perfect competition, monopolistic competition Flashcards
what is perfect competition?
- many small buyers + sellers
- each firm doesnt have price setting- they sell at market price
- demand perfectly elastic
what are the characteristics of a perfectly competitive market?
- homogenous - unbranded generic good
no difference between products available - lots of buyers + selling
- small firms
- all firms have access to factors of production
- no barriers to entry/exit→ easy to join the market
- perfect info for both buyers and sellers
- profit maximising objective
draw a diagram to show firms making a loss in perfect competition?
in perfect competition if AC is lower than D=AR=MR=> supernormal profit
if AC is above D=AR=MR=> loss
when can supernormal profit happen for monopolistic competition and perfect competition ?
supernormal profit can only happen in the short run
- assume that the aim of each firm is to find a profit maximising profit
why may the firm leave the market?
in the long run if a firm is making a loss- leave market
why cant a firm leave the market in the short run?
- cant leave in SR → at least one factor is fixed
- in long run- all firms make normal profit
what are the characteristic of monopolistic competition?
- many buyers and sellers
- each firm selling slightly differentiated goods
- firms are price makers
- however firms can raise prices significantly as there are other substitutes in the market
- price elastic demand
- low barriers to entry/exit
- good information of market conditions
- because firms cant raise price significantly to make very high supernormal profit→ lots of non price competition
e.g quality, branding, advertising, innovation
- because firms cant raise price significantly to make very high supernormal profit→ lots of non price competition
- assume firms are profit maximisers
what do firms make in the short run in monopolistic competition? draw a diagram to show this
average revenue is greater than average cost→ supernormal profit
why is the demand curve downward sloping in monopolistic competition?
downward sloping demand curve because they have some price setting power
what happens to profits in the long run in monopolistic compettion?
- supernormal profits will be eroded away
- new firms will enter the market being attracted by the supernormal profits + compete with firms
- demand for individual firms will shift to the left (decrease) as consumers are shared across a large number of new firms
- demand will keep shifting to the left until there is normal profit made
what are the steps for drawing a cost/revenue diagram?
- draw AR/MR curve
- then draw MC curve
- then show price and quantity on the diagram
- MC has to cut AC at its lowest point so draw AC curve last
what are the evaluations of monopolistic competition?
allocative efficiency isnt being achieved in the long run
productive efficiency not being achieved in the long run
no dynamic efficiency
why isnt allocative efficiency being achieved in the long run in monopolistic competition?
- allocative efficiency isnt being achieved in the long run as price doesnt equal marginal cost
- price is greater than marginal cost
- consumers are exploited
- choice restricted
- price greater than cost in theory
why isnt productive efficiency being achieved in the long run in monopolistic competition?
- productive efficiency not being achieved in the long run as we are not on the minimum point on the AC curve
- forgoing economies of scale- higher prices
why is there no dynamic efficiency in the long run in monopolistic competition?
- no dynamic efficiency- no long run supernormal profit
- not enough profit being made to be reinvested back into the company
how can you evaluate the disadvantages of monopolistic competition?
- there is competition and price making ability of firms is lower, so price exploitation is nowhere near as bad as a monopoly
- in perfect competition where there is allocative efficiency, consumers wouldnt want homogenous goods
- productive efficiency for monopolistic isnt nearly as bas as in monopolies as there is competition as firms cant afford to forgo economies of scale
- productive inefficiency may come from consumers demand for differentiation in goods
- supernormal profits from the short run may be enough to reinvest
- reinvestment may be part of competition in monopolistic competition
why do firms in monopolistic competition only have some price setting power
because they sell slightly differentiated goods
however there are many close substitutes
why is normal profit made in the long run in perfect competition
firms enter the market as theyre attracted to the supernormal profit
they know about the supernormal profit due to the perfect information
this causes the price decreases
why does D=AR=MR in perfect competition
this is because price stays the same at all levels of output
draw a diagram to show what firms in a perfectly competitive market make in the short run
draw a diagram to show what firms in a perfectly competitive market make in the long run
what is the effect of perfect knowledge in a perfectly competitive market
all buyers and sellers are aware of the price
in the long run- competitors copy changes in production techniques
therefore the short run benefits of lower production costs disappear in the long rn
however this means as a whole that the industry becomes more productively efficient
in the short run what efficiencies are there in perfect competition
no productive efficiency as they arent producing at the lowest point on the AC curve
there is allocative efficiency as P=MC
no dynamic efficiency as they wouldnt reinvest their profits since other firms would copy them
in the long run what efficiencies are there in perfect competition
both productive and allocative efficiency as they produce at the lowest point on the AC curve and P=MC
what are the criticisms of perfect competition
small firms are unlikely to achieve economies of scale of large firms
the average total cost for firms are likely to show higher levels of costs than for a larger firm
individual demand ignores externalities and doesnt consider whether goods are merit or demerit goods
demand is also based on income which encourages allocation of resources to the rich at the expense of the poor
what can be considered as the best allocation of resources
the best allocation of resources is therefore not where P=MC, but where social benefits are considered
ideal allocation of resources is when MSB=MSC
this can be used to evaluate perfect competition
why are there little barriers to entry in monopolistic competition
because each firm is free to create their own version of goods
the small scale of firms exclude barriers such as high capital costs, internal EoS, sunk costs, legal or marketing barriers
what differences in products could there be in monopolistic competition
product differences
marketing and promotional differences
service differentiation
what type of demand is there in monopolistic competition
relatively elastic demand as theres many close substitutes
what is the likely impact of firms who are loss making exiting the industry on firms that remain in the industry and why
firms remaining in the market will make normal profits in the long run
if firms are making a loss this means their AC>AR
low entry exit barriers make it easy for firms to leave
causes industry price to rise
normal profit is the level at which firms will stop leaving
for a firm operating under conditions of perfect competition and is making super normal profit, what is likely to happen to the firm in the LR
both its output and price will fall
they make normal profit in the LR
this is becuase firms are attracted to the supernormal profit so they enter the market
industry competition increases which causes price to reduce as industry supply increases
each individual firms output will fall
in monopolistic competition what happens when theres supernormal profit and what is the effect on the price/AR
firms are attracted to the supernormal profit and enter the market
when this happens the demand for each individual firm falls
therefore prices fall and therefore AR shifts inwards
Which inefficiencies are present in monopolistic competition in the long run
Dynamic inefficiency
Productive inefficiency
Allocative inefficiency
