Perfect Competition, Imperfectly Competitive markets and Monopoly Flashcards
Name 4 market structures
Perfectly Competitive Market
Monopolistc Competition
Oligopoly
Monopoly
Name 4 factors that one can use to determine a market structure
Product Differentiation
Limit/predatory pricing
No. of firms in market
Entry/exit barriers
What are entry barriers
Obstacles that make it difficult for a new firm to enter a market
What are exit barriers
Give 2 examples
Obstacles that make it difficult for an established firm to leave a market
Product Differentiation
Sunk Costs
What are natural barriers
Barriers that result from inherent features of the industry
What are sunk costs
Costs that have already been incurred and cannot be recovered
What are artificial barriers
Barriers erected by the firms themselves
What are limit prices
Prices set low enough to make it unprofitable for other firms to enter the market
A firm may use cross subsidization to be able to do this
What is predatory pricing
Prices set below average cost with the aim of forcing rival firms out of business
What is product differentiation
The marketing of generally similar products with slight differences, or just completely different products by firms in the same market
What is profit maximisation
Why
When MR = MC
Above this point, the cost of producing the next product will exceed the revenue receive from it
Name 6 firm objectives apart from profit maximisation
Survival
Public sector organisation - P=MC - maximise society welfare
Corporate Social Resposnibility
Sale Maximisation
Satisficing
Revenue Maximisation
What is the Divorce of Ownership from Control
The owners and those who manage the firm are different groups with different objectives
This causes the principal agent problem
Explain the Principal-Agent Problem and what the different objective might be
- Problem caused by the divorcee of ownership from control
- Agents are the managers
- They have the monopoly of technical knowledge on how to run the firm
- May want to maximise their career
- Principles are the shareholders
- May just want profit maximsation
What are downsides of the existence of the divorce of ownership from control
- May affect agents incentives
- They bear the cost of fulfilling the task, but don’t receive the full benefit, the principal does
- Agents may take on excessive risks
- If risk goes well, they will benefit a bit, if risk fails, the principal will be the one who loses money
How might the agent succeed in not acting in the principals best interest
- Cost to principal of sacking/punishing agent
- Information Asymmetry
- Principal has little way of knowing if bad performance is down to poor management or external factors
How do firms try to solve the principal - agent problem
Executive stock options
Giving managers company shares - company related pay
Explain the principle of satisficing
A firm has different stakeholders that want different things
Managers try to make as many stakeholders happy as possible by achieving a satisfactory outcome instead of the best one
Name 5 assumptions of a perfectly competitive market
All firms are price takers
There are many buyers and sellers
Products are homogenous
No barriers to entry/exit
All have perfect information
Diagram for a perfectly competitive market in the short run
MC cuts ATC at the lowest point
The firm doesn’t produce at the lowest point on the ATC
Firm produces where MR=MC
Supernormal profit is from ATC to AR
What does the diagram for a PCM in the SR show
There is allocative efficiency, as P=MC
There is no productive efficiency, firm doesn’t produce at the bottom of the ATC
There is supernormal profit
Diagram for a PCM in the Long Run, explain the diagram
D, MC, ATC all meet at the point where the firm produces
In the long run, the supernormal profit is an incentive for new firms to enter the market, increasing market supply, lowering D=AR=MR=P
What does the diagram for a PCM in the LR show
There is allocative efficiency, as P=MC
There is productive efficiency, at the bottom of the ATC
There is static efficiency
There is normal profit
What is a Pure Monopoly
One firm in a market
Name the 5 assumptions of a pure monopoly
1 firm in the industry
No close substitutes
Barriers to entry
Firm earns a supernormal profit
Firm is a price maker
What is monopoly power in the UK
When a firm has 25%+ of the market share
Monopoly diagram in the short run
What is the diagram for a monopoly in the long run
The same thing
How does a Pure Monopoly change in the short run vs long run
Why
It doesn’t
There are barriers to entry
Name and explain 2 advantages to a monopoly
- Economies of scale
- Enough space for it, can pass on lower cost to consumers, or they can be more efficient
- Dynamic Efficiency
- Supernormal profit made can be used for R&D - innovation
What is a counter argument to the advantages of a monopoly
It will reduce incentive for innovation
Firm is protected from competitive pressures, may decide they want to profit satisfice and not maximise
Name 5 disadvantages of a monopoly
Market Failure
Possible diseconomies of scale
Static inefficiency
Supernormal profit
May take advantage and pay lower prices to suppliers
How is market failure a disadvantage of monopoly
Use a diagram
Monopoly is a quantity setter, will produce where MR=MC, restricting output.
This represents a misallocation of resources and a loss of consumer surplus due to the deadweight loss
Why/How do governments tolerate monopolies
It’s difficult to break them up
They can be dynamically efficient
Their higher profits will mean more corporation tax (given that they don’t evade tax like many large corporations such as Starbucks/Amazon do)
Governments use regulation to keep them in check. Eg. OFWAT regulate the prices of water companies
Define Allocative efficiency
When it’s impossible to improve overall economic welfare by reallocating resources between industries/markets
When P=MC
What is a monopolistically competitive market
Give 2 examples
A market that resembles both a monopoly and a PCM
Restaurants - compete on quality of food
TV programmes - Diversity of TV shows
What are 5 assumptions of monopolistic competition
Widespread, but not perfect knowledge
Firms are price makers and profit maximisers
Low barriers to entry/exit
Large no. of independent firms
Differentiated products
How is monopolistic competition similar to a PCM
- There are many firms
- No barriers to entry in the long run
- New firms enter in the long run, reducing supernormal profits to normal
How is monopolistic competition similar to a monopoly
Firms are price makers as there is a degree of product differentiation
So each firm has monopoly power, if a firm raises its price, it won’t lose all its customers - demand isn’t perfectly elastic
Monopolistic competition diagram in the short run
MR and AR should be more elastic than in a monopoly
What does the diagram for monopolistic competition in the short run show
There is no productive efficiency
No allocative efficiency
There is supernormal profit
Diagram for monopolistic competition in the long run
The point are ATC=AR, is also where MR=MC and is where the firm produces
The lowest point on the ATC should be after it meets AR
What does the diagram show about monopolistic competition in the long run
No productive efficiency
No allocative efficiency
Normal profits
What is an oligopoly
A market dominated by a few producers, each of which have control over the market
Name 4 assumptions/characteristics of an oligopoly
Product Branding
Entry Barriers
Interdependent decision making
Non Price Competition
Describe the market conduct of firms in an oligopoly
Firm affects its rivals through its price and output decisions
Its own profit can also be affected by how rivals behave and react to the firm’s decisions
How is there uncertainty in some oligopolies, how do firms get rid of this
In competitive oligopolies, there is uncertainty as firms don’t know how firms will react to changes in price, output or marketing
To avoid it, they collude, making the oligopoly more uncompetitive
What is a competitive oligoply
Exists when the rival firms are interdependent as they must take into account other’s reactions when forming strategy
But independent in that they don’t cooperate/collude in these strategies
What is a cartel
Give an example of one
A collusive agreement by firm to fix prices and sometimes restrict output, deter entry of new firms
OPEC
How might a firm benefit from joining a cartel, how does this become a disadvantage to society
If the firm is the most productively inefficient
If they join all firms can decide to charge a price to keep the firm in business
So inefficient firm can survive, and the efficient firms can enjoy supernormal profit
So this displays the disadvantages of a monopoly - (high prices, restriction of choice)
What is Overt Collusion
When a formal agreement is made between firms
Illegal in many countries
What is Tacit Collusion
Informal Collusion, more implied
What is cooperation
Firms working together to develop a product, how they are managed or organsied
Usually with good intentions, so are allowed by governments
The Kinked demand curve diagram
What is the diagram used to explain
How price rigidity is caused by a competitive oligopolist trying to factor in the possible reactions of rival firms to its price/output decisions
Explain how Kinked Demand Curve shows price rigidity in a competitive oligopoly
- Let the point where the kink is be P1, Q1
- If a firm increases its price, demand is very elastic as no other firms will follow suit, so consumers will move to other firms.
- If a firm lowers its price, they expect other firms will do the same to avoid losing customers. If all firms decrease prices, a small amount of customers will move so demand will be inelastic. So it would only lower all the firms profit, in an extreme case this will spark a price war.
Name 3 criticisms of the kinked demand curve theory
- Incomplete theory
- Doesn’t expalin why a firm produces at Q1 in the first place
- Model assumes firms will react in a certain way
- In the real world, evidence has clearly shown this isn’t necessarily how firms react
- Ignores price competition
What is price leadership, what type of collusion is this
The setting of prices in a market, usually by dominant firms, which is then followed by other firms in the same market
Tacit collusion
What is a price agreement
An agreement between a firm, similar firms, suppliers or customers regarding the pricing of a good or service
Cartels do it when it is between similar firms
What is a price war
What market structures can it occur in
When rival firms continuously lower prices to undercut each other.
Aim to increase market share or even force rival firms out of business
Can occur in monopolistic competition or in oligopoly
What is price discrimination
Charging different prices to different customers for the same product or service, with the prices based on different willingness to pay
What are the 3 conditions that must be met for a firm to use price discrimination
Different elasticities of demand
Firm must be a price setter
No arbitrage (Resale)
Name 3 disadvantages to price discrimination
Not allocatively efficient
Administration cost
Loss of consumer surplus
Name 3 advantages of price discrimination
Higher revenue, can be used for dynamic efficiency
THose with higher incomes are likely to pay more, can be used for cross subsidisation
What is a contestable market
A market in which the potential exists for new firms to enter the market, so incumbent firms act more competitively.
So it can deliver the theoretical benefits of perfect competition but without the need for many firms
So a firm in a monopoly can act efficiently
Name 4 assumptions of a perfectly contestable market
Threat of hit and run entry
No entry/exit barriers
No sunk costs
Perfect information, access to the best available tech
What is 1st degree price discrimination
Give an example of it
When each customer is charged the maximum they are willing/able to spend
There is a complete transfer of consumer surplus to the producer.
Car dealerships
What is second degree price discrimination
Charging different prices based on the quantity of a purchase.
More revenue as some consumer surplus is transferred. Rewards buying more
What is 3rd degree price discrimination
Charging different prices based on groups with different Elasticities of demand.
Consumers with more inelastic demand charged higher, so receive less consumer surplus
Define Consumer Surplus
A measure of the economic welfare enjoyed by consumers
The surplus utility received over and above the price paid for a good
Define Producer Surplus
A measure of the economic welfare enjoyed by firms or producers
The difference between the price a firm succeeds in charging and the minimum price it would be prepared to accept
Diagram for 2nd degree price discrimination
Diagram for 3rd degree price discrimination
How does a contestable market deliver the theoretical benefits of perfect competition but without the need for many firms
As they are about the ease/difficulty with which new firms can enter the market
The threat of entry of potential competition is enough to ensure the efficient behaviour of incumbent firms
What kind of monopoly policy has the UK started to use in light of contestable market theory
Deregulatory policies
To minimise barriers to entry/exit and keep reasonable contestability
What is hit and run competition
When a firm temporarily enters a market to get supernormal profit, then leaves when they have been competed away due to no barriers to exit
Why don’t incumbent firms want hit and run competition
How do they usually combat this
As they come into a market and get rid of all firms supernormal profits, then leave
By reducing selling price to a price where only normal profit is made
How might a firm reduce market contestability
Explain each
- Predatory behaviour
- Increasing barriers to entry/exit
- Raising rivals’ costs
- Will make it difficult for new rivals to appear
- Reducing Rival’s revenues
- Make it difficult for new rivals to appear
- Cross - subsidisation
- Be able to charge a price so low, new firms cannot compete
How might a firm raise rival’s costs
Vertical integration
Act as a component supplier to other firms, have control over the supply chain
Name 3 problems with Contestable Market Theory
No perfectly contestable markets actually exist
The threat of entry of new suppliers may not be enough to affect behaviour
Doesn’t include how structural changes in costs in the industry can affect degree of contestablity
What are restrictive trade practices?
Name 4
Chargng Discriminatory prices
Resale price maintenance
Refusal to supply certain outlets/markets
Full line forcing
What is resale price maintenance
Give an example of one
When manufactuers fix prices that retailers must sell at - prevents price competition
E.g Drink bottles that have the price printed on them
What is full line forcing
When a supplier forces a firm that wants to sell 1 of its products to stock the whole product range.
Leaves not as much space for other manufactuers
Give an example of refusal to supply certain outlets/markets
How some high end suppliers will only supply Harrods and not Lidl
Diagram comparing Monopoly and Perfect competition
But MC line is straight
No need to show consumer surplus
Defien Deadweight Loss
The reduction in consumer and producer surplus when output is reduced to less than its optimal level
Diagram for Dynamic Efficiency
Name 4 reasons why a firm would want to maximise profit
- Reinvestment
- Dividends for shareholders
- Lower costs and lower prices for consumers
- As the reward for entrepeneurship
Explain 4 reasons why a firm may not want to maximise profit
- Greater scrutiny
- Authorities may be more likely to investigate them, force them to change in an undesirable way
- No knowledge of where MC=MR
- Other objectives more appropriate
- May harm key stakeholders
- Making it more appropriate to focus on other objectives
Name 6 key stake holders for a business, whether they are likely to be happy with profit maximisation and how a firm might suffer from not keeping them happy.
- Managers
- Happy - Higher bonuses
- Shareholders
- Happy - Higher dividends
- Consumers
- Unhappy - Higher prices
- Hurt reputation of firm
- Workers
- Unhappy
- May strike
- Government
- Unhappy
- Investigate - anti business interest outcomes
- Environmental groups
- Unhappy
- Ruin reputation - on social media
Define Revenue Maximisation
Name 3 reasons why a firm may want to do it
- When MR is 0
- Economies of scale - Higher output, lower cost than MR=MC
- Predatory Pricing
- Costs are lower here
- Principal - Agent Problem
- May want to get higher revenue to get more perks - company cars/nice hotels
Define Sales maximisation
- When AC=AR, break even output
- Economies of scale
- This price is the limit price - takes away the incentive for firms to want to come in
- Principal agent problem
- May use this as leverage and get perks
- Flood the market
- More consumers know about your product, developing loyalty
How may one show Profit, Revenue and Sales Maximisation on a diagram
Use monopoly diagram
Profit : MC=MR
Sales : AC=AR
Revenue: MR=0
Satisficing : Any in the quantity range between Sales and Profit max
