiation). However, there are a lot of relatively close substitutes. This makes
the XED of the goods and services sold high.
The model is based on the assumption that there are a large number of buyers and
sellers, which are relatively small and act independently.
Each seller has the same
degree of market power as other sellers, but their market power is relatively weak.
Firms in a monopolistically competitive market compete using non-price
competition.
There are no barriers to entry to and exit from the market.
Since firms have a downward sloping demand curve, they can raise their price
without losing all of their customers. This is because firms have some degree of price
setting power.
Buyers and sellers in a monopolistically competitive market have imperfect
information.
Examples of monopolistic competition include hairdressers and regional plumbers.
short run profit maximising ( monopolistic comp)
In the short run, firms profit maximise at the point MC = MR. The area P1C1A B
represents the supernormal profits that firms in a monopolistically competitive
market earn in the short run.
long run profit maximising ( monopolistic comp)
, new firms enter the market since they are 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 (the demand curve) to the left
disadvantages of monopolistically competitive
markets
Firms are not as efficient as those in a
perfectly competitive market. In a
monopolistically competitive market,
firms have x-inefficiency, since they
have little incentive to minimise their
costs.
In the long run, dynamic efficiency
might be limited due to the lack of
supernormal profits.
advantages of monopolistically competitive
markets
Firms are allocatively inefficient in the
short and long run (P > MC)
In the long run, dynamic efficiency
might be limited due to the lack of
supernormal profits.
Since firms do not fully exploit their
factors, there is excess capacity in the
market. This makes firms productively
inefficient (also note: the firm does
not operate at the bottom of the AC
curve). This is in both the short run
and long run#
Consumers get a wide variety of
choice.
The model of monopolistic
competition is more realistic than
perfect competition.
The supernormal profits produced in
the short run might increase dynamic
efficiency through investment.
Characteristics of an oligopoly
High barriers to entry and exit
High concentration ratio
Interdependence of firms
Product differentiation
High barriers to entry and exit (oligopoly)
There are high barriers of entry to and exit from an oligopoly. High barriers to entry
make the market less competitive.
High concentration ratio (oligopoly)
In an oligopoly, only a few firms supply the majority of the market. For example, in
the UK the supermarket industry is an oligopoly. The high concentration ratio makes
the market less competitive.
Interdependence of firms (oligopoly)
Firms are interdependent in an oligopoly. This means that the actions of one firm
affect another firm’s behaviour.
Product differentiation (oligopoly)
Firms differentiate their products from other firms using branding. The degree of
product differentiation can change how far the market is an oligopoly.
Oligopoly as a market structure and a behaviour
Firms can either operate in a market which is oligopolistic, or several firms can
display oligopolistic behaviour.
Firms which display oligopolistic behaviour might be interdependent, have stable
prices, collude or have non-price competition.
The difference between collusive and non-collusive oligopoly
Collusive behaviour occurs if firms agree to work together on something. For
example, they might choose to set a price or fix the quantity of output they produce,
which minimises the competitive pressure they face.
Collusion leads to a lower consumer surplus, higher prices and greater profits for the
firms colluding. It can allow oligopolists to act as a monopolist and maximise their
joint profits.
Firms in an oligopoly have a strong incentive to collude. By making agreements, they
can maximise their own benefits and restrict their output, to cause the market price
to increase. This deters new entrants and is anti-competitive.
Collusion is more likely to happen where there are only a few firms, they face similar
costs, there are high entry barriers, it is not easy to be caught and there is an ineffective competition policy. Moreover, there should be consumer inertia. All of
these factors make the market stable.
Non-collusive behaviour occurs when the firms are competing. This establishes a
competitive oligopoly. This is more likely to occur where there are several firms, one
firm has a significant cost advantage, products are homogeneous and the market is
saturated. Firms grow by taking market share from rivals.
overt collusion
Overt collusion is when a formal agreement is made between firms. It works best
when there are only a few dominant firms, so one does not refuse. It is illegal in the
EU, US and several other countries.
tacit collusion
Tacit collusion occurs when there is no formal agreement, but collusion is implied.
For example, in the UK supermarket industry, firms are competing in a price war.
Price wars are harmful to supermarkets and their suppliers
The 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.
Collusion generally refers to market variables, such as quantity produced, price per
unit and marketing expenditure. Cooperation might refer to how a firm is organised
and how production is manag
The kinked demand curve model
The kinked demand curve illustrates the feature of price stability in an oligopoly. It
assumes other firms have an asymmetric reaction to a price change by another firm.
It is an illustration of interdependence between firms.
cartel
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. This reduces uncertainty for
firms, which would otherwise exist without a cartel.
Price leadership
occurs 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
This
explains why there is price stability in an oligopoly; other firms risk losing market
share if they do not follow the price change. The price leader is often the one judge
to have the best knowledge of prevailing market conditions.
Price wars:
A price war is a type of price competition, which involves firms
constantly cutting their prices below that of its competitors. Their competitors then
lower their prices to match. Further price cuts by one firm will lead to more and
more firms cutting their prices. An example of this is the UK supermarket industry
(see notes above).
Non-price competition
n aims to increase the loyalty to a brand, which makes demand
for a good more price inelastic.
For example, firms might improve the quality of their customer service, such as
having more available delivery times. They might keep their shops open for longer,
so consumers can visit when it is convenient.
ways to increase non price competition
Special offers, such as buy one get one free, free gifts, or loyalty cards, might be used
to attract consumers and increase demand.
Advertising and marketing might be used to make their brand more known and
influence consumer preferences. However, it is difficult to know what the effect of increased advertising spending will be. For some firms, it might be ineffective. This
would make them incur large sunk costs, which are unrecoverable.
Barriers 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.
dominant strategy
The two prisoners are not allowed to communicate, but they can consider what the
other prisoner is likely to choose. This relates to the characteristic of uncertainty in
an oligopoly
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
The advantages of oligopoly
Oligopolies can earn significant
supernormal profits, so they might invest
more in research and development. This
can yield positive externalities, and make
the monopoly more dynamically efficient
in the long run. There could be more
invention and innovation as a result.
Moreover, firms are more likely to
innovate if they can protect their ideas.
This is more likely to happen in a market
where there are high barriers to entry.
Higher profits could be a source of
government revenue.
Industry standards could improve. This is
especially true in the pharmaceutical
industry and for car safety technology.
This is because firms can collaborate on
technology and improve it. It saves on
duplicate research and development.
access to economies of scale
disadvantage of oligopoly
The basic model of oligopoly suggests
that higher prices and profits and
inefficiency may result in a misallocation
of resources compared to the outcome
in a competitive market.
If firms collude, there is a loss of
consumer welfare, since prices are raised
and output is reduced.
Collusion could reinforce the monopoly
power of existing firms and makes it
hard for new firms to enter. The absence
of competition means efficiency falls.
This increases the average cost of
production
Characteristics of monopoly:
o Profit maximisation. A monopolist earns supernormal profits in both the
short run and the long run.
o Sole seller in a market (a pure monopoly)
o High barriers to entry
o Price maker
o Price discrimination
what is a monoploy
when one firm dominates the market with more than 25% market share,
the firm has monopoly power.
what is pure monopoly
when a firm has 100% market share
(THEORETICAL) not many examples of this
Barriers to entry (Monopoly)
The higher the barriers to entry, the easier it is for firms to
maintain monopoly power.
Economies of scale (monopoly)
As firms grow larger, the average cost of
production falls because of economies of scale. This means existing
large firms have a cost advantage over new entrants to the market,
which maintains their monopoly power. It deters new firms from
entering the market, because they are not able to compete with
existing firms
limit pricing (monopoly)
This involves the existing firm setting the price of their
good below the production costs of new entrants, to make sure new
firms cannot enter profitably.
Owning a resource (monopoly)
Early entrants to a market can establish their
monopoly power by gaining control of a resource. For example, BT
owns the network of cables so new firms would find it very difficult to
enter the market.
Sunk costs: (monopoly)
: If unrecoverable costs, such as advertising, are high in an
industry, then new firms will be deterred from entering the market,
because if they are unable to compete, they do not get the value of
the costs back.
Brand loyalty: (monopoly)
If consumers are very loyal to a brand, which can be
increased with advertising, it is difficult for new firms to gain market
share.
Set-up costs: (monopoly)
If it is expensive to establish the firm, then new firms
will be unlikely to enter the market.
The number of competitors: (monopoly)
The fewer the number of firms, the lower the
barriers to entry, and the harder it is to gain a large market share.
Advertising (monopoly)
Advertising can increase consumer loyalty, making demand price
inelastic, and creating a barrier to entry.
The degree of product differentiation
The more the product can be
differentiated, through quality, pricing and branding, the easier it is to gain
market share. This is because the more unique the product seems, the fewer
competitors the firm faces
Profit maximising equilibrium: (monopoly)
A monopolist earns supernormal profits in both the short run and the long run. This
is at the point MC = MR, so the monopolist produces an output of Q1 at a price of
P1
disadvantages of monopoly
The basic model of monopoly suggests
that higher prices and profits and
inefficiency may result in a misallocation
of resources compared to the outcome
in a competitive market
Monopolies could exploit the consumer
by charging them higher prices. This
means the good is under-consumed, so
consumer needs and wants are not fully
met. This loss of allocative efficiency is a
form of market failure
Monopolies have no incentive to
become more efficient, because they
have few or no competitors, so
production costs are high.
There is a loss of consumer surplus and a
gain of producer surplus. If a monopolist
raises the market price above the
competitive equilibrium level, output will
fall from Q1 to Q2. This leads to gains in
producer surplus.
Consumers do not get as much choice in
a monopoly as they do in a competitive
market.
Advantages of monopoly
Monopolies can earn significant
supernormal profits, so they might invest
more in research and development. This
can yield positive externalities, and make
the monopoly more dynamically efficient
in the long run. There could be more
invention and innovation as a result.
Moreover, firms are more likely to
innovate if they can protect their ideas.
This is more likely to happen in a market
where there are high barriers to entry,
If there is a natural monopoly, it might be
more efficient for only one firm to
provide the good or service, since having
duplicates of the same infrastructure
might be wasteful. For example, it might
be considered inefficient and wasteful to
have two lots of water suppliers.
Monopolies could generate export
revenue. For example, Microsoft
generates a lot of export revenue for
America.
Since monopolies are large, they can
exploit economies of scale, so they have
lower average costs of production. The
long run average cost curve can be used
to show this:
