Perfectly Perfect And Imperfect Markets And Monopolies Flashcards
What is the market structure?
How the market is organised
What is the spectrum of market structures?
Perfect competition - Monopolistic competition - Oligopoly - Monopoly
As you shift more towards the left of the market spectrum what happens?
There is more market power and less efficiency
How are markets characterised?
The n. firms in the market
The degree of product differentiation
Ease of entry into the market
Explain the market characteristic: The n. Firms in the market
The more firms there are the more competitive it is. This also includes the extent of competition abroad
Explain the market structure characteristic: The degree of product differentiation
The more differentiated the product is the less competitive the market is.
What type of products are sold in perfectly competitive markets?
Homogenous products
How can you differentiate a product?
What effect does this have?
Price, branding and quality, however this effects the elasticity of demand of the product
Explain the market structure characteristic: Ease of entry into a market
This is about the number of barriers and the difficulty to overcome them to enter a market
Barriers are erected to stop other companies from making profit in a market. This increases producer surplus. The higher the barriers to entry are the less competitive the market is.
What are some barriers to entry to a market?
Economies of scale
Brand loyalty
Controlling the technology
Strong reputations for existing firms
Backwards vertical integration
Why is brand loyalty a barrier to entry?
It makes demand more inelastic. It will be harder to persuade customers to buy your product
Why is backwards vertical motion a barrier to market entry?
It controls supply. This therefore means that firms can control their prices as there is no invisible hand of the market.
This makes it hard for firms to compete in price
What are the different types or barriers a firm can erect to stop competition entering a market?
Structural
Strategic
Statutory
Describe the barrier to entry types: Structural
When barriers are formed due to differences in production costs
Describe the barrier to entry types: Strategic
When firms use different pricing policies
Describe the barrier to entry types: Statutory
The use of patents protecting a franchise
What do models that consider that traditional theory consider?
All firms want to maximise profit
What is profit?
The difference between total revenue and total cost. It is the reward that entrepreneurs get if they take risks
When do firms break even?
When TR=TC
How does a profit maximised firm operate?
When they are operating at a price and quantity of production that derives the most profit whilst having the lowest costs possible
When does profit maximisation happen?
MC=MR
Marginal costs = Marginal Revenue
What is the case when MC=MR
Profit has been maximised so an increase or decrease in unit production will not be beneficial
How does a graph show profit maximisation and the break even point?
When do profits increase/decrease?
Profits increase when MR>MC
Profits decrease when MR<MC
Why may some firms choose to maximise profits?
Provided greater wages
More dividends for shareholders - which may increase investment
Retained profits are a cheap source of finance, so you don’t have to use loans
Which type of business is most likely to want to maximise profits?
Why?
PLC may have short run profit maximisation as their goal because they need to keep shareholders happy with high dividends
What can the principle- agent problem be linked to?
Asymmetric information
What is the principle- agent problem?
When the agents make decisions for the principle but they are inclined to act in their own interest rather than those of the principle
For example a manager may give himself a bonus rather than give the money to the shareholders
Why are funds being limited be a problem?
In the short run Shareholders want profit to be turned into dividends
In the long run the firm wants to improve for example giving better managers more pay to keep them
This conflicts what the firm and the shareholders want
What is the problem for a manager to sell his firm’ sells
The shareholders could gain a big portion of the shares and could get a lot of control over the firm
This is called shareholder activism
What are some objectives of firms?
Profit maximisation
Survival
Growth
Increasing their market share
Quality
Maximising sales revenue
Sales maximisation
To improve: society, the environment, being ethical, personal gains, worker welfare
Satisficing
Explain the objective of the firm: Survival?
Normally new firms
This is a short term view
This may happen when their is low global economic growth like in 2008
This may involve selling assets to get cash to pay of loans etc
Explain the objective of the firm: Growth?
May happen through taking advantage of economies of scale to lower the average cost of the firm to eventually make them more profitable.
It could happen through takeovers or mergers
Large firms may use innovation through expensive methods of R and D
This is normally a long term goal
Explain the objective of the firm: Increasing their market share?
This helps increase a firms chances of survival and this can also be achieved by maximising sales
In the short run you may make a loss but in the long run (if done correctly) you should make a profit
This is normally a long run goal
Explain the objective of the firm: Quality?
This may be done to try and increase competitiveness through a USP (quality)
This could be done through product quality or customer service quality
This could be achieved through innovation
This may be done as if the firm gains a good reputation of quality it could result in the firm being able to charge higher prices
Explain the objective of the firm: Maximising sales revenue?
This occurs when MR=0
On the graph (at Point P1O) the firm is at MR=0 so sales are maximised
Explain the objective of the firm: Sales Maximisation?
This is where a firm tries to sell as much as their good or service as possible without making a loss
This may be common in charities
On a graph this is where AC=AR
Draw and label a diagram that shows the objective of firms
When is a firm profit Satisficing?
When a firm makes just enough profit to make its shareholders happy
Why may profit satisficing happen?
A manager is more concerned about ethics and therefore makes enough profit to keep shareholders happy whilst following his ethical code
Essentially this happens when there is a divorce of ownership and control
What are the characteristics of a perfectly competitive market?
Many buyers and sellers
Sellers are price takers
Free entry and exit to the market
Perfect information
Homogeneous goods
Firms are short run profit maximisers
Factors of production are perfectly mobile
In a perfectly competitive market, how is the price decided?
Why?
By the market
Because all firms are price takers
In a perfectly competitive market, why are profits likely to be low?
Each firm has a very small market share so they can’t set their own prices
As there are many firms the price should average out to the firms break even point as firms will compete on price but since homogeneous goods are being sold the buyers will buy the lowest priced good.
If a firm is making profit due to the perfect information other firms will join and compete that profit away
In what state can supernormal profits be made?
The short run only
Can supernormal profit be made in a perfectly competitive market?
Yes but only in the short run which would only last for a couple days as other firms enter the market
Draw a diagram showing the short run equilibrium for a perfectly competitive market
The yellow box is supernormal profits
I would expect the the demand price in the industry to increase in the long term so that it is in line with the turning point of the AC curve so the firms break even
In a perfectly competitive market, explain the short run equilibrium graph
The firm is a price taker and therefore it accept the price of the industry of P1.
In the short run the firm produces Q1 (as it is assumed that they want to maximise profit)
Describe the yellow box
In a perfectly competitive market, draw a diagram showing the long run equilibrium
In a perfectly competitive market, describe the long run equilibrium graph?
Die to the supernormal profits being made in the short term more firms have entered the market and they have competed away the supernormal profits. Since there are no barriers to entry and exit they can enter the market at any time.
This causes the supply in the market to increase. Therefore the price in the market falls so the firms (who are price takers) set a lower price
The mew equilibrium at P=MC means that firms produce at a new quantity in the long run
What are the advantages of a perfectly competitive market?
In the long run there are lower prices and allocative efficiency
Since firms are producing at the bottom of the AV curve there is productive efficiency
The supernormal profits produced in the short run could increase innovation and dynamic efficiency
What are the disadvantages of a perfectly competitive market?
In the long run dynamic efficiency is limited due to no supernormal profits
There are few economies of scale
This is not applicable in real life
What are the characteristics of a monopolistic competitive market?
Imperfect competition
Forms are short run profit maximisers
Firms sell non-homogeneous goods (due to branding)
Lots of relatively close substitutes
There are a large amount of sellers and buyers who act independently
All firms have equal and small market control
Pricing competition is not used
No barriers to entry and exit
Imperfect information
Give some examples of monopolistic competition?
Hairdressers
Regional plumbers
When on a graph do firms maximise profit in the short run?
MC=MR
Draw a diagram to show what is happenings in a monopolistically competitive market in the short run
P1C1AB is an area that represents supernormal profit
In the long term in a monopolistically competitive market why do new firms enter the market?
What effect does this have?
They are attracted by the supernormal profits
This makes demand for the firms original product more elastic which shifts the AR curve to the left. A new equilibrium point in reached and supernormal profits have been competed away
Draw a diagram to show what is happenings in a monopolistically competitive market in the long run?
What are the advantages of monopolistic competition?
Firms are allocatively efficient in the long run
Consumers get a wide range of choice
This model is more realistic than the one of perfect monopolistic competition
The supernormal profits in the short run could increase dynamic efficiency
What are the disadvantages of monopolistic competition?
In the long run dynamic efficiency might be limited due to the lack of supernormal profits
Firms aren’t as efficient as perfect competition markets
There is a lot of X- inefficiency as there is little incentive to minimise costs
What are the characteristics of an oligopoly?
High barriers to entry and exit
High concentration ratio
Interdependence of firms
Product differentiation
Explain the characteristics of an Oligopoly: high barriers to entry and exit?
This makes the market less competitive
Explain the characteristics of an Oligopoly: high concentration ratio
Only a few firms own the majority of the market. This makes the market less competitive. For example the UK supermarket market is an oligopoly.
Explain the characteristics of an Oligopoly: interdependence of firms
Firms in an oligopoly are interdependent. This means that the actions of 1 firm affects another firms behaviour
Explain the characteristics of an Oligopoly: product differentiation
This may be done using methods such as branding
The more oligopolistic a market is the harsher the degree of product differentiation there will be
How can oligopoly form?
There may be a few firms who have a high market concentration
Or some firms in a market decide to act Oligopolistically
Firms that display oligopolistic behaviour might be:
Interdependent, have stable prices, collude, or have non price competition
What is the concentration ratio?
The concentration ratio of a market is the combined market share of the top few firms in the market
How do you calculate the market concentration of a market?
You add the market shares of the top few firms in a market
How does the concentration ratio effect the competition in the market?
Why?
The higher the concentration ratio the less competitive the market will be because fewer firms are supplying the bulk of the market
When does collusive behaviour happen?
When firms agree to work together on something eg fixing the price
Why is collusion bad for consumers?
It leads to a lower consumer surplus, higher prices
But greater profits for the firm colluding.
Collusion allows oligopolies to act like monopolies who can charge higher prices
Why do firms in an Oligopoly have high incentives to collude?
By making agreements they can maximise their own benefit and restrict their output to cause the market price to increase.
What is a by product of collusion?
It is anti competitive and acts as a barrier to market entry
Why is collusion most commonly found in Oligopoly markets?
Monopolies can’s collude as there is only 1 firm
Collusion is most likely ro happen when there is only a few firms. The is what an oligopoly is
Give disadvantages of collusion?
It isn’t easy to catch.
It is anti competitive
It erects high barriers to entry
It causes ineffective competition policy .
There is often consumer inertia (the tendency for consumers to buy a product from a certain brand even though there is a superior alternative option) so the market stays stable so the collusion is allowed to continue unnoticed
When does non collusive behaviour happen?
When firms are competing. This establishes a competitive Oligopoly.
When is non collusive behaviour in an oligopoly most likely to happen?
When there are several firms, on firm has a significant cost advantage, products are homogenous and the market is saturated
How do firms grow in an non collusive oligopolies market?
Taking market share from rivals
What are the 2 types of collusion?
Overt and tacit
What is overt collusion?
When collusion is a formal agreement between firms
Eg it has often been expected that Uk gas companies do overt collusion
When is overt collusion most likely?
When there are only a few dominant firms in a market (so one doesn’t refuse)
Is overt collusion legal?
Not in the UK and USA etc
What else may companies in an oligopoly collude to do?
Cut their advertising costs
What is tacit collusion?
When there is no formal agreement of collusion but it is implied
Give an example of tacit collusion?
In the UK supermarket industry
Are price wars good for firms in an oligopoly?
No
What is the difference between co-operation and collusion?
Co-operation is legal where collusion is illegal
Collusion is usually with poor intentions whilst co-operation will usually be beneficial
Collusion usually involves market variables like quantity and price where cooperation is usually to do with management etc
What does the kicked demand curve try to show?
The feature of price stability in an oligopoly
What does the kinked demand curve model assume?
Other firms will have a asymmetric reaction to price change by another firm
If price is increased other firms will no nothing
If price is decreased other firms will follow
Draw a kinked demand curve?
In the kinked demand curve why is it assumed that other firms won’t follow an increase in price?
The firm that increases in price will loose a lot of market share compared to the revenue that they gain from the price increase so it isn’t worth it
What is a cartel?
A group of 2 or more firms which have agreed to control prices , limit output or prevent the entrance of new firms into the market
They could also agree to divide up the market so firms agree not to compete in other cartel member’s areas
What is an example of a cartel?
OPEC fixes their output of oil
When does price leadership happen?
When 1 firm changes their prices, and other firms follow. This firm is usually the dominant firm so other firms are usually forced into changing their prices too, or they risk loosing market share
How does price leadership help explain price rigidity in an oligopoly?
If less dominant firms don’t change their prices on accordance with the dominant firm they risk loosing market share. Furthermore, the dominant firm is judged to have the best information about the future market conditions
What is price war?
It is a type of price competition, which involves firms constantly cutting their prices below it’s competitors prices. Your competition will then lower it’s prices to match
What is non-price competition?
It aims to increase the loyalty to a brand, which makes demand for a good more price inelastic
Give an example how non-price competition may happen?
A firm may increase the quality of their customer service
Increasing the customers convenience (it is easier for them)
Advertising and branding
What does a special offer attempt to do?
Attempt to increase demand temporarily
What is a disadvantage of advertising?
It may not work for some firms. This would make them incur a large sunk cost.
How are brands used?
To differentiate between products and increase brand loyalty
What are barriers to entry trying to do?
Why do firms do this?
Prevent new firms entering the market profitably
To reduce the amount of market share going towards their competitors
Briefly explain game theory?
The concept of interdependence between firms. It is used to predict the outcome of a decision made by 1 firm when it has incomplete information about the other firm
What is the “dominant strategy”?
The best option regardless of what someone else does
In the prisoner dilemma this would be for them both to deny
What is Nash equilibrium?
A concept in game theory which describes the optimum strategy for all players, whilst taking into account of what your opponent does. They can’t improve their position given the choice of the other.
Why is the mash equilibrium unstable?
It will be unstable if there is an incentive to cheat to improve your individual position
What are the disadvantages of an oligopoly?
The basic model of an oligopoly suggests that higher prices and profits and inefficiency may result in 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 reduced
Collusion could reinforce the monopoly power of existing firms and makes it hard for new firms to enter. Because of the absence of competition efficiency falls
What are the advantages of an oligopoly?
They can earn significant supernormal profits which could be reinvested in r&d which could yield positive externalities and make the firm more dynamically efficient in the long run. There could also be more invention and innovation.
Furthermore, firms are more likely to innovate when they can protect their ideas. When there are high barriers to entry then there is more protection
Higher profits could be a source of government revenue
Industry standards could improve because collaboration could improve the standards of safety etc.
Also collusion could save on duplicate r&d costs
Since oligopolies are large they can exploit economies of scale. Ao they will have lower average costs of production. This can be shown through the long run average cost curve.
What are the characteristics of a monopoly?
Profit maximisation. (Monopolies earn supernormal profits in the long run and short run)
Sole seller in a market
High barriers to entry
Price maker
Price discrimination
In the UK when does a firm have monopoly power?
25%
Is google a monopoly?
Yes, they had 90% market share
When does a firm/firms have monopoly power?
When a firm has a market share above 25%
If 2 firms have a market share above 25% they they are considered to have monopoly power
Give an example of monopoly power between two firms?
Sainsbury’s and Asda
What factors influence monopoly power?
Barriers to entry
The number of competitors
Advertising
The degree or product differentiation
What are the different barriers to entry?
Economies of scale
Limit pricing
Owning a resource
Sunk costs
Brand loyalty
Set up costs
Explain the barrier to entry: economies to scale?
AC falls as a firm gets larger
So existing firms have a cost advantage over new, smaller firms. This deters new entrants as they will be at an disadvantage
Explain the barrier to entry: Limit pricing?
This is when a firm sets their price below the production costs of a new entrant so that they can’t make profit
Explain the barrier to entry: Owning a resource?
Give an example?
If you own what is needed to enter a market you can make it very hard to get that resource
Bt own the network of cables so it would be very hard for s new firm to enter the market successfully
Explain the barrier to entry: Sunk costs?
If unrecoverable costs are high in an industry new firms may not want to risk entering the market because they could make a big loss
Explain the barrier to entry: Brand costs?
If consumers are very loyal to a brand, which can be increased with advertising, it is very difficult for new firms to gain market share
What is maket share an example of
Explain what this is?
A zero sum game
You can’t benefit without someone else loosing something
Explain the barrier to entry: Set up costs?
If it is expensive to set up in a industry less firms will try it
Explain the influence on monopoly power: Barriers to entry?
When there are high barriers it is harder for new firms to enter the market profitably. This will help a firm keep their monopoly power
Explain the influence on monopoly power: The number of competitors?
The fewer the number of competitors the harder it is to gain a large market share
Explain the influence on monopoly power: Advertising?
This can increase customer loyalty (which is a barrier to entry)
This makes demand inelastic
Explain the influence on monopoly power: The degree of product differentiation?
The more a product can be differentiated the easier it is to gain market share because the more unique the product looks the less firm are in that specific market
How may you differentiate your product?
Quality, pricing, branding…
When does a monopoly earn supernormal profits?
The short run and the long run
At what point on a graph does a monopoly earn supernormal profits?
MC = MR
Draw a graph showing supernormal profits on a graph?
What is special about a monopoly graph?
Since the firm is the sole supplier the costs and revenue curves are the same as the industry’s
P>MC in the diagram due to profit maximisation which occurs at MC = MR, so there is allocative efficiency in a monopoly
AR>AC so there are supernormal profits
What are the disadvantage of a monopoly?
The basic model of a monopoly suggests that higher price 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 that the good is under consumed so customer needs and wants aren’t fully met. This loss of allocative efficiency is a form of market failure
Monopolies have no incentive to become efficient so production costs are often high ^^^*
There is a loss in consumer surplus and a gain of producer surplus. So if a monopolist raises the price to be above the competitive equilibrium quantity produced will drop (leading to gains in producer surplus
Consumers don’t get as much choice in a monopoly market
What are the advantages of a monopoly?
Significant supernormal profits are made. This could be reinvested in r&d which could yield positive externalities and increase dynamic efficiency in the long run. This could result in more intention and innovation
Furthermore, firms are more likely to do this if they know that what they do will be protected from other companies (high barriers in a monopoly ensures this)
If there is a natural monopoly it may be more efficient for 1 firm to run the market because having duplicates of the same infrastructure could be inefficient
Monopolies could generate export revenue
They can exploit economies of scale to get a lower AC of production - this can be shown through the LRAC curve shown below
High profits could be a source of government profit through taxation
When does price discrimination usually occur?
In a monopoly when they decide to charge different prices for different groups of people for the same service or good
Why does price discrimination normally happen?
There are different elasticities of demand for each group
There is little costs to the firm to do this (or it wouldn’t be worth it)
Draw a diagram illustrating price discrimination
Why may a firm price discriminant?
They can earn a higher total profit
What is first degree price discrimination?
When each consumer is charged a different price
Give an example of first degree price discrimination?
A layer may charge more for a high income family than a low income family
What is second degree price discrimination?
When prices are different according to the volume purchased
Economies of scale
Give an example of second degree price discrimination?
For example the purchase of gas
What is third degree price discrimination?
Different groups of consumers are charged a different price for the same good or service
Give an example of third degree price discrimination?
Trains - peak/off peak prices
What are the cost of price discrimination for consumers?
Usually this result in a loss of consumer surplus.
Since P>MC there is a loss of allocative efficiency
It strengthens the monopoly power of a firm which may lead to higher prices in the long run
What are the benefits of price discrimination for the consumer?
They could benefit from a net welfare gain if they are on the off peak trains for example
Some consumers who couldn’t afford a product may now be able to afford it
What are the costs of price discrimination for a producer?
If it is using a predatory pricing method, the firm could face investigation from the CMA
It may cost the firm to segment the market
What are the benefits of price discrimination for the producer?
Producers can make better use of spare capacity
The higher supernormal profits could be used to be dynamically efficient
Because of higher profits the business could subsidise another industry to make prices there more affordable
What are some short run benefits that are likely to happen in the short run because of competition?
Firm may make supernormal profits which could be reinvested to achieve dynamic efficiency and lower LRAC
For consumers quality is likely to increase as firms try to compete by increasing customer loyalty
What are some long run benefits that are likely to happen in the long run because of competition?
Firm are more likely to be productively efficient and allocatively efficient
Why, in the long run, are firms more likely to be allocative and productively efficient?
Because the firms face competitive pressure which forces them to lower their LRAC
What could firms do to compete apart from competing on price?
Improve products
Reduce costs
Improve quality
How may improving a firms production be competitive for a firm?
Improving the quality or being innovative or using the latest technology will mean that the product remains competitive in the market
How may reducing a firms costs be competitive for a firm?
By reducing costs new firms will find it much harder to enter the market profitably so there will ne less competition.
This will also likely mean that the firm is being more productively efficient
How may improving a firms quality of the product or service be competitive for a firm?
Things like customer service will be the deciding point in many firms as a lot of customers want things to be easy
Explain creative destruction?
The idea that new entrepreneurs are innovative. This forces existing companies to improve their productivity. Firms that can’t do this then are forced to leave the market. In the end this results in an expansion of the economies productive potential
What may happen if a monopoly is making large supernormal profits
If firms have monopoly power and are making large profits there is an incentive for new firms to enter the market. So they will innovate to overcome the high barriers to entry. This is liked to technological changes as if there is new technology it may become easier to overcome these barriers
Simply what should creative destruction lead to?
More innovation
Production of new goods and services
Give an example of creative destruction?
Netflix has put Blockbusters largely out of business by adapting to use the internet
Give an example of how technological changes caused creative destruction?
The development of
DVD - Blu-ray - online streaming
What are the characteristics of a contestable market?
They face actual and potential competition
Entrants have free access to production techniques and technology
There are no significant entry and exit barriers to the market
There are no sunk costs
There is low customer loyalty
The number of firms in the market varies
How may being in a contestable market change how a firm behaves?
More likely to have allocative efficiency
In the long run firms operate at the bottom of the LRAC curve so they are productively efficient
Highly contestable markets are like perfectly competitive markets (because existing firms act as if there are loads of competition
Supernormal profits may only be available in the short run and not the long run - in the short run there are less firm in the market so there is less firms for supernormal profits to be shared out to. But in practise firms tend to only earn supernormal profits because then there won’t be any more competition entering the market.
What is hit and run competition?
When firms enter a market when there are high profits then leave the market when the supernormal profits stop
State some barriers to entry in a contestable market?
Economies of scale
Legal barriers
Branding
Predatory pricing
Limit pricing
Anti competitive practices
Vertical integration
Brand proliferation
State some barriers to exit in a contestable market?
Write off assets and pay leases
Losing a brand
The cost of making workers redundant
Explain the barrier to entry in a contestable market: economies to scale
LRAC will become cheaper for existing firms which gives them a big advantage
Explain the barrier to entry in a contestable market: Legal barriers
Patents etc
You may need to gain a licence to do it so it is harder to start
Explain the barrier to entry in a contestable market: Branding
It makes demand more inelastic because consumers are less likely to try other brands
Explain the barrier to entry in a contestable market: Predatory pricing
This involves setting low prices to drive out firms already in the industry. This may result in short tern losses. But when the firms leave the market the firms slowly raise their prices to regain the revenue lost
They price their goods and service below their average costs. This reduces contestsbility.
Explain the barrier to entry in a contestable market: Limit pricing
This discourages the entry of other firms. This is when the business ensures that their price is below the cost of production for a new firm which would mean that the new entrant can’t make many sales
Explain the barrier to entry in a contestable market: anti competitive practises
Such as refusing to supply retailers which stock competitors products
Explain the barrier to entry in a contestable market: Vertical integration
This is when one firm gains control of more of the market, which creates a barrier to entry as they now supply the market.
This may include controlling the sales of technology that is needed in that market
Explain the barrier to entry in a contestable market: Brand proliferation
Firms may saturate the market with their goods using brand proliferation. This disguises the actual market concentration from the consumers
Give an example of brand proliferation
The soap industry has lots of different brands but they are all made by a few firms
Explain the barrier to exit in a contestable market: write off assets and pay leases
If firms have to continue paying costs even if they leave the industry it may be cheaper for them to stay in the industry. This makes the market less contestable
Explain the barrier to exit in a contestable market: Loosing a brand
Customer loyalty is hard to put a monatary value on but it is still considered a cost of leaving the market
Explain the barrier to exit in a contestable market: The cost of making workers redundant
This may discourage a firm from leaving a industry
What does the degree of contestability in a market depend on?
The kind of costs a firm face
How loyal customers are
Why is it hard to judge the degree of contestability in a market?
In all markets there will be some costs to enter and exit
What is a barrier to contestability?
Sunk costs
What is a sunk cost?
Costs which can’t be recovered once they are spent
Give an example of a sunk cost?
Advertising
Why do high sunk costs act as a barrier to entry?
There is a higher risk of entering a market with high sunk costs
What do high sunk costs do in terms of price?
It is likely that when there are high sunk costs a firm will set a price and quantity that is similar to a monopoly
What is static efficiency?
It describes the level of efficiency at one point in time
Give 2 examples of static efficiencies?
Productive and allocative efficiency
What is dynamic efficiency?
To do with new technology and increases in productivity, which causes efficiency to increase over a period of time
When does productive efficiency happen?
When firms minimise their average total costs
(When a firm produces at the lowest point on the AC curve
When MC = AC (because the MC curve always cuts the AC curve at its minimum
In what graph are all points productively efficient?
A PPF graph
When does allocative efficiency happen?
When resources are distributed to the goods and services that consumers want. This maximises utility.
When does allocative efficiency happen?
Why?
P=MC
Consumers pay for the value of the marginal utility they derive from consuming the good or service
Which markets are considered to be allocatively efficiency
Free markets
How is dynamic efficiency effected?
Eg. R&d, technological changes
Short run - demand, interest rates and past profitability
What leads to falling LRAC?
Long Run Average Costs
When all resources are allocated efficiency AND the rate of innovation is at an optimum level
When is a market dynamically efficient?
If consumer needs and wants are met as times go on
Why could dynamic efficiency lead to?
Lower costs of production in the future
An invention of a new product
What are 3 obvious costs of dynamic efficiency?
Short run costs may be increased in order to increase long run costs
The time between costs and rewards is large
A firm may need to make a choice between giving out dividends or investing in dynamic efficiency
When is a firm x-inefficient?
When it is producing inside the AC boundary
What is a cost of x-inefficiency?
Costs will be higher than they would be in a competitive market
Show x-inefficiency on a graph?
Why may x-ineficiency occur?
Organisational lack
Unnecessary waste in the production process
Poor management
Laziness
Which type of market tends to be x-inefficient?
Why?
Monopolies
They have little incentive to become efficient
Where are consumers and producer surpluses maximised?
At the market equilibrium
What is the consumer surplus in words?
The difference between the price the consumer is able and willing to pay and the price they actually pay
What is consumer surplus based on?
What the consumer perceives their private benefit will be from consuming the good
What is consumer surplus on a graph?
The area above the price of the good and below the demand curve
What generally happens to consumer surplus with each extra unit comsumed?
Why?
Generally it declines
Because of the law of diminishing marginal utility because the extra unit derives less utility than the one before it. Therefore consumers are willing to pay less for the extra unit
Does elastic or inelastic demand curves give more consumer surplus?
Why?
Inelastic
Because consumers are willing to pay a much higher price for a good
In terms of consumer surplus what does an increase in demand cause?
Show this on a graph?
An increase on consumer surplus
How does the supply curve effect consumer surplus?
When it moves the market price is changed so it can effect consumer surplus
If it shifts to the left the price is now higher so consumer surplus is decreased
What is producer surplus in words?
The difference between the price that is charged and the lowest price that they would be willing to sell the product for
What is consumer surplus explain on a graph?
The area beneath the market price and above the supply curve
What is the same thing as producer surplus?
Supplier surplus
How is producer surplus increased?
Explain each way
Shift in the supply curve to the right
An increase in demand because prices increase
What is economic welfare?
The total benefit society receives from an economic transaction
How do you calculate economic welfare?
Consumers surplus + producer surplus
What is important to consider when talking about government policies?
The impact on producer and consumer surplus and economic welfare
What does price discrimination usually lead to in terms of surplus?
Loss in consumer surplus
What may happen to a monopoly if they price discriminate in terms of surplus?
They may increase their producer surplus
What is deadweight loss?
The loss of economic efficiency when the economic price and quantity is not achieved
Draw a graph showing the area of deadweight loss and a profit maximising monopoly?
